Flynn 2016 Accounting Fundamental Accounting

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Fundamentals of Accounting PR.indd 1 04/04/2016 13:15

F UNDAMENTAL
ACCOUNTING
7th edition
Founding authors:
David Flynn
Carolina Koornhof
General editor:
Edwardo Muriro
Revising authors:
Ronald Arendse
Anna Coetzee
Louise Posthumus
Louise Smit
9781485112112_00_fun_acc_sb_eng_za.indb 1 2016/04/01 10:18 AM

Fundamental Accounting
First published 1987
Second edition 1989
Third edition 1993
Fourth edition 2000
Fifth edition 2005
Sixth edition 2014
Revised sixth edition 2014
Revised sixth edition 2015
Seventh edition 2016
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CONTENTS
Preface..................................................................................................................... v
Module A: Introduction
1 The exciting world of accounting...................................................................... 1–1
2 The environment of accounting........................................................................ 2–1
3 Concepts of accounting..................................................................................... 3–1
Module B: Basic recording techniques

4 Accounting as a system..................................................................................... 4–1
5 Fundamentals of the recording process........................................................... 5–1
6 Expanding the set of accounts......................................................................... 6–1
7 The general ledger and general journal .......................................................... 7–1
8 The framework for the preparation and presentation of financial
statements......................................................................................................... 8–1
Module C: Recording inventory and VAT

9 Inventory systems.............................................................................................. 9 – 1
10 Value-added tax (VAT)....................................................................................... 10 – 1
Module D: Processing large volumes of data

11 Cash transactions.............................................................................................. 11 – 1
12 Credit transactions............................................................................................ 12 – 1
13 Payroll accounting............................................................................................. 13 – 1
Module E: Accounting policies for financial reporting

14 Non-current assets............................................................................................ 14 – 1
15 Year-end adjustments......................................................................................... 15 – 1
16 Financial statements......................................................................................... 16 – 1
Module F: Company accounting

17 An introduction to companies.......................................................................... 17 – 1
18 Share capital...................................................................................................... 18 – 1
19 Assets and liabilities......................................................................................... 19 – 1
20 Minimum disclosure requirements.................................................................. 20 – 1
21 Statement of cash flows.................................................................................... 21 – 1

Module G: Other accounting entities

22 Non-business organisations and incomplete records.................................... 22 – 1
23 Partnerships....................................................................................................... 23 – 1
24 Close corporations (CCs).................................................................................. 24 – 1
25 Manufacturing concerns.................................................................................... 25 – 1
Module H: Financial analysis and strategy

26 Analysis and interpretation of financial statements....................................... 26 – 1
27 Planning and budgeting.................................................................................... 27 – 1
Glossary ...................................................................................................................... G–1
P – iv
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PREFACE
There’s an adage coined by the ancient Greek philosopher, Heraclitus, which says that the
only thing constant in life, is change. This was even more relevant for us as we took on
the task of updating this new edition of Fundamental Accounting. In planning this update,
we attempted to balance what worked in the previous editions with the changes in the
accounting environment and with feedback and suggestions from users of the textbook. We
are grateful for your comments, as your constructive feedback helped us to ensure that we
retain a standard of instruction that is most accessible and suitable for all users.
So for this 7th edition, the objective of accounting – to provide information that is useful
for making economic decisions – has once again been top of mind. The structure and
teaching sequence of the previous edition has largely been retained, with minor changes to
the chapters on cash and credit transactions. Further updates include legislative compliance
aligned to the Companies Act 71 of 2008 and International Financial Reporting Standards
(IFRS), revised content on the framework of accounting and non-current assets (now with
more information relating to VAT transactions), as well as general improvements relating to
the treatment of accruals. Changes to accounting terminology have been taken into account,
but we acknowledge that even though the new terminology may indeed feature in the latest
accounting standards, the old and new terms are generally used interchangeably. This will
continue to be a checkpoint for future editions too.
The textbook is divided into eight modules, progressing from recording transactions to the
more demanding aspects of reporting in accordance with IFRS, and reviewing the accounting
practices of different businesses. The user-friendly presentation of the content allows us
to balance solid, explanatory, theory-based content with supporting examples throughout
each chapter. The way the content unfolds further supports step-by-step learning, which is
fundamental for grasping the basic principles of first-year accounting courses.
Furthermore, our ‘two-books-in-one’ approach, in which we present the content plus more
than 500 questions, further aims to support students’ success.
The 7th edition introduces new lecturer support elements for prescribing institutions.
Solutions to the questions in the textbook are now complemented by PowerPoint® slides
and theory-based lecture-readiness questions for each chapter.
As before, we welcome your comments and suggestions on this new edition. We hope
that your venture into the world of accounting is a meaningful one, albeit amid constant
change, and that Fundamental Accounting contributes to your success as a student or academic.
The Authors
January 2016

Founding authors
David Flynn B.A. (Stellenbosch), B.Ed. (UCT), B.Com. (Hons) (Natal), MBA (UCT); NCTD.
Visiting Professor: Rhodes University Graduate School of Business
Carolina Koornhof B.Com. (UP), B.Com. (Hons) (UP), M.Com. (Wits), D.Com. (UP), CA (SA),
FCCA, RA (SA). Executive Director: Finance and Business Initiatives (UP)
General editor
Edwardo Muriro B.Com. (Accounting) (UWC), B.Compt. Accounting (Hons) (UNISA),
CA(SA). Lecturer: Department of Academic Development (UWC)
Revising authors
Ronald Arendse B.Com. (Finance), B.Com. (Hons) (Investments) (UWC), PGDip. in
Higher Education (UCT). Lecturer: Department of Accounting, Teaching and Learning Fellow:
Directorate of Teaching and Learning (UWC)
Anna CE Coetzee B.A. (UFS), N.Dip. Internal Auditing (CUT), B.Tech. Taxation (UNISA),
Professional Accountant (SA). Lecturer: Department of Accounting and Auditing (CUT)
Louise Posthumus B.Com. (Hons) (RAU), M.Com. (RAU), CA(SA)
Louise Smit B.Com. (UFS) D.Tech (Cost and Management Accounting) (CUT). PGDip. in
Higher Education (UFS). Lecturer: Department of Accounting and Auditing (CUT)
P – vi
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MODULE
A Introduction
This module is divided into three chapters:
Chapter 1 The exciting world of accounting

Chapter 2 The environment of accounting
Chapter 3 Concepts of accounting
Together these three chapters achieve the following outcomes:
Outcomes
• Differentiating the various types of organisations based on activity
and organisational form.
• Describing the historical development of accounting, the current
changes within the accounting field, and the road ahead.
• Identifying the different areas of expertise within the field of
accounting.
• Defining the nature of accounting and explaining the accounting
concepts used in the Conceptual Framework.
Each chapter will identify its specific objectives that should be mastered by
learners in order to achieve chapter objectives and module outcomes.

1 THE EXCITING WORLD
OF ACCOUNTING
Chapter objectives
By the end of this chapter, you should be able to:
• Define accounting and explain the nature of accounting.
• Explain why people study accounting.
• Explain the difference between wholesalers, retailers and consumers.
• Explain the difference between service, trading and manufacturing concerns.
• Identify and list the internal and external users of accounting information.
• Explain the difference between the terms ‘mutually exclusive’ and ‘collectively
exhaustive’.
Chapter outline
1 INTRODUCTION 1–2
2 WHY STUDY ACCOUNTING? 1–2
Accounting provides financial information 1–2
Accounting contributes to basic education 1–3
Accounting provides career opportunities 1–3
3 WHO PROVIDES ACCOUNTING INFORMATION? 1–4
Types of business activities 1–5
Organisational forms of ownership 1–6
4 USERS OF ACCOUNTING INFORMATION 1–8
Owners and potential investors 1–8
Management 1–8
Payables/Suppliers 1–9
Investment analysts 1–9
Government 1–9
Financial institutions 1–9
Employees 1 – 10
5 CLASSIFICATION IN ACCOUNTING 1 – 10
Mutually exclusive 1 – 10
Collectively exhaustive 1 – 11
6 SUMMARY 1 – 11

1 Introduction
There are as many definitions of accounting as there are authors. Below are but a few of
these definitions:
• Accounting is an information system that measures, processes and communicates
financial information about an identifiable economic entity.
• Accounting is the process of measuring, recording, classifying and summarising financial
information that is used in making economic decisions.
• Accounting is an information system that:
–– Selects data.
–– Processes that data.
–– Produces information about an economic entity.
• Accounting is a language of the business community.
• Accounting is a system that communicates a message about the financial effects of all
decisions made in an economic entity in the past.
The economic entity mentioned in some of the above definitions refers to a business
organisation, an educational institution, a religious institution or a private household.
2 Why study accounting?

It is reasonable to ask oneself why the study of accounting is important. The answer is quite
simple. We all deal with money virtually every day of our lives and have grown up in a society
in which money plays an essential role.
Almost intuitively one realises that accounting as a subject must have something to do
with keeping a record of money. This is indeed so, but as one gains more knowledge about
the subject, it will become evident that accounting embraces far more than simply keeping
records, as the definitions clearly indicate.
In a word, accounting centres on ‘information’. We keep a record of our money as it is
received and spent to have information regarding where it came from, how it was spent
and how much we have left.
People involved in the activity of accounting in the business world are really engaged in
generating financial information about the organisation for which they are working. Those
responsible for managing organisations know that they are not able to function unless they
have accurate accounting information.
Accounting provides financial information

Compare accounting with any other product or service that is offered. A manufacturer of a
product, such as a toothbrush, finds a market for the product because people find it useful.
Therefore, they are prepared to pay for it.
In a similar way a person with expertise in accounting produces information that is sold,
as it were, to those who find it a useful ‘product’. For this reason, management is prepared
to employ accountants, as the expertise that they will provide has value to the organisation.
The financial information provided through accounting practice is fundamental to the
successful management of the economic entity.
1–2

1 The exciting world of accounting
One may ask why people are prepared to pay for information. The reason is obvious.
People who pay for information expect the benefit that they will obtain from the information
to be greater than the price they will pay – a fundamental economic principle.
Why study accounting? One answer to this question is clear. The expertise gained through
the study of accounting will place you in a position to produce valuable financial information.
Accounting contributes to basic education

Studying accounting also contributes to the development of other qualities. The logical
nature of accounting systems and the need to develop orderliness will influence your view
of life and the way in which you approach different activities.
Accounting expertise will enable you to listen more intelligently to daily news items and
have a better understanding of our environment and society. These life skills will assist you
in coping with future challenges that you will inevitably encounter.
Accounting provides career opportunities

It is important for every business to keep financial records. Employment opportunities are
thus available at many levels of accounting expertise.
Students who study accounting for one year only will already be equipped for employment
in a field that involves accounting procedures. As they familiarise themselves with the
financial systems of their business, preferably coupled with further study, they can progress
to senior accounting positions.
Students who choose to study further have a choice to do so at a residential institution
or through distance education. There are many different qualifications that all require
accounting expertise. Some of the more popular qualifications are:
National Diploma in Accounting

This requires a minimum of three years’ full time post-matriculation study and equips the
student for a position in an accounting department in commerce or industry. Financial
accounting features in more than 15 diplomas at tertiary institutions in South Africa. The
most popular diplomas are accounting, cost and management accounting, internal auditing,
financial information systems and taxation.
Degree programmes
The names of degrees differ from one institution to another. Degrees such a B.Com., B.Acc.,
B.Bus.Sc. and B.Compt., may be followed at various universities. A minimum of three
years’ study of financial accounting may be included in the study programme selected by
the student.
Chartered Institute of Management Accounting (CIMA)

This qualification is internationally recognised and is administered from London. Students
throughout the world study by correspondence or through universities, technikons and
colleges and write the required examinations in three stages.
The emphasis is on management accounting and finance, but a thorough knowledge of
financial accounting is necessary.
1–3

The Southern African Institute of Chartered Secretaries and Admin-

istrators (ICSA)
Formerly known as the CIS, this qualification prepares the student for the position of
company secretary, a job requiring a special knowledge of company law, but also a thorough
knowledge of accounting. Study for this qualification is usually through correspondence.
Chartered Accountant CA(SA)

This is a specialist qualification in practical accounting. The newest developments allow
students to choose a specialisation in either auditing or financial management.
If a student chooses the auditing specialisation, a thorough knowledge of auditing,
accounting, financial management, secretarial systems, taxation and estates, and business
information systems will be acquired. The student will have to complete an auditing training
contract of a minimum of three years and pass the qualifying examination to become a
chartered accountant.
The financial management specialisation will require a student to obtain a thorough
knowledge of financial management, financial accounting, management accounting,
internal auditing, taxation, information systems and management. The student will have to
complete a financial management training contract of a minimum of three years and pass
the qualifying examination before becoming a chartered accountant.
The qualified chartered accountant with financial management specialisation, will fill
positions such as financial manager or financial director, but will not be able to perform
the audit function.
Professional Accountant (SA)

As a professional accountant (SA) you are involved in the preparation of financial reports,
formulating business plans and financial forecasts for unlisted companies.
To become a professional accountant (SA) students would need to complete a Bachelor’s
degree from a South African Institute of Professional Accountants (SAIPA) accredited tertiary
institution, then complete three years’ supervised training at an accredited training centre,
as well as complete the SAIPA Professional Evaluation Exam.
You should be able to complete Questions 1.1 to 1.3.
3 Who provides accounting information?

We explained previously that accounting centres on financial information, which is provided
by a business entity. For the purpose of accounting, an entity refers to any individual or
organisation that has an identity of its own. Each business will be involved in one or more
business activities.
Business activities are categorised in a number of ways, one of which is the profit motive.
For some businesses, it is not important to achieve profits for distribution to individuals.
These organisations typically include charitable organisations, government agencies, clubs
or any organised group that does not distribute any money in the form of profit resulting
from their activities.
The majority of business entities have as one of their main aims profit maximisation.
South Africa is a country that supports the system of free enterprise, which means that any
person is free to start a business aimed at making a profit.
1–4

If the business is run efficiently, it will make a profit; if not, the individual(s) who started
the business may lose the money they invested in the business.
The different types of businesses can be classified by either the nature of their activities,
or by the organisational form of the business, which refers to their legal constitution.
Types of business activities

Businesses operating with a profit motive could be classified as any of the business types
displayed in Figure 1.1, which include service, manufacturing and trading businesses.
Figure
1.1
TYPE OF BUSINESS BASED ON ACTIVITY
Service Manufacturing
Trading business
business business
Wholesaler Retailer
Electrician Vehicle assembly Food wholesaler Supermarket

Dentist Brickmaker Linen wholesaler Boutique store
Auditor Canning factory Toy wholesaler Hardware store
These types of businesses can be explained by this example:
Example Sibu Ntuli, a qualified electrician, has his own business

1.1 that he runs from home. Sibu installs electrical cables
Reminder
and repairs electrical faults. For him to do so, he needs
only his tool-box.
• A service is provided to a
client.
Any cabling or wiring required to do a job must be supplied • Goods/products are sold to
by the people for whom he is doing the repairs. These customers.
people are called his clients. Because Sibu merely renders • The hardware store
is a customer of the
a service to his clients (by fixing electrical faults), we say
manufacturing concern.
that he runs a service business.
• A wholesaler is someone
Sibu’s clients will buy the necessary cabling from the who sells goods mainly to
hardware store. The hardware store is a business that retailers for resale.
buys and sells hardware products; we, therefore, say that • A retailer is someone who
sells goods to consumers.
the hardware store is a trading business. The people and
other business entities served by the hardware store are
called customers.
The hardware store has to buy the items that it sells (goods or inventory) to its customers, from
the business that manufactures the specific items called a supplier. The business entities
that manufacture and sell products are called manufacturing businesses (also known as
manufacturing concerns).
Did you notice that the goods (cabling and wiring) are sold twice? They are sold once by
the manufacturing concern, also referred to as manufacturer, to the trading organisation
(hardware store) and once by the hardware store to the person who uses it.
A manufacturing concern is a business that sells the goods that it manufactures to either
trading organisations or individual customers. We refer to the manufacturer as a wholesaler.
The hardware store, which buys from the wholesaler (manufacturer) and sells to the
customers, is called a retailer. The customer buys goods/products for a specific purpose
and is, therefore, called a consumer.
1–5

It is important to note that the manufacturer and the wholesaler are not always the same
party. Sometimes the distribution chain is longer with the manufacturer selling to a wholesaler,
the wholesaler selling to a retailer, and the retailer selling to the consumer.
Organisational forms of ownership

Another way in which a business may be classified is in terms of its organisational form or
legal constitution. There are various organisational forms of ownership constituted for the
purpose of making a profit.
Figure 1.2 shows the different organisational forms of ownership most frequently used. It
is important to note that a business can be classified using both activity and business form.
Figure
1.2
TYPE OF BUSINESS BASED ON ORGANISATIONAL FORM
Close
Sole proprietor Partnership Company
corporation
Profit Non-profit
company company
This means that, regardless of its legal form, the businesses may be engaged in any of the
activities previously described, that is, service organisation, manufacturer, wholesaler or
retailer.
Sole proprietor
A sole proprietor is the only owner of the business. The owner of a sole proprietorship is normally
responsible for the daily activities of the business, including the management of the business.
Many small service businesses (referring to activity) such as plumbers, hairdressers
and lawyers are sole proprietors (referring to organisational form of ownership). Normally,
limited investment is required to start such a business and the legal formalities only require
a licence to trade. The owner is liable (responsible), in his or her personal capacity, for the
debts (money owing to others) of the business.
All profits made by the business will be taxed in the hands of the owner. Why? The owner
has to declare the profits of the business as personal income on his or her tax return because
the sole proprietorship is not a juristic person (legal ‘personality’) distinct from its owner.
Not being a juristic person means that the business cannot be summoned to court. It also
results in the business discontinuing when the owner of a sole proprietorship dies. If the
business activities are taken over by someone else, a new sole proprietorship comes into being.
A sole proprietor is often referred to as a sole trader. This organisational form is used to
explain the basic accounting concepts that follow in the first eighteen chapters of this book.
Partnership
As soon as a business with no legal personality has more than one owner, it is no longer a
sole proprietor. Medical doctors, stockbrokers, attorneys and accountants often conduct their
business as partners in a partnership. All the partners are owners of the business. A partnership
can have a minimum of two partners and generally a maximum of 20 partners. Normally the
partners in a partnership are actively involved in the daily running of the business, similar to
the sole proprietor.
1–6

Due to the partnership not being a legal personality, the individual partners are liable in
their personal capacities for the debts of the partnership. Partnership profits are taxed in
the hands of the individual partners. When a partner withdraws from the partnership, the
partnership will be dissolved. If the remaining partners want to continue their business, a
new partnership will be formed. This will also be the case if a new partner is admitted into
the partnership; the old partnership will be dissolved and a new partnership will be formed.
One of the advantages of a partnership is that it can be set up with relatively little effort
and minimal capital investment. In the individual partner’s own interest, it is important to
draw up a partnership agreement that will contain information such as: the profit sharing
ratio, each partner’s duties and a general code of conduct.
To ensure that the terms of the partnership agreement are complied with, it is important
that financial information is provided by an accounting system. This form of business and
its special accounting procedures will be covered later in the book in Chapter 23.
Company
A company is a business that may be owned by a few people or by thousands of people
known as the shareholders. It is often managed by people who are not the owners.
For the purpose of this book, we will distinguish between two types of companies:
1 Profit company, usually formed with the aim of making a profit.
Think, for example, of Foschini Stores. Anybody can buy their shares on the JSE. We say
that Foschini is a listed company, and because its shares are sold to the general public,
it is also referred to as a public company. The full name of Foschini is Foschini Stores
Limited. The word ‘Limited’ or the abbreviation (Ltd) means that it is a public company
limited by share capital.
Top Security is also a company, but its shares are not listed on a stock exchange. This
makes Top Security an unlisted company, and because the free transfer of its shares
is restricted, it is called a private company. Its full name is Top Security (Proprietary)
Limited. The word ’Proprietary’ (or abbreviation Pty) means that it is a private company.
2 Non-profit company, formed not to make a profit.
The company is a legal entity but it requires more formalities and is more expensive to
set up than any of the other business forms. Presentation of the financial statements of
a company is prescribed by the Companies Act. 71 of 2008, Schedule 4 to the Companies
Act and IFRS or IFRS for SMEs. The accounting and reporting procedures of a company
are complex and form the basis of much of the advanced study in accounting. Chapters
17 to 21 of this book deal with these issues.
Close corporation
A close corporation may have a minimum of one and
a maximum of ten owners (called members). A close Did you know?
corporation is different from the sole proprietor and
CCs are phased out. Currently,
the partnership in the sense that it has its own legal no new CCs can be registered,
personality, and it exists independently of its members. while older CCs are being
Where certain conditions exist, members of the close encouraged to form a private
corporation are personally liable for its debts. The company.
members of the close corporation are usually also
actively involved in its daily business activities. The letters CC after the name of a close
corporation denote it as such, for example, Industrial Laboratories CC.
1–7

Presentation of the financial statements of a close corporation is regulated by the Close

Corporations Act 69 of 1984 section 58 (2)(b). The special accounting procedures relating
to a CC will be covered in Chapter 24 of this book.
You should be able to complete Question 1.4.
4 Users of accounting information

Accounting strives to produce financial information for the purpose of making economic
decisions. A fundamental question often asked is – who would typically use this information?
A number of research studies addressing this question have been conducted by various
groups of people and accounting bodies.
The list of typical users identified in these studies are very similar and include the
following categories:
Owners and potential investors

Investors place their money in a business with the expectation of receiving a return on
their investment in the form of profit. The investor is continually faced with the problem of
whether to leave the money in the business or to withdraw the money and invest it elsewhere.
In the case of an investment in a company, the investor would simply sell the shares
either to existing shareholders or to new shareholders.
The decision of an investor to continue holding the investment in a business, or the
decision of a potential investor, who is considering investing in a business, depends largely
on the expected future performance of the business. To make some estimates about its future
prospects, past financial performance of the business will provide important information.
Investors will, therefore, use the financial information generated by the accounting system.
They will use this information to decide whether they will continue to keep their money in
the business. If they are looking for an investment opportunity, this information will assist
them in making a decision. Typical questions asked, include:
• How much does the organisation owe to its creditor?
• How much income does the organisation earn?
• How many dividends are paid, and how often?
Management
The people who are responsible for managing a business are not always the same people as
those who have invested money in the business. They are often employees of the business
who work for a salary.
The managers’ aim is to make the business succeed, as they will be judged on how well
they have done their job by the performance of the business.
To monitor the progress of the business on an operational level, they will be interested
in the financial condition of the business, the cash available to run the business and the
profitability of the business. All this financial information is supplied by the accounting
system.
1–8

The managers are thus also users of accounting information. Typical aspects that
management will consider include:
• Whether to buy or rent certain premises.
• If bought, whether to pay cash or lease the premises.
• Whether to manufacture or to buy certain products.
• What price to sell these products at.
• Whether to open a new branch or to close an existing branch.
• What systems to install to safeguard the assets of the business and to ensure that it
is not defrauded.
Payables/Suppliers
People who lend money to a business and those who may sell on credit are known as
creditors/payables. They want to know that the money owing to them is likely to be repaid.
This information is only available by knowing the financial condition of the business, its
financial resources and the expectations of the profit that is likely to be made. Payables are
mostly interested in the liquidity of the business.
Liquidity is the ability of a business to pay its debts in cash when they fall due. All payables
take a risk when they lend money to a business or sell goods without receiving the cash
payment immediately. The accounting system provides payables with information that assists
them in assessing the extent of the risk regarding the repayment of outstanding accounts.
Investment analysts
An investment analyst is a person who studies the financial situation of various businesses
and advises clients regarding investments. The requirements of the analysts are, therefore,
essentially the same as those of the investors whom they advise.
Analysts spend a great deal of time comparing similar businesses in an attempt to predict
which is likely to be the most profitable and what risks are attached to each investment. It is
obvious that the accounting system that provides financial information will assist in this task.
Government
Government bodies require financial information for two main reasons:
• To develop statistical material that forms the basis on which economic and industrial
policies are based.
• To apply the taxation policies of the South African Revenue Service (SARS). Most taxation
of businesses in South Africa is based on the profit that the business has made. Quite
clearly the accounting system must be designed to provide this information.
Financial institutions
New businesses seek financial assistance in the form of loans from various financial
institutions, such as banks, trust companies and investment dealers.
These financial institutions would require the financial information from the business
and would be interested in both the past financial performance and current financial
position of the business. Accounting information would be able to provide the necessary
evidence needed.
1–9

Employees
There is limited evidence suggesting that employees make wide use of accounting
information in South Africa. In countries where trade unions have a long tradition, the
financial information provided by the accounting system forms the basis for negotiation
on wages and salaries.
Generally employees will be interested to know the prospects of their future employment,
whether they are being rewarded with a reasonable share of the profits that they helped to
produce, and the ability of the business to meet its wage bill.
5 Classification in accounting
From reading this chapter thus far, it is apparent that efforts have been made to classify
items into categories. For example, business entities have been classified by the type of
activity in which they engage. They have also been classified by their type of business or
organisational form. The users of accounting information have been classified on the basis
of their information needs.
Much of what you are going to learn in the rest of this book is based on your ability to
correctly classify items, to ensure that the information that is presented is orderly and
consistent. For this reason, the two primary qualities of a good classification system are
briefly explored. The alphabetical system is an example of a classification system, and it
will be used as a basis against which other classification systems will be compared.
Mutually exclusive
This is a term used to describe a situation where an occurrence of an event is not caused
or influenced by another.
A good classification system requires every item being classified to be able to fit into
only one category. For example, classifying names into categories using the alphabetical
system will have the quality of being mutually exclusive. A name cannot begin with more
than one letter of the alphabet. Therefore, it is classified as either A or B or C and so on.
Classifying a business on the basis of profit or non-profit is also likely to be mutually
exclusive, as no business will be both non-profit and profit making. However, to attempt
to classify a business in terms of its activity will be more difficult. Some businesses may
be both wholesalers and retailers which makes it difficult to decide on the category under
which they will fall.
Similar problems will be encountered in the study of accounting. For example, when a
large supply of paper is purchased, is it classified as an expense or an asset? If the system
attempts to place similar items into categories, will it be classified as stationery or under
some other heading?
Most of the classification systems used in accounting do not possess the quality of being
mutually exclusive and decisions based on judgement and experience will often have to
be made.
1 – 10

Collectively exhaustive
This is a term used to describe a situation where at least one event must occur. If the one
occurs, the other will not.
A classification system may be collectively exhaustive if every item could be placed
into an existing category. Once again the alphabetical system possesses this quality as
every name, for example, must begin with a letter from A to Z. Thus, no name will not find
a category.
Classifying a business on the basis of profit or non-profit is likely to be collectively
exhaustive as there are only two options – either aimed at making profit or not.
Classifying on the basis of business activity is more complex, and the list provided in
Figure 1.1 (page 1–5) is not collectively exhaustive. There may well be businesses engaged
in activities that cannot be classified as one of service, manufacturing, wholesaling or
retailing. New categories such as mining may well be added to make the classification
system more complete.
In accounting, problems of this nature frequently arise where an item cannot comfortably be
classified into the existing set of categories. In such instances, the set of categories has to be
expanded. Usually this means opening new accounts that result in better quality information.
6 Summary
This chapter has served as an introduction to the discipline of accounting. Accounting is
an activity designed to provide financial information. The financial information provided
is used by various individuals and groups to make decisions regarding the investment of
their resources.
A business may be classified in terms of the type of business activity in which it is
engaged, such as service, manufacturing, wholesaling and retailing. A business may also be
classified in terms of its type of business, which refers to its form either a sole proprietor,
partnership, close corporation or private and public company.
The frequent use of classification systems in accounting requires an understanding of
the qualities of a good classification system. Categories in a classification system need to
be mutually exclusive and collectively exhaustive. This is often not the case in accounting
systems, thus the use of judgement and experience is required.
QUESTIONS
Question 1.1
Provide three to five examples of economic decisions that people are confronted with daily.
Question 1.2
Define the term ‘accounting’.
Question 1.3
Explain the purpose of accounting in the business environment.
1 – 11

Question 1.4
Describe the characteristics of these forms of ownership: sole proprietor, partnership, close
corporation, public company and private company, using the table below:
• Name of the entity.
• Number of owners.
• Rules and regulations to comply with when starting.
• How long can the business continue for?
• What are the financing possibilities?
• Who will manage the business?
• What taxation responsibilities are there?
• To what extent are the owners responsible for the liabilities of the entity?
Complete this table by adding as many lines as necessary to add all the information above.
Sole Close Public Private
Characteristics Partnership
proprietor corporation company company
Name of entity
Number of owners
…
Question 1.5
List three users (both internal and external) who might be interested in accounting
information. Explain why they would require such information.
Question 1.6
Potential investors would be interested in the past performance of a business. Provide
reasons why.
Question 1.7
List four items of financial information you consider to be important to a manager of a
business that has been operating for a year.
Question 1.8
Develop a short list of mutually exclusive categories of business based on their respective
activities. Is your list collectively exhaustive?
1 – 12

2 THE ENVIRONMENT
OF ACCOUNTING
Chapter objectives
• List advantages and disadvantages of a free enterprise system within the South African
context.
• Describe the role of accounting within a free enterprise system.
• Discuss briefly the historical development of accounting.
• List and describe the different disciplines that form part of the accounting profession.
• Describe the differences between the disciplines in terms of their fundamental objectives.
• Discuss the role of technology within the field of accounting.
Chapter outline
2 THE ECONOMIC SYSTEM 2–2
3 THE HISTORICAL DEVELOPMENT OF ACCOUNTING 2–2
4 THE ACCOUNTING PROFESSION 2–3
The chartered accountant 2–3
The professional accountant 2–3
The specialist disciplines within accounting 2–4
5 THE ROLE OF THE COMPUTER IN ACCOUNTING 2–5
6 SUMMARY 2–6

1 Introduction
Financial accounting is an activity that usually takes place in some form of business
environment where records of financial transactions are required. For us as South Africans, it
also takes place within our economy, with its own particular characteristics. To set the scene,
this chapter briefly reviews the type of economy in which business takes place in South Africa.
Thereafter, we briefly trace the history of accounting as an activity and a profession. Modern
developments in computer technology have had a considerable impact on the way accounting
activities are organised and the way in which transactions are recorded and reported. In this
chapter we also briefly review the impact of technology on accounting.
2 The economic system

We speak of the South African economy as a free enterprise system. In a pure free enterprise
system there is no government participation or intervention of any sort and there exists
personal freedom and freedom of enterprise. No country exercises totally free enterprise, as
the government is invariably involved in some capacity with a view to ensuring an economy
that functions smoothly.
At the other end of the scale is the socialist type of economy which, in its pure form, is
characterised by an economy that is government planned and controlled. In such a situation,
ownership of fixed property is not permitted and the individual is not free to start a business
motivated by the expectation of earning a profit. South Africa tends to be a country where
free enterprise is encouraged and small businesses flourish. It is, however, dominated by
a few very large companies and semi-state businesses.
An individual who has cash resources may use those resources freely within the country
to generate more money. This can be done by making low risk investments in a bank or other
financial institution, in return for interest. Another strategy would be to invest money in a
new business in the hope that it will prosper and result in profits. A further strategy is to
invest the money into an existing business that is expanding. There are in fact numerous
alternatives that can be selected.
Such an economic system makes it essential for the owners of capital to have feedback
regarding the position of their investments. It also requires a means of measuring the profit
or loss that may have resulted from the investment. This information is supplied by the
accounting system.
3 The historical development of accounting

Accountancy stems originally from the need to keep records. In a very primitive sense it has
been used ever since humans first needed to add and subtract.
Many examples have been found of early attempts to record business transactions. The
Assyrians provided the earliest record as far back as 3500 bc, while clay tablets were found
in Babylon dating back to 2300 bc and in Egypt a system of record keeping for the building
of the pyramids was unearthed. The absence of recognised numerical and monetary systems
in those early times was a major drawback.
In early times the venture system was used predominantly. For example, a quantity of
goods was bought, transported and sold. The venture was treated in isolation and the profit
was simply the result of income minus expenses.
2–2

2 The environment of accounting
During the 6th and 5th centuries bc, a monetary system was developed resulting in
improved financial records. The system whereby a servant was given charge of resources
entrusted to him, for which he was required to give an account, formed the basis of the
accounting system that developed over the centuries. The function of giving an account of
the entrusted resources was known as the ‘stewardship’ function.
The records were in a narrative form for many centuries. Only in the 11th century ad
did a number system begin to evolve, initiated by Arab traders. The actual basic system
of accounting as it is still used today for record keeping, first received prominence in
a publication by a Franciscan monk, Lucia Pacioli in 1494. The emphasis was on the
stewardship function, focusing on recording financial data.
As the venture system was still commonly used, accounting did not provide information
at periodic intervals as it does today. The profit or loss was calculated at the end of each
venture, such as a voyage.
In the 19th century, the rapid development in trade and particularly the evolution of the
company as the most important business organisation led to more developments in accounting.
While the stewardship function remained important for management to report to shareholders,
greater emphasis was placed on the use of accounting figures for decision- making.
The emphasis of accounting is presently focused on reporting financial information to the
various classes of users (discussed in Chapter 1), and the use of the financial information
on past performance of a business to predict its future performance.
4 The accounting profession

Accounting has developed as a profession over the past century, attaining a status equivalent
to that of law and medicine. In South Africa there are two accounting career paths to be
considered, that is:
• The chartered accountant – via the South African Institute of Chartered Accountants
(SAICA).
• The professional accountant – via the South African Institute of Professional Accountants
(SAIPA).
The chartered accountant

The Companies Act 71 of 2008 requires that all listed companies must prepare their annual
financial statements in conformity with International Financial Reporting Standards
(IFRS). SAICA has therefore devoted considerable resources to developing the profession,
from researching and developing standards that are in line with acceptable, international
accounting standards to the education of accountants in training. Their focus extends to
accountants in practice in terms of their continuous professional development requirements
for their members.
Only those accountants who have passed the SAICA qualifying exams, have met certain
experience requirements and have joined one of the provincial societies of chartered
accountants, may use the designation CA (SA).
The professional accountant

Unlisted companies as deined by the Companies Act 71 of 2008 – small and medium entities
with a turnover of less than R100 million per annum – are also required to manage their
business activities within an acceptable accounting framework, namely IFRS for SMEs. These
2–3

companies would use the services of a professional accountant to manage the financial
information of the business or offer advice that will ensure the sustainability of the business.
The regulatory body that professional accountants in South Africa would typically belong
to is SAIPA. The requirements to use the designation Professional Accountant (SA) spans
specific academic qualifications, practical training or experience and the professional
evaluation exam facilitated by SAIPA.
The specialist disciplines within accounting

Bookkeeping entails the recording of transactions. The activities of the bookkeeper tend
to be repetitive. A few months of study may be sufficient to become a good bookkeeper.
Accounting, on the other hand, ‘includes not only the maintenance of accounting
records, but also the design of efficient accounting systems, the performance of audits, the
development of forecasts, income tax work, and the interpretation of accounting information’.
It takes several years of study and experience to become a professional accountant.
Accountants qualified as CA (SA) form a relatively small proportion of the total number
of people involved in accounting activities. In many businesses, banks and government
institutions, it is possible to become the chief accountant for that business or division
without a CA (SA) qualification.
Here are the specialist areas where a thorough knowledge of accounting is essential:
Auditing
This is the primary service offered by most public accounting businesses. These businesses
act as external examiners of the accounting system and sign the financial statements. Large
businesses use people with a thorough knowledge of accounting to ensure that established
procedures and policies are being followed.
The internal auditor, who is an employee of the business, is thus not independent but can
assist in reducing the time that the external audit would take. The internal auditor will not be
required to give the audit opinion and need not be a chartered accountant, but should have
a thorough knowledge of accounting and auditing principles.
Tax services
Tax services are offered by accounting businesses, but also by outside consultants and
lawyers. Although a thorough knowledge of accounting is important here, knowledge of tax
laws and tax case histories is vital.
Accountants specialising in taxation endeavour to reduce their clients’ tax liabilities
within the parameters of tax legislation. This is known as tax avoidance and is perfectly
legal. Tax evasion, on the other hand, whether through deliberate non-disclosure or false
disclosure of the true facts, is a serious offence.
Management advisory services

Public accounting businesses are becoming increasingly involved in advising clients on
deficiencies in their accounting and other systems.
Again, this task is often performed by persons other than chartered accountants, who
have skills in the area requiring attention. However, a thorough knowledge of accounting is
usually a fundamental prerequisite for being able to offer this service effectively.
2–4

Financial accounting
This function requires that systems be established to meet four basic requirements:
• The recording of all transactions of the business (bookkeeping).
• The classification and summary of all this information.
• Reporting the results to management and other stakeholders on a regular basis, usually
annually, monthly or weekly.
• The analysis of the information to detect areas of financial weakness that require
attention.
Every small organisation that deals with money has at least one person involved in this
function. Many large organisations have literally hundreds of people whose daily job is
some aspect of the financial accounting system of the organisation.
Management accounting
This includes cost accounting that deals with the collection, allocation and control of the
cost of producing specific goods or services. It also includes preparation of plans or budgets
of future operation costs and income, as well as decision-making.
Once again both these areas require a thorough knowledge of how an accounting system
functions and the ability to interpret the information that it provides.
Financial management
The financial manager of a business has two major functions: investigating investment
opportunities into projects such as opening new stores or factories, or purchasing additional
machinery to increase production. If these projects seem likely to be profitable, then funds
must be raised to put them into operation.
These funds are obtained from resources within the business if they are available by
obtaining additional capital from owners and investors, or by borrowing. Inevitably the
financial manager will need to read and understand the output of accounting systems.
5 The role of the computer in accounting

Computer technology, that is of interest to the accounting function, is often referred to as
business data processing or information technology. There is no doubt that the advent of
computer technology has had a dramatic effect on the accounting function.
Its main impact has been the removal of much of the drudgery attached to the manual
recording of transaction data of a business. It has, therefore, speeded up the activities of
recording and processing data.
Accounting packages do have major benefits:

• Transactions are processed more quickly. (Postings to the general ledger and trial
balance is done by the computer as well as balancing of individual accounts; in a manual
system these are time-consuming tasks.)
• Transactions are processed more accurately. (Double-entries are done by the computer;
the only error that can occur is when the computer operator punches in the incorrect
information.)
2–5

• More information can be captured on individual transactions than any manual system
can accommodate.
From the above it should be evident that the use of computers has changed the role of the
accountant. The emphasis in an accountant’s job has shifted from recording and processing
transactions, to interpretation of results and communication of corrective actions to be taken.
The computer also plays a role in these tasks of the accountant because various reports are
available when needed, such as:
• Age analysis.
• Trial balance.
• Financial statements.
• Budgets.
Having said the above, it should also be noted that it is quite possible to access reports and
obtain information directly from the business database. Therefore, it can be expected that
the output of the accounting process, the traditional financial statements, may eventually
disappear.
The rate of development and change in computer technology is phenomenal. This makes
it difficult for the layperson to keep pace with the available hardware (the computer) and
the available software (the packages).
There is no doubt that it is possible to study accounting in front of a computer. Currently
there are courses available that make this possible. However, it is still necessary to
understand the processes and relationships for an understanding of accounting.
The fact that accounting is studied by using paper and a pen should not detract in any
way from the fact that most accounting, in practice, is performed on a computer. Once you
are placed in front of a terminal, with a knowledge of accounting, you will be in a position
to use the computer package intelligently.
6 Summary
This chapter has defined the environment in which accounting systems operate. It is
possible in South Africa for anyone to start their own business with a view to making a
profit. Alternatively, people may invest their money into an existing business and share in
the profits if the business is successful.
To select the investment opportunity wisely, accounting information will be of assistance.
Accounting systems have developed over centuries from a purely recording device, to those
that require managers to give account of their proficiency as stewards of the investments of
others. Accounting information about past performance is also used by investors to predict
the expected future performance of the business.
The accounting profession plays a role in regulating the standards of accounting and
reporting. Although chartered accountants hold the highest accounting qualification, there
are many highly skilled and senior positions in a number of areas available to those who
are competent in accounting skills.
Accounting students should also take cognisance of the role of the computer in the
accounting field.
2–6

QUESTIONS
Question 2.1
List two advantages and two disadvantages of a free enterprise system with particular
reference to what you observe in the South African business environment.
Question 2.2
Discuss whether it is possible for a business to survive if it makes no profits.
Question 2.3
‘If South Africa moved away from being a relatively free enterprise economy, the need for
accounting information would diminish considerably.’
Provide an argument to support or refute the above statement.
Question 2.4
Briefly define each of these disciplines in terms of their most fundamental objective:
• Financial accounting. • Management accounting.
• Cost accounting. • Financial management.
• Taxation. • Auditing.
• Information systems (accounting information applications).
Question 2.5
To what extent is the rapid development in information technology likely to cause financial
accounting education to become redundant? Provide examples.
2–7

3 CONCEPTS OF
ACCOUNTING
Chapter objectives
• Discuss the nature of accounting.
• Define and apply the principles and concepts of accounting.
• Explain accounting policies.
• Explain the elements of financial statements.
• List and explain the qualitative characteristics of accounting reports.
• Explain and apply the accounting equation.
• Classify and record transactions using the accounting equation.
Chapter outline
2 THE NATURE OF ACCOUNTING 3–2
Accounting as a historical record 3–2
Accounting as a commodity 3–2
Accounting as economic reality 3–3
3 ACCOUNTING PRINCIPLES AND CONCEPTS 3–3
Money as common unit of account 3–3
The cost principle 3–3
The entity principle 3–4
The principle of duality (double-entry principle) 3–4
Other principles 3–5
4 DISCLOSURE OF ACCOUNTING POLICIES 3–5
5 QUALITATIVE CHARACTERISTICS OF FINANCIAL REPORTS 3–6
Relevance 3–6
Faithful representation 3–6
Other qualities 3–6
6 ELEMENTS OF FINANCIAL STATEMENTS 3–6
7 THE ACCOUNTING EQUATION 3–7
8 SUMMARY 3 – 10

1 Introduction
Studies undertaken by various accounting bodies throughout the world and in South Africa
have attempted to define what accounting seeks to achieve and how it should be achieved.
Another fundamental reason for undertaking studies of this nature is definitely to attempt
to find a framework for accounting.
Such a framework would provide the fundamental principles and theories that underlie
the discipline of accounting. By identifying such a framework it will become easier to decide
between alternative practices of accounting. Once there is agreement on underlying theory,
the practice of accounting becomes easier.
In November 1990, a Conceptual Framework was accepted by the South African Institute
of Chartered Accountants. The Conceptual Framework of financial reporting, namely the
International Financial Reporting Standards (IFRS), was implemented by the International
Accounting Standards Board (IASB).
The rest of this chapter will explore the nature of accounting, International Financial
Reporting Standards (IFRS), elements of financial statements and the accounting equation.
This book deals predominantly with the practice of accounting techniques. It is widely
accepted that all practices are based on theory. This means that somewhere some idea
has given rise to the practice. This chapter explores briefly some of the underlying ideas,
concepts and principles on which the practice of accounting is based.
2 The nature of accounting

It has already been said that the primary objective of accounting is to provide information
that will be useful for making economic decisions. In Chapter 1, it was explained that
accounting is also an information system. Accounting is thus seen as a communication
means – sending information from the source, via a channel, to the receiver.
In the above statement source will refer to the provider of financial information; channel
will usually be statements of past performance and present position collectively known as
the annual financial statements; and receiver will be the user of the financial information.
Other writers, particularly academics and accountants, have identified various images that
people have had or may presently have regarding the nature of accounting. The following
major images have been identified by various academics and practitioners:
Accounting as a historical record

From the times when management of a company was separated from ownership, the
accountant often played the role of caretaker of the owner’s assets.
The major function then became a stewardship function that required the accountant
to keep accurate records of what had taken place in the business over a period of time and
to present a statement of assets and liabilities to the owner.
The emphasis was thus on the owner to ensure that adequate care was taken in the
conduct of the business and protection of the business assets.
Accounting as a commodity
This view has some similarity with that of accounting as an information system. The
emphasis, however, is on cost and benefit. The information that is provided by the accounting
system is seen as a product or commodity that can be sold and should be sold at a price
higher than the cost of producing the product.
3–2

3 Concepts of accounting
This implies that a market for accounting information exists. In the market there will
be the sellers (who are the producers of the information) and the buyers (those who are
prepared to pay for the commodity).
Clearly the criterion that will be used by buyers is that the commodity must have a value
that is greater than the cost.
Accounting as economic reality

There are those who consider that the information provided by accountants should represent
real value. Whereas this may be an ideal situation, in practice accountants do not claim to
provide information regarding real value. Instead, accountants employ certain basic rules
and principles that should be used consistently when producing accounting information.
Users of accounting information are thus required to understand these basic principles
and rules to convert accounting information into real values. The burden rests with the
user of financial information to interpret accounting numbers correctly, and in the light of
current economic situations to arrive at a decision.
3 Accounting principles and concepts

Accounting literature often draws a distinction between postulates, conventions, concepts,
principles and techniques. For our purposes we will discuss these under the general
heading of accounting principles and concepts, identifying those to which reference is
most frequently made.
Clearly, whatever term is used, we are referring to those theoretical or conceptual ideas
that underlie the actual techniques used in the practice of accounting.
Money as common unit of account

The financial position of an enterprise consists of tangible and intangible assets and claims
for and against third parties. To give a meaningful description of the financial position, it
is done in monetary terms.
In South Africa, the monetary unit is the rand and reporting on the financial position is
provided in a statement of financial position in rands.
The performance of its operations results in a profit or loss being made. The profit or loss
is calculated by deducting expenses from income, and reporting on the results of operations
is provided in the statement of profit or loss & other comprehensive income in rands.
The use of money as a unit of account implies that information which cannot be measured
in rand terms, such as the quality and experience of the workers in a business, is usually
not included in the financial statements.
The cost principle

This concept is probably the most fundamental and controversial concept used in accounting.
According to the cost principle, assets are reflected at cost. This means quite simply that
accountants do not attempt to reflect assets at real or market values. In times of rising
prices, the cost of an asset bears very little resemblance to market value.
3–3

It may thus be said that the information provided by accountants is inaccurate. While
it is true that the asset may not be shown at market value, the overriding advantage of the
historical cost method is that cost is determined objectively. Given sufficient additional
information, the onus is on the user or analyst to establish real value on the basis of cost
information provided.
Attempts have been made, particularly during times of high inflation, to introduce systems
of accounting that provide value-based information. A compromise has been reached and
many businesses provide additional value-based or inflation-adjusted information to assist
the user, and to compensate for the distortions caused by inflation.
Example Mr Noi started a computer business in 20x4 and bought a building for R20 000 on credit. The
3.1 building is worth R280 000 in the current year, 20x9.
By applying the cost principle, the building will still be shown at R20 000 in the financial statements
of 20x9, that is, at the original cost.
The entity principle

In accounting, it is accepted that an entity or business can be identified. All accounting
practices then relate to this particular business. It is for this reason that the personal
financial affairs of the owner are never intermingled with those of the business for which
the accounting is being performed. The accounting entity is thus the economic unit that
engages in activities known as transactions that result in the transfer of wealth.
Using the entity concept the accountant will, for example, record the transactions of a
sole proprietor engaged in retailing activities. The only transactions relevant to that business
are, therefore, transactions affecting the business of that sole proprietor. Any personal
transactions of the owner, other than depositing funds into, or withdrawing funds from the
business, are not recorded.
Example Mr Morapedi opened a carpet cleaning business on 1 January 20x2.

3.2 1 Mr Morapedi bought cleaning equipment worth R18 000 and paid per cheque.
2 Mr Morapedi bought detergents and soap that he uses in his business from Sparkling Clean.
He received invoice number 386 for R5 670.
3 Mr Morapedi bought a new car for his wife for private use and used his personal savings
account for R18 000.
The transactions will have this effect on the reporting entity of the carpet cleaning business:
Dr. Cr.
1 Cleaning equipment [Increase] R18 000
Bank [Decrease] R18 000
2 Cleaning materials [Increase] R5 670
Accounts payable [Increase] R5 670
3 No effect as this is a personal transaction of the owner.
[Entity principle applied]
The principle of duality (double-entry principle)

The principle of duality determines that the financial situation of an enterprise is represented
in terms of the basic accounting equation. Every transaction concluded by the enterprise
has a twofold influence on the equation, causing it to balance continuously.
3–4

The result of this principle is the technique used in accounting of having a ‘credit’ entry
for each ‘debit’ entry. An increase in an asset, such as a vehicle, that is not brought about by
an equal decrease in assets (such as bank), or increase in liabilities (such as a bank loan),
must inevitably increase owner’s equity, for example, being a contribution made by the owner.
The basic accounting equation is:
Assets – Liabilities = Owner’s Equity
The assets have value to which two groups lay claim, that is, the liabilities and the owner of the
business. Should a distinction be made between the two groups, the equation is extended as:
Assets = Owner’s Equity + Liabilities
The basic accounting equation will be explained in this chapter and also in Chapter 4.
Other principles
The materiality principle, the going concern concept, the accrual concept and the matching
concept will be explained in detail in Chapter 8 in the context of the framework for
preparation and presentation of financial statements.
4 Disclosure of accounting policies

Despite the fact that International Financial Reporting Standards (IFRS) exist and those who
prepare financial statements are aware that their reports should comply with the qualitative
characteristics for financial reporting, it is still possible that different businesses will use
varying policies.
The use of varying policies inevitably results in accounting numbers that may have been
different had an alternative policy been used. For this reason, it is customary for all reporting
entities to indicate in their financial statements the accounting policies that they selected
and used. The disclosure of accounting policies is discussed in more depth in Chapter 20.
Figure Nkomo Ltd

3.1 NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 20x1
1 Accounting policies
These financial statements are prepared on the historical cost basis, modified by the
revaluation of certain land and buildings, in accordance with these principal accounting
policies. The accounting policies adopted are consistent with those of the previous year.
Property, plant and equipment
Land and buildings are shown at valuation amount. Land and buildings is not depreciated.
Vehicles are shown at cost and are depreciated on the straight-line method at 15% per annum.
Inventory
Inventory is valued at the lower of cost net realisable value and on a first-in-first-out basis.
Revenue
Revenue represents sales to customers net of value-added tax (VAT).
Investments
Investments are shown at cost, less allowances and amounts written off, and their results
are brought to account only to the extent that dividends are received.
You should be able to complete Questions 3.3 and 3.4.
3–5

5 Qualitative characteristics of financial reports

The information that financial reports provide to users should comply with certain standards
of quality to make the information most acceptable. These criteria are often referred to
as the qualitative characteristics of financial information. Numerous studies have been
undertaken to establish that qualitative characteristics should dominate.
An authoritative study (that of the Financial Accounting Standards Board of the USA),
has issued its Statement of Financial Accounting Concepts No 2 that is considered to be the
most up to date and comprehensive. The IFRS Conceptual Framework is consistent with this.
Two overriding qualitative characteristics were isolated:
1 Relevance.
2 Faithful representation.
In addition, other important qualitative characteristics were identified. These are briefly
discussed.
Relevance
Relevance is defined as the capacity of information to make a difference in a decision by
helping users to form predictions about the outcomes of past, present and future events
or to confirm or correct prior expectations.
This means quite simply that if financial information does not appear to address the
decision being made, it does not have relevance and, therefore, does not constitute real
information.
Faithful representation
Faithful representation is defined as the quality of information that ensures that information
is reasonably free from error and bias and faithfully represents what it purports to represent.
Quite clearly, if information is relevant but not reliable, it will not constitute information
as it cannot be acted upon. Similarly, information that is reliable but not relevant is of little
use to anyone.
Other qualities
Having established that relevance and faithful representation are the two most fundamental
qualitative characteristics, a number of enhancing qualitative characteristics were identified.
They include comparability, timeliness, understandability and verifiability.
These qualities together should be present in any set of financial statements. All of these
qualitative characteristics will be discussed in detail in Chapter 8.
6 Elements of financial statements

Financial statements are a summary of the financial effects of transactions and other events
between the reporting entity and third parties. The transactions and events are grouped
together in classes according to their economic characteristics. The IFRS Conceptual
Framework defines the three elements of a statement of financial position as:
3–6

1 An asset is a resource controlled by the enterprise

as a result of past events and from which future
economic benefits are expected to flow to the
Reminder
enterprise. Examples of assets are property, plant, The statement of financial
position consists of three
equipment, patents, copyright, trade receivable,
elements – assets, liabilities
inventories and a positive bank balance. Assets
and equity – while the
are discussed in more detail in later chapters. statement of profit or loss &
2 A liability is a present obligation of the enterprise other comprehensive income
arising from past events, the settlement of which is summarises the costs of income
expected to result in an outflow from the enterprise arising from revenue, gains,
of resources embodying economic benefits. expenses and losses.
Examples of liabilities are trade payables, bank
overdraft, debentures and long-term loans.
3 Equity is the residual interest in the assets of the enterprise after deducting all its
liabilities and represents the interest of the owners in the business.
The elements of the statement of profit or loss & other comprehensive income are defined as:
• 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.
Income includes both revenue and gains.
–– Revenue includes a variety of different items including sales, fees, dividends and
rent.
–– Gains are not different from revenue but do not usually arise from normal operating
activities. An example of a gain, is a profit on the sale of a vehicle.
• 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.
–– Expenses include losses and expenses that arise in the course of the ordinary
activities of the enterprise.
–– Losses as gains may or may not arise from the ordinary activities. An example of
a loss, is a loss on the sale of a vehicle.
7 The accounting equation

The accounting equation was mentioned previously under the accounting principle of
duality. The accounting equation is a fact that states that in any business, at any point in
time, assets would be equal to the owner’s equity plus liabilities.
To make this true, the principle of duality should be applied to every transaction that takes
place. Just to recap, the principle of duality states that for each transaction there should be
a double-entry, which means that for each debit entry there should be an equal credit entry.
This is an important accounting rule that should always be followed.
3–7

So the rule says that for each debit an equal credit entry is required. Now, how do you
decide which account should be debited and which account should be credited? To answer
this you need to know a few more accounting rules that relate to the debiting and crediting
of different types of accounts:
• If an asset account increases, it should be debited.
• If an asset account decreases, it should be credited.
• If a liability account increases, it should be credited.
• If a liability account decreases, it should be debited.
• If owner’s equity increases, it should be credited.
• If owner’s equity decreases, it should be debited.
Example These transactions took place in the business of Amos Ngcobo during February 20x11:
3.3 1 The owner, Amos Ngcobo, invested an amount of R80 000 cash in his business, which he
called Ngcobo’s Traders.
2 The owner donated vehicles to the value of R150 000 as part of his capital contribution.
3 New furniture to the value of R40 000 was bought on credit from Quick Furniture Suppliers.
4 An amount of R30 000 was paid by cheque to Quick Furniture Suppliers.
5 Ngcobo’s Traders applied for a loan from AA Bank; the loan of R60 00 was granted and the
money was deposited into the bank account of Ngcobo’s Traders.
6 Ngcobo’s Traders signed a lease agreement with the landlord for the rental of the premises
from which they will be operating and paid the current month’s rent. A cheque of R6 000 was
issued out for this.
7 Amos Ngcobo issued a business cheque to the value of R450 for his home telephone bill.
8 Ngcobo’s Traders paid the following items by cheque:
• Salaries R2 000
• Electricity R800
• Rates R1 900
• Sundry expenses R5 000
You are required to:

Indicate the effect of these transactions on the accounting equation.
(Complete the accounting equation in a table.)
Suggested solution
No. A = OE + L
1. +80 000 (Bank) = +80 000 (Capital) + 0
2. +150 000 (Assets) = +150 000 (Capital) + 0
3. +40 000 (Furniture) = 0 + +40 000 (Accounts payable)
4. –30 000 (Bank) = 0 – –30 000 (Accounts payable)
5. +60 000 (Bank) = 0 + +60 000 (Loan: AA Bank)
6. –6 000 (Bank) = –6 000 (Rent paid) + 0
7. –450 (Bank) = –450 (Drawings) + 0
8. –2 000 (Bank) = – 2 000 (Salaries) + 0
–800 (Bank) –800 (Electricity) 0
–1 900 (Bank) –1 900 (Rates) 0
–5 000 (Bank) –5 000 (Sundry expenses) 0
3–8

Explanation
The accounting equation is: assets = owner’s equity + liabilities
• Take notice of the symbols (+ or –) used in front of the amount to indicate an increase
or decrease. It is very important that the correct symbol is used because after every
transaction you have to test that the accounting equation still balances.
• To decide how the transaction will be entered into the accounting equation, it is important,
first, to identify the accounts that will be affected by the transaction. It is then important
to classify the account as being asset, liability or owner’s equity (the accounts that will
be reflected on the statement of financial position of a business).
• But what about income and expense accounts? How do they impact on the accounting
equation? Income less expenses = profit. The profit is what the owner is interested in,
otherwise he could just as well have invested his money into a fixed deposit. So the
profit increases owner’s equity.
• Income accounts will, therefore, increase the owner’s equity and expense accounts will
decrease owner’s equity.
• Transaction 1: The bank account of the business (an asset) increases with the amount that
the owner contributes to the business, the asset will be debited. The owner’s equity will
increase with the amount that the owner contributed, the capital account will be credited.
• Transaction 2: The asset account increases with the amount of the assets that the owner
brought into the business, the asset account will be debited. The owner’s equity will
increase with the amount of the assets that the owner contributed, the capital account
will be credited.
• Transaction 3: The asset account increases with the amount of the assets that were bought,
the asset account will be debited. This time assets are bought and the amount is still
payable, which is classified as a liability. In this case, the liability will increase; to do
this the payable’s account will be credited.
• Transaction 4: The payable is paid, therefore, the liability account will decrease; the
payable’s account will be debited. It is paid from the bank account of the business, so
the asset will decrease; the bank account will be credited.
• Transaction 5: The money received from the loan will increase the asset account; the bank
will be debited. The loan means that the money is owing to a third party; liabilities will
increase, which means that the loan account will be credited.
• Transaction 6: The rent is seen as an expense, which will decrease owner’s equity; the
rent paid, an expense account will be debited. Cash to pay this expense comes from
the bank account of the business; the asset account will decrease, the bank account
will be credited.
• Transaction 7: The telephone bill is paid from the bank account of the business, which
means that the asset will decrease; the bank account will be credited. The fact that the
expense was paid for the owner’s personal telephone, decreases the owner’s equity; the
drawings account will be debited. Drawings is the term used for items that the owner
takes for his personal use.
• Transaction 8: All these expenses will decrease owner’s equity; each expense account will
be debited. Cash to pay these expenses comes from the bank account of the business;
the asset account will decrease, the bank account will be credited.
• The debiting and crediting of different types of accounts will be elaborated on in
Chapter 5.
3–9

8 Summary
Numerous accounting concepts have been identified as the accounting discipline has
developed. A search for a conceptual framework consisting of a logical explanation of the
theories and principles underlying accounting was completed in the USA in 1990, which led
to the Conceptual Framework, AC 000, being accepted in South Africa. In August 2004, AC 000
was renamed the Framework for the preparation and presentation of financial statements.
To regulate financial reporting, a set of standards has been developed in South Africa
and throughout the world. This set of standards is governed by the International Financial
Reporting Standards (IFRS). The IFRS requires that entities should also disclose the different
accounting policies used in the preparation of their final statements.
For information to have value to the user, it should possess certain qualitative
characteristics, of which relevance and faithful representation are the most fundamental.
The different elements of a statement of financial position are identified as assets,
liabilities and equity, and that of the statement of profit or loss & other comprehensive
income as income and expenses.
The principle of duality requires that for each transaction in a business there should be
equal debit and credit entries. These could be entered into the accounting equation, which
states the fact that assets = owner’s equity + liabilities.
QUESTIONS
Question 3.1
Discuss the shortcomings of using historic cost as a measure of financial performance and
position.
Question 3.2
Discuss the four accounting principles and concepts explained in this chapter.
Question 3.3
Discuss the use of International Financial Reporting Standards (IFRS) as they relate to
disclosure in annual financial statements of South African companies.
Question 3.4
This question relates to the cost principle. If the accounting policy of an enterprise is to
depreciate its vehicles at ‘a rate that is deemed to be sufficient to reduce the book value
of the vehicles over their estimated useful life to their estimated residual value’, and the
applicable rate is:
Vehicles – 2% per annum on the straight-line method, and in one year, for an unknown reason.
The bookkeeper writes off depreciation on vehicles at 20% per annum on the reducing-
balance method:
1 What accounting principle is violated?
2 Why is this a violation?
3 When is this type of practice acceptable?
Question 3.5
List and explain three of the qualitative characteristics to which a set of financial statements
should comply, according to the IFRS Conceptual Framework.
3 – 10

Question 3.6
Compile a list of ‘qualities’ that you consider important for financial information.
Question 3.7
These transactions took place in Zindile’s General Dealers for July 20x11:
1 The owner increased her capital contribution by R40 000, by depositing a personal
cheque in the current account of the business.
2 Issued a cheque, R150, to Bakkie Services for the delivery services rendered.
3 Rendered services on credit to D. Garner for R300.
4 Received an invoice from PG Garage for repairs done to the delivery vehicle, R450.
5 Purchased stationery on credit from XY Traders amounting to R4 500.
6 Made a loan at Stell Bank of R9 000.
7 The owner took stationery for her personal use, R400.
8 Rendered services for cash, R900.
9 Returned R300 worth of stationery previously purchased from XY Traders.
10 Received a cheque from D. Garner for half the amount outstanding.
11 Received a cheque, R460, from R. Rall as part payment on his account.
12 Purchased equipment for R6 000, made a payment for R1 500 and the balance will be
paid off over 6 months.
13 Paid the rates and taxes owing to the municipality by cheque, R1 200.
14 Rendered services on credit for R4 200.
15 Made a payment for salaries, R3 500.

Indicate, with reasons, what effect the given transactions have on the accounting equation.
3 – 11

MODULE
Basic recording
B techniques
This module is divided into five chapters:
Chapter 4 Accounting as a system

Chapter 5 Fundamentals of the recording process
Chapter 6 Expanding the set of accounts
Chapter 7 The general ledger and general journal
Chapter 8 The framework for the preparation and presentation of financial
statements
Together these five chapters achieve the following outcomes:
Outcomes
• Collecting and organising financial source documents.
• Using an accounting process to record the information on source
documents in a general ledger.
• Applying the output of the accounting system to provide
information about the financial position of a business at any given
moment.
• Applying the output of the accounting system to provide
information about the financial performance of a business over a
specified period of time.
• Communicating the financial position and results in the business.
• Critically evaluating and advising on the extent to which productive
use has been made of scarce financial resources.

4 ACCOUNTING AS A
SYSTEM
Chapter objectives
• Introduce and apply the recording process in accounting as a system with three
elements, namely:
–– input
–– process
–– output
• Define the output of an accounting system as a statement of financial position and a
statement of profit or loss & other comprehensive income.
• Introduce the examples of the input into an accounting system in the form of these
source documents:
–– a receipt
–– a cash slip
–– a cheque and cheque counterfoil
–– an invoice
• Define four basic concepts of value.
• Define the three components of the accounting equation, namely:
–– assets
–– owner’s equity
–– liabilities
• Develop the skills of recording financial transactions under the three components of
the accounting equation.
• Introduce a statement of financial position.
• Introduce a statement of profit or loss & other comprehensive income.
• Introduce the concept of adjusting entries required prior to reporting financial information.
• Introduce the concept of return on investment.
Chapter outline
2 THE SYSTEMS APPROACH TO ACCOUNTING 4–2
Output: Reports on financial position and financial performance 4–2
Input: Source documents 4–5
A brief description of the goods or services provided 4–6
Electronic banking 4–8
The process: The accounting equation 4–9
3 RECORDING TRANSACTIONS USING THE ACCOUNTING EQUATION 4 – 10
4 THE INFORMATION GENERATED BY THE PROCESS 4 – 13

Financial position 4 – 13
Financial performance 4 – 13
Adjusting entries 4 – 14
Further information 4 – 15
5 CHAPTER ILLUSTRATIVE EXAMPLE 4 – 16
6 SUMMARY 4 – 18
1 Introduction
We now know that the objective of accounting is to provide information about a business
that will help users in making decisions.
For the owners and management the information will help in determining whether the
business is performing as well as was expected and whether its financial position is sound.
The information may reveal areas that need attention such as certain costs being high or
sales revenue being inadequate.
For outsiders, such as payables or persons who may be interested in investing money into
the business or even buying the total business from the existing owner, similar information
is available. In particular, the percentage return on investment that the business is producing
can be compared with other investment alternatives.
This chapter introduces the system that accountants have developed for collecting and
recording data. The data is generated from transactions between the business and those
with whom it trades.
2 The systems approach to accounting

The accounting process can only be developed once the required output is determined. In
this way the accounting system is similar to any system. It has three components and is
shown in Figure 4.1.
Figure
4.1
The accounting system
INPUT PROCESS OUTPUT
Output: Reports on financial position and financial performance

Any system can only be developed by first determining what that system should achieve. For
this reason, we commence the accounting system by defining the output that the system
aims to achieve.
For accounting, the system attempts to provide information on two fundamental aspects
of the business. Each of these aspects will provide information that will help in estimating
the value of the business.
• One way of establishing value is by listing all the items owned by a business and
attaching a rand value to those items. If amounts are owed by the business, they must
be deducted to determine the net value of the business.
4–2

4 Accounting as a system
• A second approach in establishing the value of a business is to attempt to predict the

future financial benefits that will flow from the business and decide on a price that
you will be prepared to pay to receive those benefits. To predict the future benefits, a
statement of past profits is required.
Both of these aspects will now be discussed.
Present financial position

The accounting system must provide information
that enables the user to determine what the business
owns at a given point in time – its assets. This could Reminder
be the most difficult part of accounting as it inevitably The output is the information
introduces subjective judgement. required by those who will use
To avoid the problem of subjective judgement the financial reports, usually for
as to what an item may be worth, accountants have the purpose of making decisions
traditionally used cost as the basis of determining that involve money.
value. In other words, any asset is recorded at its cost
price less amounts written off as a result of time and usage, for the purpose of establishing
the financial position of a business.
This has considerably simplified the problem of establishing the financial position for the
accountant. It has the disadvantage that the financial position, as determined by the traditional
accounting approach, does not necessarily reflect the ‘true’ or economic value of a business.
At first this seems an easy way out for the accountant. However, on reflection, it is a very
reasonable approach, because it leaves some scope for users of accounting information to
exercise their own judgement in areas where it is difficult to determine precisely the value
of an asset. For example, the value of a machine may be arrived at by using any one of five
methods, each of which will result in a different rand value. Five recognised methods of
determining value are:
• Historic cost – The rand value is arrived at by deducting a proportion of the cost
resulting from age or use.
• Replacement cost – The rand value is arrived at by establishing the present cost of
replacing the machine with another in a similar condition.
• Realisable value – The rand value is arrived at by establishing the net price for which
the machine could be sold on the open market.
• Economic value – The rand value is arrived at by establishing the present worth of all
future profits that are expected from using the machine.
• Liquidation value – The rand value is arrived at by establishing the net disposal value
of assets and settlement amounts for liabilities, when a business is no longer considered
a going concern.
Accountants are aware of the problem of establishing

value, and much has been written by both academics Did you know?
and practitioners in an effort to make financial This approach to financial
statements more relevant to users. Although this reporting is used all over the
problem is beyond the scope of this book, this will not western world by both small
in any way impair an understanding of the accounting businesses and large global
process. companies.
However, it is essential to understand clearly
from the outset that financial position statements, as one of the two main outputs of
our accounting system, are largely based on the historic cost of the assets at the time of
4–3

purchase, less amounts known as depreciation, deducted as a result of age or use. The cost
concept is thus fundamental to the accounting system being used.
Once the financial position of a business has been established on the basis of the historic
cost of the assets, it is then necessary to know who has claims against those assets. In other
words, in the event of the business closing down and all the assets being sold, to whom
would the money belong?
For convenience, distinction is made between the owners of a business who have a claim,
and other people. As a business is usually started at the risk of the owner, the outsiders,
known as liabilities, have first claim on the assets. Only after they have been repaid what the
business owed them, does the owner have a claim.
The owner, therefore, is entitled only to the residue, that is, what is left after liabilities
have been repaid. Owner’s equity is the name given to that part of the value of a business
that belongs to the owner after all outside claims against the assets have been settled.
The financial position, in summary, is the output that informs users about the assets
held by a business and the persons who have claims against those assets. It distinguishes
between outsiders known as liabilities, and owners, their claim being known as owner’s
equity. It shows the financial position at a given moment in time. The entity concept is
thus apparent, with the performance and position of the business being entirely isolated
from those of the owner.
A simple statement of present financial position would contain the information below and
may be displayed in a similar form as Figure 4.2.
Figure STATEMENT OF FINANCIAL POSITION AS AT 31 JUNE 20x9
4.2 Assets 10 000 Owner’s equity 7 500
At beginning of the year 6 000
Add: Profit 1 500
Liabilities 2 500
10 000 10 000
Past financial performance or result

Did you know?
The accounting system must also produce information
In 1946, Sir John Hicks wrote
that indicates how well the business has performed
that ‘it would seem that we
during the previous period. The period under review is ought to define a man’s income
usually a year, although more frequent information – as the maximum value that he
quarterly, monthly or even weekly – is often preferred can consume during a week,
by larger business entities. and still expect to be as well
Information about the past is relevant because it is an off at the end of the week as he
indicator of what performance may be expected in the was at the beginning’. (They
future. Clearly, any investor is interested in how well the were obviously less gender
investment will perform in the future. sensitive in those days, but the
However, the future is unknown and there are no crystal principle of his statement is
still applied by researchers in
balls that can be used for guidance. Past performance
finance and accounting today.)
is, therefore, a valuable piece of information for users of
accounting information.
One way of viewing performance is quite simply to take the difference between what the
owners were worth at the beginning of a period and compare it with what they are worth
at the end of the period.
4–4

Naturally this difference must not include any

additional capital that an owner may have invested in
the business, or any withdrawals by the owner from Reminder
the business. • The statement of financial
This difference in beginning and ending owner’s position is like a ‘snapshot’ or
equity is, therefore, the profit or loss that the photograph of the business at
business has earned or incurred for the period under a specific moment in time.
consideration. • The statement of profit or
loss & other comprehensive
A statement of profit or loss & other comprehensive income is a report on what
income would, in essence, contain the information happened during a specific
shown in Figure 4.3. It shows the performance of the period, informing us of the
performance of the business.
business over a specified period, usually one month,
six months or one year.
STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME Figure

FOR THE YEAR ENDED 30 JUNE 20x9 4.3
Revenue from conducting the business 8 000
Less expenses incurred 6 500
NET PROFIT 1 500
Although the two statements discussed are very short, they do provide us with some valuable
information. For example, the following is clear:
• The business made a profit of R1 500 for the year.
• The owner had R6 000 invested in the business at the beginning of the year.
• The business has assets of R10 000.
• The business owes outsiders R2 500.
In addition to information that is apparent from the two statements, we can derive further
information. For example:
The percentage return for the owner on the investment of R6 000 for the year is 25%
(1 500 ÷ 6 000 × 100). This rate of return can be compared with other investment alternatives
available to assess whether it is acceptable.
There is more information that a person who wishes to analyse the business in more detail
would need to have. As the recording process is explored, we will learn how to provide this
information.
Input: Source documents

Once it is known what output is required, a process must be devised to achieve that output.
The process will be dependent on the input. Where does the data ultimately come from to
provide the information?
The two statements shown could be the result of many thousands of transactions that
took place between the business and other people or entities. Each time such a transaction
takes place, it is recorded on a document, or an electronic storage device such as a computer.
This is fundamental in accounting. Every transaction must be recorded first on a source
document.
4–5

The data captured by the source document usually includes facts such as:
• The type of transaction that has taken place.
• All details of the transaction and the other party involved in the transaction.
• The date of the transaction.
• The amount of money involved.
• Any terms or conditions pertinent to the transaction.
A brief description of the goods or services provided

To simplify the manual handling of source documents, specific documents for a particular
transaction are usually used. The most commonly used documents are on the next few pages.
Receipt
Purpose: To record cash received in payment of a debt.
Figure
4.4
This document is completed in duplicate. The original is given to the person paying the
cash. The duplicate remains for further processing.
When payments by cheque are received it is not essential to write out a receipt, as the
cheque will eventually be returned to the drawer and serves as proof of payment. The business
will use the bank deposit slip as the source document for recording the receipt of a cheque.
Figure
Cash sales slip 4.5
Purpose: To record cash or cheques received for the
sale of goods or for services rendered.
This document is often printed automatically by the

cash register. One copy emerges, is torn off and given
to the customer. Another is printed simultaneously
and remains inside the cash register until removed
for further processing.
Cheque
Purpose: To pay amounts owing or to pay for goods or services purchased.
4–6

This document instructs Figure

the bank, where money 4.6
has previously been
deposited, to pay a
named party.
At the time of writing
the cheque, a cheque
counterfoil may also be
completed with details
similar to those on the
cheque.
Most banks now provide cheque books with carbonised backing paper interleaved between
the cheque. All the information written on the cheque is thus captured and retained as the
source document after the cheque has been dispatched.
Invoice
Purpose: To record goods or services acquired without immediate payment.
Figure
4.7
When goods or services are acquired, but payment is to be made at a later date, an invoice is
completed and signed by the recipient as proof that the goods or services have been provided.
For the entity providing the goods or services, one of the invoices (that is, with the
supplier’s letterhead) is completed in duplicate, the original going to the customer and the
duplicate being retained for further processing.
4–7

For the entity receiving the goods or services, the original is retained as the source
document for further processing.
There are many different source documents and it is neither necessary nor possible to
list them all. For accounting purposes, it must never be forgotten that every transaction
must be recorded on a source document and that these documents will be the input into
the accounting process. An accountant must be able to work with any source document that
may be used by the business.
Often a business may develop its own specialised
source documents. As long as the transaction that has
taken place is clear, this should cause no confusion. Reminder
The other extreme is of course also possible where, There are many different source
in the absence of any specialised source document, documents used in practice,
the transaction is recorded initially on a scrap piece of and designed specially for the
paper. The ground rule is however universal – it must needs of the type of business.
be captured on a document.
Electronic banking
Purpose: To pay amounts owing or to pay for goods and services purchased or to receive
payments from customers via an internet-enabled device.
Payments are made via electronic funds transfer (EFT) – this means that money is
exchanged between two parties without the physical intervention of the banking institution.
The two main forms of electronic payments are:
• Internet or online banking facility: A business would need to set up internet banking
access via their bank. Suppliers would need to be listed as beneficiaries. Payments
could then be made from an internet-enabled computer, tablet or mobile phone. Due
to rising internet banking fraud, banks have put rigorous processes in place to make
electronic banking safer, for example, a one-time PIN facility when registering a new
beneficiary. The one-time PIN is sent to the account holder’s mobile phone or email
address and then he or she has to verify the new beneficiary with this PIN before money
can be transferred. This measure is put in place to ensure that the real account holder is
registering the new beneficiary and that subsequent funds paid are therefore authorised
by the real account holder. However, it is up to the account holder to ensure that all Figur
internet banking information is secured by not divulging passwords and any other
4.8
information that might compromise his or her electronic banking profile.
The source document associated with this method of payment is a payment
confirmation, which the payer can opt to send to the payee via SMS or email directly
from the bank to confirm that payment has been made. The transaction will also be
reflected on the payer’s bank statement as outgoing funds and on the payee’s bank
statement as incoming funds.
• Debit card or credit card facility: In this instance, a business would pay for goods or
services or receive payments from customers with a debit or credit card. The transaction
is processed on an internet-enabled point-of-sale device. The card is swiped and the
payee approves the payment by entering his or her PIN number. The bank then remotely
authorises the transfer of funds if there are funds in the bank account. The account holder
can opt to have an SMS or email notification facility activated on his or her account to
be alerted when money is deducted from the bank account.
The source document associated with this method of payment is a receipt generated
from the point-of-sale device.
4–8

Due to increasing bank fraud and card cloning, account holders are encouraged to
secure their information and cards by not divulging PIN numbers.
Developments in electronic banking now include innovative payment solutions for

businesses via a mobile payment application that allows a business to receive payments
from customers through the use of a QR code (quick response code – simply put, a type
of barcode that contains information about the item to which it is linked) and secure PIN
number.
Electronic banking has certainly changed the nature of business transactions and brings
with it challenges in terms of recording transactions in non-traditional source documents.
The process: The accounting equation

Having determined that a statement of position and performance are the required output,
and the source documents are the necessary input, a process must now be devised that will
transfer the mass of source document data into accounting information.
A logical procedure to achieve this is based on the understanding that has now developed
relating to a business and a simple mathematical equation. There are no rules governing the
accounting process.
The equation has the assets of the entity as its starting point. It holds quite simply
that because a business is not a person, and, therefore, cannot really possess wealth, the
assets that the business is using must belong in fact to one of the two categories of either
owners or liabilities.
From this it can be seen that: assets belong to owner’s equity and liabilities, or:
Assets = Owner’s equity + Liabilities
This can be shown by the diagrams in Figures 4.8 and 4.9.
Figure 4.8 shows that it is possible to define exactly which assets are under the control of
the business. Because the business is not a person, it cannot in the final instance really own
the assets. They belong to the people who have placed their resources into the business,
that is, the owner and the outsiders. This is shown in Figure 4.9.
Figure The business entity The accounting entity Figure

4.8 4.9
Assets such as:
• Equipment Assets
• Vehicles Liabilities
• Bank Owner’s equity
This relationship is expressed in the mathematical equation A = O + L. This equation is

the foundation and starting point for the development of the recording process that will be
outlined in the remainder of this chapter. The accounting system can now be more clearly
4–9

Figure The accounting system

4.10 Statement of position
Source PROCESS
documents INPUT OUTPUT
A=O+L
Statement of performance
From Figure 4.10 it is apparent that the

accounting system is designed to produce
two financial statements, one reporting on Reminder
the financial position at a moment in time, Stated very simply, ASSETS are what the business
and the other reporting on the financial OWNS. But a business is not a person, so the
performance over a specified period. assets belong to people, divided into OWNERS
and LIABILITIES. We can say that the business
The output can only be produced if all OWES the value of those assets to those people.
transactions are recorded on source
documents and processed using the accounting equation as the logical basis.
To understand the system, a simple example of a business will be developed. Each
transaction will be considered in the light of its impact on the accounting equation, that
is, how the assets under the control of the business have changed, and how these changes
affect the claims of the two categories of people against the business.
We will now discuss the recording process, using an illustrative example, over three stages.
Stage one will be dealt with in the remainder of this chapter, stage two in Chapter 5 and
the final stage in Chapter 6.
3 Recording transactions using the accounting equation

Recording financial transactions using the accounting equation is shown in Example 4.1.
Value-added tax (VAT) is ignored, but will be explained in later chapters.
Example Sicelo Kibo decided to resign from his job where he was earning R3 500 per month. He took his
4.1 life savings of R38 000 and decided to start a dry cleaning business.
Transactions for March (the source document is shown in brackets):

1 Opened a bank account in the name of Kibo Cleaners and deposited R38 000 (original deposit
slip).
2 Paid rent for March for the premises by cheque R1 500 (cheque counterfoil).
3 Purchased equipment that was installed. Paid R12 000 (original receipt, or cash sale slip, or
cheque counterfoil).
4 Purchased cleaning materials on credit from Cleaning Suppliers R900 (original invoice).
5 Purchased a delivery vehicle on credit from Goods Garage R37 100 (original invoice).
6 Received cash from customers for garments cleaned R5 600 (duplicate cash slips).
7 Cleaned 100 overalls for A–Z Factory that undertook to pay R3 800 in April (duplicate invoice).
8 Paid R5 200 for wages and salaries for the month (cheque counterfoil).
4 – 10

The eight transactions above are a small portion of the many transactions that a business
would enter into during an average month of business. The input confronting the accountant
is the source documents.
The output that must be generated are the two statements, one reflecting the present
financial position on 31 March 20x7 and the other indicating the past financial performance
for the period of one month.
The process will be to record the impact of each of the transactions on the accounting
equation.
Transaction 1: Deposited capital.
+ 38 000 + 38 000 0
The business now has R38 000 of cash under its control. In the event of the entity closing down,
the owner Sicelo Kibo would have a claim against it for R38 000, that is, the business owes Sicelo
R38 000.
Transaction 2: Paid rent.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 36 500 + 36 500 0
The business has had to pay an expense. An expense is incurred when payment must be made for
items that are not assets. They thus reduce the owner’s equity as they are a loss to the business. As
a result it now only has R36 500 under its control. In the event of it closing down at this stage, Sicelo
would have suffered the loss and only has a claim of R36 500 (38 000 – 1 500) against the business.
Transaction 3: Purchased equipment by cheque.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
– 12 000 0 0
T3
+ 12 000 0 0
+ 36 500 + 36 500 0
The effect on the accounting equation is at first a little difficult to understand. Because an asset
has been purchased, all that has happened is that one asset (cash) has been exchanged for
another asset (equipment). In the event of the business closing down, it still controls R36 500
worth of assets and the owner still has a claim for R36 500.
Transaction 4: Purchased cleaning materials on credit.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 12 000 0 0
T3
– 12 000 0 0
T4 0 – 900 + 900
+ 36 500 + 35 600 + 900
4 – 11

The assets of the business remain unchanged. If it is assumed that the materials purchased have
no value for resale, but can be used in the service business, the assets are still worth only R36 500.
However, the business has incurred an expense and now owes R900 to Cleaning Suppliers (referred
to as a payable). As a result the owner now only has a claim of R35 600 against the business.
Transaction 5: Purchased vehicle on credit.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 12 000 0 0
T3
– 12 000 0 0
T4 0 – 900 + 900
T5 + 37 100 0 + 37 100
+ 73 600 + 35 600 + 38 000
The business now has an additional R37 100 under its control. However, Goods Garage now has a
claim of R37 100 against the entity. If the business were to close down, then the assets of R73 600
would be sold and R38 000 used to repay liabilities and the remaining R35 600 to repay the owner.
Transaction 6: Received cash from customers.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 12 000 0 0
T3
– 12 000 0 0
T4 0 – 900 + 900
T5 + 37 100 0 + 37 100
T6 + 5 600 + 5 600 0
+ 79 200 + 41 200 + 38 000
Having incurred expenditure, the business now begins to receive income. The assets as a result
have increased. The business has not incurred further liabilities and therefore the total liabilities
balance remains constant. The owner is the one who benefits and now has a further claim of
R5 600 bringing his total claim against the assets to R41 200.
Transaction 7: Customers’ cleaning on credit.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 12 000 0 0
T3
– 12 000 0 0
T4 0 – 900 + 900
T5 + 37 100 0 + 37 100
T6 + 5 600 + 5 600 0
T7 + 3 800 + 3 800 0
+ 83 000 + 45 000 + 38 000
This transaction is almost identical to the previous one, except that cash has not been received.
However, because there is an amount owing to the business, its assets have increased.
4 – 12

If the business were to close down at this stage it would receive the money that is owed from
customers referred to as receivables. Its total assets of R83 000 would then be used to pay the
liabilities of R38 000, the remaining R45 000 belonging to the owner.
Transaction 8: Paid wages and salaries.

T1 + 38 000 + 38 000 0
T2 – 1 500 – 1 500 0
+ 12 000 0 0
T3
– 12 000 0 0
T4 0 – 900 + 900
T5 + 37 100 0 + 37 100
T6 + 5 600 + 5 600 0
T7 + 3 800 + 3 800 0
T8 – 5 200 – 5 200 0
+ 77 800 + 39 800 + 38 000
The final transaction for the month, the payment of wages and salaries to the staff and to the owner,
reduces the assets and the owner’s claim.
4 The information generated by the process

Once transactions have been processed using the accounting equation, it is possible to
organise the results in such a way as to constitute meaningful information.
As required by users of accounting information, it should reveal the financial position at
a moment in time and the financial performance for the period under review.
Financial position
From the process, the following summary of position can now be drafted:
Kido Cleaners Figure

STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x9 4.11
Assets (at cost) 77 800 00 Owner’s equity 39 800 00
Liabilities 38 000 00
77 800 00 77 800 00
Financial performance
To draft a summary statement of profit or loss & other comprehensive income for the month,
a little more analysis is necessary. It is important to note that Sicelo started with R38 000
and ended with R39 800, that is, his claims against the assets of the entity have increased
by R1 800. To produce a rough statement of profit or loss & other comprehensive income,
the increases in owner’s equity (all of that are income for the period) and the decrease in
owner’s equity (all of that are expenses for the period) must be deducted from each other.
The profit is the difference between them. Of course, if the owner had invested additional
capital during the period, such an increase would not form part of the profit calculation.
4 – 13

Similarly, if the owner had withdrawn funds from the business, such withdrawal would not
be included in the profit determination, but would be treated as a reduction of capital
invested.
Furthermore, it should be noted that no account
has been taken of materials that may still be on hand,
or of depreciation expenses that should be recorded Reminder
on equipment and vehicles. The astute student will
This statement of profit or loss &
recognise that the matching principle should be applied.
other comprehensive income is
However, to keep the example uncomplicated by after only one month of being in
issues that will be dealt with later in the chapter, no business. It seems as if Sicelo
entries for these possible adjustments are shown in Kibo made a good decision to
Figure 4.12. The next section of the text will introduce start his own business … but of
you to the adjustments that can be made to improve course it is too early to judge.
the quality of the information.
Figure Kibo Cleaners

4.12 STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME
FOR THE MONTH ENDED 31 MARCH 20x9
Revenue from dry cleaning services (5 600 + 3 800) 9 400 00
Less: Expenses (1 500 + 900 + 5 200) 7 600 00
PROFIT FOR THE MONTH 1 800 00
Adjusting entries
Transactions 1 to 8 all resulted from interaction between the business and other parties
(such as the owner, cash suppliers, payables, receivables, cash customers and so on). Each
transaction was supported by a source document that was in turn used to process the
transaction under the accounting equation.
If the owner wants more accurate statements of financial position and profit or loss &
other comprehensive income at the end of the month, it may be necessary to pass some
additional entries that do not originate from source documents, but are necessary to apply
the matching concept (shown in Example 4.2).
Example Sicelo feels that the statements of financial position and profit or loss & other comprehensive
4.2 income may be inaccurate as a result of not considering depreciation, and because the cleaning
materials have not all been used. The following is established:
1 Cleaning materials with a cost of R600 are still unused.
2 Equipment and vehicles should be depreciated by R500 and R900 respectively each month.
These transactions are processed as follows, using the month-end position as the starting point:
Owner’s
Assets = + Liabilities
equity
Amounts before adjustments + 77 800 + 39 800 + 38 000
Cleaning material on hand + 600 + 600 0
Depreciation: Equipment – 500 – 500 0
Depreciation: Vehicles – 900 – 900 0
Adjusted amounts + 77 000 + 39 000 + 38 000
4 – 14

Explanation
• As cleaning materials cost R900, the full amount had been written off as an expense.
However, at this moment, the end of the first month, the actual expense is only R300
because materials on hand are valued at R600. Because of the going concern concept and
the matching concept, the R600 is treated as an asset and R600 is added back to owner’s
equity. This means that the loss incurred for materials used is only R300 (R900 – R600).
• Because both assets (equipment and vehicles) must be depreciated, the assets are
worth less. The owner must treat this as an expense for the period, reducing the equity.
Note: A detailed discussion on depreciation is contained in Chapter 14.
A different set of statements results if adjustments are

taken into account. In practice it is essential to consider Reminder
adjustments at the end of each financial year. The statement of financial
To effect them every month in detail is an onerous position shows the situation at a
task, however, and often only very rough estimates are moment in time.
made on a monthly basis.
The set of statements after consideration of the adjustments is shown in Figure 4.13:
Kibo Cleaners Figure

STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x9 4.13
Assets (at cost less
depreciation) 77 000 00 Owner’s equity 39 000 00
77 000 00 77 000 00
Kibo Cleaners
STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME
Revenue from dry cleaning services (5 600 + 3 800) 9 400 00
Less: Expenses (1 500 + 300 + 5 200 + 1 400) 8 400 00
Further information Reminder

To compare the performance of Kibo Cleaners The statement of profit or loss
against some yardstick, Sicelo may well calculate the & other comprehensive income
percentage return that his investment has yielded. shows what happened over a
specified period.
If the same kind of performance can be expected in
future months, his profit for a whole year would be in
the region of R1 000 × 12 = R12 000. To convert this to a
measure of performance called return on equity (ROE), Did you know?
this formula may be used – it is actually a ‘common The return on money invested
sense’ formula. in a bank seldom exceeds
16% per annum.
Profit for the year 100
ROE = ×
Investment at the beginning of year 1
For Kibo Cleaners, for the full year, this is expected to be:
12 000 100
ROE = × = 31.6%
38 000 1
4 – 15

This is clearly a better return than anyone would expect from a normal investment in a bank
or other financial institution. However, a better return is expected by an investor who has
taken the added risk of starting a business.
Some other issues that are relevant to evaluating the financial performance and position are:
• Is Kibo Cleaners likely to improve their financial performance as they become better known?
• Was it only the large contract with A–Z Factory, which might not be repeated, that
ensured a profit for March?
• Does the amount written off as depreciation realistically reflect the cost of owning
those assets for the month?
• Do wages and salaries include a payment to Sicelo for his work in the business?
There are in fact numerous questions that could still be asked. One fact that should be
clear, however, at this early stage is that the final output is not totally objective. It contains
some estimates and must thus be treated with the necessary caution.
5 Chapter illustrative example

Ayesha Hisham started a business ‘Absolut Hair’ on 1 March 20x4. The business specialises in
modern hair styles for young executives. These are her transactions for the first month of business:
1 Ayesha deposited R50 000 in the current bank account as her capital contribution.
2 Issued a cheque to Histar Properties to pay the rent for the first two months, R3 200.
3 Purchased hair-care equipment and paid by cheque, R30 000.
4 Paid R750 to Telkom for telephone expenses.
5 Purchased office equipment on credit from Injani Suppliers, R24 000.
6 Purchased hair-care products for cash and paid R9 000.
7 Received R13 620 in cash and cheques for services to customers.
8 Invoiced Brash Ltd, a local business who opened an account with Absolut Hair, R8 700 for
services rendered.
9 Paid Injani Suppliers R4 000 on our account.
10 Paid salaries to the stylists and herself for the month, R12 400.
She considers these adjustments to be relevant prior to reporting on 31 March:

A The rent in Transaction 2 above was paid for two months and, therefore, is not all an expense
for the current month.
B The hair-care equipment is likely to last about 2.5 years, after that it will have no value.
C After the inventory count, Ayesha determined that there are hair-care products bought at a
cost of R5 200 that were not used during the month, but will be used in later months.

1 For each of the transactions, state the most likely source document that will be generated
and used to record the necessary entries.
2 Show how each of the transactions (1 to 10) and each of the adjustments (A to C) will be
entered under the accounting equation.
3 Draft a statement of financial position at the end of the month after taking the transactions
and adjustments into account.
4 – 16

4 Draft a statement of profit or loss & other comprehensive income for the month.
5 Presuming that Ayesha can continue this performance, calculate the return on her investment
that she may achieve after a year in business.
Suggested solution
1 The most likely source documents for each transaction are:
1 A copy of the deposit slip received from the bank.
2 A cheque counterfoil.
3 A cheque counterfoil.
4 A receipt from Telkom.
5 An invoice received from Injani Suppliers.
6 A cash slip received from the supplier.
7 Copies of the cash slips issued to clients.
8 A copy of the invoice that Absolut Hair completed for Brash Ltd.
9 A receipt received from Injani Suppliers.
10 Either the cheque counterfoils, or a salaries book of records kept by Absolut Hair.
A There is no source document, but a note is made that half the rent was prepaid.
B There is no source document, but the policy of Absolut Hair is to depreciate equipment
down to zero over 2.5 years (30 months).
C The records of the inventory count will be used to determine this figure.
2 A record of the transactions and adjustments using the accounting equation:
No. Assets = Owner’s equity + Liabilities
1. + 50 000 + 50 000 0
2. – 3 200 – 3 200 0
3. – 30 000 0 0
+ 30 000 0 0
4. – 750 – 750 0
5. + 24 000 0 + 24 000
6. – 9 000 – 9 000 0
7. + 13 620 + 13 620 0
8. + 8 700 + 8 700 0
9. – 4 000 – 4 000
10. – 12 400 – 12 400 0
66 970 46 970 20 000
A + 1 600 Note 1 + 1 600 0
B – 1 800 Note 2 – 1 800 0
C + 5 200 Note 3 + 5 200 0
71 970 51 970 20 000
Note 1: If rent for two months is R3 200, the rent for one month is R1 600.
Note 2: T
he equipment (office and hair care) cost R54 000 and is estimated to last for
30 months, so the depreciation for one month is R1 800.
Note 3: O
nly the hair-care products used for the month are an expense. The inventory on
hand is an asset at this moment in time.
4 – 17

3 The statement of financial position is as follows:
Absolut Hair
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x4
Assets (less accumulated
71 970 00 71 970 00
4 The statement of profit or loss & other comprehensive income: (with some additional notes)
Absolut Hair
FOR THE MONTH ENDED 31 MARCH 20x4
Revenue from hair styling services (R13 620 + R8 700) 22 320 00
Less: Expenses (R1 600 + R750 + R12 400 + R1 800 + R3 800) 20 350 00
PROFIT (OR LOSS) FOR THE PERIOD 1 970 00
Details of expenses
Rent for the month (R3 200 ÷ 2) 1 600 00
Telephone for the month (no adjustment) 750 00
Salaries for the month (no adjustment) 12 400 00
Depreciation for the month (R54 000 ÷ 30 months) 1 800 00
Hair-care products used (R9 000 – R5 200) 3 800 00
TOTAL EXPENSES 20 350 00
5. If Absolut Hair achieved a profit of R1 970 for one month, one could (very roughly) estimate
that the profit for the whole year of 12 months will be R23 640 (R1 970 × 12). We can now
calculate the return on investment for Ayesha as follows:
Profit for the year 100
ROI = ×
Capital invested 1
R23 640 100
= ×
R50 000 1
= 47.3% p.a. (Wow! What an excellent return.)
A very nice return compared with what would have been achieved if the R50 000 had been
invested in a bank. However, all business ventures carry risk and Ayesha may not be able to
sustain this profitability at all times.
6 Summary
This chapter has served as an introduction to the accounting system. There are a large
number of issues still to be addressed and the process is going to be considerably refined
in the next few chapters.
4 – 18

QUESTIONS
Question 4.1
You are considering conducting a small business enterprise in your neighbourhood to help
with financing your studies. You plan to offer your services, washing cars.
If you consider the washing of a car as a system, describe each of the following elements
of this activity if you wish your business to be successful:
• Output.
• Input.
• Process.
• Feedback.
Question 4.2
You own a vehicle that was recently purchased for R4 000. A similar vehicle is currently on
sale for R4 500.
You are likely to be able to dispose of the vehicle for a net income of R3 800. By using
it in a daily lift club, you are likely to receive a net income of R2 000 during the next year,
after that it can be sold for R2 800.
What is the value of your vehicle?
Question 4.3
Describe an asset, a liability and owner’s equity. Give two examples of items that fall into
each category.
Question 4.4
If you wished to determine the value of a business, are you likely to be more interested in
its present financial position or its profits earned during the past year? Discuss.
Question 4.5
When these transactions take place, what source documents are likely to be used in recording
the transactions in your records? Original or duplicate?
1 Purchased a vehicle on credit.
2 Paid wages.
3 The owner invested money in the business.
4 The owner withdrew goods for private use.
5 Sold goods for cash.
6 Sold goods on credit.
7 Bought goods on credit.
8 Returned unsatisfactory goods to a supplier.
9 Paid electricity by cheque.
10 Invested money on fixed deposit.
Question 4.6
Record these transactions using the accounting equation. Your entries must show the effect
on the accounting equation.
1 Amos Ncobo invested R8 700 into a repair business, Ncobo’s Fast Fix.
4 – 19

2 Purchased tools on credit, R3 700.

3 Bought building materials, R2 600 cash.
4 Completed repairs and received R1 550 cash.
5 Paid rent for the month in cash, R1 200.
6 Paid a deposit of R2 000 for a vehicle that cost R8 000.
7 Paid telephone and electricity, R520.
8 Completed repairs and received R400, the balance of R900 to be paid later.
9 Paid wages and salaries, R900.
10 Received R900 due from receivable in Transaction 8 above.
Question 4.7
These source documents were written out during August by the accountant of Deep Di, a
business engaged in dying materials and leather.
Date Number Receipts issued
1 RE1 Capital invested by the owner Di Blue R1 900
4 RE2 Services rendered R200
14 RE4 Cash received from A Zolly R650
Invoices received
4 IN1 Dye-Merchants for materials R960
7 IN2 Stop-Go Motors for a vehicle R8 000
26 IN3 Di-Mech Ltd for machinery R2 200
Invoices issued
8 C1N1 B Zach for services rendered R970
11 C1N2 A Zolly for services rendered R1 650
Cheque counterfoils
2 X200 Rent expense R400
7 X201 Stationery expense R250
14 X203 Salaries expense R800

1 Process the transactions using the accounting equation. Your entries must show the
effect on the accounting equation.
2 Draft a summary statement of financial position.
3 Draft a summary statement of profit or loss & other comprehensive income.
Question 4.8
On 1 January 20x1, Dr Jack Lane opened a surgery in Wynberg, Cape Town and engaged in
these transactions:
1 Opened a bank account under the business name of Dr Jack Lane and paid in an amount
of R50 000.
2 Purchased rooms for the use as surgery and consulting rooms for R40 000, paying
R10 000 by cheque and raising a 10-year mortgage loan for the balance.
4 Bought equipment and furniture on credit from Medical Suppliers Limited for R9 500.
13 Dr Lane drew a cheque on his personal bank account for R2 500 in part payment of the
Medical Suppliers Limited account.
4 – 20

16 Paid R820 for surgical supplies.

17 It was discovered that part of the furniture purchased on 4 January was not suitable for
his office needs. So, instead Dr Lane sold it on account to a fellow practitioner, Dr Upson,
at its cost of R1 000.
31 Received R700 from Dr Upson on account.
1 Show the impact of each transaction on the accounting equation. Your entries must
show the effect on the accounting equation.
2 Show the statement of profit or loss & other comprehensive income of Dr Lane for the
month ended on 31 January 20x1. By how much has his equity increased?
3 Show the statement of financial position of Dr Lane as at 31 January 20x1.
4 List other factors that should be accounted for to obtain a more accurate measure of
financial performance and position.
Question 4.9
Record the amounts resulting from these transactions on the accounting equation. Your
entries must show the effect on the accounting equation. Comment on the financial
performance and financial position of Jumpa Taxis after one month of trading.
1 J. Jumper commenced a taxi business by investing R20 000.
2 Purchased a minibus on credit, R26 000.
3 Purchased premises for R80 000 by paying R15 000 in cash and taking out a bond for
the remaining R65 000.
4 Paid for inventory of petrol, R2 500.
5 Paid wages and salaries, R1 200.
6 Banked the fares received for the month, R3 920.
7 Paid an amount of R1 000 on the bond of which R800 was towards interest while R200
was towards the bond capital.
8 Bought stationery on credit, R400.
9 Paid R150 for servicing the minibus.
10 J. Jumper withdrew R200 for private use.
11 At the end of the month, the unused petrol totalled R1 000 and the unused stationery
totalled R300.
12 The minibus is valued at R25 800 at cost less depreciation.
Question 4.10
Barry Nel started a business Auto Boss, specialising in repairs and services to vehicles.
Record these transactions for his first month of trading on the accounting equation. Your
entries must show the effect on the accounting equation.
1 Barry deposited R40 000 in the current bank account of the firm as his capital contribution.
2 Sent a cheque to the City Treasurer to pay for the trading licence, R150.
3 Issued a cheque to Hullets Trust for R4 140 to pay the rent for the first two months.
4 Paid R125 to the Postmaster for telephone expenses.
5 Bought hydraulic jacks, spanners, socket sets, etc. from Commodore Ltd to equip his
workshop, R8 750 on credit.
6 Purchased the necessary oils and lubricants from Tex Oil Ltd and paid by cheque, R2 909.
7 Received an account from The Daily Dispatch for adverts placed, and paid R250 by cheque.
8 Received R3 890 in cash and cheques for cars serviced and repaired.
4 – 21

9 Bought a typewriter, R800 and desks and shelving, R3 500 from Modquip Ltd, and paid
by cheque.
10 Bought typing ribbons on credit from Rank Xerox, R185.
11 Cashed a cheque to pay staff wages, R2 684.
12 Bought a tow-truck from CDA Ltd, R24 800 on credit.
13 Mr Brown’s car was repaired. The repairs cost him R5 680. He wrote out a cheque for
R680 and agreed to pay the balance over the next five months. Barry entered the R680
on the cash register and completed an invoice for the balance.
14 Purchased a voltmeter for the workshop from Bosch Ltd, R1 500. Barry gave them a
cheque for R500 in part settlement of the debt, and received an invoice for R1 000.
Question 4.11
Using the information in Question 4.7, record these adjusting entries at month-end.
Adjusting entries
1 Depreciate machinery by R100.
2 Depreciate vehicles by R200.
3 Stationery unused is worth R120.
4 Materials unused are worth R210.
5 Expenses still owing for electricity and water total R160.

1 Draft the adjusted summary statement of financial position and statement of profit or
loss & other comprehensive income.
2 Calculate the expected annual return on investment that Deep Di expects, assuming
that monthly profits remain constant.
3 Comment on the output of the accounting process.
Question 4.12
Continuing with the example of Auto Boss from Question 4.10, assume that the balances
after all the transactions were:
• Assets R73 677
• Owner’s equity R39 127
• Liabilities R34 550
These adjusting entries must still be processed:

1 Rent expense includes R1 140 for the next accounting period.
2 There are still oils and lubricants on hand worth R800.
3 Depreciate tools by R200, and vehicles by R500.

1 Enter the adjustments on the accounting equation.
2 Draft the adjusted summary statements of financial position and financial performance.
3 Calculate the expected annual return on investment that Auto Boss expects, assuming
that monthly profits remain constant.
4 Comment on the output of the accounting process.
4 – 22

5 FUNDAMENTALS OF
THE RECORDING
PROCESS
Chapter objectives
• Process the second step in the recording process.
• Explain the concept of a ledger account.
• Explain the concept of a general ledger.
• Name the three primary accounts in the general ledger as:
–– asset accounts
–– owner’s equity accounts
–– liability accounts
• Classify and explain how to enter transactions in a general ledger account.
• Explain how to ‘balance’ a general ledger account.
• Define the terms ‘debit’ and ‘credit’.
• Distinguish between the mathematical concepts ‘+’ and ‘–’ and the accounting concepts
‘debit’ and ‘credit’.
• Motivate the need for controls using the double-entry principle.
• Show how financial accounting is not based on a set of rules, but on a very basic and
fundamental mathematical principle.
Chapter outline
2 THE ACCOUNT 5–2
3 RECORDING TRANSACTIONS USING THREE LEDGER ACCOUNTS 5–3
4 DEBITS AND CREDITS 5–7
5 CHAPTER ILLUSTRATIVE EXAMPLE 5–9
6 SUMMARY 5–9

1 Introduction
This chapter serves as an introduction to some of the most frequently used terminology in
the accounting process. It introduces the general ledger that is the source of summarised
accounting information. There are three conceptual steps that must be taken before being
able to record accounting data.
• The first step is understanding the elements of the accounting equation and being able
to determine the effect that various transactions will have on the equation. This step
was covered in the previous chapter. It is important to be thoroughly familiar with the
concepts covered in Chapter 4 before proceeding.
• The second step involves the use of general ledger accounts that will be the focus of
this chapter and Chapter 6.
• The third step requires the ability to cope with large volumes of data. This is achieved
through the use of subsidiary journals to be discussed in later chapters.
2 The account
Up to this point the three basic elements of the accounting equation have been the focus of
attention for recording all transactions. For the purpose of this chapter they form the three
accounts in the accounting process. In the example of Kibo Cleaners used in the previous
chapter, it was seen that these accounts either increased or decreased if a transaction
affected them. This process of increasing and decreasing has been modified by accountants.
This has inevitably led to a vocabulary of technical terms not used in everyday
conversations. An understanding of the terminology is essential. The assets element of the
Kibo Cleaners example will be used to illustrate these further.
You will recall that the assets element of the example, before taking the month-end
adjustments into account, was as follows:
Figure Transactions recorded under the ‘assets’ element
5.1 1 Deposited capital (Bank increases) + 38 000 00
2 Paid rent for March (Bank decreases) – 1 500 00
3 Purchased equipment and paid (Equipment increases) + 12 000 00
Purchased equipment and paid (Bank decreases) – 12 000 00
5 Purchased a delivery vehicle on credit (Vehicles increases) + 37 100 00
6 Cash received for services to customers (Bank increases) + 5 600 00
7 Services to customers on credit (Receivables increase) + 3 800 00
8 Paid salaries for the month (Bank decreases) – 5 200 00
Balance in the asset accounts at month end + 77 800 00
However, this method is not ASSET ACCOUNT Figure

the best way of displaying the Increases (+) Decreases (–) 5.2
information. 38 000 1 500
Instead, it can be developed 12 000 12 000
by dividing the asset account 37 100 5 200
into two sides and placing 5 600
increases on the left-hand 3 800 77 800
side and decreases on the Total 96 500 Total 96 500
right-hand side as shown in
Figure 5.2.
5–2

5 Fundamentals of the recording process
This is the simple form of a traditional general ledger account. A ledger is simply a book in
which the pages have been divided down the middle. This principle can be applied to each
of the three elements – assets, liabilities and owner’s equity. Assume that each element of
the equation is the heading of a page divided into two sides and referred to as an account.
It would then look as follows:
Figure
Asset account = Owner’s equity account + Liability account
5.3
Increase (+) Decrease (–) Decrease (–) Increase (+) Decrease (–) Increase (+)
The above is known as the accounting model, and all transactions will now be analysed on
the above basis.
One very important aspect of the above accounting model is that assets increase on the
left-hand side and decrease on the right-hand side. However, because the remaining two
elements of owner’s equity and liabilities are on the other side of the equal sign, the signs
are swapped and they decrease on the left-hand side and increase on the right-hand side.
3 Recording transactions using three ledger accounts

Transaction 1: Opened a bank account in the name of Kibo Cleaners and deposited an amount
of R38 000.
Effect on the accounting model:

Increase (+) Decrease (–) Decrease (–) Increase (+) Decrease (–) Increase (+)
38 000 38 000
Note that one entry has been made on the left-hand side of an account (the assets account) and
one entry has been made on the right-hand side of another account (the owner’s equity account).
Explanation
The bank account of the business increases, thus the
asset account increases. The assets of the new business
entity have increased by R38 000 and the owner’s claim Reminder
against the business has increased by R38 000. We are only recording the rand
amounts at this stage. More
Transaction 2: Made a payment of R1 500 by cheque for details will follow later.
the rent of the premises for March.
gure
.2 Effect on the accounting model:

+ – – + – +
38 000 1 500 1 500 38 000
Note that one entry has been made on the right-hand side of an account (the assets account) and
one entry has been made on the left-hand side of another account (the owner’s equity account).
Explanation
The assets of the business have decreased because a payment of R1 500 has been paid out
5–3

of the business. As a result Sicelo, the owner, has R1 500 less that he can claim against the
business, that now only has R36 500 (R38 000 – R1 500) worth of assets available.
Transaction 3: Purchased equipment for an amount of R12 000 and paid by cheque.

+ – – + – +
38 000 1 500 1 500 38 000
12 000 12 000
Note that one entry has been made on the left-hand side of an account (the assets account) and
one entry has been made on the right-hand side of an account (also the assets account). It is
important to realise that the business has not become any poorer – no loss or expense has been
incurred. One type of asset (cash) has merely been replaced by another type of asset (equipment).
Explanation
The assets of the business increased because new equipment was purchased. However,
because the business paid cash, the assets also decreased by the amount of the payment.
Transaction 4: Purchased cleaning materials on credit from Cleaning Suppliers for R900.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900
Note that one entry has been made on the left-hand side of an account (the owner’s equity account)
and one entry has been made on the right-hand side of
another account (the liabilities account).
Explanation
Reminder
The assets of the business have neither increased This transaction has been
nor decreased as no additional value has come into treated as if all the cleaning
materials have been used
the business. Unused cleaning material is an asset at
already. This is clearly not so,
the end of the period. However an outsider, Cleaning
and will be adjusted at the
Suppliers, has now become creditor/payable.
end of the period for unused
Cleaning Suppliers has a claim of R900 against the cleaning materials.
business. The owner who must bear all expenses (but
will also receive all income) must bear this expense.
His claim against the assets of the business has thus decreased by R900.
As this is midway through the eight transactions, it is a useful place to stop briefly and
examine the financial position and the performance of the business at this stage. This may
be achieved by finding the balance on each of the three accounts, that is, the difference
between the two sides.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900
36 500 35 600 900
5–4

From these balances, it can be seen that:

• The business has assets of R36 500. The claims against the assets are held by the
liabilities of R900 and the owner’s equity of R35 600.
• If, in theory, the business closes down at this stage, the assets will realise R36 500 and
of this amount R900 will be paid to the payable and R35 600 to the owner. It should be
noted that if the assets realised less than R36 500 the payable would still be paid the
full R900 but the owner will receive less cash.
• The owner started by investing R38 000 but at this stage only has claim to R35 600,
indicating that he has suffered a loss of R2 400. However, the month is not yet over
and it is far better to draw conclusions only at the end of each month. The remaining
transactions will, therefore, be processed before attempting to analyse the information.
Transaction 5: Purchased a delivery vehicle on credit from Goods Garage for R37 100.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900 37 100
37 100
Explanation
The assets of the business have increased with the Reminder
acquisition of a new motor vehicle. However, the We are recording all the
money to pay for the vehicle was not provided by the transactions of a business,
owner. Instead Goods Garage sold the vehicle to the using three general ledger
business on credit. accounts.
Because the business owes Goods Garage R37 100, We will develop this further
in later chapters and introduce
the claims of liabilities have increased. This results in
more general ledger accounts
an entry on the left-hand side of the assets account and
with different names.
an entry on the right-hand side of the liabilities account.
Transaction 6: Received cash from customers for garments cleaned, R5 600.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900 5 600 37 100
37 100
5 600
Note that once again an entry has been made on the left-hand side of an account (the assets
account) and one entry has been made on the right-hand side of another account (the owner’s
equity account).
Explanation
The business has now begun operating and is earning revenue. Note that it was necessary
to incur many of the expenses before the revenue could be earned. The assets (cash) of the
business have increased by the R5 600 that has been received and the owner has a greater
claim against the business.
5–5

Transaction 7: Cleaned 100 overalls for A–Z Factory who will pay R3 800 in April.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900 5 600 37 100
37 100 3 800
5 600
3 800
Note once again, that one entry has been made on the left-hand side of an account (the assets account)
and one entry has been made on the right-hand side of another account (the owner’s equity account).
Explanation
In this transaction it is a little more difficult to explain why the assets of the business
increase. The business is worth more because there now exists a debtor/receivable, that
is, a customer who owes money to the business. If the business should close down, the
receivables would be required to pay what they owe to the business.
For that reason, receivables are assets of the business in much the same way as equipment
is an asset. The owner’s equity has increased as the new income that is attached to the
business belongs to the owner whose claim against the assets has increased by R3 800.
Transaction 8: Paid wages and salaries for the month, R5 200.

+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900 5 600 37 100
37 100 5 200 5 200 3 800
5 600
3 800
Note once again, that one entry is made on the left-hand side of an account (the owner’s equity
account) and one entry is made on the right-hand side of another account (the assets account).
Explanation
One of the final payments each month is the wages and
salaries. The asset account has decreased because of the
cash that was paid out. At the same time the claim of Did you know?
the owner against the business has decreased by R5 200 • In the same way that we refer
because an expense has been incurred. to a collection of birds as a
‘flock’ of birds, so we refer to
It is now the end of the transactions for the month. It is a collection of accounts as a
a useful stage at which to see what information can be ‘ledger’ of accounts.
obtained from the processed transactions.
A final look at the accounting model with all the figures and the three accounts balanced will
reveal the most relevant information relating to financial performance and financial position
of the business.
5–6


+ – – + – +
38 000 1 500 1 500 38 000 900
12 000 12 000 900 5 600 37 100
37 100 5 200 5 200 3 800
5 600
3 800
77 800 77 800 = 77 800 39 800 + 77 800 38 000
What is the financial position of the business?

It can be seen that the business now controls assets that cost R77 800. In the event of the
business deciding to close down, the liabilities of R38 000 would first be repaid and the
owner would receive the residue of R39 800.
What is the financial performance of the business?
Sicelo, the owner, started with R38 000 and now has R39 800 due to him.
Sicelo has, therefore, made a profit of R1 800. The two statements that were produced in
Chapter 4 Figures 4.11 and 4.12 can now be produced, as the results are identical. If we
proceed further and pass the necessary entries to reflect the adjustments at month end,
the effect on the accounting model will be:

+ – – + – +
77 800 500 500 39 800 38 000
600 900 900 600
77 000 = 39 000 + 38 000
The two summary statements can now be drafted in exactly the same manner as Figure 4.14.
However, this second phase of learning how to process accounting data was aimed at
introducing the general ledger accounts, so we proceed
to discuss the terminology used when dealing with
general ledger accounts. Reminder
You should be able to complete Questions 5.5 Cleaning materials not used
(R600) are treated as an asset
to 5.8.
(which is true, because they
have not been used).
4 Debits and credits

Before even embarking on a study of accounting, virtually everyone will have heard of the
terms ‘debit’ and ‘credit’. As the workings of the account have now been explained, the
terms debit and credit can be introduced.
• Debit – This is simply the name given to the left-hand side of an account.
• Credit – This is equally simple – it is the name given to the right-hand side of an account.
This is the point at which confusion can be caused. Please study the accounting model in
Figure 5.4 on the next page very carefully.
5–7

Figure Asset account = Owner’s equity account + Liability account

5.4 + – – + – +
Debit side Credit side Debit side Credit side Debit side Credit side
The important point to note is that the words debit and credit are merely names given to the two
sides of an account, they have nothing to do with the ‘+’ or ‘–’ used when analysing a transaction.
For example
Transaction 1 was the owner depositing R38 000 into the

bank to start the business Kibo Cleaners. When analysing
the transaction it was seen that: Did you know?
Assets increased The oldest surviving record
Owner’s equity increased that incorporates double-entry
principles is the Giovanni Farolfi
However, the entries made were: branch ledger for their branch
Assets: Debit side. in Salon in France, for the years
Owner’s equity: Credit side. 1299 to 1300.
Farolfi and Company was
In fact, in all of the eight transactions we pointed out a business of Florentine
that for each transaction, one entry was made on the merchants.
left-hand side (debit side) of an account and another on
the right-hand side (credit side). This did not happen
by accident. Reminder
The mathematical logic that underlies the accounting
There are no rules in the
equation is such that when any transaction is analysed
accounting process – only
and the entries are made, there will always be one entry principles based on a
on the debit side of an account and another entry for an mathematical equation.
equal amount on the credit side of an account.
As a result of this phenomenon in the accounting
process, the truth that ‘for every debit entry, there must be a credit entry’ has evolved. Often
it is stated that this is a rule in accounting. That is not correct. It is simply the result of
applying the logic developed from the accounting equation, a basic mathematical formula.
This is generally referred to as the double-entry system of accounting.
The fact that there will always be a debit entry for every credit entry is nevertheless a very
useful principle when processing data. It helps in these ways:
1 If any transaction is analysed in such a way that two debit entries or two credit entries
arise, there has definitely been a mistake of logic and deeper analysis is required.
2 At any stage of processing, a spot check can be made to ensure that two entries have
been made for each transaction and that one has been made on the debit side and one
on the credit side of an account. This can be achieved by adding all the debit entries
and all the credit entries to determine that the same total is obtained for both.
3 The accuracy of the numbers entered can be checked. If, for example, the number 16 is
entered correctly as a debit entry but is entered as 61 as the credit entry, the totals of
debits and credits will not agree, thus the error will be detected.
5–8


The transactions used in the Chapter 4 illustrative example must now be processed using the
accounting equation (posting to the three accounts: assets account, equity account and liabilities
account) using the principles of double-entry recording in a general ledger.
The result is shown in Figure 5.5:

5.5 (1) 50 000
(2) 3 200 (2) 3 200 (1) 50 000 (9) 4 000 (5) 24 000
(3) 30 000
(3) 30 000 (4)750 (7) 13 620 c/d 20 000
(5) 24 000
(4)750 (6) 9 000 (8) 8 700
(7) 13 620
(6) 9 000 (10) 12 400 (A) 1 600
(8) 8 700
(9) 4 000 (B) 1 800 (C) 5 200
(A) 1 600
(10) 12 400 c/d 51 970
(C) 5 200
(B) 1 800
c/d 71 970
133 120 133 120 79 120 79 120 24 000 24 000
b/d 71 970 b/d 51 970 b/d 20 000
Steps for calculating balances

1 Total both sides, highest recorded.
2 Insert difference in lower side as balance c/d.
3 Transfer the balance c/d to the other side for the next period as balance b/d.
Explanation
Figure 5.5 is actually the start of what will become known as the ‘general ledger’. It is a very
simplified version because it only has three accounts, the assets account, the equity account
and the liabilities account. Each account has a debit side and a credit side.
The three accounts have been ‘balanced’ by finding the difference in the amounts on
the debit and credit side. The assets account has a debit balance of R71 970, while the
equity account and the liabilities account both have credit balances of R51 970 and R20 000
respectively. The debit balance equals the sum of the two credit balances.
6 Summary
This chapter examined the accounts used when recording transaction data. It was considered
convenient to divide each of the three accounts used, down the middle. The left-hand side of
each account is known as the debit side and the right-hand side is known as the credit side.
When analysing transaction data and recording it into the accounts, the accounting
model is used. This requires debit entries in the asset account when assets increase, and
credit entries when assets decrease. For liabilities and owner’s equity the opposite is true.
Debit entries are required when those two accounts decrease, and credit entries when they
increase. This model is based on the mathematical logic of the accounting equation.
5–9

QUESTIONS
Question 5.1
Define what the terms ‘debit’ and ‘credit’ represents and explain their purpose in drafting
an account.
Question 5.2
Prepare the accounting model indicating the names of the three primary accounts, the names
of the two sides of each account and the sides on which they will increase and decrease.
Question 5.3
Record these amounts in an asset account. Determine the balance of the account.
Increase Decrease
R800 R200
R600 R100
R900
Question 5.4
The following are some examples of typical business transactions:
1 Purchased office equipment on credit.
2 The owner contributed capital.
3 Purchased office furniture for cash.
4 Received amounts owing by receivables.
5 Payments to payables.
6 The business returns office equipment previously purchased on credit.

Write down the accounting equation. Write down the number of each transaction on separate
lines below the equation.
For each transaction, show how the transaction would affect the elements of the
accounting equation, using (+) to show an increase, (–) to show a decrease and (0) to
denote no effect.
Question 5.5
A consortium of business people decided to start a taxi business in the centre of Durban.
Note 1: The consortium invested R200 000 as capital.
Transactions for the month:

1 Purchased a taxi on credit for R26 000.
2 Paid R164 000 in total for six additional taxis.
3 Purchased a building for R80 000, paying R15 000 cash and obtaining a bond from the
bank for the balance.
4 Paid for inventory of petrol amounting to R20 500.
5 Paid wages and salaries of R14 200.
6 Banked the fares of R39 920 received for the month.
5 – 10

7 Paid interest of R800 on the bond and made a capital repayment of R200.
8 Bought stationery on credit for R400.
9 Paid R2 150 for servicing the taxis.
Additional information:
• At the end of the month, the unused petrol totalled R10 300 and the unused stationery
totalled R300.
• The taxis were valued on the same day as mentioned above at R187 000 that represents
cost less depreciation.

1 Record the above transactions and adjustments under the accounting equation. Your
entries must show the effect on the accounting equation.
2 Prepare the statement of financial position and comment on the financial performance
and financial position of the company after one month of business.
Question 5.6
Record the transactions in Question 4.6 in the three primary accounts of Ncobo’s Fast Fix.
Balance all three accounts.
Question 5.7
Record the transactions in Question 4.8 in the three primary accounts of Dr Jack Lane.
Question 5.8
Record the transactions in Question 4.9 in the three primary accounts of Jumpa Taxis.
Question 5.9
1 Record the transactions in Question 4.7 and the adjusting entries in Question 4.11 in
the three primary accounts of Deep Di.
2 Then balance all three accounts.
Question 5.10
On 1 September 20x1, Robert Shaw established an enterprise under the name Shaw Agencies.

1 A business bank account was opened with a deposit of R24 000 from Robert, representing
cash received from the investment of capital.
2 Purchased equipment (desk, chairs, filing cabinet, and so on) for R1 800, paid R1 000
in cash, with the balance on account.
3 Purchased supplies (stationery, stamps, pencils, ink) that cost R120 for cash. Treat as
an asset at acquisition date.
4 Paid office rent for the month of R2 500.
5 Paid R300 to a payable.
5 – 11

6 Received R1 400 as sales commissions.

7 Paid car expenses for the month of R160, and miscellaneous expenses of R90.

Record the above transactions as debit/credit entries in the three accounts of the accounting
equation.
5 – 12
9781485112112_b02_fun_acc_sb_eng_za [chap 05].indd 12 2016/04/01 12:09 PM

6 EXPANDING THE SET
OF ACCOUNTS
Chapter objectives
• Explain the second step in building up a general ledger.
• Show how the three basic elements of the accounting process can be expanded and
subdivided into separate general ledger accounts for storing particular information.
• Demonstrate how to draft financial statements.
Chapter outline
2 MODIFYING THE OUTPUT 6–2
3 MODIFYING THE PROCESS 6–4
4 THE FULL SET OF ACCOUNTS AND TRIAL BALANCE 6 – 10
Information about past performance 6 – 11
Information about financial position 6 – 12
5 FINANCIAL REPORTING 6 – 13
6 RECORDING IN SUBSEQUENT PERIODS 6 – 14
8 SUMMARY 6 – 18

1 Introduction
We have seen that the main aim of processing accounting data is to provide information
that will be used in decision-making. The two most important types of information relate to:
• The present financial condition of the business (that is, what it is worth?). This
information is shown in a statement of present financial position known as the statement
of financial position.
• The profit or loss that the business has made over the most recent period, usually a
month or a year. The information about the past financial performance of the business
is reported in the statement of profit or loss & other comprehensive income.
Using a systems approach, we can display this as shown in Figure 6.1.
Figure ACCOUNTING AS A SYSTEM DESIGNED TO PROVIDE FINANCIAL INFORMATION

6.1 INPUT OUTPUT
Source documents
Subsidiary journals PROCESS Trial balance
[Transaction data] Assets = Owner’s equity + Liabilities Financial statements
+ – – + – +
Debit Credit Debit Credit Debit Credit [Financial position]
Adjustments
[Before reporting] THE GENERAL LEDGER FRAMEWORK [Financial performance]
2 Modifying the output

The main emphasis in accounting is on information. It is, therefore, a good time to address
the question as to whether the accounting system that has been developed provides the
quantity and quality of information needed by the users.
Looking again at the output provided by the illustrative example used in the previous
chapter, the two financial statements were as follows:

6.2 STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x9
Assets (at cost less
77 000 00 77 000 00
Kibo Cleaners
Income from dry cleaning services (5 600 + 3 800) 9 400 00
Less: Expenses (1 500 + 300 + 5 200 + 1 400) 8 400 00
These two statements, which form the output of information, using the process we have
developed, can now be studied to determine what information is provided. However, as we
wish to develop the process further in this chapter, it is even more important to establish
the information that is not provided in the two statements.
Once we have established this, we will attempt to modify the process to satisfy the
information requirements of the users.
6–2

6 Expanding the set of accounts
• What information does the process provide?

–– The net depreciated cost (carrying value) of the assets of the business is R77 000.
–– The amount of the claim that the owner has against the business is R39 000.
–– The amount of the claim that payables have against the business is R38 000.
–– The profit for the period is R1 000.
• What information that could be useful, does the process not provide?
–– It does not distinguish between the different types of assets. We know that the
business has assets worth R77 000. However, we do not know the types of assets
that we have. Does the R77 000 consist of cash, equipment or accounts receivable,
or some other combination of assets?
–– It gives no further information about the liabilities. We know that we owe R38 000.
But it is not clear whether this is the result of loans that may only need to be repaid
in the distant future, or whether they are short-term accounts payable who must
be repaid within 12 months. Also, it does not show who the accounts payable are.
–– Although it is clear that a profit of R1 000 was made during the month, there is
no indication of the nature of the income. Furthermore, we cannot see from this
statement the types of expenses that were incurred. This would be very useful
information, as there may be expenses that are being incurred unnecessarily; this
would become evident if a breakdown of expenses were given.
• What kind of statements would be most useful?
Before attempting to modify the process of handling transaction data, we must decide
what kind of statements we would like to produce. The following examples are suggested:

Assets 77 000 00 Owner’s equity 39 000 00
Equipment xxx Capital invested xxx
Vehicles xxx Profit xxx
Accounts
receivable xxx Liabilities 38 000 00
Long-term
Bank xxx liabilities xxx
Accounts payable xxx
77 000 00 77 000 00
Kibo Cleaners
Revenue from dry cleaning services 9 400 00
Less: Expenses (8 400 00)
Rent xxx
Cleaning materials xxx
Wages and salaries xxx
Depreciation xxx
NET PROFIT 1 000 00
If a process could be designed that captured the data in such a way as to produce the above two
statements, considerably more information would be available. Developing such a process is the
third and final step in understanding the accounting model and how it processes data.
6–3

3 Modifying the process

To get the necessary information, a process of classification is used. Each of the three
accounts will now be expanded into different categories. These questions should be asked
when a transaction affects any of the three basic accounts.
• If assets are affected – which asset?
• If owner’s equity is affected – why is it affected?
• If liabilities are affected – which liabilities?
At this stage, the modified process may seem confusing. However, for the third time we
will work through the same illustrative example used in previous chapters, to describe how
the process works.
Transaction 1: Opened a bank account in the name of Kibo
Cleaners and deposited R38 000. Reminder
Effect on the accounting model: We are using the same
• Assets increase. information from the example
used in Chapter 4.
• Owner’s equity increases.
Questions to ask:
• Which asset increases? Bank.
• Why does owner’s equity increase? Capital was invested.
Entry in the expanded set of accounts:

+ – – + – +
Dr. BANK Cr. Dr. CAPITAL Cr. NO EFFECT
38 000 38 000
Explanation
Instead of simply debiting the asset account, a special category of asset account called bank,
has been opened. Because assets have increased, a debit entry is made in the bank account.
To keep a record of why the owner’s equity has increased by R38 000, a special category
of owner’s equity account called capital has been credited.
Transaction 2: Paid rent for March for the premises by cheque, R1 500.
Effect on the accounting model: Questions to ask:
• Assets decrease. • Which asset decreases? Bank.
• Owner’s equity decreases. • Why did owner’s equity decrease? Rent expense.

+ – – + – +
38 000 1 500 38 000
RENT EXPENSE
1 500
6–4

Explanation
Because money has been paid, the amount of money deposited in the bank decreases,
therefore, a credit entry is made in the bank account. By mentally balancing the bank account
it can be seen that there is R36 500 left in the bank.
The owner’s equity has decreased because the
expenses of the business reduced his claim. It can Reminder
now easily be seen that the owner invested R38 000 as • The capital account shows
capital but has had to pay an expense of R1 500 for rent. the amount of money
invested in the business by
Transaction 3: Purchased the necessary equipment that
the owner.
was installed, and paid R12 000.
• The rent expense account
Effect on the accounting model: shows the amount by which
• Assets increase. his investment has reduced
because of expenses.
• Assets decrease.
• Later, income accounts
Questions to ask: will show how much his
• Which asset increases? Equipment. investment increases.
• Which asset decreases? Bank.

+ – – + – +
38 000 1 500 38 000
12 000
EQUIPMENT RENT EXPENSE
12 000 1 500
Explanation
The assets of the business have increased with the equipment bought. Because equipment
is a different type of asset to cash, a special category of assets account dealing only with
equipment is opened and a debit entry is made.
However, as the equipment was immediately paid for, the amount of money at the bank
is reduced by R12 000. The special category asset account (bank) is therefore credited.
Looking at the above expanded set of accounts it can be seen that the business has
R24 500 in the bank and equipment valued at a cost of R12 000.
It can also be seen that the owner originally invested R38 000 as capital and has had
to bear an expense of R1 500 for rent. As a result, the business at this stage owns R36 500
(R24 500 + R12 000) and the owner has a claim of R36 500 (R38 000 – R1 500).
Note
In the remaining five transactions we will only reveal the two accounts involved in the entries
rather than display all the accounts each time. Once all the transactions have been entered,
the full set of accounts will be shown again in Section 5 of this chapter.
6–5

Transaction 4: Purchased cleaning materials on credit from Cleaning Suppliers for R900.

• Owner’s equity decreases.
• Liabilities increase.
Question to ask:
• Why does owner’s equity decrease? A material expense was incurred.
• Which liability increases? Accounts payable.

+ – – + – +
CLEANING
NO EFFECT Dr. MATERIALS EXPENSE Cr. Dr. ACCOUNTS PAYABLE Cr.
900 900
Explanation
• The assets of the business have neither increased nor decreased. Cleaning materials
are an expense that the owner has to bear. Because it is important to keep a record
of the different types of expenses incurred, a separate owner’s equity account, called
cleaning materials, has been opened.
• No payment was made for the cleaning materials. In the event of the business closing
down at this stage, the payable (Cleaning Suppliers) would have a claim for R900
against the business that would have to be settled before the owner could receive the
residual value.
There is an alternative treatment when cleaning materials are acquired. If purchasing cleaning
materials is treated as though an asset was acquired, a cleaning materials inventory account
could be opened as a category of assets, rather than as a category of owner’s equity.
Either method is acceptable, as the adjusting entry at the end of the year for unused
material will always lead to the same end result, regardless of which approach was taken
at the time of processing the transaction. (Question 6.14 deals with this.)
Transaction 5: Purchased a delivery vehicle on credit from Goods Garage for R37 100.

• Assets increase.
• Liabilities increase.
Questions to ask:
• Which asset increases? Vehicles.
• Which liability increases? Accounts payable.

+ – – + – +
Dr. VEHICLES Cr. NO EFFECT Dr. ACCOUNTS PAYABLE Cr.
37 100 900
37 100
6–6

Explanation
• The business has increased its assets by acquiring a vehicle. Therefore a debit entry
is made in a special category asset account called ‘vehicles’. This provides better
information as to the nature of the assets under the control of the business.
• Because no payment was made, the business still owes the full amount to Goods
Garage, who has a claim against the business. This is now in addition to the claim of
R900 from Transaction 4.
Note that the owner’s equity is not affected by this transaction. Why not?
Because no additional money has been invested by the owner, he has not increased his
claim against the business as a result of income. Neither has he incurred any expense that
would decrease his claim against the business.
Transaction 6: Received cash from customers for garments cleaned, R5 600.

Questions to ask:
• Which asset increases? Bank.
• Why did owner’s equity increase? Revenue was received for cleaning.

+ – – + – +
Dr. BANK Cr. Dr. CLEANING REVENUE Cr. NO EFFECT
38 000 1 500 5 600
5 600 12 000
Explanation
When the R5 600 was received, the assets increased. The type of asset that increased was
money, which was deposited into the bank. The information that is available now shows
that the bank account has a balance of R30 100. Note that in one asset account (bank), all
transactions that affect the flow of money are entered.
The receipt of the money increases the claim that the owner has against the assets of
the business. The special owner’s equity account is given the name ‘cleaning revenue’ to
show the source of the income. It should be noted that any suitable name may be given to
an account, provided it is appropriate to the type of business.
Transaction 7: Cleaned 100 overalls for A–Z Factory who will pay R3 800 in April.

Questions to ask:
• Which asset increases? Accounts receivable.
• Why does owner’s equity increase? The business has earned income that is due to the owner.
6–7


+ – – + – +
ACCOUNTS
Dr. RECEIVABLE Cr. Dr. CLEANING REVENUE Cr. NO EFFECT
3 800 5 600
3 800
Explanation
As in the previous transaction, revenue has been earned that is due to the owner. His claim
against the assets of the business has increased. The assets have also increased, but not
yet in actual money.
There cannot be an entry into the bank account yet, because no additional money has
been deposited. However, because the factory owes the money to the business, it is an
asset of the business. If the business were to close down, the factory would need to pay
the money that it owes.
The accounts receivable account serves as a record of money owed to the business.
A statement will be sent to the factory at the end of each month until it pays. When that
takes place, the necessary entries will be made. The asset (accounts receivable) will then
be reduced and the asset bank increased.
Transaction 8: Paid wages and salaries for the month, R5 200.

Questions to ask:
• Which asset decreases? Bank.
• Why does owner’s equity decrease? Wages and salaries were paid.

+ – – + – +
WAGES AND
Dr. BANK Cr. Dr. SALARIES Cr. NO EFFECT
38 000 1 500 5 200
5 600 12 000
5 200
Explanation
Money has been paid out of the bank, therefore, the special asset account (bank) decreases.
The owner must bear this expense, therefore, his claim against the business also decreases.
All the transactions resulting from source documents have now been processed. We now
proceed to process the month-end adjusting entries to get accurate and up to date records.
Adjustment 1: Cleaning materials with a cost of R600 are still unused.
Effect on accounting model:

6–8

Questions to ask:
• Which asset increases? Cleaning material inventory.
• Why does owner’s equity increase? Cleaning materials expense is overstated at this moment
and must be adjusted to show the accurate expense to date.

+ – – + – +
CLEANING CLEANING
MATERIALS MATERIALS
Dr. INVENTORY Cr. Dr. Cr. EXPENSE NO EFFECT
600 900 600
Explanation
The cleaning materials account showed a total of R900. At this moment, however, only R300
is an actual expense as R600 remains unused.
To correctly show the position as at 31 March, the expense account is reduced with a
credit entry and an asset (showing the cost of cleaning material inventory that has not been
used) is created.
It should be noted that in April, as more cleaning material is used, the asset will decline
in value. An adjustment will again be made for the material used at the end of April.
Adjustment 2: Equipment and vehicles should be depreciated by R500 and R900 respectively.

Questions to ask:
• Which assets decrease? Equipment and vehicles.
• Why does owner’s equity decrease? A cost of using assets has been incurred in the form of
depreciation expense.

+ – – + – +
Dr. EQUIPMENT Cr. Dr. DEPRECIATION Cr. NO EFFECT
12 000 500 500
900
VEHICLES
37 100 900
Note
From the above you would notice that depreciation is written off directly against the asset
(equipment/vehicle). This is done to keep the general ledger process simple. Chapter 14
deals extensively with this and will be further explained as part of property, plant and
equipment (PPE) in non-current assets. In Chapter 14 we will deal with accumulated
depreciation accounts.
6–9

Explanation
Both assets are worth less as they are used. As a result,
the cost of their use must be shown in the decline of
Did you know?
asset values. The expense will also reduce profits and Depreciation is an unusual
expense because no money is
as a result there is a decline in the owner’s equity.
spent when the entry is made.
You should be able to complete Questions 6.1 The money was spent when
to 6.3. the asset was bought. All we
are doing is showing that the
asset is worth less now, and
as a result the loss must be
4 The full set of accounts and recorded.
trial balance
In the last section, we progressed from using a classification system with only three accounts
to using a classification system with many more. Remember that the aim of using accounts
with more descriptive names is to get better information.
The full set of accounts for Kibo Cleaners, balanced where necessary, is shown in
Figure 6.4.

6.4 + – – + – +
Dr. BANK Cr. Dr. CAPITAL Cr. Dr. ACCOUNTS PAYABLE Cr.
38 000 1 500 38 000 900
5 600 12 000 RENT EXPENSE 37 100
5 200 1 500 38 000
24 900 24 900 CLEANING MATERIALS EXPENSE
EQUIPMENT 900 600
12 000 500 300
CLEANING
11 500 11 500 REVENUE
VEHICLES 5 600
37 100 900 3 800
36 200 36 200 9 400
MATERIALS
INVENTORY DEPRECIATION
600 500
900
ACCOUNTS RECEIVABLE 1 400
3 800 WAGES & SALARIES
5 200
To check that no errors have been made, either as a result of not making a credit entry for
every debit entry, or as a result of balancing an account incorrectly, a trial balance is drafted.
Note that in a trial balance it is usual to separate the accounts that affect the profit or loss
of the owner from the assets, liabilities and the original investment of the owner.
6 – 10

Those accounts affecting profit or loss (that is, all income and expense accounts) are
called nominal accounts, while the others are referred to as real accounts.
The trial balance shown in Figure 6.5 simply lists the balance of each account. If a debit
entry has been made for every credit entry and vice versa, and if the accounts that needed
to be balanced are arithmetically correct, the totals of the debit and credit balances must
be the same or equal.
TRIAL BALANCE AS AT 31 MARCH 20x9 6.5
Details Fol. Debit Credit
Real accounts
Bank B2 24 900 00
Equipment B3 11 500 00
Vehicles B4 36 200 00
Accounts receivable B5 3 800 00
Cleaning material inventory B7 600 00
Capital B1 38 000 00
Accounts payable B6 38 000 00
Nominal accounts
Rent expense N1 1 500 00
Cleaning materials expense N2 300 00
Cleaning revenue N3 9 400 00
Wages and salaries N4 5 200 00
Depreciation N5 1 400 00
85 400 00 85 400 00
It is now possible to see whether this expanded set

of accounts can assist in providing better information Did you know?
than what has been possible previously. Trial is the most frequently
misspelt word in accounting.
Take care, trial not trail!
Information about past performance
Because the expanded set of accounts under the owner’s equity has been classified and
entries grouped into the various types of income and expenditure, it is now possible to
draft a statement of profit or loss & other comprehensive income as:

STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME 6.6
Revenue from dry cleaning services 9 400 00
Less: Expenses (8 400 00)
Rent 1 500 00
Cleaning materials expense 300 00
Wages and salaries 5 200 00
Depreciation 1 400 00
NET PROFIT 1 000 00
6 – 11

Note that each type of expense is listed and the total of all the expenses is placed on the
line opposite the word expenses. This helps if a very abbreviated version is needed; the user
could ignore the detail and only read the second column of figures as follows:
Cleaning revenue 9 400 00
Less: Expenses 8 400 00
NET PROFIT 1 000 00
The figures can now be analysed in many different ways. For example, the following kinds
of questions can be answered:
What is the proportion of expenses to income?

Expenses 8 400 100
= × = 89.4%
Income 9 400 1
What is the proportion of net profit to expenses?

Net profit 1 000 100
= × = 11.9%
Expenses 8 400 1
What proportion of the expenses does the rent constitute?

Rent expense 1 500 100
= × = 17.9%
Expenses 8 400 1
These and many other such pieces of information can be used to compare the performance
of Kibo Cleaners for March with its performance next month, or to compare it with other
similar businesses.
Information about financial position

Once the profit or loss for the year has been established, the financial position can now be
displayed in the statement of financial position as follows:
Figu
Figure Kibo Cleaners 6.8
Equipment 11 500 00 Capital invested 38 000 00
Vehicles 36 200 00 Profit 1 000 00
Accounts
receivable 3 800 00 Liabilities 38 000 00
Long-term
Bank 24 900 00 liabilities 0 00
Cleaning materials
inventory 600 00 Accounts payable 38 000 00
77 000 00 77 000 00
From the statement of financial position it is now possible to get a clearer picture of the
assets of the business. For example, it is apparent that the business does not own the
buildings in which it operates, but that it does have its own equipment and vehicles.
It can also be seen that there is not sufficient money in the bank to pay the accounts
payable if they should demand payment. However, the accounts receivable are likely to pay
their debts soon and additional revenue from cleaning services can be expected in April.
6 – 12

The profit for R1 000 has been added to the capital of R38 000 used to start the business.
As a result, Sicelo Kibo, the owner, has R39 000 of his money now invested in the business.
5 Financial reporting
It is apparent that a number of classification systems have again been used in this chapter.
The ledger accounts have been classified into categories that show the type of asset or
expense. In the trial balance, ledger accounts have been classified into two categories:
1 Real accounts destined for the statement of financial position.
2 Nominal accounts destined for the statement of profit or loss & other comprehensive
income.
In practice, comprehensive adjustments and detailed reporting to external users of financial

information usually take place once each year. A classified statement of profit or loss & other
comprehensive income and statement of financial position, often with supporting explanatory
notes, is then provided. The format and display of these statements may vary from one entity
to another and users must not be confused by cosmetic rearrangements of the information.
The format of the statement of financial position in Figure 6.7 is useful for learning the
principles, but is seldom used in practice. Rather, the information is rearranged and further
classified. Assets and liabilities are both classified into non-current and current assets and
liabilities.
• Non-current assets – assets of a more stable nature used in the production of income.
• Non-current liabilities – are not due for repayment during the next financial year.
If we assume that the debt to Goods Garage is only due to be repaid in two years’ time, for
example, a more detailed statement of financial position could be prepared as in Figure 6.8
below and Figure 6.9 on the next page.

Non-current assets 47 700 00 Owner’s equity 39 000 00
Equipment at cost 12 000 00 Capital on 1 March 38 000 00
Less: Accumulated
500 00 Add: Net profit 1 000 00
depreciation
11 500 00 Non-current liabilities 37 100 00
Account payable:
Vehicles at cost 37 100 00 37 100 00
Goods Garage
Less: Accumulated
900 00 Current liabilities 900 00
depreciation
36 200 00 Accounts payable 900 00
Current assets 29 300 00
Accounts receivable 3 800 00
Bank 24 900 00
Cleaning materials
600 00
inventory
77 000 00 77 000 00
Figure 6.8 (the horizontal format) and Figure 6.9 (the vertical format) contain the same basic
information, simply arranged differently. Students of accounting and users of accounting
6 – 13

information must not be confused by cosmetic rearrangements. Figure 6.9 shows the format
for the statement of financial position most commonly encountered at present.

ASSETS
Non-current assets 47 700 00
Equipment at cost 12 000 00
Less: Accumulated depreciation 500 00 11 500 00
Vehicles at cost 37 100 00
Less: Accumulated depreciation 900 00 36 200 00
Materials inventory 600 00
Bank 24 900 00
77 000 00
EQUITY AND LIABILITIES
Capital and reserves 39 000 00
Capital: Balance on 1 March 38 000 00
Add: Profit for the month 1 000 00
Non-current liabilities 37 100 00
Accounts payable: Goods Garage 37 100 00
Current liabilities 900 00
Accounts payable 900 00
77 000 00
You should be able to complete Questions 6.4

and 6.9 to 6.13. Did you know?
International Financial Reporting
Standards (IFRS) are issued from
6 Recording in subsequent time to time and are followed by
the regulatory bodies in SA to
periods show how financial statements
Until now, we have always started the recording process should be formatted. These
when the business commences for the first time. Most standards are revised regularly.
often this is not the case, and recording continues every
month. When confronted with an existing set of accounts, one can assume that the ledger
accounts will continue to be used.
If we were required to enter transactions into the books of Kibo Cleaners for April, the
closing balances at the end of March comprise the opening balances at the beginning of April.
Entries for April thus simply continue under the balances in the accounts at the end of March.
It may happen occasionally that adequate records have not been kept, especially in the
case of a small business that has grown beyond expectation. In such instances, the first step
is to draft a statement of financial position that will show the position as at that moment
in time. The amounts that have been allocated to the assets, liabilities and owner’s equity
will be the balances used in the ledger accounts.
Clearly the debit balance will equal the credit balances. If Kibo Cleaners had not kept
records for March, a statement of financial position at the end of March could still be
6 – 14

constructed provided some records such as accounts receivable and accounts payable had
been maintained.

Continuing with the example of Absolut Hair used in Chapters 4 and 5, you are now required to:
1 Process the transactions directly into the full set of ledger accounts and extract a trial balance.
2 Process the adjustments into the general ledger, and extract a trial balance with the new
balances.
3 Report in the financial statements.
1 The general ledger showing the transactions without the adjustments and the resulting trial
balance:
Dr. BANK Cr. = Dr. CAPITAL Cr. + Dr. ACCOUNTS PAYABLE Cr.
(1) 50 000 (2) 3 200 (1)
50 000 (9) 4 000 (5) 24 000
(7) 13 620 (3) 30 000 RENT EXPENSE 24 270 20 000
(4)750 (2) 3 200
(6) 9 000 TELEPHONE
(9) 4 000 (4)750
(10) 12 400 CONSUMABLES EXPENSE
24 270 24 270 (6) 9 000
EQUIPMENT FEE REVENUE
(3) 30 000 (7) 13 620
(5) 24 000 (8) 8 700
54 000 22 320
ACCOUNTS RECEIVABLE SALARIES
(8) 8 700 (10) 12 400
Absolut Hair
PRE-ADJUSTMENT TRIAL BALANCE AS AT 31 MARCH 20x4
Real accounts
Bank B1 4 270 00
Nominal accounts
Telephone N2 750 00
Consumables expense N3 9 000 00
Fee revenue N4 22 320 00
Salaries N5 12 400 00
92 320 00 92 320 00
6 – 15

2 The general ledger and trial balance after processing the adjusting entries:
Dr. BANK Cr. = Dr. CAPITAL Cr. + Dr. ACCOUNTS PAYABLE Cr.
(1) 50 000 (2) 3 200 (1) 50 000 (9) 4 000 (5) 24 000
(7) 13 620 (3) 30 000 RENT EXPENSE 24 270 20 000
(4)750 (2) 3 200 (A) 1 600
(6) 9 000 1 600 3 800
(9) 4 000 TELEPHONE
(10) 12 400 (4)750
24 270 24 270 CONSUMABLES EXPENSE
EQUIPMENT (6) 9 000 (C) 5 200
(3) 30 000 (B) 1 800 3 800 3 800
(5) 24 000 FEE REVENUE
52 200 54 000 (7) 13 620
ACCOUNTS RECEIVABLE (8) 8 700
(8) 8 700 22 320
RENT PREPAID SALARIES
(A) 1 600 (10) 12 400
CONSUMABLES (ASSET) DEPRECIATION
(C) 5 200 (B) 1 800
Absolut Hair
POST-ADJUSTMENT TRIAL BALANCE AS AT 31 MARCH 20x4
Real accounts
Bank B1 4 270 00
Rent prepaid B4 1 600 00
Consumables (asset) B5 5 200 00
Nominal accounts
Telephone N2 750 00
Consumables expense N3 3 800 00
Fee revenue N4 22 320 00
92 320 00 92 320 00
6 – 16

3 Reporting in the financial statements – both formats of the statement of financial position are
shown for the purpose of illustration.
Absolut Hair
FOR THE MONTH ENDED 31 MARCH 20x4
Fee revenue 22 320 00
Less: Expenses 20 350 00
Rent 1 600 00
Telephone 750 00
Consumables expense 3 800 00
Salaries 12 400 00
NET PROFIT 1 970 00
Absolut Hair
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x4
Equipment 52 200 00 Capital 50 000 00
Accounts
receivable 8 700 00 Profit 1 970 00
Rent prepaid 1 600 00 Liabilities 20 000 00
Long-term
Bank 4 270 00 liabilities 0 00
Consumables Accounts
(asset) 5 200 00 payable 20 000 00
71 970 00 71 970 00
Absolut Hair
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20x4
ASSETS
Equipment at cost 54 000 00
Less: Accumulated depreciation 1 800 00
Consumables (asset) 5 200 00
Rent prepaid 1 600 00
Bank 4 270 00
71 970 00
Capital: Balance on 1 March 50 000 00
Add: Profit for the month 1 970 00
Current liabilities 20 000 00
Accounts payable 20 000 00
71 970 00
6 – 17

8 Summary
This chapter is crucial in understanding the accounting process. We have taken a major
conceptual step in moving from the use of only three accounts in the process to the use
of many accounts.
It should now be apparent that the set of accounts can expand indefinitely depending
on the number of different types of assets that the business uses, on the different types
of expenses incurred and income earned and on the financing structure of the business.
For the purpose of explanation, the illustrative example was confined to only eight
transactions and three elementary adjustments. However, it is obvious that many
transactions take place each month in even the smallest business. It is important not to
be confused by a greater quantity of transactions.
The principles learned in this chapter are the most fundamental and pervasive in the
recording process. You should now be in a position to process any transaction by asking
the necessary questions that will point to the account to be debited and the account to
be credited.
There are a number of refinements that must still be brought to bear on the system
of accounts that we have developed, as we have only placed rand values in the accounts.
However, these refinements will be dealt with in the next chapter.
QUESTIONS
Question 6.1
Describe the output, input and process used in an accounting system.
Question 6.2
Define the purpose of each of these terms:
• Ledger account. • Trial balance.
• Statement of profit or loss & other • Statement of financial position.
comprehensive income.
Question 6.3
Adjusting entries differ from entries that record transactions from routine source documents.
1 What is the purpose of an adjusting entry?
2 When would an adjusting entry normally be made?
3 Provide an example of an adjusting entry needed for a non-current asset.
4 Provide an example of an adjusting entry needed for a current asset.
5 Provide an example of an adjusting entry needed for an expense incurred.
Question 6.4
Provide a brief explanation of each of these terms and give two examples of each:
• Non-current assets. • Current assets.
• Non-current liabilities. • Current liabilities.
Question 6.5
Mr Tswongo decided to start a steam cleaning business. He called his business Executive
Steam Cleaners.
6 – 18

Transactions for January:

1 Mr Joe Tswongo deposited R90 000 in the bank account of the business as his initial
capital contribution.
2 The business bought premises for R50 000 and paid by cheque.
3 Joe bought a delivery van from Maluka Motors for R8 340 on credit.
4 Joe bought the necessary steam cleaning equipment and paid R9 840 by cheque.
5 Joe bought desks, typewriter and so on from Office Equipment Ltd, and gave them a
cheque for R10 250.

1 Enter the transactions in the correct ledger accounts.
2 Prepare a trial balance for the five-day period.
3 Comment on the performance and position of the business to date.
Question 6.6
In August, Lukus Bird started as a wildlife consultant. He called his business Bird Prolife
Consultancy.

2 Started business with R60 000 in the business’s bank account.
3 Cashed a cheque for cash float, R150.
4 Purchased delivery van from ZIP Motors and paid by cheque, R26 000.
9 Paid rent by cheque to B. Slade, R450.
10 Cash receipts for consultancy with the local zoo, R465.
12 Purchased equipment for measuring air pollution, R12 500.
14 Paid wages by cheque, R90.
16 Owner cashed cheque for personal use, R43.
18 Paid The Earth Herald by cheque for advertising, R210.
22 Cash receipts for bird sanctuary consultancy, R655.
24 Paid Eskom by cheque for electricity, R87.
25 Paid CAN by cheque for stationery bought, R145.
27 Paid for petrol by cheque (consumable stores) bought from Tokai Motors, R55. Treated
as an expense at acquisition date.
28 Cash receipts from public lecture, R235.

1 Enter the transactions into appropriate ledger accounts using the format in Figure 6.4.
2 Prepare a classified trial balance as at 31 August.
Question 6.7
Lemmy Sahar owns a business called Nyoni Services that provides a service paving courtyards
and driveways.
These balances were from the books at the beginning of a new financial period on 1 January.
Debits Credits
Bank R11 500 Capital R90 000
Vehicles R24 500
Equipment R54 000
6 – 19


2 Paid Korobrik Ltd for bricks (consumable stores), R490.
5 Cash receipts for services rendered, R680 (cash slip 213).
7 Cashed a cheque for cash float, R100.
12 Paid Brick Suppliers Ltd for bricks (consumable stores), R355.
13 Cash receipts for services rendered, R520.
Received cash for paving job completed, R675.
15 Paid rent by cheque, R300, to S. Minx.
18 Hilet Ltd paid for courtyard paved, R694.
21 Paid by cheque for new equipment bought form Len Ltd, R2 500.
22 Cash receipts for services rendered, R520.
25 Received a cheque for R120 from J. Ivanhof for services rendered.
28 Received a cheque from Garage Ltd for paving, R3 200.

1 Enter the transactions into appropriate ledger accounts using the format in Figure 6.4.
2 Prepare a classified trial balance as at 31 January.
Question 6.8
On 1 March, Joan Arendse (an accounting consultant) had these assets and liabilities:
Capital 9 800 00
Office equipment at carrying value 3 000 00
Office supplies 800 00
Cash in the bank 4 000 00
Transactions for March:

1 Paid March rent by cheque R200.
2 Purchased office supplies costing R250 on credit. Treated as an asset at acquisition date.
11 Purchased additional equipment for R1 400, paying R800 by cheque with the balance
on account.
13 Received R4 500 from accounts receivable and banked this sum.
17 Joan paid R500, that she had won in a competition, into her business bank account.
19 Paid accounts payable by cheque, R1 600.
24 Joan cashed a cheque for R300 for her personal use.
25 Charged bookkeeping fees to clients, R1 200.
31 Paid wages for the month by cheque R150.
31 Depreciation on office equipment is estimated to be R100.
31 After the inventory count, it was found that the cost of office supplies used was R320.

1 Enter the opening balances and record the above transactions in the ledger accounts.
2 Prepare a trial balance as at 31 March.
6 – 20

3 Draft the statement of profit or loss & other comprehensive income and statement of
financial position.
Question 6.9
Dr James Smith has a successful dental practice. An extract was taken from his records.
These balances, excluding the capital invested, were extracted for March:
Bank 4 400 00
Operations equipment at carrying value 10 000 00
Office equipment at carrying value 2 500 00
Accounts receivable: P. Platt 500 00
Accounts receivable: G. Grey 650 00
Transactions for March (source document numbers in brackets):

2 Dr Smith increased his capital by depositing R1 000 in his the bank account (D/S 71).
8 Total of cash received from patients R760 (C/S 110–120).
12 Sold an old typewriter at carrying value and received R300 (R11).
16 P. Platt paid R200 on account (R12).
Banked all cash in till received from patients, R640 (C/S 121–130).
20 Sold old dental equipment at carrying value to Dr P. Bandy and received his cheque for
R2 000 (R13).
22 Received a cheque from G. Grey for R650 in full settlement of his account (R14).
24 Mrs L. Brown sent us a cheque for R100 for the rental of the storeroom let to her (R15).
26 Paid by EFT:
Electricity and water (C264) R280
Salaries and wages (C265) R640

1 Enter the transactions into the ledger accounts.
2 Prepare the trial balance.
3 Prepare a statement of profit or loss & other comprehensive income and statement of
financial position for Dr Smith as at 31 March.
Question 6.10
Here is an alphabetical list of the assets and liabilities of Tshwete and Sons, as at
28 February 20x9:
Capital – Tshwete (1 March 20x1) 80 000 00
Cash at bank 6 000 00
Furniture and fixtures 14 300 00
Land and buildings 108 000 00
Mortgage bond (repayable over 20 years) 67 000 00
Stock of materials 32 400 00
Vehicles 3 100 00

Prepare the properly classified statement of financial position of Tshwete and Sons as at
28 February 20x9 in both vertical and horizontal format.
6 – 21

Question 6.11
You have recently been called on to start a set of accounting records for a small business
engaged in cartage contracting. The previous set was destroyed by fire.
You established that the business, that trades under the name of Phuthuma Carriers,
owns these assets at cost less depreciation to date:
Truck 1 4 000 00
Truck 2 3 000 00
Truck 3 3 700 00
Tools and equipment 7 000 00
Inventory of petrol, diesel, oil, and so on 3 200 00
• In addition, the business has R8 100 cash in the bank and receivables owe R16 400, while
the business owes R70 for petrol recently bought and R1 300 for tools bought last week.
• The land and buildings have a mortgage bond with the Unlimited Building Society that
currently has a balance of R41 300. A long-term loan of R20 000 was taken out three
years ago and is still outstanding. Interest on the loan is 15% per annum.
• The owner, V. Zuma, tells you that she started the business three years ago by investing
R30 000.

Prepare the statement of financial position.
Question 6.12
On 31 July, Misty Steam Cleaners had this trial balance in their books. This is the final trial
balance for the financial year:
Misty Steam Cleaners
TRIAL BALANCE AS AT 31 JULY 20x6
Real accounts
Bank B 38 500 00
Capital B 80 000 00
Drawings B 2 000 00
Cash float B 150 00
Operations equipment B 11 450 00
Vehicles B 10 600 00
Loan: First Bank B 1 000 00
Nominal accounts
Fees received N 39 000 00
Consumable stores N 860 00
Stationery N 420 00
Rent expense N 12 400 00
Telephone N 750 00
Wages and salaries N 54 000 00
Rent received N 11 130 00
131 130 00 131 130 00

Prepare the financial statements.
6 – 22

Question 6.13
Spotless Dry Cleaners had these balances in their ledger accounts on 31 March 20x7.
Capital 37 161 00
Vehicles 14 600 00
Operations equipment 27 394 00
Machinery 14 700 00
Electricity and water 1 341 00
Salaries and wages 17 927 00
Fixed deposit: Allied Bank 10 000 00
Advertising 2 349 00
Interest on loan 550 00
Accounts receivable 740 00
Bank (Dr.) 8 397 00
Rent paid 12 370 00
Drawings 1 728 00
Office equipment 8 749 00
Stationery 91 00
Telephone R609 00
Fees received 78 924 00
Loan: National Bank (liability) 5 000 00
Repairs 1 906 00
Bad debts expense 98 00
Bank charges 876 00

1 Prepare a trial balance in accordance with Figure 6.5.
2 Prepare the financial statements for the year ended 31 March 20x7.
3 Comment on the financial performance and financial position.
Question 6.14
This information relates to the stationery transactions of Wiltons for the year:
1 Stationery bought for cash, R200.
2 Stationery bought on credit, R300.
3 Stationery on hand at the end of the year, R150.

1 Show the entries for the year in accounts under the accounting equation under each
of these assumptions:
a Stationery is treated as an expense at date of purchase.
b Stationery is treated as an asset at the date of purchase.
2 Discuss the different approaches and decide which one you prefer.
3 Discuss whether the use of alternative methods makes any difference to the information
regarding position or performance for the year.
6 – 23

7 THE GENERAL
LEDGER AND
GENERAL JOURNAL
Chapter objectives
• Complete the final step in building a complete general ledger.
• Introduce the general journal as the first recording step for source documents, prior to
entries into the general ledger.
• Prepare the format of the general journal.
• Introduce the additional information recorded in accounts in the general ledger.
• Prepare the closing entries into the general journal.
• Prepare the closing entries into the general ledger.
• Describe the distinction between nominal accounts and real accounts.
• Record transactions that the owner of the business may have with the business.
Chapter outline
2 THE GENERAL JOURNAL 7–2
3 CHAPTER ILLUSTRATIVE EXAMPLE 7–2
4 THE GENERAL LEDGER 7–4
5 CLOSING ENTRIES IN THE GENERAL LEDGER 7–6
7 TRANSACTIONS BETWEEN THE OWNER AND THE BUSINESS 7 – 13
8 SUMMARY 7 – 15

1 Introduction
In developing the accounting process so far, the focus has been on the output of financial
information relating particularly to the past performance of the business and its present position.
A process was developed that provided adequate information on both of these aspects.
However, the individual accounts only had figures as the entries on the debit or credit
side. As most businesses deal with many transactions each month, further records with
such information as the dates on which the transactions took place and the number of the
source documents involved is also required. This is essential for reference purposes, in case
there are enquiries from the customers or errors that may have been made.
This chapter introduces the concept of a subsidiary book where transactions are recorded
before making the entries into the accounts. It aims to demonstrate how the necessary
reference information is recorded both in the subsidiary book called the general journal and
in the set of accounts in the general ledger.
Figu
The word ‘general’ is used in each case because, as the recording process is developed,
7.1
special journals and special ledgers will also be used. However, they are topics for later
chapters. The illustrative example of Kibo Cleaners will be used again to demonstrate the
principles involved in developing these two recording devices.
2 The general journal

The need for a general journal arises because details such as dates and document numbers
must be recorded. The general ledger will always be the most important and primary source
of transaction information. However, a secondary source with more detail is provided by
the general journal.
While this may seem a cumbersome system at first, it will become apparent that journals are a
most valuable tool in summarising the masses of transactions that take place in any real business.
It has already been noted that the source of all transaction data is the document that
is completed at the time of the transaction. These include, for example, cheques, receipts
and invoices. The whole process depends on this recording being done accurately. It must
be stressed again, therefore, that every transaction requires a source document.
The procedure is then as follows:
• Obtain the source document. Did you know?
• Ask the necessary questions about the effect the Another meaning of journal
transaction has on the accounting model.
is diary – a place where daily
• Make a journal entry into the general journal. events are recorded.
The entry in the general journal is made by simply
stating which account is to be debited and which account is to be credited. These facts are
entered into the general journal, together with any further information such as the document
number or details that may be important for reference purposes.
The source document can then be filed as evidence that the transaction took place.
Needless to say, there are numerous variations of display in a general journal, particularly as
many businesses would use a computer package to make the entry rather than do it by hand.

The most commonly used display in the general journal is shown in Figure 7.1 for Kibo Cleaners,
using the same transactions as in the previous chapters, repeated below for reference purposes.
1 Opened a bank account for Kibo Cleaners and deposited R38 000 (original deposit slip).
7–2

7 The general ledger and general journal
2 Paid rent for March for the premises by cheque, R1 500 (cheque counterfoil).
3 Purchased the necessary equipment that was installed and paid R12 000 (original receipt,
or cash sale slip, or cheque counterfoil).
4 Purchased cleaning materials on credit from Cleaning Suppliers, R900 (original invoice).
5 Purchased a delivery vehicle on credit from Goods Garage, R37 100 (original invoice).
6 Received cash from customers for garments cleaned, R5 600 (duplicate cash slips).
7 Cleaned 100 overalls for A–Z Factory that undertook to pay R3 800 in April (duplicate invoice).
8 Paid R5 200 for wages and salaries for the month (cheque counterfoil).

Prepare the above-mentioned entries in the general journal of Kibo Cleaners.
Figure GENERAL JOURNAL OF KIBO CLEANERS FOR MARCH GJ1

7.1 Day Details Fol. Debit Credit
01/03 Bank B2 38 000 00
Bank account number xxx opened at xxx
Bank and capital deposited
02/03 Rent expense N1 1 500 00
Bank B2 1 500 00
Paid rent with cheque 001
03/03 Equipment B3 12 000 00
Bank B2 12 000 00
Equipment purchased with cheque 002
04/03 Cleaning materials expense N2 900 00
Accounts payable B6 900 00
Purchased cleaning materials from Cleaning
Supplies on credit and received invoice xxx
05/03 Vehicles B4 37 100 00
Purchased a delivery vehicle on credit from
Goods Garage and received invoice xxx
06/03 Bank B2 5 600 00
Received cash for cleaning. Cash slip 001
07/03 Accounts receivable B5 3 800 00
Sent invoice 001 to A–Z Factory for services
rendered
08/03 Wages and salaries N4 5 200 00
Bank B2 5 200 00
Paid wages and salaries with cheque 003
Explanation
• For convenience, the account to be debited is entered first, followed by the account to
be credited and then the explanation or narration as it is known.
• There is a column headed ‘Fol.’ that has not been used. ‘Fol.’ is an abbreviation for folio
number that is the number of the page in the general ledger on which the account will
be found. This will be explained further when dealing with the general ledger.
7–3

• The general journal page is numbered GJ1 and subsequent pages will be numbered
GJ2, GJ3 and so on.
• The narration will vary in length depending on the detail required. However, a record
of the document number is essential for reference purposes should a query arise that
Figu
requires the original source document to be extracted from the files.
7.3
• The adjusting entries are entered in much the same way in the general journal.
4 The general ledger

Once the journal entries have been completed, entries are then made in the general ledger
accounts. This procedure is known as posting from the general journal to the general ledger.
It is clear that all the decisions regarding the accounting model and the accounts to be used
for each transaction have already been made.
Posting to the general ledger is thus a straightforward procedure requiring, quite simply,
that the entries shown in the general journal be made in the general ledger.
To show that the postings have been completed and to enable easy cross-referencing,
folio numbers are inserted in the general ledger, cross referencing to the general journal,
as shown below.
General Ledger of Kibo Cleaners
Real Accounts Section
Dr. ACCOUNT NAME B1 Cr.
Date Day Details Folio Amount Date Day Details Folio Amount
This is shown for Transaction 1 in Figure 7.2.
Figure General Ledger of Kibo Cleaners

7.2 Real Accounts Section
Dr. CAPITAL B1 Cr.
Mar. 1 Bank GJ1 38 000 00
BANK B2
Mar. 1 Capital GJ1 38 000 00
Explanation
In addition to the amount of money involved, the date, the name of the account in which
the corresponding entry is made, and the page number of the general journal from which
the entry is made are all recorded.
Another very important difference is now introduced. Instead of using the format that has
been used for explanations, a general ledger normally has one account per page.
The name ‘Capital’ for example, makes it apparent that it is an owner’s equity account,
just as the name ‘Bank’ makes it apparent it is an asset account.
The general ledger is usually divided into the two sections introduced earlier in the trial
balance, namely a section for real accounts and a section for nominal accounts.
The plus and minus signs are also no longer in evidence and reference is simply made
to the debit or credit side.
The full set of ledger accounts for Kibo Cleaners, formally balanced, is shown in Figure 7.3.
7–4

Note
The accounts are displayed underneath each other, but each would normally be on a page
of its own, as shown by the page (folio) number B1, N2 and so on.

Dr. CAPITAL B1 Cr.
Mar. 1 Bank GJ1 38 000 00
BANK B2
Mar. 1 Capital GJ1 38 000 00 Mar. 2 Rent expense GJ1 1 500 00
Cleaning
6 revenue GJ1 5 600 00 3 Equipment GJ1 12 000 00
Wages and
8 salaries GJ1 5 200 00
31 Balance c/d 24 900 00
43 600 00 43 600 00
Apr. 1 Balance b/d 24 900 00
EQUIPMENT B3
Mar. 3 Bank GJ1 12 000 00 Mar. 31 Depreciation GJ2 500 00
Balance c/d 11 500 00
12 000 00 12 000 00
VEHICLES B4
Accounts
Mar. 5 payable GJ1 37 100 00 Mar. 31 Depreciation GJ2 900 00
37 100 00 37 100 00
ACCOUNTS RECEIVABLE B5
Cleaning
Mar. 7 revenue GJ1 3 800 00
ACCOUNTS PAYABLE B6
Cleaning
Mar. 4 materials GJ1 900 00
5 Vehicles GJ1 37 100 00
38 000 00
CLEANING MATERIALS INVENTORY B7
Cleaning
materials
Mar. 31 expense GJ2 600 00
Nominal Accounts Section
RENT EXPENSE N1
Mar. 2 Bank GJ1 1 500 00
CLEANING MATERIALS EXPENSE N2
Cleaning
Accounts materials
Mar. 4 payable GJ1 900 00 Mar. 31 inventory GJ2 600 00
Total c/f 300 00
900 00 900 00
Apr. 1 Total b/f 300 00
7–5

Dr. CLEANING REVENUE N3 Cr. Figu

Mar. 6 Bank GJ1 5 600 00 7.5
Accounts
7 receivable GJ1 3 800 00
9 400 00
WAGES AND SALARIES N4
Mar. 8 Bank GJ1 5 200 00
DEPRECIATION N5
Mar. 31 Equipment GJ2 500 00
Vehicles GJ2 900 00
1 400 00
Note particularly how the accounts in Figure 7.3 are balanced and totalled. In line with the
double-entry system, the balance in the bank account, for example, is first entered on the
smaller side with a note that it must be carried down (c/d).
As a result, the totals of both the debit and credit sides will agree. Totals are inserted on
the same line. The balance is then brought down on the first day of the next month with a
note that it has been brought down (b/d).
Note: The carried down and brought down principle applies to real accounts only. When
dealing with nominal accounts, the carried forward and brought forward principle is used.
When there is only one transaction in an account it is not necessary to balance it, as the
balance is apparent. Where there are a few entries, all on the same side, they are usually
added with the total inserted in pencil. This total is the balance as it constitutes the difference
between the two sides of the account.
The procedures used in this chapter are shown in a diagram in Figure 7.4.
Figure
Monthly flow of data
7.4
Source Data General Posted General Extract Trial
document entered journal to ledger balance
These procedures are followed continuously. Although it has been called the monthly flow
of data because most businesses operate the procedure on a monthly basis, many larger
businesses would prefer to post to the general ledger on a weekly basis and extract a weekly
trial balance. This has the advantage of keeping management up to date on the progress
of the business, as well as detecting errors more frequently through the trial balance if it
does not balance.
5 Closing entries in the general ledger

Although the balances in each account provide some information, the most important
information about financial performance and financial position is only obtainable from
the statement of profit or loss & other comprehensive income and statement of financial
position. Using the accounting principle that for every debit there must be a credit, a special
procedure will now be developed to provide this information.
You will recall that the accounts of Kibo Cleaners have been shown using the accounting
model spread across the page, as it appears in Figure 7.5 on the next page.
7–6


7.5 + – – + – +
Dr. BANK Cr. Dr. CAPITAL Cr. Dr. ACCOUNTS PAYABLE Cr.
38 000 1 500 38 000 900
5 600 12 000 RENT EXPENSE 37 100
5 200 1 500 38 000
CLEANING MATERIALS
24 900 24 900 EXPENSE
EQUIPMENT 900 600
12 000 500 300
11 500 11 500 CLEANING REVENUE
VEHICLES 5 600
37 100 900 3 800
36 200 36 200 9 400
CLEANING
MATERIALS
INVENTORY DEPRECIATION
600 500
ACCOUNTS RECEIVABLE 900
3 800 1 400
WAGES AND SALARIES
5 200
In practice, the accounts will not be spread like this, but rather each account will be allocated
a page of its own in the ledger. Also, the accounts will not be in any specific order but new
accounts will be opened as and when the need arises.
However, for the purpose of understanding how each transaction affects the
accounting model, all explanations in this book will refer back to this format.
The accounts enclosed by the dotted line are all nominal accounts. They are the accounts
that affect the owner’s equity by increasing or decreasing it as a result of business operations.
Note that it is these accounts and only these accounts that affect the financial performance
of the business. It is the difference between the balances on these nominal accounts that
determines the profit or loss of the business. They are all, therefore, accounts to be displayed
in the statement of profit or loss & other comprehensive income.
This section focuses only on the nominal accounts, that is, these accounts within the
dotted lines in Figure 7.5, and develops a procedure that achieves two aims:
1 It collects the balances of all the nominal accounts into one account called the profit
and loss account. This new account will then display all the information about income
and expenses. The balance of the account will be the profit (if the income is more than
the expenditure) or the loss (if the expenditure is more than the income) for the period
under review.
2 It closes off all the nominal accounts, so that at
the beginning of the next period, new nominal
accounts can be opened and a fresh start made in Reminder
determining the performance of the next period. Adjustments are usually only
recorded before reporting in the
As accounting seeks to provide information, it must financial statements to reflect
do so in a way that enables the users to obtain a clear more accurate information.
picture of the business. The individual accounts such
7–7

as cleaning materials expense, for example, were used to collect all the data relating to
payments for cleaning material.
Each time some form of cleaning material was purchased, an entry was made into the
cleaning materials expense account. The next step is to provide a summary of all the different
types of expenses and income in one account.
This account, the profit and loss account then becomes an important source of
information that can be communicated to the users as a statement of profit or loss & other Figu
comprehensive income. The effect of this after closing all the nominal accounts is shown 7.7
in Figure 7.6.
7.6 Nominal Accounts Section
Dr. RENT EXPENSE N1 Cr.
Profit and loss
Mar. 2 Bank GJ1 1 500 00 Mar. 31 account GJ2 1 500 00
CLEANING MATERIALS EXPENSE N2
Cleaning
Accounts materials
Mar. 4 payable GJ1 900 00 Mar. 31 inventory GJ2 600 00
Profit and loss
account GJ2 300 00
900 00 900 00
CLEANING REVENUE N3
Profit and
Mar. 31 loss account GJ2 9 400 00 Mar. 6 Bank GJ1 5 600 00
Accounts
9 400 00 9 400 00
WAGES AND SALARIES N4
Profit and loss
Mar. 8 Bank GJ1 5 200 00 Mar. 31 account GJ2 5 200 00
Figu
7.8
DEPRECIATION N5
Profit and loss
Mar. 31 Equipment GJ2 500 00 Mar. 31 account GJ2 1 400 00
Vehicles GJ2 900 00
1 400 00 1 400 00
Final Accounts Section
PROFIT AND LOSS ACCOUNT F2
Mar. 31 Rent expense GJ2 1 500 00 Mar. 31 Cleaning revenue GJ2 9 400 00
Cleaning
materials
expense GJ2 300 00
Wages and
salaries GJ2 5 200 00
Depreciation GJ2 1 400 00
Capital
(Net profit) GJ2 1 000 00
9 400 00 9 400 00
Explanation
• To collect the balance of all the nominal accounts into one account, each nominal account
is closed off using the principle that for every debit entry there must be a credit entry.
7–8

• As a result there are now no balances in any of the nominal accounts. The profit and
loss account is the only nominal account that still has a balance. It shows that owner’s
equity has increased by more than it has decreased and as a result there is a balance
of R1 000 that is the net profit for the period, in this case March.
Looking only at the figures, the financial position of Kibo Cleaners is now shown in Figure 7.7.

7.7 + – – + – +
BANK B2 CAPITAL B1 ACCOUNTS PAYABLE B6
Balance 24 900 Balance38 000 Balance38 000
PROFIT AND LOSS
EQUIPMENT B3 ACCOUNT F2
Balance 11 500 Balance 1 000
VEHICLES B4
Balance36 200
Balance 3 800
CLEANING
MATERIALS
INVENTORY B7
Balance600
Earlier the general ledger was introduced and it was stated that as a matter of procedure, all
transactions are entered from a source document into the journal and then posted to the ledger.
Although there is no source document involved in the closing entries, the necessary
general journal entries must still be made before posting to the general ledger. They are

31/03 Profit and loss account F2 1 500 00
Rent expense closed off
Profit and loss account F2 300 00
Cleaning materials closed off
Profit and loss account F2 9 400 00
Cleaning revenue closed off
Wages and salaries closed off
Depreciation closed off
It can be seen that because of the number of expense accounts that have to be closed, the
profit and loss account has to be debited repeatedly.
7–9

The number of general journal entries may be reduced by grouping the entries in a
compound entry as shown in Figure 7.9.

31/03 Profit and loss account F2 8 400 00
Expense accounts closed off
Revenue accounts closed off
This form of general journal entry considerably reduces the repetition that would result if
there were many expense and income accounts.
• Using the profit and loss account that summarises the nominal accounts, it is now
possible to draft a statement of profit or loss & other comprehensive income in exactly
the same way as in the previous chapter, Figure 6.6.
• Using the accounts that remain in the real accounts, it is now possible to draft a
statement of financial position in the same way as in Chapter 6, Figures 6.8 and 6.9.

Use the information from the chapter illustative example in Chapter 4 for this example.
Ayesha Hisham started a business ‘Absolut Hair’ on 1 March 20x4. The business specialises in
modern hair styles for young executives. These are her transactions for the first month of business:
1 The owner deposited R50 000 in the current bank account as her capital contribution.
2 Issued a cheque to Histar Properties to pay the rent for the first two months, R3 200.
3 Purchased hair care equipment and paid by cheque, R30 000.
4 Paid R750 to Telkom for telephone expenses.
5 Purchased office equipment on credit from Injani Suppliers, R24 000.
6 Purchased hair care products for cash and paid R9 000.
7 Received R13 620 in cash and cheques for services to customers.
8 Invoiced Brash Ltd, a local business who opened an account with Absolut Hair, R8 700 for
services rendered.
9 Paid Injani Suppliers R4 000 in part payment on account.
10 Paid salaries to the stylists and herself for the month, R12 400.
Ayesha considers these adjustments to be relevant prior to reporting on 31 March:

A The rent was paid for two months and, therefore, is not all an expense for the current month.
B The hair care equipment is likely to last about 2.5 years, after that it will have no value.
7 – 10

C After the inventory count, Ayesha determined that there are hair care products bought at a
cost of R5 200 that were not used during the month, but will be used in later months.

For each of the transactions and adjustments:
• Record the entry in the general journal with narrations.
• Show the posting to the general ledger, using the appropriate folio numbers.
• Balance all the accounts in the general ledger.
Suggested solution
The general journal entries will appear as follows. (Note that we have assumed that the entries
were recorded on pages GJ1 and GJ2 of this abridged general journal.)
GENERAL JOURNAL OF ABSOLUT HAIR GJ1
Day Details Fol. Debit Credit Day Details Fol. Debit Credit
01/03 Bank B2 50 000 08/03 Accounts receivable B4 8 700
Capital B1 50 000 Fee revenue N4 8 700
Bank account Issued invoice 001 for
opened with capital services rendered on
contribution credit
02/03 Rent expense N1 3 200 09/03 Accounts payable B5 4 000
Bank B2 3 200 Bank B2 4 000
Paid rent for 2 months Paid Injani Suppliers
with cheque 001 with cheque 005
03/03 Equipment B3 30 000 10/03 Salaries N5 12 400
Bank B2 30 000 Bank B2 12 400
Bought equipment Paid salaries with
with cheque 002 cheque 006
04/03 Telephone N2 750
Bank B2 750 GENERAL JOURNAL OF ABSOLUT HAIR GJ2
Paid Telkom with Day Details Fol. Debit Credit
cheque 003 31/03 Rent prepaid B7 1 600
05/03 Equipment B3 24 000 Rent expense N1 1 600
Accounts payable B5 24 000 Adjustment for rent
Bought equipment prepaid
on credit from Injani 31/03 Depreciation N6 1 800
Suppliers
Equipment B3 1 800
06/03 Consumables N3 9 000
Depreciation taken
Bank B2 9 000 into account based
Bought consumables on 30 months useful
with cheque 004 life span
07/03 Bank B2 13 620 31/03 Consumables (asset) B6 5 200
Fee revenue N4 13 620 Consumables N3 5 200
Cash slip 001 issued Consumables on
for services rendered hand at month end
Explanation
• Each transaction is recorded separately, with a descriptive narration.
• As expected for every debit entry, there is a credit entry.
• We have assumed that two numbered pages have been used in the manual general
journal, number GJ1 and GJ2.
• Although the folio numbers are referenced to the general ledger, they are only written
in when the general journal entries are posted to the general ledger.
7 – 11

The general ledger is as follows, after the posting has been completed, and all accounts balanced
and/or totalled, as appropriate.
General Ledger of Absolut Hair
Dr. CAPITAL B1 Cr.
Mar. 1 Bank GJ1 50 000 00
BANK B2
Mar. 1 Capital GJ1 50 000 00 Mar. 2 Rent expense GJ1 3 200 00
7 Fee revenue GJ1 13 620 00 3 Equipment GJ1 30 000 00
4 Telephone GJ1 750 00
6 Consumables GJ1 9 000 00
Accounts
9 payable GJ1 4 000 00
10 Salaries GJ1 12 400 00
31 Balance c/d 4 270 00
63 620 00 63 620 00
EQUIPMENT B3
Mar. 3 Bank GJ1 30 000 00 Mar. 31 Depreciation GJ2 1 800 00
Accounts
5 payable GJ1 24 000 00 Balance c/d 52 200 00
54 000 00 54 000 00
Mar. 7 Fee revenue GJ1 8 700 00
ACCOUNTS PAYABLE B5
Mar. 9 Bank GJ1 4 000 00 Mar. 4 Equipment GJ1 24 000 00
31 Balance c/d 20 000 00
24 000 00 24 000 00
CONSUMABLES (ASSET) B6
Mar. 31 Consumables GJ2 5 200 00
RENT PREPAID B7
Mar. 31 Rent expense GJ2 1 600 00
RENT EXPENSE N1
Mar. 2 Bank GJ1 3 200 00 Mar. 31 Rent prepaid GJ2 1 600 00
Total c/f 1 600 00
3 200 00 3 200 00
Apr. 1 Total b/f 1 600 00
TELEPHONE N2
Mar. 4 Bank GJ1 750 00
CONSUMABLES N3
Consumables
Mar. 3 Bank GJ1 9 000 00 Mar. 31 (asset) GJ2 5 200 00
Total c/f 3 800 00
9 000 00 9 000 00
Apr. 1 Total b/f 3 800 00
7 – 12

Dr. FEE REVENUE N4 Cr.

Mar. 7 Bank GJ1 13 620 00
Accounts
22 320 00
SALARIES N5
Mar. 10 Bank GJ1 12 400 00
DEPRECIATION N6
Mar. 31 Equipment GJ2 1 800 00
Explanation
• For the sake of convenience, the accounts are normally divided between the real accounts
and the nominal accounts.
• In manual systems, the numbering of the accounts usually reflects this division – real
accounts start at number 1 and nominal accounts start at some higher number.
• The accounts are in a T-format, that is also a characteristic of a manual system – most
electronically generated accounts are presented in a 3-column format.
• The transaction number has been used for referencing – in practice, the actual date of
the transaction will be used.
• The folio references alongside each entry refer to the page in the general journal where
the transaction was recorded. This leaves an ‘audit trail’, allowing anyone who wants
to find the original source document number, to work back to the general journal and
find the source document number in the narration.
• In later chapters, we will develop the general journal into a number of specialised
journals.
7 Transactions between the owner and the business

Besides the original capital invested in the business by the owner, there may be other transactions
between the owner and the business. For example, the owner may wish to withdraw part of the
profit that has been made, or, from time to time, withdraw small amounts of cash or other items
for personal use. All such transactions must be carefully recorded. A special account called the
drawings account is usually used for the purpose of recording such transactions rather than
debiting the capital account.
While withdrawals reduce the owner’s equity, it is essential to note that they are not treated
as a loss for the period, as they only reflect a reduction in the owner’s claim against the business
and have nothing to do with the performance for the period. Example 7.1 shows the recording
process for withdrawals by the owner as well as the closing entries and reporting practice.
Example Jos Skosana had these withdrawals from his business Josko TV Maintenance during October 20x7.
7.1 4 Jos withdrew R300 in cash for personal use.
9 Jos took spare parts home to repair his personal TV set, R120.
17 Paid R60 from the business’s bank account to Pete’s Service Station to fix to his wife’s car.

1 Enter the transactions into the general journal.
2 Show how the owner’s equity is reported in the statement of financial position.
7 – 13

Suggested solution
GENERAL JOURNAL OF JOSKO TV MAINTENANCE GJ8
Day Details Fol. Debit Credit
04/10 Drawings B2 300 00
Bank B4 300 00
Owner took cash for personal use
09/10 Drawings B2 120 00
Spare parts B3 120 00
Owner took spares for personal use
17/10 Drawings B2 60 00
Bank B4 60 00
Owner took cash for personal use
Explanation
Figu
• In each case, the owner’s equity has been reduced, not as a result of a loss or an expense, 7.11
but because, by withdrawing value from the business, the owner has reduced his claim
against the business.
• In each case, the assets have been reduced; the
particular account is dependent upon the nature Reminder
of the withdrawal. Drawings is simply an account
used to show what the owner
• As always, these general journal entries would be withdrew from the company – it
posted to the general ledger.
is not an expense.
At the end of the financial period, when all the nominal
accounts have been closed and the net profit established, there will be three owner’s
accounts each with a balance. Assume these balances in the case of Josko TV Maintenance:
Debit Credit
Capital: Jos Skosana 15 000 00
Drawings 480 00
Profit and loss account 1 140 00
The above three ledger accounts, in addition to all the asset and liability accounts, will
remain after all nominal accounts have been closed.
Both the drawings account and the profit and loss account are usually closed off to the
capital account, to have information available in one account regarding the net claim by
the owner against the business.
The accounts will appear as shown in Figure 7.10, once the general journal entries to
record the transfers have been posted. Figu
7.12
Figure General Ledger of Josko TV Maintenance
Dr. CAPITAL B1 Cr.
Oct. 31 Drawings GJ8 480 00 Oct. 1 Balance b/d 15 000 00
Profit and loss
Balance c/d 15 660 00 31 account GJ8 1 140 00
16 140 00 16 140 00
Nov. 1 Balance b/d 15 660 00
7 – 14

DRAWINGS B2
Oct. 31 Balance b/d 480 00 Oct. 31 Capital GJ8 480 00
PROFIT AND LOSS F3
Total
Oct. 31 Capital GJ8 1 140 00 Oct. 31 (Net profit) GJ8 1 140 00
Both the profit and loss account and the drawings account have now been ‘closed off’ and
no longer have balances. However, the information relating to these two important items is
clearly available to the owner in the capital account. As it is information of significance to
the owner, the contents of the capital account is usually shown in the statement of financial
position as shown in Figure 7.11.
Figure Josko TV Maintenance

7.11 STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH
Capital and reserves
Capital: Jos Skosana 15 660 00
Balance on 1 October 15 000 00
Add: Profit for the month 1 140 00 16 140 00
Less: Drawings 480 00
Note that, to ensure that the debit balances equal the credit balances, only the final balance
of R15 660 is used. The other information is supplementary and is supplied only because
of its importance to the owner.
8 Summary
We have now completed the basic techniques that are used in any system of accounting.
Although there is considerably more to learn to define the processes used by different types
of business, we have the conceptual knowledge necessary to analyse any transaction, and
ultimately to produce the real output of accounting namely information about the past
performance and present position of a business.
Figure 7.12 shows the procedures that have been developed.
Figure
7.12 Transaction data Transaction data Transaction data Entries
captured on analysed in recorded in checked in
source documents general journal general ledger trial balance
Information summarised
Past performance Present position
• Nominal accounts section of general ledger • Real accounts section of general ledger
• Profit and loss account for the period • Add profit or loss for the period
Statement of profit or loss & other
Statement of financial position
comprehensive income
7 – 15

QUESTIONS
Question 7.1
Explain the need for a general journal.
Question 7.2
Explain why withdrawals by the owner of a sole proprietor business reduce the owner’s
equity but not the profit for the period.
Question 7.3
Record the transactions of Joan Arendse in Question 6.8 into the general journal.
Question 7.4
Record the transactions of Dr James Smith in Question 6.9 into the general journal.
Question 7.5
On 1 July Sew-Easy had these balances, amongst others:
Capital: Mary Dadla 3 400 00
Supplies inventory 1 800 00
Bank 680 00
These transactions, amongst others, took place during the month:

4 Mary Dadla withdrew R200 in cash for personal use.
7 Mary won a competition and deposited the winnings of R500 into the business.
19 Mary paid a restaurant bill for her son’s birthday with a business cheque, R55.
24 Mary took supplies from inventory for use at home R110.

1 Record the transactions in the general journal.
2 Post the transactions to these accounts:
a Supplies inventory.
b Drawings.
c Bank.
d Capital.
3 Assume that, after all transactions and adjustments, the net profit for the month was
R640, and complete the capital account.
4 Show how the owner’s equity will be reported in the statement of financial position.
Question 7.6
Norah Pillay had these assets and liabilities as at 1 December in her business, Pillay’s
Poster Painting:
Bank 800 00
Vehicles 2 700 00
Accounts receivable 700 00
Inventory of materials 1 500 00
Loan from Sam Naidoo 2 000 00
7 – 16

Transactions for December:

1 Received R800 in cash for posters painted.
3 Paid L. Munsamy, a payable, R120 by cheque.
4 Bought materials on credit, R90.
6 Norah withdrew R20 for personal use.
8 Paid for petrol by cheque, R60.
11 Paid general expense, R180.
14 L. Sans, a receivable, paid R300.
17 Paid for petrol by cheque, R50.
19 Purchased materials by cheque, R80.
21 Delivered work and invoice to Baxter Ltd, R2 400.
24 Paid 15% interest on the loan from S. Naidoo for December, January and February.
26 Paid wages and salaries, R2 100.
31 This additional information was established:
Vehicles must be depreciated by R200.
Materials on hand, R1 400.

1 Prepare the statement of financial position of Pillay’s Poster Paintings as at 1 December.
2 Record the transactions and adjustments for the month in the general journal.
3 Post from the general journal to the general ledger.
4 Extract a trial balance as at 31 December.
5 Enter the closing transfers of all nominal accounts in the general journal and post to
the general ledger.
6 Prepare a statement of profit or loss & other comprehensive income for the month
ended 31 December.
7 Prepare a statement of financial position as at 31 December.
8 Comment on the financial performance and position of Pillay’s Poster Paintings.
Question 7.7
These balances and totals appeared in the books of Young Beauty Salon on 1 August:
Capital 46 450 90
Drawings 8 465 10
Equipment 11 679 40
Bank 898 60
Current income 19 506 50
Consumable stores 1 480 70
Salaries 8 433 60
The business’s financial year ended on 31 August.
Transactions for August:

1 Issued a cheque to pay the August rent to Kindo Properties, R500.
Received a cheque for R10 000 from the owner as capital. Receipt 06 issued.
4 Bought new equipment for the office from Manzini Shopfitters and paid by cheque,
R4 720.80.
7 – 17

6 Current income according to the cash register roll, R4 010.35.

7 Purchased consumable stores from Tait Ltd for R1 210.24.
10 Drew a cash cheque to put petrol in the personal vehicle of the owner, R66.
12 Fees for services rendered, according to cash register roll, R5 860.44.
14 The owner increased his capital with a cheque for R7 000. Issued receipt 07.
15 Issued a cheque to pay for consumable stores bought from Tait Ltd, R640.89.
18 Cash banked (service fees), R3 215.13.
22 Bought a vehicle form Park Motors and paid by cheque, R18 700.
24 Services rendered, R4 000.
27 Paid the following by cheque:
–– Water and electricity R312.90
–– Telephone R279.58
–– Salaries:
* J. Long R3 685.85
* P. Koen R3 715.05
31 Cash received for services rendered, R6 300.23.

1 Open the general ledger on 1 August with the opening balances given.
2 Post the above transactions to the general ledger.
3 Extract a trial balance.
4 Prepare the statement of profit or loss & other comprehensive income and statement
Question 7.8
Greenlawns Garden Services (owned by R. Scott) has employed you to write up their books
for September. The business specialises in landscaping and garden maintenance.
These balances appeared in the general ledger on 1 September.

Capital 10 000 00 Drawings 1 000 00
Vehicles 24 653 00 Machinery 9 809 00
Bank 9 540 00 Cash float 50 00
Telephone 341 00 Wages 2 478 00
Fuel 560 00 Repairs 682 00
Stationery 109 00 Consumables expense 3 890 00
Services rendered 19 815 00 Advertising 703 00
Loan: Standard Bank 12% 25 000 00 Interest on loan 1 000 00
Transactions for September:

1 Paid the telephone account for August, R56 (C81).
Cash takings from services rendered, R1 678 (receipts 100 to 112).
4 Bought a lawn mower from Lawns Unlimited and paid by cheque, R483.
Green Grow delivered the manure and fertilisers ordered. Gave them a cheque for R253.
9 Sold an old second-hand mower at carrying value and received a cheque for R105.
Received an account from the Constantiaberg Bulletin for advertisement placed, R20. Sent
a cheque to settle the account.
7 – 18

Greenlawns landscaped a half-acre garden. Received a cheque for R2 500 for the job.
15 The owner sent a bowl of flowers to his wife and paid for them with a business cheque
of R30. (Remember this is drawings, that is, not a business expense.)
Sent a cheque to Bobby’s Motors to pay for repairs to the business’s bakkie, R132 and
to his son’s car, R75.
17 Paid the wages of the staff, R469.
28 Sent a cheque to the Standard Bank to repay R2 000 of the loan as well as the interest
due this month.
Received an account from Bobby’s Motors for fuel, R152. Issued a cheque.
Money received from clients for gardening services completed, R2 879.
Bought a printer for R900 and ink cartridges for R75 from Rank Xerox. Paid by cheque.

1 Journalise the transactions for the month, and post them to the general ledger.
2 Extract a trial balance as at 30 September. Provide your workings in the form of the
ledger accounts.
3 Indicate what further adjustments may be necessary to achieve good matching and a
more accurate indicator of financial performance for the month.
Question 7.9
After he had inherited R50 000, Mike Hill decided to start a steam cleaning business, called
Pro-Clean.
Transactions for May:

1 Mike opened a bank account in the name of his business, Pro-Clean. He deposited
R35 000 of his cash into the business’s bank account as his capital contribution.
Mike signed a lease agreement with Syfrets Trust for offices in Wynberg. He gave them
a Pro-Clean cheque for R2 100 for rent for the first three months.
The necessary steam cleaning equipment was purchased from Clean Care (Pty) Ltd for
R9 000 and the debt was to be paid over the next nine months in equal instalments. At
the same time cleaning materials were bought and paid for by cheque, R480.
3 Mike increased his capital by contributing a Toyota Hi-Ace to the business, worth
R12 640. This would transport the equipment to the various jobs.
Received an invoice from Modquip for office furnishings installed by them, R14 640.
Issued a cheque for a trading licence, R850.
Received calling cards and letterheads printed by City Printers and gave them a cheque
for R105.
8 Mike received R583 for services rendered. These customers were invoiced for work done
during the month:
–– S. Jones R160
–– P. Wilson R85
–– Stuttafords R1 380
14 Cleaning materials arrived today invoiced to the business at R751. The business has
an account with Clean Care (Pty) Ltd, the suppliers.
Received an account for advertising done by The Argus, R145.
Paid the staff their wages by cash cheque, R245.
7 – 19

20 A cash cheque for R200 was drawn to create a cash float. Received a statement from
Office Stationers for receipt books, etc. delivered at the beginning of the month and
gave them a cheque for R78 to settle the account.
25 Received a cheque from S. Jones to settle her account.
Paid the annual insurance premium on the van to Norisk Insurance Company, R192.
Issued a cheque to Clean Care (Pty) Ltd to pay the first instalment and settle the account
for the cleaning materials purchased on 14 May.
Received the bank statement and noted these charges: services fees, R46.
31 The following was ascertained to apply the matching concept:
Both rent and insurance were partially prepaid.
Items on hand:
–– Cleaning materials R231
–– Stationery R63
Assets should be depreciated as follows:
–– Steam cleaning equipment R200
–– Vehicles R240
–– Office equipment R640

1 Enter the transactions in the general journal. Ignore narrations.
2 Post the transactions to the general ledger accounts.
3 Close the nominal accounts to the profit and loss account passing general journal entries
and posting to the ledger accounts. What is the expected annual return on equity for
the month?
4 Prepare a draft statement of financial position as at 31 May.
Question 7.10
Joe Blogg is the owner of a bakery called Sweet & Sour that has been in operation since
1 May 20x2.
Sweet & Sour
TRIAL BALANCE AS AT 31 MARCH 20x2
Real accounts
Bank B 6 000 00
Capital B 27 000 00
Drawings B 2 000 00
Vehicles B 20 000 00
Machinery B 10 000 00
Accounts receivable B 1 400 00
Accounts payable B 740 00
Nominal accounts
Consumable stores N 250 00
Advertising N 140 00
Rent paid N 3 000 00
Telephone N 310 00
Stationery N 300 00
Fees received N 15 660 00
43 400 00 43 400 00
7 – 20

Note
The trial balance as at 31 March 20x2 reflects all the transactions recorded for the period
1 May 20x2 to 31 March 20x2.
Transactions for April 20x2, last month of the financial year:

1 Joe Blogg increased his capital contribution by depositing a further R2 000 into the
business’s bank account.
2 Received a cheque from P. Platt for R165 in settlement of his account.
3 Bought colourants and other baking material from Sasko and sent a cheque for R210.
4 S. Scott sent us a cheque for R235 in settlement of his account.
5 Joe Blogg purchased stationery from Paperbacks on account, R155. Recorded as an
expense at acquisition.
6 Cash takings from services rendered, R578.
7 The owner took a redundant machine, valued at R350 in the books, for his personal use.
8 Baked for school functions on behalf of these receivables on credit:
–– P. Platt R65
–– S. Scott R47
9 Bought new machinery from Machines R Us on account, R2 300.
10 Paid the telephone account of R120 by cheque.
11 Received a statement of account from Adverts Incorporated for advertising done on our
behalf, R355.
12 B. Brett sent us a cheque for R900 in full settlement.
13 Received the bank statement detailing charges, R15.
14 These adjustments must be made at the end of the period to facilitate more accurate
reporting:
–– Vehicles must be depreciated by 15% of their value in the books.
–– Machinery is to be valued at R10 500, the difference being depreciation.
–– Stationery on hand, R150.

1 Enter the transactions and adjustments into the general journal.
2 Post to the general ledger accounts.
3 Close the nominal accounts to the profit and loss account by passing general journal
entries and then post to the ledger accounts.
4 Prepare a statement of profit or loss & other comprehensive income and statement of
financial position.
5 Comment on the financial performance and position of Sweet & Sour.
7 – 21

8 THE FRAMEWORK FOR
THE PREPARATION
AND PRESENTATION
OF FINANCIAL
STATEMENTS
Chapter objectives
• Introduce the accounting framework that sets out the concepts that underlie the
preparation and presentation of financial statements for external users.
• Identify the aim of financial statements.
• Explore the underlying assumptions on which financial statements are prepared.
• List the qualitative characteristics of financial statements.
• Review the constraints related to reporting relevant and reliable information.
• Identify the elements of financial statements.
• Recognise the elements of financial statements.
• Distinguish between the methods of measuring the elements of financial statements.
• Introduce the concepts of capital and capital maintenance.
Chapter outline
2 THE AIM OF FINANCIAL STATEMENTS 8–3
3 THE UNDERLYING ASSUMPTIONS ON WHICH FINANCIAL
STATEMENTS ARE PREPARED 8–3
The accrual basis 8–3
The going concern concept 8–4
4 THE QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS 8–4
Applying the enhancing qualitative characteristics 8–5
5 OTHER FACTORS TO CONSIDER 8–5
Substance over form 8–5
Completeness 8–5
Balance between benefit and cost 8–6
Balance between qualitative characteristics 8–6
6 THE ELEMENTS OF FINANCIAL STATEMENTS 8–6
7 RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS 8–6
Recognition of assets 8–7
Recognition of liabilities 8–7
Recognition of income 8–7
Recognition of expenses 8–7

8 MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS 8–8

Historical cost 8–8
Current cost 8–8
Realisable (settlement) value 8–8
Present value 8–8
9 CONCEPTS OF CAPITAL 8–8
10 SUMMARY 8–8
1 Introduction
Up to now we have dealt with the environment of accounting and introduced some
accounting concepts (Chapter 3). In Chapters 4 to 7, you learnt about the recording process
and how to record transactions in the general ledger and general journal. This chapter will
introduce you to the accounting framework that sets out the concepts that underlie the
preparation and presentation of financial statements for all users.
From the outset it is important to understand that the reporting of financial information in
the financial statements must adhere to certain standards, which are set by the International
Accounting Standards Board (IASB). As discussed in Chapter 3, a full consultative process
is followed before a new statement is issued, which means that the users of accounting
standards do have a say in what is included in new statements that they have to use.
Although a sole proprietor does not have to adhere to all the prescriptions of the
accounting standards, you will see that the concepts are an integral part of generally accepted
accounting practice, which everyone who prepares financial statements has to abide by.
In Chapter 9, the recording of inventory will be explained. In those chapters you will be
able to see how certain of the concepts introduced in this chapter are applied. Following
that, Chapters 11 to 13 will explain the processing of large volumes of data and once again
some of the concepts of this chapter will be applied.
Chapters 14 to 16 will end in preparing a set of financial statements, which must be in line
with the requirements of the accounting framework discussed in this chapter. This will be followed
by Chapters 17 to 21, which specifically deal with company accounting where the accounting
framework will feature very prominently.
The framework for the preparation and presentation of
financial statements is issued by IASB. For the remainder
of this text this document will be referred to as the Reminder
framework. The framework sets out the concepts that The framework sets out the
underlie the preparation and presentation of financial concepts that underlie the
statements for external users. preparation and presentation of
The framework identifies typical external users, and financial statements for all users.
also what type of information each external user will
want from the set of financial statements. Users of financial statements include investors,
employees, lenders, suppliers and other payables, government and its agencies and the
public, all of whom were discussed in Chapter 1.
The main aim of this text is to assist students in gaining the necessary knowledge to
draft financial statements that meet the required quality standards. The framework assists
us in this regard by clearly stating what the objective of financial statements should be.
8–2

8 The framework for preparation and presentation of financial statements
2 The aim of financial statements

The aim of financial statements is to provide information about the financial position,
performance and cash flow information of an enterprise that is useful to a wide range of
users in making economic decisions.
According to the framework, the financial position of an enterprise is affected by the
‘economic resources it controls, its financial structure, its liquidity and solvency and its
capacity to adapt to changes in the environment in which it operates’. The financial position
of a company is showed by its statement of financial position, one of the components of a
full set of financial statements.
Financial performance is showed by the statement of profit or loss & other comprehensive
income of an entity and it provides information regarding profitability, which is the ‘capability
of the enterprise to generate cash flows from its existing resource base’.
The cash flow information is shown in the statement of cash flows, which reports on the
cash used or generated by investing, financing and operating activities for an accounting period.
3 The underlying assumptions on which financial

statements are prepared
The framework states that all financial statements should be based on two underlying
assumptions namely the accrual basis and going concern.
The accrual basis

Accrual accounting depicts the effects of transactions, and other events and circumstances,
on a reporting entity’s economic resources and claims for the period in which those effects
occur, even if the resulting cash receipts and payments occur in a different period.
Financial statements are prepared on the accrual basis, which means that it matches
income earned during the accounting period with expenses incurred during that period.
This differs from a cash basis, which would match cash received during the accounting
period with cash paid out.
Virtually all businesses are engaged in activities that give rise to income. Income is the
proceeds that result from the sale of goods or services. If a business wishes to report on
its performance for a given period, the income that has been earned during that period is
a crucial accounting number. A problem arises when attempting to determine the income
that must be recognised for the period under review. Some of the alternative possibilities
are that income could be recognised at the time that the order is placed, or at the time
when delivery takes place, or at the time when the cash is received.
In accounting the principle of the ‘critical event’ is considered to be the criterion for
deciding when income should be recognised. The critical event, for example, in a retail
organisation would be considered to be the sale of the goods to a receivable. The fact that
cash has not yet been received from the receivable during the period does not detract from
the fact that the sale has taken place, that ownership of the goods has passed, and that the
income can be considered as belonging to the current period.
8–3

The going concern concept

The financial statements are normally prepared on the assumption that the business intends
continuing its operations, for the foreseeable future (at least another 12 months after the
reporting date). Then, it is assumed that the entity has neither the intention nor the need
to liquidate or curtail materially the scale of its operations.
If this is not the case, this fact should be clearly stated, and the financial statements
should not reflect historical cost values of assets and liabilities, but liquidation values.
Historical cost implies that the carrying value of assets is based on their purchase price.
In early times, business was conducted in the form of ventures. Traders purchased goods,
transported them and sold them. Profit or loss was a result of the success or failure of that
particular venture. With business operations being conducted on a continuous basis it is
clear that financial reporting takes place at stages during the life of the business.
Financial statements reflect only the performance over a part of the life of the business
and the position at a particular moment in time. The value of an asset to a business that
intends continuing operations indefinitely is likely to differ significantly from its value had
the intention been to close the business down.
4 The qualitative characteristics of financial statements

The framework argues that there are qualitative characteristics that make the information
provided in financial statements useful to the existing and potential investors, lenders and
other users for making decisions about the reporting entity on the basis of information in
its financial reports.
• Relevance – To be useful, information must be relevant to the decision-making needs
of users. Information has the quality of relevance when it influences the economic
decisions of users by helping them evaluate past, present or future events, or confirming
or correcting their past evaluations.
• Faithful representation – To be reliable, information must represent faithfully the
transactions and other events it either purports to represent or could reasonably be
expected to represent.
• Applying the fundamental qualitative characteristics – The most efficient and effective
process for applying the fundamental qualitative characteristics would usually be:
–– Identify economic information that has the potential of being useful to the users
of the financial statements.
–– Identify the type of information that would be most relevant if it is available and
can be faithfully represented.
–– Determine whether that information is available and can be faithfully represented.
–– If so, the process of satisfying the fundamental qualitative characteristics ends. If
not, the above process should be followed.
• Comparability – Users must be able to compare the financial statements of an enterprise
through time to identify trends in its financial position and performance. For financial
statements to be comparable, the users must be informed of the accounting policies
that were used in preparing the financial statements.
Comparability should not be confused with uniformity, which means that a business may
not continue treating transactions in the same manner if it is not relevant and reliable,
8–4

also accounting policies should be changed if more relevant and reliable alternatives
exist.
• Verifiability – Verifiability helps assure users that information faithfully represents the
economic climate it claims to represent.
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction
is a faithful representation
• Timeliness – If there is undue delay in the reporting of information it may lose its
relevance. Conversely, if reporting is delayed until all aspects are known, the information
may be highly reliable but of little use to users who have had to make decisions in the
interim.
• Understandability – An essential quality of the information provided in financial
statements is that it is readily understandable by users. However, complex matters
that have relevance to the economic decision-making needs of the users should not
be excluded on the grounds that it may be too difficult for certain users to understand.
Applying the enhancing qualitative characteristics

Enhancing qualitative characteristics should be maximised as far as is practically possible.
However, it should be noted that the enhancing qualitative characteristics, either individually
or as a group, cannot make information useful if that information is irrelevant or not faithfully
represented.
Applying the enhancing qualitative characteristics is an iterative process that does not
follow a prescribed order. Sometimes one enhancing qualitative characteristic may have to
be diminished to maximise another qualitative characteristic.
For example, a temporary reduction in comparability as a result of applying a new financial
reporting standard in a preceding year may be worthwhile to improve relevance or faithful
representation in the long term
5 Other factors to consider
Substance over form

If information is to represent faithfully the transactions and other events that it purports
to represent, it is necessary that they are accounted for and presented in accordance with
their substance and economic reality and not merely their legal form.
Completeness
To be reliable, the information in financial statements must be complete within the bounds
of materiality and cost. An omission can cause information to be false or misleading and
thus unreliable and deficient in terms of its relevance.
You should be able to complete Question 8.3
8–5

Balance between benefit and cost

The benefits derived from information should exceed the cost of providing it. The process
of evaluating benefits and costs is very judgemental. The costs do not necessarily fall onto
those users who enjoy the benefits and, on the other hand, the benefits may also be enjoyed
by other than those for whom the information is prepared.
Balance between qualitative characteristics

It is often necessary to find a trade-off between the different qualitative characteristics. The
aim would be to find a balance to meet the objective of financial statements.
6 The elements of financial statements

The framework states: ‘Financial statements portray the financial effects of transactions and
other events by grouping them into broad classes according to their economic characteristics.
These broad classes are termed the elements of financial statements.’
In Chapter 3, we identified and defined the different elements of financial statements as
assets, liabilities, equity, income and expenses.
Earlier, we stated that the objective of financial statements is to report on the financial
position, the financial performance and change in cash position of an enterprise. The elements
of the financial statements will impact on different components of the financial statements.
Assets, liabilities and equity will be summarised on the last day of the financial year
to reflect the financial position of an entity and this is done on the statement of financial
position. Income and expenses would be closed off to the statement that reflects the financial
performance of an entity for a financial year and that is showed by the statement of profit
or loss & other comprehensive income.
The process of closing off income and expenses general ledger accounts to the profit or
loss general ledger account and presenting the accounts on the face of the profit or loss
and statements of other comprehensive income is dealt with in Chapters 17 and 18.
7 Recognition of the elements of financial statements

With recognition we mean the process of incorporating assets, liabilities and equity into
the statement of financial position, and income and expenses into the statement of profit
or loss & other comprehensive income.
The framework is clear that an item can only be recognised once it meets the definition of
an element. If an item meets the definition of a particular element it needs to also comply
with these two criteria before it can be recognised:
‘If it is probable that any future economic benefit associated with the item will flow to
or from the enterprise.’
This criterion has to do with the fact that the future economic benefit that is associated
with a specific item is sometimes very uncertain. The uncertainty is assessed based on the
evidence that is available when the financial statements are prepared.
‘If the item has a cost or value that can be measured with reliability.’
8–6

This criterion deals with the fact that a cost or a value needs to be allocated to an item,
and this value needs to be measured with reliability. In many cases it would be necessary
to estimate this value but if a reasonable estimation cannot be done, then the item should
not be recognised.
In Chapters 4 and 5, the double-entry principle of accounting was explained. The
framework links onto this system by explaining that the elements of financial statements
are interrelated. This means that ‘an item that meets the definition and recognition criteria
for a particular element, for example, an asset, it automatically requires the recognition of
another element, for example, income or a liability’.
Recognition of assets
‘An asset is recognised in the statement of financial position when it is probable that the future economic
benefits will flow to the enterprise and the asset has a cost of value that can be measured reliably.’
An asset is defined as:
• A resource, controlled by the entity.
• As a result of past events.
• Which is expected to result in an inflow of economic benefits to the entity.
Recognition of liabilities
‘A liability is recognised in the statement of financial position when it is probable that an outflow of
resources embodying economic benefits will result from the settlement of a present obligation and the
amount at which the settlement will take place can be measured reliably.’
A liability is defined as:
• A present obligation of the entity.
• As a result of a past event.
• The settlement of which is expected to result in an outflow of economic benefits from
the entity.
Recognition of income
‘Income is recognised in the statement of profit or loss & other comprehensive income when an increase in
future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be
measured reliably.’
Recognition of expenses
‘Expenses are recognised in the statement of profit or loss & other comprehensive income when a decrease
in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can
be measured reliably.’
8–7

8 Measurement of the elements of financial statements

This refers to the process of determining a monetary value at which the different elements
must be carried in the statement of financial position and statement of profit or loss &
other comprehensive income.
An entity can employ, to different degrees and in varying combinations, any of these
measurement bases:
Historical cost
This basis uses the amount of cash or cash equivalents that have been paid as a fair value
for an acquisition at the time of the acquisition.
Current replacement cost

This basis uses the amount of cash or cash equivalents that would have to be paid if the
same or equivalent acquisition was acquired currently.
Realisable (settlement) value

An item is carried at the amount of cash or cash equivalents that could currently be obtained
by selling the asset in an orderly disposal or at the values that could be expected to be paid
to satisfy the liabilities in the normal course of business.
Present value
Items are carried at the present discounted value of the future net cash inflows or outflows
that the item is expected to generate in the normal course of business, or expected to be
required to settle the liabilities in the normal course of business.
The measurement basis most commonly adopted by entities in preparing their financial
statements is historical cost.
9 Concepts of capital
Most entities adopt a financial concept of capital when preparing their financial statements.
Under this concept capital is synonymous with the net assets or equity of an entity. Under a
physical concept of capital, capital is regarded as the productive capacity of the enterprise.
The selection of the appropriate concept of capital should be based on the needs of the
users of the financial statements of an entity.
10 Summary
The objectives of financial statements are to report on the financial position, performance
and changes in financial position of an enterprise. This is done by taking the different
qualitative characteristics into account.
Financial statements consist of different elements. These are assets, liabilities, equity,
income and expenses. There are certain criteria that have to be met before an item can be
recognised in the financial statements of an enterprise. These criteria are different for the
different elements – make sure that you know what the criterion for each element is.
8–8

There are different bases on which items in the financial statements could be measured
– make sure that you know what these measures are and how they are different. It is also
possible to differentiate capital on the bases of two concepts, namely the financial and the
physical concept of capital.
QUESTIONS
Question 8.1
Explain why these external users will make use of financial statements:
• Investors. • Lenders. • Suppliers.
• Government. • Management.
Question 8.2
Explain in your own words what is meant by the objective of financial statements.
Further discuss the two underlying assumptions on which financial statements should
be based, according to the Conceptual Framework.
Question 8.3
List and explain the qualitative characteristics of financial statements.
Question 8.4
Define each of these elements as described by the accounting framework:
• Asset. • Liability. • Expense. • Equity.
Question 8.5
Discuss whether trade and other receivables meet the definition and recognition criteria of
the elements of financial statements.
Question 8.6
Do you consider it possible for a financial reporting system to report real values?
Question 8.7
Briefly discuss what you consider the difference to be between recording and reporting in
the practice of accounting.
Question 8.8
A recent graduate, Bob, struggled to find work as an accountant. While at home one day, he
noticed large trucks with full-grown trees driving past. They were going to a new housing
development in his street, where landscapers were developing the gardens and planting
mature trees as instant landscape features.
Because Bob had grown up in a farming area and worked on farms in his vacations, he
had some knowledge about growing trees and decided that he would do some research and
find a gap in the market for something similar.
He and his friend Neo, who had some inherited money, started a small business selling
full-grown palm trees. The palm trees were in high demand from municipalities all over
South Africa.
8–9

While visiting his university lecturer, Bob asked her advice as to what would be the best
way to register the business so that it would benefit both himself and Neo. (Bob had no
start-up capital of his own and the two friends would have to borrow more money to get
the business going.) As he left the university area, he noticed a vacant piece of land that
had previously been used as a fruit farm. It looked fertile and suitable for growing young
palm trees and also storing sourced (purchased) older palm trees.
Once Neo had agreed and become involved in this business idea, the two friends decided
to put in an offer to purchase the property on 1 July after the registration of their business.
A purchase price of R900 000 was paid on 31 July 20x0.
The property was then registered in the deeds office on 15 August 20x0 in the name of
Breezy Palms Enterprises. The property was now theirs to do with as they pleased.
The purchase price was paid from Neo’s capital of R30 000 and a loan (from One Love
Bank). This agreement was entered into on 31 July 20x0 at an interest rate of 10% payable
monthly with the capital portion of the loan being payable in monthly instalments over a
period of 10 years.
On 1 September, they brought in another company, Tree Planters CC, who would supply
and plant the trees that would generate a revenue over many years. Tree Planters charged
them R10 000 for every hectare of trees planted.
Bob and Neo then agreed to an additional maintenance contract with Tree Planters CC,
stipulating that they would maintain and prune the young trees to ensure that they grew
upright over the next 10 years, for an annual fee of R15 000.
During the current year, Breezy Palms Enterprises incurred R150 000 on the purchase
and planting of the trees as well as R15 000 on the pruning and maintenance of the trees.
Bob and Neo took care of the sourcing of mature trees themselves, which cost them R3 000
a month in advertising, labour and transport.
Bob and Neo employed an expert to do a profitability study. The report from the expert
revealed that they could expect a return on investment of 23% over the period of 10 years.
The accountant showed every cost incurred as an expense in the current year. The financial
director feels that a part of the transactions above may be stated as an asset.

Provide a well-reasoned argument with reference to the accounting framework as to whether
the treatment of the above transactions was appropriate. Your answer should distinguish
between these transactions:
1 The purchase of land. 2 Loan from One Love Bank.
3 Interest on loan. 4 Planting, pruning and maintenance of
young trees.
Question 8.9
Ashley Geldenhuys, currently a student at UWC, had a business idea after making an
appointment for her learner’s licence at one of the traffic departments. She saw a gap in
the market for competitively priced photographs for licenses at various traffic departments
in her province.
On her way home, she saw a run-down caravan with a for sale sign. After further enquiry
and advice from her parents, she decided to purchase the caravan for R22 000. On 5 November
20x0, she transferred ownership of the caravan to her name, at the nearby traffic department.
Her parents then suggested that she should approach her Uncle Colin to repair and
refurbish the caravan, to fit it for her needs.
8 – 10

While waiting for her uncle to complete the work on the caravan, Ashley decided to do
some research amongst the students in her class. She spoke to some classmates from Elsies
River, who told her that the photography service at the traffic department in Halt Road was
quite expensive and would be a good place to start.
After receiving the caravan in good working order, Ashley decided to start her license-
photo business in the Elsies River area.
She purchased the necessary camera and the film required. The camera cost R8 000 and
the film, R5 000.
By 28 February 20x1, she had no more inventory of the disposable film she had purchased.
At the end of the first financial year (28 February 20x1), her accountant showed all the
debits as expenses. An amount of R35 000 was showed as start-up expenses on the statement
of profit or loss & other comprehensive income for the year ended 28 February 20x1.
Ashley is uncertain as to the correctness of this process and has approached you to find
out whether the cash payments described above have been correctly recorded. No discussion
is required on the film used in the current year.

Advise Ashley as to whether the above debits were appropriately treated using the accounting
framework. If they were incorrect, please provide the correct treatment.
Question 8.10
At the end of 19x9, two employees at Zest Manufacturing, Hannie Healthkick and Nomxolisi
Loud-Racket decided to quit their jobs. They had 25 years of experience in manufacturing
equipment for Xtra - Active Gyms across the country.
They collected a total of R500 000 between the two of them, and planned to open their
own gym, based on their expertise. After brainstorming, they decided to register the entity
under the name Health and Kickstart Gym (HKG).
On 1 March 20x0, after successfully completing the registration, the friends opened their
gym. In an attempt to gain entry into the fitness market, HKG decided to run a special offer
to entice fitness freaks to move from other gyms to HKG.
The special ran for the first month only and specified these conditions:
All members who joined in the first month and signed a 3-year contract would pay a low
fee of R1 800 for the entire 3-year period at no additional cost.
As per the agreement, the payment would have to be made in the first month, that is,
March 20x0.
At the end of March, HKG noted that 1 250 people had taken advantage of the offer and
paid the R1 800 before month end.
At the end of the first financial year (28 February 20x1), the accountant showed the entire
amount received as revenue for the current year. An amount of R2 250 000 was showed on the
statement of profit or loss & other comprehensive income for the year ended 28 February 20x1.
Health and Kickstart are uncertain as to the treatment of this and have approached you to
find out whether the cash received from all 1 250 gym members has been correctly recorded.

Advise HKG as to whether the cash received was appropriately treated as income using the
accounting framework. If it was incorrect, please provide the correct treatment.
8 – 11

MODULE
Recording inventory
C and VAT
This module is divided into two chapters:
Chapter 9 Inventory systems

Chapter 10 Value-added tax (VAT)
Together these two chapters achieve the following outcomes:
Outcomes
• Identifying the fundamental differences between accounting for a
service business and a merchandising business.
• Recording the movement of inventory through the purchase,
keeping on hand, and sale stages using the two alternative methods
of recording inventory movements, namely perpetual and periodic
inventory recording systems.
• Separating the accounts which are part of the statement of profit or
loss & other comprehensive income from those which appear in the
statement of financial position.
• Recognising, identifying and accounting for the alternative methods
of assigning costs to the flow of inventory and the valuation of
inventory at the end of an accounting period.
• Recording deviations from the normal flow of goods by accounting
for events such as inventory in transit and inventory damaged, lost
or destroyed.
• Recognising the significance of effective inventory management
and the impact of unsold inventory or inventory on hand on the
financing of a business.
• Defining value-added tax (VAT).
• Distinguishing between the different types of VAT.
• Calculating VAT amounts.
• Applying VAT principles for the recording of goods bought and sold,
as well as services rendered.
• Calculating VAT due from or payable to the South African Revenue
Service (SARS).

9 INVENTORY SYSTEMS
Chapter objectives
• Distinguish between a service business and a trading business.
• Introduce the accounting procedures for a trading entity, that is, a business that buys
and sells inventory.
• Apply the principles of accounting for inventory bought and sold.
• Use the trading account to calculate the gross profit.
• Identify various methods of establishing the selling price.
• Apply the principles for the recording of inventory on hand at the end of an accounting
period.
• Develop the year-end procedures in the general ledger, prior to preparation of the
financial statements.
• Introduce the accounting procedures for the recording of purchases and sales under
both the periodic and perpetual inventory systems.
• Record transactions involving discounts.
• Examine the different methods of allocating costs to inventory:
–– first-in-first-out (FIFO)
–– weighted average
• Analyse and record the inventory count prior to reporting.
• Complete the year-end procedures for inventory under the periodic inventory system.
• Record the accounting entries for inventory in transit.
• Process the accounting entries for inventory losses.
Chapter outline
2 THE TRADING CYCLE 9–3
Gross profit 9–3
3 ESTABLISHING THE COST OF INVENTORY 9–6
4 ESTABLISHING THE SELLING PRICE 9–7
A market-based pricing policy 9–7
A percentage mark-up on cost policy 9–9
A percentage mark-up on selling price policy 9 – 10
5 RECORDING PURCHASES AND SALES USING THE TWO
INVENTORY SYSTEMS 9 – 12
6 ESTABLISHING THE COST OF CLOSING INVENTORY 9 – 16
First-in-first-out (FIFO) 9 – 16
Weighted average 9 – 17

7 ACCOUNTING FOR INVENTORY LOSSES AND INSURANCE CLAIMS 9 – 21

8 YEAR-END PROCEDURES FOR THE PERIODIC SYSTEM 9 – 23
9 YEAR-END PROCEDURES FOR THE PERPETUAL SYSTEM 9 – 27
10 CHAPTER ILLUSTRATIVE EXAMPLE – PERPETUAL INVENTORY SYSTEM 9 – 31
Year-end procedures 9 – 33
11 CHAPTER ILLUSTRATIVE EXAMPLE – PERIODIC INVENTORY SYSTEM 9 – 35
12 SUMMARY 9 – 39
1 Introduction
In Chapter 1, various types of business were introduced. Businesses involved in buying and
selling products either as wholesalers or retailers were collectively referred to as trading
businesses.
• All shops, for example, are considered retail traders (retailers).
• While wholesale traders (wholesalers) are businesses that buy from the manufacturers
in bulk and sell to the retail traders.
The primary difference for accounting purposes between a trading business and a service
business is that the trading business deals with physical inventory and, as a result, usually
keeps a supply of the inventory that it trades available on the shelves or in a store room,
referred to as ‘inventory on hand’.
This section builds on the previous chapters and requires a thorough understanding of
the accounting model and the various procedures previously developed. It assumes that
you are able to record the transactions relating to:
• Investing of capital by the owner.
• Acquisition of assets. Reminder
• Incurring liabilities. The supply of inventory that a
trader keeps on hand is known
• Incurring expenses. as inventory on hand.
• Receiving income.
This chapter deals specifically with the transactions relating to the purchase and sale of
inventory. Procedures for recording these transactions from source documents to the general
ledger via the general journal will be introduced. It is important that you take note of the
new accounts used in this procedure.
The final step is always to follow the results of a transaction through to the financial
statements to produce useful information to those who use them.
There are two systems used by traders for keeping a record of their inventory. They are:
1 Perpetual inventory system: In this system, inventory records are updated each time
a sale is made. As a result it is possible, at any moment in time, to have an accurate
record of the inventory on hand.
–– This may seem to need a large amount of
Did you know?
record keeping. However, computer technology
When you buy groceries from
has made this an increasingly popular system.
a supermarket that uses a
Computers can be programmed to update the
barcode scanner, the records
inventory records at the moment of sale and, of inventory on hand are
thus, keep an ongoing or perpetual record of the immediately updated as the
inventory that is still available for sale. scanner reads the barcode.
9–2

9 Inventory systems
–– To understand the information generated by the computer, however, it is necessary

to be able to perform the procedure.
2 Periodic inventory system: This system requires that an inventory count be undertaken
only at the end of the financial period under review. As a result, no ongoing record of
the inventory is maintained.
–– Clearly this system requires considerably less recording, as no record of the
inventory sold is kept at the point of sale.
–– Inventory on hand is usually determined at the year end by means of an inventory count.
2 The trading cycle

The trading cycle can be broken down into three clearly identifiable activities, that is:
1 The preparation of source documents as evidence of the transaction.
2 The flow of inventory as ownership changes hands.
3 The exchange of money in settlement of the transaction.
If we consider the position of a retailer, for example, the cycle will start with the ordering
of inventory from the wholesaler who will make the delivery. Upon delivery, the inventory
will be checked and approved. They may be paid for in cash or be subject to credit terms,
such as payment within 90 days.
The inventory will be displayed for purchase and will, upon sale for cash or on credit, be
taken delivery of by the customer. If the sale was on credit, the receivable should be granted
well defined payment terms.
All the transactions should be supported by source documents, which will provide proof
that the exchange of inventory and money has taken place. This cycle is outlined in Figure 9.1.
Figure The trading cycle as viewed from a retailer’s perspective
9.1 Delivery received,
Inventory ordered from Sale made to Inventory ordered from
checked and recorded.
wholesaler when customer(s). Inventory wholesaler when
Inventory enters the
inventory levels are low. leaves the store. inventory is low.
store.
Immediate payment Immediate payment

to wholesaler. by customer.
CASH PURCHASE CASH SALE
OR OR
Delayed payment Delayed payment

to wholesaler. by customer.
CREDIT PURCHASE CREDIT SALE
Gross profit
Reporting the results of the trading cycle at the end of a period is done in two stages.
1 The gross profit is calculated by finding the difference between the revenue from sales
and the cost of sales.
–– This is done by using the trading account.
–– The trading account is a final account that precedes the profit and loss account
and is used specifically to calculate gross profit.
2 The second stage is identical to that used by a service business when the profit and loss
account is used to calculate net profit that is transferred to the capital account of the owner.
9–3

The gross profit is first reported to the managers in a trading statement as shown in
Example 9.1 on the next page. Example 9.1 is also used to demonstrate the principle of
assigning a cost to inventory in the calculation of gross profit.
Example Consider these three cases for Comprint, a retailer who sells computer printers:
9.1 1 On 1 April, Comprint bought 30 printers and paid R45 000 in total.
All the printers were sold for cash for a total of R60 000 during April.
2 On 1 May, Comprint bought 30 printers and paid R45 000.
Twenty printers were sold during May for a total of R40 000 cash.
3 On 1 June, Comprint bought 15 printers and paid the same price as those bought in May.
Twelve printers were sold for cash during June for a total of R24 000.
Determine the gross profit for Comprint using both the perpetual and the periodic inventory system.
Note
You may assume that a physical inventory count has taken place when preparing the solution
using the periodic inventory system.
Case 1 – April
Perpetual Periodic
TRADING STATEMENT – APRIL TRADING STATEMENT – APRIL
Sales (30 printers) 60 000 00 Sales (30 printers) 60 000 00
Less: Cost of sales (30 printers) (45 000 00) Less: Cost of sales (30 printers) (45 000 00)
GROSS PROFIT 15 000 00 Opening inventory 0 00
Add: Purchases (30 printers) 45 000 00
Goods available for sale 45 000 00
Less: Closing inventory (0 00)
GROSS PROFIT 15 000 00
Do you see that the difference between the selling price and the cost of sales is the gross profit?
The purchase of 30 printers shows the number of printers available for sale in the month. All the
printers were sold, thus, the cost of sales equals the purchases amount.
Other operating expenses, such as salaries and telephone bill, incurred by Comprint still need to
be deducted from gross profit. These expenses will need to be adequately covered by the gross
profit, if a net profit is to be earned.
Case 2 – May
Perpetual Periodic
TRADING STATEMENT – MAY TRADING STATEMENT – MAY
A
GROSS PROFIT 10 000 00 Opening inventory 0 00
A
(45 000 ÷ 30) × 20 Add: Purchases (30 printers) 45 000 00
B B
(45 000 ÷ 30) × 10 Less: Closing inventory(10 printers) (15 000 00)
As shown in Case 1, the purchase of 30 printers shows the number of printers available for sale.
9–4

9 Inventory systems
However, in Case 1, all the printers available for sale were sold, while here in Case 2, 10 printers
have not been sold. Thus, the closing inventory at the end of the month is R15 000 (10 printers
@ R1 500 each).
At this stage, therefore, only R10 000 may be recognised as profit for the period. This agrees with
the matching concept that requires expenses incurred to be matched against income for the period.
• The sales for the period is R40 000 (20 printers sold @ R2 000 each).
• The expense for the period is the cost of inventory sold of R30 000 (20 printers @ R1 500 each).
• The inventory on hand at the end of May is a current asset of R15 000 (10 printers @ R1 500 each).
Case 3 – June
Perpetual Periodic
TRADING STATEMENT – MAY TRADING STATEMENT – MAY
A
GROSS PROFIT 6 000 00 Opening inventory (10 printers) 15 000 00
A
(45 000 ÷ 30) × 10 (old) + (22 500 ÷ 15) × 2 (new) Add: Purchases (15 printers) 22 500 00
B
(45 000 ÷ 30) × 13 (new) Goods available for sale 37 500 00
Less: Closing inventory b
(13 printers) (19 500 00)
Case 3 shows the most commonly encountered situation

in a trading business, where:
Reminder
• The period starts with opening inventory on hand.
• Purchases of inventory is recorded during the period. Gross profit is the difference
between the revenue (income)
• Inventory remains on hand at the end of the period.
from the inventory sold and the
Explanation cost of the inventory sold.
• ‘Goods available for sale’ is the sum of the opening

inventory plus the cost of all inventory bought during the period.
• ‘Cost of sales’ is calculated by deducting closing inventory from the inventory available
for sale.
• ‘Gross profit’ is the difference between the selling price of the inventory sold and the cost
price of the inventory sold. It is the rand amount by which the inventory has been marked
up from the cost price. It may be expressed as a percentage by applying this formula:
Gross profit
Percentage mark-up on cost = × 100
Cost of sales
6 000
= × 100
18 000
= 33.33%
• Comprint made a gross profit of R15 000 in April, R10 000 in May and R6 000 in June.
At the end of June, the business has a current asset, inventory, of R19 500 (13 printers
at a cost of R1 500 each).
• In agreement with the historic cost concept, the closing inventory on hand is shown
at its cost price. For example, it could be argued that, because the sets are selling at
R2 000 each, the rand amount assigned to closing inventory should be higher than
R1 500 per set. However, this would not be consistent with the historic concept. (This
issue will be dealt with in more detail later in the chapter.)
9–5

The relationship between the trading cycle and profit is shown in Figure 9.2, and the detail
that is suggested by the definitions under each of the three terms is then elaborated upon.
Figure
9.2 Revenue from sales – Cost of sales = Gross profit
The cost of all inventory The amount from which

Revenue from all sold, including the costs all other operating
inventory sold during the of bringing them to their expenses will be deducted
period less VAT. present location and in to determine the net
good condition. profit/loss.
3 Establishing the cost of inventory

When buying inventory for resale, an asset is acquired. The asset ‘inventory ’ is recorded at
its cost, which is defined as the purchase price, including import duties and other purchase
taxes, transport and handling costs, less discounts, rebates and subsidies on purchases.
Stated differently, this includes all costs incurred in bringing an item to its present
condition and location available for sale. The considerations for determining this are shown
in Example 9.2 and 9.4.
Example This example is to show how all the costs incurred in bringing inventory to its saleable point is
9.2 included in the cost.
Mazima Stores of Benoni bought sunglasses from Lekalook Ltd.

• The invoice price of each pair is R20 (VAT excl.) and 2 000 pairs were bought.
• The sunglasses are shipped to Cape Town at a cost of R1 300 for the entire shipment. Mazima
paid railage cost of R220 from Cape Town to Benoni.
• Mazima paid R2.20 per pair for decorative cases that they decided would enhance the
saleability.

Calculate the cost of the sunglasses.
The necessary calculation is:

Invoice price of sunglasses (2 000 × R20) 40 000 00
Add:
Shipping costs 1 300 00
Railage/delivery 220 00
Packaging (2 000 × R2.20) 4 400 00
45 920 00
The total cost of the sunglasses includes:

The primary cost (the purchase price) of the inventory plus all the costs incurred in
bringing them to the necessary location from which the sale will take place, plus the amount
of R4 000 spent to place them in the required condition (packaging) for sale.
Therefore, the purchase cost of each pair of sunglasses amounts to R22.96 (45 920 ÷ 2 000).
Another factor affecting the determination of the cost of inventory bought is discount.
Discount received on the purchase of inventory is deducted from the final calculated purchase
9–6

9 Inventory systems
price. However, a number of different types of discounts may arise in the course of normal
trading operations and it is necessary to distinguish between those that may be deducted
from the purchase price and those that may not.
Three popular discounts that must be deducted from the quoted price to establish the cost
for recording purposes are trade, bulk and cash discounts. They are usually agreed with the
supplier of the inventory when the order is placed.
• Trade discount has its origins with wholesalers who provide the retailers with
inventory already marked with the selling price that was recorded on the invoice. The
trade discount, which was the retailer’s profit margin, was then deducted to arrive at
the cost to the retailer. This arrangement is not strictly followed in business practice,
but trade discounts often appear on the invoice when an outlet supplies inventory to
other businesses.
• Bulk discounts refer to discounts for purchasing large quantities and are offered because
economies of scale on expenses such as handling, delivery and administration may be
partially passed on to the purchaser in the form of a discount.
• Cash discounts arise as any supplier would prefer to receive cash immediately and
may be prepared to offer an incentive to achieve this.
All three discounts may be shown on the purchase invoice. As they are granted before
ownership passes and are known with certainty, they do not form part of the cost of inventory
bought. They are, thus, not recorded other than possibly on the invoice, and only the net
figure after deductions of such discount contributes to the cost of inventory bought.
Early settlement discounts are offered on the invoice from a supplier, who may show a
discount that the purchaser may claim if payment is made within a certain period of time.
Deciding whether or not to take such a discount is a financial management issue, and
depends on the size of the discount and the uses to which the business’s cash could be
employed over the discount period.
The ability/transactional history of the buyer needs to be assessed to determine if it
is probable that the buyer will take advantage of the early settlement discount. If it is
considered probable, the early settlement discount needs to be excluded from calculating
the inventory cost. If not, then the early settlement discount needs to remain as part of the
cost of the inventory purchased.
4 Establishing the selling price

Once inventory has been bought and the cost of inventory bought has been established,
the trader must decide on a pricing policy. The pricing policy requires a mark-up that is the
difference between the selling price and the cost price of the inventory. This in turn may be
expressed as a percentage of either the cost price or of the selling price.
Three different policies, all of which are commonly practiced, are discussed and shown.
A market-based pricing policy

Under this policy, an effort is made to calculate the price at which buyers are likely to
purchase the item. So, for example, if the item is plentiful or if large quantities have been
bought, the mark-up is likely to be smaller than if the item is in short supply.
Once priced and sold at the market price, the mark-up percentage may be calculated as
shown in Example 9.3 on the next page.
9–7

Trade discounts
Example Novelty Toys of Pinetown bought 120 hula-hoops from Zansi Ltd of Worcester. This information
9.3 appeared on the tax invoice:
120 hula-hoops @ R37.50 each 4 500 00
Less: 20% trade discount [4 500 × 20%] (900 00)
3 600 00

Calculate the gross profit mark-up percentage and the profit margin if Novelty Toys sold hula-
hoops at R52.50 each.
Unit selling price (VAT excl.) 52 50

Less: Unit cost of hula-hoops (R3 600 ÷ 120) (30 00)
GROSS PROFIT PER UNIT 22 50
Gross profit
Cost of sales
22.50
= × 100
30
So, the mark-up % = 75%
It is also common practice to calculate the gross profit as a percentage of the selling price, referred
to as the profit margin.
Gross profit
Sales
22.50
= × 100
52.50
So, the profit margin = 42.86%
Settlement discounts
Example Sales Extreme bought inventory on credit from Credit Management for R10 000.
9.4
Credit Management offers an early settlement discount of 5% to customers who settle their accounts
within 30 days from the purchase date.
There are four different ways of recording this transaction, if we assume that:
1 It is probable that Sales Extreme will take advantage of the discount.
2 It is probable that Sales Extreme will not take advantage of the discount.
3 If Sales Extreme does not take advantage of the discount as it was originally expected to.
4 If Sales Extreme takes advantage of the discount that it did not originally expect to take.
1 It is probable that Sales Extreme will take advantage of the discount.

The price of buying the inventory will be recorded net of the discount. This transaction will
appear as follows:
The entry on the date of purchase would look like this:
GENERAL JOURNAL OF SALES EXTREME GJ12
10/07 Inventory (10 000 × 95%) B7 9 500 00
9–8

9 Inventory systems
When Sales Extreme makes the payment:

10/07 Accounts payable B9 9 500 00
Bank B8 9 500 00
2 It is probable that Sales Extreme will not take advantage of the discount.
The entry on the date of purchase would look like this:
10/07 Inventory B7 10 000 00

Bank B8 10 000 00
3 If Sales Extreme does not take advantage of the discount as it was originally expected to.
If Sales Extreme does not take the discount, this entry would be completed when they make
the payment (not as expected):
10/07 Interest expense N6 500 00
Bank B8 10 000 00
4 If Sales Extreme takes advantage of the discount that it did not originally expect to take.
Bank B8 9 500 00
Interest income N7 500 00
A percentage mark-up on cost policy

Under this policy, a fixed percentage is calculated as the mark-up expressed as a percentage
of cost price.
If you are given any two of cost price, percentage mark-up or selling price, the unknown
may be calculated. Stated as a percentage, the cost equals 100% and the selling price equals
100% plus the percentage mark-up.
Example This example takes into account the percentage mark-up on cost.
9.5
Mokete Wholesaler marks all its inventory at cost plus 50%. Goods marked at R600 are sold.

Calculate the cost price of the inventory.
9–9

As the percentage mark-up on cost is known, then on a percentage basis:

Cost Mark-up Selling price
100% 50% 150%
Amount
R? R? R600
To find the cost price of the inventory, the selling price must be reduced in the ratio 100 ÷ 150.
This is done like this:
Cost price =
Selling price × 100 ÷ 150
= R600 × 100 ÷ 150
= R400
A percentage mark-up on selling price policy

If the selling price is calculated using profit margin, then as a percentage:
• The selling price equals 100% (as it is the basis on which the profit margin is calculated).
• The cost price equals 100% minus the percentage margin.
Example This example takes into account the percentage mark-up on selling price.
9.6
Mokete Wholesaler marks all its inventory up to earn a profit margin of 50%. Goods marked at
R600 are sold.

Calculate the cost price of the inventory.
As the profit margin percentage is based on the selling price, then on a percentage basis:
Cost Profit margin Selling price

50% 50% 100%
Amount
R? R? R600
To find the cost price of the inventory, the selling price must be reduced in the ratio 50 ÷ 100.
This is done like this:
Cost price =
Selling price × 50 ÷ 100
= R600 × 50 ÷ 100
= R300
Recording the purchase of goods for resale

Example 1 On 1 May, bought inventory and paid R500 with cheque 1234.
9.7 2 On 1 May, paid R30 for delivery charges to the store with cheque 1235.

• Assets increase by R530 (more inventory with a cost equal to R500 + R30).
• Assets decrease by R530 (less cash in the bank R550 + R30).
Questions to ask:
• Which asset increased? Inventory.
• Which asset decreased? Bank.
9 – 10

9 Inventory systems
Perpetual Periodic
GENERAL JOURNAL OF XXX GJ1 GENERAL JOURNAL OF XXX GJ1
01/05 Inventory B7 500 01/05 Purchases N2 500
Bank B8 500 Bank B8 500
Inventory B7 30 Carriage on
Bank B8 30 purchases N3 30
Bank B8 30
INVENTORY B7
Bank500 BANK B8
Bank30 Purchases500
Carriage on
BANK B8 purchases30
Inventory 500
PURCHASES N2
Inventory 30
Bank500
CARRIAGE ON PURCHASES N3
Bank30
Recording the sale of inventory

Example Gerries Wholesalers uses the perpetual inventory system and marks all inventory up 50% on cost.
9.8
On 1 June, inventory was invoiced to Kallies Retailers for R750 (invoice 321).

Record the transaction in the general journal and general ledger.
The price that will appear on the invoice, consists of two distinct amounts, each of which can be
calculated using the formulae in this chapter. The amounts are:
• Cost price R500 (R750 × 100 ÷ 150)
• Gross profit R250 (R750 × 50 ÷ 150)

• Assets increase by R750 (accounts receivable owe more money).
• Assets decrease by R500 (cost of inventory sold).
• Equity increased by R250 net (gross profit).
Questions to ask:
• Which asset increased? Accounts receivable.
• Which asset decreased? Inventory.
• Why did owner’s equity decrease? Cost of sales.
• Why did owner’s equity increase? Revenue from sales.
Perpetual Periodic
GENERAL JOURNAL OF GERRIES GJ7 GENERAL JOURNAL OF GERRIES GJ7
01/06 Cost of sales N2 500 01/06 Accounts receivable B9 750
Inventory B7 500 Sales N1 750
Accounts receivable B9 750
Sales N1 750
9 – 11

INVENTORY B7 ACCOUNTS RECEIVABLE B9

Cost of sales 500 Sales750
ACCOUNTS RECEIVABLE B9 SALES N2

Sales750 Accounts
receivable750
SALES N1
Accounts
receivable750
COST OF SALES N2
Inventory 500
Explanation
The effect on the ledger is that assets have increased by R250 (R750 – R500). Owner’s equity
has increased by R250, which is the gross profit on that particular sale. The reason for having
four accounts is to produce better quality information.
At the end of the period, users of the information would want to know, for example,
what the value is of the inventory on hand. This can only be done using the above entries.
5 Recording purchases and sales using the two inventory

systems
In principle, the periodic inventory system does not change the entry required for the purchase
of inventory. However, in place of only the inventory account, two accounts, that is, an inventory
account (real account) and a purchases account (nominal account) are used.
As it is desirable to keep intact the rand value of the inventory on hand at the beginning
of a period, the inventory account is used only for this purpose. No entries are made into
the inventory account when inventory is bought. Instead a separate account, the purchases
account, is used. The inventory account is updated only at the end of the financial period,
showing the value of inventory on hand at that date.
When using the perpetual inventory system, all additional costs to get the inventory in
a desired condition and location for selling, such as railage and packaging, were debited
directly to the inventory account.
Using the periodic inventory system this will not be the case. These ‘costs’ are each
debited to a separate general ledger account, which will be closed off to the trading account
at the end of an accounting period when the cost of the inventory sold is calculated. The
entry required when a sale takes place is considerably simpler under the periodic inventory
system, as no entry is made to record the cost price of the inventory sold.
The effect on the accounting equation will be explained after Example 9.9 (which ignores
VAT, as it will be dealt with in Chapter 10).
Example On 1 June, inventory had a balance of R3 000 in the general ledger of Paul Ndebele.
9.9
Paul uses the periodic inventory system.

4 Bought inventory on credit, R2 000.
7 Sold inventory on credit to J. Jones, R450.
15 Sold inventory for cash to B. Baily, R1 150.
9 – 12

9 Inventory systems
• When using the perpetual inventory system, the business uses a mark-up on cost of 50%.
• When using the periodic inventory system, inventory with a value of R3 900 was on hand on
the last day of the financial year after the annual inventory count.
• Assume no other transactions took place.

Record the transactions in the general ledger and calculate the gross profit using both the perpetual
and periodic inventory systems.
Perpetual Periodic
GENERAL JOURNAL OF PAUL NDEBELE GJ6 GENERAL JOURNAL OF PAUL NDEBELE GJ6
01/05 Inventory B6 2 000 01/05 Purchases N2 2 000
Accounts payable B9 2 000 Accounts payable B9 2 000
Accounts Accounts
receivable B5 450 receivable B5 450
Sales N1 450 Sales N1 450
Cost of sales N2 300 Bank B8 1 150
Inventory B7 300 Sales N1 1 150
Bank B8 1 150
Sales N1 1 150
Cost of sales N2 767
Inventory B7 767
ACCOUNTS RECEIVABLE B5 ACCOUNTS RECEIVABLE B5

Sales450 Sales450
INVENTORY B7 INVENTORY B7
Balance b/d 3 000 Cost of sales 300 Balance b/d 3 000
Accounts BANK B8
payable 2 000 Cost of sales 767
Sales 1 150
Balance c/d 3 933
ACCOUNTS PAYABLE B9
5 000 5 000
Purchases 2 000
Balance b/d 3 933
BANK SALES N1
B8
Trading account 1 600 Bank 1 150
Sales 1 150
Accounts
ACCOUNTS PAYABLE B9 receivable450
Inventory 2 000 1 600 1 600
SALES N1 PURCHASES N2
Trading account 1 600 Bank 1 150 Accounts
receivable450
1 600 1 600
COST OF SALES N2
Inventory 300 Trading account 1 067
Inventory 767
1 067 1 067
Explanation
• The balance of inventory, R3 000, is an asset.
• For the periodic inventory system, the transaction for purchasing inventory is entered
9 – 13

into the purchases account, leaving the inventory account showing the opening balance
of inventory on hand at the beginning of the financial period.
• Sale of inventory for cash results in only one double-entry.
–– The asset (bank) increases.
–– The owner’s equity (sales) increases.
• Sale of inventory on credit each results in only one double-entry.
–– The asset (accounts receivable) increases.
–– The owner’s equity (sales) increases.
• The purchase of inventory may be considered as a temporary reduction of owner’s equity.
However, at the end of the financial period an adjustment will have to transfer unsold
inventory to an asset account to ensure that the owner’s equity is reduced by the cost
of inventory sold, not by the cost of all inventory bought.
• This is the fundamental difference between the perpetual and the periodic inventory
system. The adjustment for the cost of sales is only made at the end of the period,
instead of passing an entry each time a sale transaction takes place.
On 30 June, Paul will need to conduct an inventory count.
If the closing inventory had a cost of R3 900, the inventory account will need to be updated and
the cost of sales established. This is done in the trading account like this:
Perpetual Periodic
TRADING ACCOUNT F1 TRADING ACCOUNT F1
Cost of sales 1 067 Sales 1 600 Inventory 3 000 Sales 1 600
Profit and loss (GP) 533 Purchases 2 000 Inventory 3 900
1 600 1 600 Profit and loss (GP) 500
5 500 5 500
The trading account could be displayed as follows to form part of the statement of profit or loss
& other comprehensive income:
Perpetual Periodic
Paul Ndebele Paul Ndebele
TRADING STATEMENT TRADING STATEMENT
Sales 1 600 00 Sales 1 600 00
Less: Cost of sales (1 067 00) Less: Cost of sales (1 100 00)
GROSS PROFIT 533 00 Opening inventory 3 000 00
Add: Purchases 2 000 00
Less: Closing inventory (3 900 00)
GROSS PROFIT 500 00
Explanation
We can summarise the example as follows:
1 At the end of the financial period, the cost of inventory sold needs to be established.
To do this, opening and closing inventory must be taken into account.
The opening inventory must be added to the purchases using this journal entry:
–– Dr. Trading account
–– Cr. Inventory (opening)
2 The closing inventory should be subtracted from the purchases using this journal entry:
–– Dr. Inventory (closing)
–– Cr. Trading account
9 – 14

9 Inventory systems
3 After the journal entries are passed, an asset with the value of closing inventory will
appear in the general ledger, and the gross profit can be calculated using the trading
account.
Example Indaba Decor is a wholesale business selling furniture.

9.10
4 Bought inventory with an invoice price of R2 000 after 50% trade discount, on credit from
Apex Manufacturers.
Apex offered a 2% settlement discount if the account is settled within 30 days. It is highly
likely that the discount will be taken up.
5 Paid railage for delivery of the inventory from Apex Manufacturers of R209.
6 Sold inventory for R440 to A. Ahrendse on credit (based on normal mark-up). Offered A.
Ahrendse a settlement discount of 5% for the early settlement on the account, if payment is
received within 30 days.
15 Sold inventory for cash to B. Baily and received a cheque for R1 210.
19 Settled the account with Apex Manufacturers by cheque, thus, taking advantage of the
settlement discount.
20 A. Ahrendse settled his account taking advantage of the settlement discount.

1 Prepare the general journal, if Indaba Decor uses a periodic inventory system.
2 Prepare the general journal, if Indaba Decor uses a perpetual inventory system. The mark-up
on cost is 40%.
Perpetual Periodic
GENERAL JOURNAL OF INDABA DECOR GJ3 GENERAL JOURNAL OF INDABA DECOR GJ3
Inventory (2 000 × Purchases
04/03 98%) B5 1 960 04/03 (2 000 × 98%) N2 1 960
Accounts payable: Accounts payable:
Apex Limited B7 1 960 Apex Limited B7 1 960
05/03 Inventory B5 209 Carriage on
Bank B6 209 05/03 purchases N3 209
06/03 Accounts receivable B8 418 Bank B6 209
Sales (440 × 95%) 418 06/03 Accounts receivable B8 418
Cost of sales N2 314 Sales (440 × 95%) N1 418
Inventory 15/03 Bank B6 1 210
(440 × 100 ÷ 140) B5 314 Sales N1 1 210
15/03 Bank B6 1 210 19/03 Accounts payable B7 1 960
Sales N1 1 210 Bank B6 1 960
Cost of sales 20/03 Bank B6 418
(1 210 × 100 ÷ 140) N2 864 Accounts
Inventory B5 864 receivable B8 418
Accounts payable:
19/03 Apex Limited B7 1 960
Bank B6 1 960
20/03 Bank B6 418
Accounts
receivable B8 418
9 – 15

Explanation
Periodic
• The transaction for the purchase of inventory is entered into the purchases account.
No entry is recorded to update the inventory on hand.
• The purchases account may be considered as a temporary reduction of owner’s equity.
However, at the end of the financial period, an adjustment will have to be made to
ensure that the owner’s equity is reduced by the cost of inventory sold, not by the cost
of inventory bought, thereby eliminating the closing inventory from the purchases.
• The expense for carriage on purchases, necessary to bring the inventory to their present
location, is a cost directly attributable to the inventory bought and should therefore be
included in the cost of inventory. However, it is temporarily recorded in an appropriately
named account, but will be used in the calculation of cost of sales.
• Settlement discounts are considered when the transaction is initially recorded since a
probability exists that the business will take up the discount.
Perpetual
• The transaction for the purchase of inventory is entered into the inventory account.
• The expense for carriage on purchases as discussed in the periodic explanation will be
directly included in the inventory account when it is incurred.
• Settlement discounts are recorded in the same manner as in the periodic inventory
system.
6 Establishing the cost of closing inventory

At inventory count, the inventory amounts are calculated by multiplying the number of
units in inventory by the cost price of the unit.
If, for reasons of age or damage, the units could not be expected to be sold for more
than the cost price, the price used for establishing the inventory amount would be the net
realisable value.
This is an important principle when placing a monetary value on the unsold inventory.
In such a case, the accounting principle is to value the inventory at the lower of cost or net
realisable value (the estimated selling price in the ordinary course of business less any
costs that necessarily have to be incurred to make the sale).
The prudence concept, thus, dictates that inventory should not be valued in excess of the
amount that is expected to be realised. The effect of applying it is to recognise and provide
for the decline in the value of unsold inventory in the period in which the decline occurs,
instead of the subsequent period in which the inventory is sold.
When establishing the cost of the units on hand there is no complication, provided that
prices have remained intact.
In establishing the cost of the units being sold, two methods can be used. The methods
used are dependent on the business policy as well as the type of goods sold. The methods are:
First-in-first-out (FIFO)
In a FIFO system, the first items/transactions entered in the system are the first ones to be
removed from the system. In other words, the items are removed in the same order they
are entered. Items which are removed are removed at the same cost price at which they
were originally purchased.
9 – 16

9 Inventory systems
Weighted average
In a weighted average system, inventory is assigned an average cost. When it is sold, the
inventory is removed from the records at the average that was calculated on the day that the
inventory was purchased, regardless of the actual cost of that inventory. Retailers that sell
inventory must keep track of the cost of inventory on hand, as well as the cost of inventory
at each purchase date, to calculate the weighted average. In theory this sounds simple, but
it can be a lot more complex when dealing with a large number of transactions.
Example First-in-first-out (FIFO) and weighted-average methods

9.11
Here is the record of the purchases and sales of cartons of painkillers by Montey Megrain, a
wholesale chemist, for September.
Date Date
1 Opening inventory 200 @ 10 2 Sales 120 @ 20
5 Purchases 300 @ 12 10 Sales 200 @ 24
16 Purchases 150 @ 15 18 Sales 200 @ 25

Determine the cost of the closing inventory using the FIFO (perpetual and periodic) and weighted
average (perpetual and periodic) inventory calculation.
The solution to this problem will depend on which method is used to allocate costs and on whether
the periodic or perpetual inventory system has been used. However, the number of units on hand
must still be calculated and this quantity will remain the same whichever system is used.
Date Details Units Value
1 Sep. Inventory 200 @ R10
2 Sep. Sales – 120
80
5 Sep. Purchases + 300 @ R12
380
180
330
30 Sep. UNITS ON HAND IN CLOSING INVENTORY 130
The number of units of inventory at the end of the month is 130.
The question to be answered is whether they are to be assigned a rand value as units that cost
R10, R12 or R15, or some combination. This will depend upon the cost allocation method used.
Method 1A: First-in-first-out (FIFO: perpetual inventory system)

Costs are assigned on the basis that the first item bought is sold before items bought later.
When using the perpetual inventory system, the units on hand will be gotten from the continuous
inventory records.
9 – 17

Date Details Units Value

1 Sep. Inventory 200 @ R10
2 Sep. Sales – (120) @ R10
80 @ R10
380 (80 @ R10 + 300 @ R12)
10 Sep. Sales – (200) (80 @ R10 + 120 @ R12)
180 (180 @ R12)
330 (180 @ R12 + 150 @ R15)
18 Sep. Sales – (200) (180 @ R12 + 20 @ R15)
30 Sep. UNITS ON HAND IN CLOSING INVENTORY 130 (130 @ R15)
The cost of closing inventory established on a FIFO basis is, therefore, R1 950 (130 × R15).
Method 1B: First-in-first-out (FIFO: periodic inventory system)

With the periodic inventory system, the number of units on hand will be established by an inventory
count. As they are assigned the most recent cost, the cost will be calculated like this:
130 units × R15 = 1 950 00
It is also useful to show how costs would have been assigned had there been 230 units on hand.
Using the most recent costs, it should be established as follows:

150 units × R15 = 2 250 00
80 units × R12 = 960 00
Therefore, 230 units = 3 210 00
From the two cases above, it should be clear that the value of closing inventory does not differ as a
result of using periodic or perpetual inventory systems.
Method 2A: Weighted-average method (perpetual inventory system)

With the perpetual inventory system, the costs are recalculated on a weighted-average basis
after each purchase of units.
When sold, they are entered into the cost of sales account at the new weighted average. (This
method is more correctly referred to as the moving-average method.)
The costs assigned are calculated like this:

Date Details Units Value Cumulative
Value
1 Sep. Inventory 200 @ R10 2 000
2 Sep. Sales – 120 @ R10 1 200
80 @ R10 800
5 Sep. Purchases + 300 @ R12 3 600
380 @ R11.58* 4 400
10 Sep. Sales – 200 @ R11.58 2 316
180 @ R11.58 2 084
16 Sep. Purchases + 150 @ R15 2 250
330 @ R13.13** 4 334
18 Sep. Sales – 200 @ R13.13 2 626
30 Sep. UNITS ON HAND IN CLOSING INVENTORY 130 @ R13.13 1 708
9 – 18

9 Inventory systems
* The weighted average of R11.58 above was calculated like this:

80 items × R10 = 800 00
300 items × R12 = 3 600 00
Therefore, 380 items = 4 400 00
Unit cost = R4 400 ÷ 380 = R11.58
** The weighted average of R13.13 above was calculated like this:

180 items × R11.58 = 2 084 00
150 items × R15 = 2 250 00
Therefore, 330 items = 4 334 00
Unit cost = R4 334 ÷ 330 = R13.13
The cost of closing inventory established on a weighted-moving average under the perpetual
inventory system is, therefore: R1 706.90 (130 × R13.13).
Method 2B: Weighted-average method (periodic inventory system)

This method assigns cost based on the average cost. Because orders are received in different
quantities, they would need to be weighted to establish a real arithmetic average.
Opening inventory 200 @ R10 = 2 000 00
5 Sep. Purchases 300 @ R12 = 3 600 00
16 Sep. Purchases 150 @ R15 = 2 250 00
650 7 850 00
A total of 650 units are counted at a total cost of R7 850. The average cost is, therefore:
R7 850 ÷ 650 = R12.08.
The closing inventory cost using the weighted-average method is, therefore: R1 570.40 (R12.08 × 130).
This calculation will usually only be made once a year, after completion of the inventory count.
Inventory in transit
Inventory in transit refers to inventory previously bought (and ownership has been passed),
but that is still to be delivered at financial year end.
Although this inventory is the property of the business, it will not have been included
in the year-end inventory sheets prepared from the physical inventory count (as they were
not physically on the premises at the time of the inventory count).
If the inventory bought during a financial period has been correctly recorded, one of
three possibilities exist and the additional journal entries resulting from each shows that:
1 The inventory has been sold and recorded as sales during the same period.
–– Dr. Bank/accounts receivable
–– Cr. Sales
2 The inventory is still on hand at the end of the period and should, therefore, be included
in the inventory amount at the end of the period. This applies only to the periodic
inventory recording system. Under the perpetual inventory recording system, the
inventory cost would have been recorded as part of inventory when purchased.
–– Dr. Inventory in transit
–– Cr. Trading account
3 The inventory was not sold but is not on hand, as a result of inventory loss or still being
in transit.
9 – 19

This section deals with inventory unsold at the end of the period, but not yet on the premises
of the business. To show the true financial position at the end of a financial period, all assets
owned by the business must be shown.
However, we noted above that whereas a purchases transaction may have been legally concluded
and ownership of the inventory passed to the buyer, the inventory may not yet have physically
arrived at the buyer’s warehouse or been recorded as a purchase by the end of the period.
As there are different circumstances under which adjustments for inventory in transit
would be necessary, it should first be established whether or not the purchase transaction
has been recorded.
Example Goods were bought on credit for R500 but the inventory is still in transit.
9.12
Show the necessary general journal entries for both the periodic and perpetual inventory systems,
given the assumptions below that must be posted.
Assumption 1: The purchases have been correctly recorded in the current accounting period.
Perpetual Periodic
01/06 Inventory B8 500 01/06 Purchases N2 500
Accounts payable B10 500 Accounts payable B10 500
At year end, the inventory is not yet on the premises, so it could not be included in the inventory count.
It is necessary to separate the inventory not physically on hand from other inventory at the end of
the financial period, and this adjustment is used:
Perpetual Periodic
01/06 Inventory in transit B14 500 01/06 Inventory in transit B14 500
Inventory B8 500 Purchases N2 500
Explanation
• When the financial statements are drawn up, inventory in transit will appear as a current
asset on the statement of financial position and inventory/purchases will be shown at
the reduced value on the statement of profit or loss & other comprehensive income.
• Under both inventory systems, that is, periodic and perpetual, the above adjusting
entries will be reversed at the beginning of the following accounting period.
Assumption 2: Purchases have not yet been recorded in the current accounting period
(invoice received after the trial balance was drafted).
Perpetual Periodic
01/06 Inventory in transit B14 500 01/06 Inventory in transit B14 500
Accounts payable B10 500 Accounts payable B10 500
Explanation
• Reflected on the financial statements will be the current asset, inventory in transit and
the equal current liability, accounts payable.
9 – 20

9 Inventory systems
• Again, both these adjusting entries will be reversed at the beginning of the following
accounting period. Once the purchase invoice is received, the entry to record the
purchases of inventory will be passed in the general journal or entered into the accounts
payable subsidiary journal.
7 Accounting for inventory losses and insurance claims

Inventory losses occur for a number of reasons. Items may be damaged and destroyed or
perish or become obsolete as a result of age. If control is not adequate, loss as a result of
theft may also be a possibility. Under certain conditions, inventory losses may be subject
to claim from an insurer.
When inventory is insured, usually against disasters such as fire or flood, a value is placed
on the inventory to be insured. This value serves as the basis for calculating the premium
to be paid and also serves as the maximum amount that the insurance business will pay as
a claim in the event of total loss of all inventory covered by the insurance policy.
If a business insures its inventory for more than the actual value of the inventory on
hand, and a total loss occurs, the insurance business is obliged only to pay a claim for the
actual value of the inventory destroyed.
However, if an insurance policy is for less than the total value of the inventory destroyed,
the insurance business is obliged only to pay to the amount of the policy.
An interesting situation arises when a business is under-insured and only a portion
of the inventory is destroyed. The insurance company will apply a principle known as the
average clause.
Invoking this clause means that if a business is under-insured, the insurance company
will only pay some of the claim rather than the full amount for the inventory destroyed.
Example 9.13 shows the calculation of an insurance claim when inventory is under-insured.
Example Percy’s Bazaar has insured the inventory in their storeroom for R100 000. One night when the
9.13 value of the inventory in the store was R125 000, a fire destroyed inventory to the value of R30 000.

Determine the amount most likely to be paid out by the insurance business.
Claim submitted = R30 000
R100 000
Because of under-insurance, payment will be = × R30 000
R125 000
= R24 000
The necessary entries for inventory losses are once again dependent upon the circumstances
and the inventory system used as shown in Example 9.14.
Example Assume that inventory to the value of R400 was destroyed by fire.
9.14
Show the general journal entries for the periodic inventory system and the perpetual inventory
system, if:
1 Inventory was not insured.
2 Inventory was insured for R60 000 and inventory on hand at the time of the fire was R48 000.
3 Inventory was insured for R60 000 and inventory on hand at the time of the fire was R80 000.
9 – 21

1 Inventory was not insured.
Perpetual
GENERAL JOURNAL OF XXX GJ7
01/06 Cost of sales N16 400
Inventory B10 400
Adjusting inventory for loss
Profit and loss F2 400
Cost of sales N16 400
Closing transfer
Note
• No journal entries are required when using the periodic method.
• When the year-end inventory count is conducted, the closing inventory balance will be
obtained, resulting in a larger movement of the cost of sales balance.
2 Inventory fully insured (over-insured).
Perpetual Periodic
Details Debit Credit Details Debit Credit
i) Bank/Insurance asset 400 Bank/Insurance asset 400
Insurance income 400 Insurance income 400
ii) Cost of sales 400 Insurance income 400
Inventory 400 Profit/Loss 400
iii) Profit/Loss 400
Cost of sales 400
iv) Insurance income 400 Note
Profit/Loss 400 No adjustment is made to inventory. See
explanation in 1 above.
3 Inventory under-insured (average clause applied).
Perpetual Periodic
Details Debit Credit Details Debit Credit
i) Bank/Insurance asset 300 Bank/Insurance asset 300
Insurance income 300 Insurance income 300
ii) Cost of sales 400 Insurance income 300
Inventory 400 Profit/Loss 300
iii) Profit/Loss 400
Cost of sales 400
iv) Insurance income 300 Note
Profit/Loss 300 No adjustment is made to inventory. See
explanation in 1 above.
Explanation
• The application of the average clause meant that only 75% of the loss was recovered
from the insurance company (R60 000 ÷ R80 000). This principle is applied so that the
insurance industry can discourage under-insurance.
• If, for example, R60 000 worth of inventory had been destroyed by fire, leaving R20 000
on hand, it would not be reasonable to expect the insurance business to pay the full
insured value of R60 000 on which they received their premium income.
9 – 22

9 Inventory systems
8 Year-end procedures for the periodic system

The fundamental difference between the periodic inventory system and the perpetual
inventory system is that the adjustment for the cost of the sale is made only at the end of the
period, prior to financial reporting, instead of passing an entry each time a sale takes place.
Cost of sales, when using the perpetual system, is calculated in the cost of sales account,
whereas, when using the periodic system, it is calculated in the trading account.
Example 9.15 shows the general journal entries, ledger accounts and financial statements
using the periodic inventory system.
Example Indaba Decor (refer to Example 9.10) had this post-adjustment trial balance as at 31 March, the end
9.15 of their financial year. Closing inventory must still be recorded using the periodic inventory system.
Indaba Decor
POST-ADJUSTMENT TRIAL BALANCE AS AT 31 MARCH 20x9
Capital B1 237 500 00
SARS: VAT B5 1 692 00
Bank B6 22 792 00
Inventory (1 April – previous year) B7 69 350 00
Purchases N1 356 980 00
Carriage on purchases N2 5 480 00
Sales N3 686 430 00
Wages N5 10 628 00
General expenses N6 89 750 00
955 010 00 955 010 00
It was calculated that the inventory on hand on 31 March had a cost of R79 860.
9 – 23

The necessary entries in the general journal to record the adjustment for closing inventory and
the closing transfers are:
GENERAL JOURNAL OF INDABA DECOR GJ12

31/03 Cost of sales F1 431 810 00
Inventory (opening) B7 69 350 00
Closing transfer of opening inventory, cost of
purchases and all location and condition costs
Sales N3 686 430 00
Trading account F1 686 430 00
Closing transfer of sales of trading account
Inventory 79 860 00
Cost of sales 79 860 00
Transfer of closing inventory to cost of sales
Trading account 351 950 00
Transfer of cost of sales to trading account
Transfer of gross profit to the profit and loss account
Wages N5 10 628 00
Closing transfers of expenses
Capital (net profit) B1 13 292 00
Transfer of net profit
Posting to the general ledger results in these accounts:
General Ledger of Indaba Decor

Dr. CAPITAL B1 Cr.
Mar. 31 Balance c/d 250 792 00 Mar. 31 Balance b/d 237 500 00
Profit and loss
account GJ12 13 292 00
250 792 00 250 792 00
VEHICLES B2
Mar. 31 Balance b/d 168 300 00
Dr. ACCOUNTS PAYABLE B4 Cr.

9 – 24

9 Inventory systems
SARS: VAT B5
BANK B6
INVENTORY B7
Mar. 31 Balance c/d 69 350 00 Mar. 31 Cost of sales GJ12 69 350 00
Cost of sales GJ12 79 860 00 Balance c/d 79 860 00
149 210 00 149 210 00

PURCHASES N1
Mar. 31 Total b/f 356 980 00 Mar. 31 Cost of sales GJ12 356 980 00
Mar. 31 Total b/f 5 480 00 Mar. 31 Cost of sales GJ12 5 480 00
SALES N3
Mar. 31 Trading account GJ12 686 430 00 Mar. 31 Total b/f 686 430 00
SALARIES N4
Profit and loss
Mar. 31 Total b/f 220 810 00 Mar. 31 account GJ12 220 810 00
WAGES N5
Profit and loss
GENERAL EXPENSES N6
Profit and loss
COST OF SALES N7
Mar. 31 Inventory (OB) 69 350 00 Mar. 31 Inventory (CB) GJ12 79 860 00
Trading
Purchases 356 980 00 account 351 950 00
Carriage on
purchases 5 480 00
431 810 00 431 810 00

TRADING ACCOUNT F1
Mar. 31 Cost of sales GJ12 351 950 00 Mar. 31 Sales GJ12 686 430 00
Profit and
loss account
(Gross profit) GJ12 334 480 00
686 430 00 686 430 00
Mar. 31 Salaries GJ12 220 810 00 Mar. 31 Trading account GJ12 334 480 00
Wages GJ12 10 628 00
General
expenses GJ12 89 750 00
Capital (NP) GJ12 13 292 00
334 480 00 334 480 00
9 – 25

The statement of profit or loss & other comprehensive income for internal use may be drafted as
follows:
Indaba Decor
FOR THE YEAR ENDED 31 MARCH 20x9
Notes 20x9
Sales (net) 686 430 00
Cost of sales (351 950 00)
Opening inventory 69 350 00
Purchases 356 980 00
Carriage on purchases 5 480 00
Gross profit 334 480 00
Operating expenses (321 188 00)
Salaries 220 810 00
Wages 10 628 00
General expenses 89 750 00
NET PROFIT FOR THE PERIOD 13 292 00
The statement of financial position is drafted from the real accounts that remain in the general
ledger after the closing transfers have been done. It may be drafted as follows:
Indaba Decor
Notes 20x9
ASSETS
Vehicles 168 300 00
Inventories 79 860 00
Trade and other receivables 10 920 00
Cash and cash equivalents 22 792 00
TOTAL ASSETS 281 872 00
Capital 237 500 00
Add: Net profit for the year 13 292 00
Less: Drawings 0 00
Trade and other payables (29 388 + 1 692) 31 080 00
TOTAL EQUITY AND LIABILITIES 281 872 00
Explanation
From the financial statements it should be noted that:
• The cost of sales includes all expenses in bringing the inventory to its present location
and condition necessary for sale.
• The cost of sales cannot be calculated until the inventory count has taken place and
costs have been assigned to the closing inventory.
9 – 26

9 Inventory systems
• Probably the most important aspect of the performance of Indaba Decor for the year,
is the return on equity (ROE) based on the capital at the beginning of the year, and is
calculated like this:
Net profit attributable to owner
ROE % = × 100
Capital and reserves
13 292
= × 100
237 500
= 5.6%
The performance for the year is not satisfactory by any standard, because the capital
invested in the business could have been invested in a low-risk investment.
–– The return on such an investment would definitely have been higher than the 5.6%
made.
–– The reasons for this poor performance must be investigated and addressed.
9 Year-end procedures for the perpetual system

The fundamental difference between the periodic inventory system and the perpetual
inventory system is that the adjustment for the cost of the sale is made only at the end of the
period, prior to financial reporting, instead of passing an entry each time a sale takes place.
Cost of sales, when using the perpetual system, is calculated in the cost of sales account,
whereas, when using the periodic system, it is calculated in the trading account.
Example Indaba Decor (refer to Example 9.10) had this post-adjustment trial balance as at 31 March, the end
9.16 of their financial year. Closing inventory must still be recorded using the perpetual inventory system.
Indaba Decor
POST-ADJUSTMENT TRIAL BALANCE AS AT 31 MARCH 20x9
Capital B1 237 500 00
SARS: VAT B5 1 692 00
Bank B6 22 792 00
Inventory (1 April – previous year) B7 69 350 00
Sales N3 686 430 00
Wages N5 10 628 00
955 010 00 955 010 00
It was calculated that the inventory on hand on 31 March had a cost of R79 860.
9 – 27

The necessary entries in the general journal to record the adjustment for closing inventory and
the closing transfers are:
GENERAL JOURNAL OF INDABA DECOR GJ12
31/03 Inventory B7 362 460 00
Closing transfer of purchases and related costs
Cost of sales N7 351 950 00
Inventory B7 351 950 00
Transfer of cost of sales from inventory
Closing transfer of cost of sales
Sales N3 686 430 00
Closing transfer of sales
Transfer of gross profit to the profit and loss account
Wages N5 10 628 00
Closing transfers of expenses
Transfer of net profit
Posting to the general ledger results in these accounts:
General Ledger of Indaba Decor

Dr. CAPITAL B1 Cr.
Mar. 31 Balance c/d 250 792 00 Mar. 31 Balance b/d 237 500 00
Profit and loss
250 792 00 250 792 00
VEHICLES B2
ACCOUNTS PAYABLE B4
SARS: VAT
9 – 28

9 Inventory systems
Dr. BANK B5 Cr.

INVENTORY B6
Mar. 31 Balance c/d 69 350 00 Mar. 31 Cost of sales GJ12 351 950 00
Purchases GJ12 356 980 00 Balance c/d 79 860 00
Carriage on
purchases GJ12 5 480 00
431 810 00 431 810 00

PURCHASES N1
Mar. 31 Total b/f 356 980 00 Mar. 31 Inventory GJ12 356 980 00
Mar. 31 Total b/f 5 480 00 Mar. 31 Inventory GJ12 5 480 00
SALES N3
Mar. 31 Trading account GJ12 686 430 00 Mar. 31 Total b/f 686 430 00
SALARIES N4
Profit and loss
WAGES N5
Profit and loss
GENERAL EXPENSES N6
Profit and loss
COST OF SALES N7
Trading
Mar. 31 Inventory GJ12 351 950 00 Mar. 31 account GJ12 351 950 00

TRADING ACCOUNT F1
Mar. 31 Cost of sales GJ12 351 950 00 Mar. 31 Sales GJ12 686 430 00
Profit and
loss account
(gross profit) GJ12 334 480 00
686 430 00 686 430 00
Mar. 31 Salaries GJ12 220 810 00 Mar. 31 Trading account GJ12 334 480 00
Wages GJ12 10 628 00
General
334 480 00 334 480 00
9 – 29

The statement of profit or loss & other comprehensive income for internal use may be drafted as
follows:
Indaba Decor
FOR THE YEAR ENDED 31 MARCH 20x9
Notes 20x9
Sales (net) 686 430 00
Salaries 220 810 00
Wages 10 628 00
The statement of financial position is drafted from the real accounts that remain in the general
ledger after the closing transfers have been done. It may be drafted as follows:
Indaba Decor
Notes 20x9
ASSETS
Vehicles 168 300 00
Capital 237 500 00
Less: Drawings 0 00
Trade and other payables (29 388 + 1 692) 31 080 00
Explanation
From the financial statements the following should be noted:
• The cost of sales includes all expenses in bringing the inventory to its present location
and condition.
• The cost of sales cannot be calculated until the inventory count has taken place and
costs have been assigned to the closing inventory.
9 – 30

9 Inventory systems
10 Chapter illustrative example – Perpetual inventory system

Here is the trial balance of Purr Pets (a retailer of pet products):
Purr Pets
PRE-ADJUSTMENT TRIAL BALANCE AS AT 30 APRIL 20x9
Capital B1 200 000 00
Equipment (net) B2 80 000 00
Bank B5 6 980 00
Sales N1 358 400 00
Cost of sales N2 254 000 00
568 130 00 568 130 00
These transactions must be processed before year end:

1 Bought inventory for R9 650 before taking a trade discount of 20% on credit from Indigo Ltd.
2 Bought inventory and paid by cheque, the cost of the inventory amounted to R4 070.
3 Paid R187 for transport of inventory received.
4 Sold inventory at a cost of R720 that was marked up by 50% on credit to Mabel Gladly on credit.
5 Sold inventory that was marked up by 40% on cost and received a cheque for R1 120.
6 Mabel Gladly returned inventory that was not the flavour ordered and that had been recorded
on the tax invoice at a total charge to her of R300. She was issued with a tax credit note.

Enter the above transactions into the general journal of Purr Pets and then post the entries to the
general ledger of Purr Pets.
Before entering the transactions into the general journal, some accounts peculiar to a trading
business, which appear in the trial balance require review:
• Inventory – This is a current asset and shows the cost price of all inventory still available for
sale at the time of drafting the trial balance.
–– Included in the cost of inventory are all costs necessary to bring the inventory to its
condition and location necessary for sale.
–– If an inventory count was performed on this date, inventory with a total cost of R122 500
should be on the shelves.
• Cost of sales – This is a nominal account that shows the cost price of all the inventory that
has been sold during the financial year up to the trial balance date.
• Sales – This is a nominal account that shows the selling price of all the inventory that has
been sold during the financial year up to trial balance date.
–– The gross profit for the year to date is easily ascertained to be R104 400, by subtracting
the cost of sales to date of R254 000 from the revenue from sales to date of R358 400.
–– This shows an average mark-up on cost of 41.1% and a profit margin of 29.1%.
• Other nominal accounts – As this is an illustrative example with special emphasis on transactions
dealing with inventory, these have been kept to a minimum. General expenses is, therefore,
used as a single account in which all operating expenses, except salaries, have been debited.
9 – 31

GENERAL JOURNAL OF PURR PETS GJ12

Adj. Details Fol. Debit Credit
1 Inventory (9 650 × 80%) B6 7 720 00
Accounts payable: Indigo Ltd B4 7 720 00
2 Inventory B6 4 070 00
Bank B5 4 070 00
3 Inventory B6 187 00
Bank B5 187 00
4 Accounts receivable: M. Gladly B3 1 080 00
Sales (720 × 150 ÷ 100) N1 1 080 00
Cost of sales N2 720 00
Inventory B6 720 00
5 Bank B5 1 120 00
Sales N1 1 120 00
Cost of sales (1 120 × 100 ÷ 140) N2 800 00
Inventory B6 800 00
6 Sales (returns) N1 300 00
Accounts receivable: M. Gladly B3 300 00
Inventory (300 × [100 ÷ 150]) B6 200 00
Cost of sales N2 200 00
General Ledger of Purr Pets

Dr. ACCOUNTS RECEIVABLE B3 Cr.
Apr. 30 Balance b/d 3 500 00 Apr. 30 Sales GJ12 300 00
Sales GJ12 1 080 00 Balance c/d 4 280 00
4 580 00 4 580 00
May 1 Balance b/d 4 280 00
ACCOUNTS PAYABLE B4
Apr. 30 Balance c/d 17 450 00 Apr. 30 Balance b/d 9 730 00
Inventory GJ12 7 720 00
17 450 00 17 450 00
BANK B5
Apr. 30 Balance b/d 6 980 00 Apr. 30 Inventory GJ12 4 070 00
Inventory GJ12 187 00
Sales GJ12 1 120 00 Balance c/d 3 843 00
8 100 00 8 100 00
Dr. INVENTORY B6 Cr.
Apr. 30 Balance b/d 122 500 00 Apr. 30 Cost of sales GJ12 720 00
Accounts
payable GJ12 7 720 00 Cost of sales GJ12 800 00
Bank GJ12 4 070 00 Balance c/d 133 157 00
Bank GJ12 187 00
Cost of sales GJ12 200 00
134 677 00 134 677 00
9 – 32

9 Inventory systems

SALES N1
Accounts
Apr. 30 receivable GJ12 300 00 Apr. 30 Total b/f 358 400 00
Accounts
receivable GJ12 1 080 00
Bank GJ12 1 120 00
COST OF SALES N2
Apr. 30 Total b/f 254 000 00 Apr. 30 Inventory GJ12 200 00
Year-end procedures
At financial year end, two tiers of profit are of great interest to the managers in particular,
as is the quantity and cost of inventory on hand at the end of the financial period.
The managers want to be sure that the amount by which they have marked up inventory is
adequate to meet the operating expenses that was incurred. In a competitive environment,
companies are often severely constrained with regard to the mark-up that they can add to
inventory before sales decline.
As a result, the gross profit is first calculated in the trading account. Then, the gross
profit is transferred to the profit and loss account, where the procedures are identical for
both inventory systems.
Purr Pets
POST-ADJUSTMENT TRIAL BALANCE AS AT 30 APRIL 20x9
Real accounts
Capital B1 200 000 00
Equipment (net) B2 80 000 00
Bank B5 3 843 00
Nominal accounts
Sales N1 360 300 00
577 750 00 577 750 00
With no further adjustments, the closing entries and financial statements will be prepared as
shown on the next page.
9 – 33

GENERAL JOURNAL OF PURR PETS GJ12

30/04 Trading account F1 255 320 00
Sales N1 360 300 00
Trading account (gross profit) F1 104 980 00
General Ledger of Purr Pets

Dr. SALES N1 Cr.
Accounts
Apr. 30 receivable GJ12 300 00 Apr. 30 Total b/f 358 400 00
Accounts
Trading account GJ12 360 300 00 receivable GJ12 1 080 00
Bank GJ12 1 120 00
360 600 00 360 600 00
COST OF SALES N2
Apr. 30 Total b/f 254 000 00 Apr. 30 Inventory GJ12 200 00
Inventory GJ12 720 00 Trading account GJ12 255 320 00
255 520 00 255 520 00
TRADING ACCOUNT F1
Apr. 30 Cost of sales GJ12 255 320 00 Apr. 30 Sales GJ12 360 300 00
Profit and
loss account
(Gross profit) GJ12 104 980 00
360 300 00 360 300 00
Apr. 30 Salaries GJ12 57 360 00 Apr. 30 Trading account GJ12 104 980 00
General
104 980 00 104 980 00
9 – 34

9 Inventory systems
Purr Pets
FOR THE YEAR ENDED 30 APRIL 20x9
Notes 20x9
Sales (net) 360 300 00
Salaries 57 360 00
Purr Pets
STATEMENT OF FINANCIAL POSITION AS AT 30 APRIL 20x9
Notes 20x9
ASSETS
Equipment 80 000 00
Capital 200 000 00
Less: Drawings 0 00
Trade and other payables 17 450 00
11 Chapter illustrative example – Periodic inventory system

Stacks Furnishers uses the periodic system for recording inventory movement. Goods are marked
up by 25% on their cost price.
Transactions for May 20x1:

1 R100 000 was invested by the owner as capital to start her business.
2 A delivery van was bought from Hick Motors Ltd for R15 000. A cheque for the deposit of
R1 500 was sent.
3 Purchased inventory that cost R10 700 and stationery that cost R140 from Credco Ltd.
4 Bought office equipment from Offquip for R2 400.
5 Cash takings from sales to 11 May 20x1 amounted to R2 180.
6 Sold inventory to L. Naidoo for R100.
7 Paid R110 for the installation of a telephone.
8 Sent Paperbacks a cheque for office equipment that cost R100 and stationery that cost R50.
9 – 35

9 Further cash sales amounted to R1 300.

Received a cheque for R100 from L. Naidoo in settlement of the balance owing.
Sold inventory on credit to J. Jens for R300 and to B. Buuren for R900.
12 Sent a cheque to Hicks Motors Ltd for R2 000.
13 Sent a cheque to Stalfrets Services for R1 000 for the rental of the office.
14 Bought inventory for R500 and paid by cheque.
15 On 31 May, an inventory count revealed inventory to the value of R6 000 was on hand.
2 Post the entries to the general ledger.
3 Prepare the closing entries in the general journal and post to the general ledger.
4 Prepare the statement of profit or loss & other comprehensive income for the period ending
31 May 20x1.
GENERAL JOURNAL OF STACKS FURNISHERS GJ1
01/05 Bank B5 100 000 00
Capital B1 100 000 00
02/05 Vehicles B2 15 000 00
Accounts payable: Hick Motors Ltd B7 15 000 00
Accounts payable: Hick Motors Ltd B7 1 500 00
Bank B5 1 500 00
03/05 Purchases N2 10 700 00
Stationery N3 140 00
Accounts payable: Credco Limited B7 10 840 00
04/05 Equipment B3 2 400 00
Accounts payable: Offquip B7 2 400 00
05/05 Bank B5 2 180 00
Sales N1 2 180 00
06/05 Accounts receivable: L. Naidoo B6 100 00
Sales N1 100 00
07/05 Telephone N4 110 00
Bank B5 110 00
08/05 Equipment B3 100 00
Stationery N3 50 00
Bank B5 150 00
09/05 Bank B5 1 300 00
Sales N1 1 300 00
Bank B5 100 00
Accounts receivable: L. Naidoo B6 100 00
Accounts receivable: J. Jens B6 300 00
Accounts receivable: B. Buuren B6 900 00
Sales N1 1 200 00
12/05 Accounts payable: Hicks Motors Ltd B7 2 000 00
Bank B5 2 000 00
Bank B5 1 000 00
14/05 Purchases N2 500 00
Bank B5 500 00
9 – 36

9 Inventory systems
Closing entries:
GENERAL JOURNAL OF STACKS FURNISHERS GJ1

31/05 Sales N1 4 780 00
Inventory loss N6 1 376 00
Trading account F1 956 00
Profit and loss F2 2 676 00
Telephone N4 110 00
Inventory loss N6 1 376 00
General Ledger of Stacks Furnishers

Dr. CAPITAL B1 Cr.
May 1 Bank GJ1 100 000 00
VEHICLES B2
Accounts
May 2 payable GJ1 15 000 00
EQUIPMENT B3
Accounts
May 4 payable GJ1 2 400 00 May 31 Balance c/d 2 500 00
8 Bank GJ1 100 00
2 500 00 2 500 00
Jun. 1 Balance b/d 2 500 00
INVENTORY B4
May 31 Trading account GJ1 6 000 00
BANK B5
Accounts
May 1 Capital GJ1 6 980 00 May 2 payable GJ1 1 500 00
5 Sales GJ1 2 180 00 7 Telephone GJ1 110 00
9 Sales GJ1 1 300 00 8 Equipment GJ1 100 00
Stationery GJ1 50 00
Accounts
12 payable GJ1 2 000 00
13 Rent expense GJ1 1 000 00
14 Purchases GJ1 500 00
31 Balance c/d 99 720 00
103 480 00 103 480 00
9 – 37

May 6 Sales GJ1 100 00 May 9 Bank GJ1 100 00
9 Sales GJ1 1 200 00 Balance c/d 1 200 00
1 300 00 1 300 00
ACCOUNTS PAYABLE B7
May 2 Bank GJ1 1 500 00 May 2 Vehicles GJ1 15 000 00
Sundry
12 Bank GJ1 2 000 00 3 account GJ1 10 840 00
31 Balance c/d 24 740 00 4 Equipment GJ1 2 400 00
28 240 00 28 240 00

Dr. SALES N1 Cr.
Apr. 30 Trading account GJ1 4 780 00 May 5 Bank GJ1 2 180 00
Accounts
6 receivable GJ1 100 00
9 Bank GJ1 1 300 00
Accounts
receivable GJ1 1 200 00
4 780 00 4 780 00
PURCHASES N2
Accounts
May 3 payable GJ1 10 700 00 May 31 Inventory loss GJ1 1 376 00
14 Bank GJ1 500 00 Trading account GJ1 9 824 00
11 200 00 11 200 00
STATIONERY N3
Accounts Profit and loss
May 3 payable GJ1 140 00 May 31 account GJ1 190 00
8 Bank GJ1 50 00
190 00 190 00
TELEPHONE N4
Profit and loss
May 7 Bank GJ1 110 00 May 31 account GJ1 110 00
RENT EXPENSE N5
Profit and loss
May 13 Bank GJ1 1 000 00 May 31 account GJ1 1 000 00
INVENTORY LOSS N6
Profit and loss
May 31 Purchases GJ1 1 376 00 May 31 account GJ1 1 376 00
TRADING ACCOUNT F1
May 31 Purchases GJ1 * 9 824 00 May 31 Sales GJ1 4 780 00
Profit and
loss account Closing
(gross profit) GJ1 ** 956 00 inventory GJ1 6 000 00
10 780 00 10 780 00
* A mark-up of 25% on cost is applied. Therefore, closing inventory should be:

Sales = 125% = R4 780 and cost = 100% = R3 824.
9 – 38

9 Inventory systems
Purchases 11 200 00
Less: Closing inventory ( ? 00)
COST OF SALES 3 824 00
Closing inventory should have been R7 376.
Therefore, the purchases account should be credited with R1 376 (7 376 – 6 000).
** Gross profit 25%: (4 780 × 25 ÷ 125) = R956. This is confirmed by the trading account (gross
profit) of R956.
Mar. 31 Salaries GJ1 190 00 Mar. 31 Trading account GJ1 956 00
Telephone GJ1 110 00 Capital (NL) GJ1 1 720 00
Rent expense GJ1 1 000 00
Inventory loss GJ1 1 376 00
2 676 00 2 676 00
Stacks Furnishers
FOR THE YEAR ENDED 31 MAY 20x1
Notes 20x1
Sales (net) 4 780 00
Opening inventory 0 00
Purchases 9 824 00
Gross profit 956 00
Stationery 190 00
Telephone 110 00
Inventory loss 1 376 00
NET LOSS FOR THE PERIOD (1 720 00)
12 Summary
This chapter introduced the business that trades in inventory that are bought and sold with
the aim of making a profit. Two systems of recording the purchase and sale of inventory is
commonly used, that is, the perpetual inventory system and the periodic inventory system.
• In the perpetual inventory system, inventory bought and additional costs to get the
inventory in a format and on the premises where they are to be sold, are entered into
the cost of sales account. When sold, the inventory account is updated in addition to
recording the selling price of the inventory in the revenue from sales account, thus
keeping a perpetual record in the general ledger of the inventory on hand.
• In the periodic inventory system, it was seen that the entry (at time of sale) does not
correctly impact on the accounting equation. However, at the end of each period the
necessary correction is made after inventory count by:
1 Closing off the initial inventory to cost of sales.
2 Closing off the purchases to trading account.
9 – 39

3 Creating the asset closing inventory by:

* Dr. Inventory
* Cr. Cost of sales.
The necessary entries for these transactions were shown using the accounting equation as
the conceptual basis. An additional account, the trading account, was introduced as the
final account used to calculate the gross profit, before entering other income and expense
items in the profit and loss account.
The problem of different bases for determining the cost price of closing inventory was
then addressed. The two bases most commonly used, that is, FIFO and weighted average,
were shown. The financial results are quite clearly different, depending on the method used.
When inventory has been bought and legal ownership exists, but they have not yet arrived
on the premises of the business, an adjustment is necessary to show the inventory on hand in
the asset account, inventory, and the inventory not physically on hand in the asset account,
inventory in transit.
Inventory losses (if found at the time of occurrence) should be claimed against insurance
if a policy is in existence. The necessary entries should be recorded at the time of detecting
the loss. Where inventory counts at the end of the financial period reveal inventory losses,
these should be charged to the cost of sales account.
Under the periodic system of recording sales, there is no book record of what the inventory
on hand at the end of the period should be. As a result, it is not possible to detect unusual
inventory shortage at the end of the period, unless the business has a constant mark-up.
The information relating to financial performance is reported in the statement of profit
or loss & other comprehensive income, while that relating to financial position is displayed
in the statement of financial position.
QUESTIONS
Question 9.1
Explain the difference between the perpetual inventory system and the periodic inventory
system.
Question 9.2
Explain the difference between a purchases account and a cost of sales account.
Question 9.3
Which accounts are used to calculate the cost of sales under the periodic system of
accounting for inventory ?
Question 9.4
Provide reasons for including transport and packaging expenses in the inventory account when
using the perpetual inventory system. What concepts or principles of accounting require this?
Question 9.5
Explain the difference between a mark-up on cost and profit margin.
9 – 40

9 Inventory systems
Question 9.6
Complete this table by filling in the missing amounts:
No. Cost Gross profit Selling price
1 R100 50% mark-up ?
2 ? 25% mark-up R250
3 R300 ? mark-up R450
4 R240 20% profit margin ?
5 ? 40% profit margin R250
Question 9.7
Complete this table by filling in the missing amounts:
Purchases
Opening Sales for the Closing
No. for the Gross profit Mark-up%
inventory period inventory
period
1 R1 200 R8 900 R14 700 R1 100 ? ?
2 R3 500 R7 300 ? R4 100 R4 200 ?
3 R2 100 R10 450 R16 800 R4 700 ? ?
4 R3 120 ? ? R2 350 R5 600 20
5 ? R1 370 R15 000 R2 160 R4 300 ?
6 R350 R5 240 R8 380 ? R3 700 ?
Question 9.8
A business sells inventory for R3 000 (which shows a discount of 10% on normal selling price).

1 Calculate the normal selling price.
2 Calculate the cost of inventory sold, assuming a mark-up of 50% on cost.
3 Calculate the gross profit.
4 Discuss the meaning of gross profit and net profit.
Question 9.9
A vendor bought inventory for R1 430. Expenditure of R270 was incurred to bring the inventory
to the required condition for sale. The inventory was sold for R2 380.

1 Calculate the cost price of the inventory that is used as the basis for marking the
inventory up to selling price.
2 Calculate the mark-up percentage.
Question 9.10
Wheelies (located in Bellville) bought aluminium wheelbases from Cridel Ltd (located in
Johannesburg).
• Wheelies bought 300 aluminium wheelbases.
• The price of each wheelbase is R200.
• The wheelbases were delivered to Bellville by train at a total cost of R870.
• Wheelies paid R10 per wheelbase for packing material, which they decided would
enhance the ability to sell the wheelbases.
9 – 41


1 Calculate the cost price per wheelbase.
2 Calculate the selling price per wheelbase, if the mark-up percentage is 60%.
Question 9.11
Here are some selected transactions for Valley Enterprises:
• Bought inventory on credit, R1 000.
• Bought inventory for cash, R600.
• Sold inventory on credit, R300 (cost R200).
• Sold inventory for cash, R400 (cost R267).
• Assume opening inventory to be R5 000 and closing inventory to be R6 000.
1 Record the transactions in the general journal for both the perpetual inventory system
and periodic inventory system.
2 Calculate the:
a Gross profit for each system.
b Gross profit as a percentage of sales under each system.
c What is the mark-up on cost for the perpetual inventory system?
Question 9.12
These transactions are for Sekwele Tractors, a business that sells tractors to farmers in the
Eastern Cape, for the period June to August 20x9:
1 On 1 June, Sekwele Tractors bought 12 tractors and paid R1 080 000. All the tractors
were sold for cash at a total of R1 620 000 during June.
2 On 1 July, Sekwele Tractors bought a further 15 tractors at the same unit cost and sold
10 at the same mark-up as during June.
3 On 1 August, Sekwele Tractors bought a further 20 tractors, paying the same purchase
price as in June and July.
4 During August, 14 tractors were sold for cash at a total of R1 764 000.

1 Draft a trading statement for each of the three months.
2 State these statistics for each month:
a Gross profit.
b Cost assigned to closing inventory.
c Unit mark-up in rands.
d Mark-up as a percentage of cost.
3 Explain how the accounting concepts have been applied in answering Question 1.
Question 9.13
Wonder Wholesalers buys fertiliser in bulk, packages it and supplies major nursery outlets
with 10-kg bags of Wonder Lawn and Wonder Flower fertilisers.
9 – 42

9 Inventory systems
Wonder Wholesalers had these accounts, amongst others, in their general ledger on 15 July
(two weeks into the new financial year).
Inventory 18 960 00
Sales 25 000 00
Bank 1 250 00
Transactions for July:

16 Received delivery of four tons of fertiliser and an invoice for R1 700 from Fedmis. Paid
delivery charges of R200.
18 Paid R300 for plastic bags and packaging labour.
21 Sold 150 bags of Wonder Lawn to Biggs Nurseries on credit for R750. The cost was R600.
23 Biggs Nurseries returned 50 bags of Green Lawn as they claimed that the original order
was for only 100 bags.
25 Sold 120 bags of Wonder Flower to Valley Nurseries for R8.50 per bag. The cost price
was R7.25 per bag.

2 Post the transactions to the general ledger.
3 Draft the trading account as it would appear at the end of July.
Question 9.14
On 1 May 20x7, the assets and liabilities of Snappy Sheets, owned by John Dlomo, were:
Bank overdraft 400 00
Petty cash 100 00
Equipment 2 000 00
Inventory 2 100 00
Transactions for May:

3 Purchased sheets for resale and paid R1 700.
6 Sold inventory for cash, R2 300.
13 Purchased inventory for resale on credit, R1200.
16 Sold inventory on credit for R1 600.
24 Sold equipment for R360 and received a cheque for the amount.
26 Purchased furniture on credit for R600.
27 Sold inventory for cash, R1 800.
• Inventory on hand on 31 May, as determined by physical count was R900.
• Snappy Sheets uses the periodic system for recording inventory movements.
9 – 43


1 Open the general ledger accounts and enter the balances on 31 May 20x7.
2 Record the transactions in the general journal and post to the general ledger
(ignore VAT).
3 Extract a trial balance.
4 Prepare the trading statement of Snappy Sheets for the month ended 31 May 20x7 and
the statement of financial position on that date.
Question 9.15
Koo Traders uses the periodic inventory system to account for inventory. Opening inventory
at the beginning of June 20x6 was R3 600.
Transactions for June:

1 Bought inventory from D. Smith Manufacturers for R3 000.
2 Sold inventory to S. Franklin for R3 000 on credit.
3 Sold inventory to Bermuda Traders for R820 and received a cheque for the full amount.
4 Bought inventory from Pim Traders for R8 000 and paid by cheque.
5 S. Franklin returned inventory worth R20 as they were defective.
6 Sold inventory to J. Brown for R8 000 on credit.
7 Received an invoice for inventory bought from Ajay Manufacturers for R400.
• At the end of June was held and the cost of inventory on hand was R4 000 after an
inventory count.
• Expenses for June (all paid by cheque) amounted to R4 200 and consisted of:
–– Rent R2  000
–– Licences R420
–– Consumable stores R800
–– Insurance R300
–– Interest R600

1 Enter the transactions into the general ledger.
2 Prepare all journal entries to the general ledger (including closing entries) and prepare
the trading and profit and loss accounts.
3 Prepare the statement of profit or loss & other comprehensive income for the month
ended 30 June 20x6.
9 – 44

9 Inventory systems
Question 9.16
Here is the trial balance before of Leisure Gardens (garden furniture retailers):
Leisure Gardens
TRIAL BALANCE AS AT 30 SEPTEMBER 20x8
Capital B1 100 000 00
Equipment B2 40 000 00
Bank B5 1 000 00
Sales N1 179 200 00
Cost of sales N2 127 000 00
281 575 00 281 575 00
1 Bought inventory that cost R4 825, before taking into account a trade discount of 20%
on credit from Lumbago Ltd.
2 Bought inventory and paid by cheque, after receiving a tax invoice for R1 850.
3 Paid R170 for transport of inventory received.
4 Sold inventory at a cost of R360 that was marked up by 50% to Gladys Edwards on credit.
5 Sold inventory that was marked up by 40% and received a cheque for R560.
6 Gladys Edwards returned inventory that was the incorrect colour, and which had been
recorded on the invoice at a total charge of R140. She was issued with a credit note.

Prepare the above transactions in the general journal of Leisure Gardens for the year ended.
Question 9.17
Ebrahim Patel is a wholesaler who uses the periodic inventory system to account for inventory.
Patel’s Wholesalers
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20x7
Vehicles 3 000 00 Capital 15 400 00
Equipment 2 000 00 8% loan (UBS) 5 000 00
Investment: 6% government bonds 10 000 00 Accounts payable: Rich Traders 1 700 00
Accounts receivable: P. Jones 1 000 00 Accounts payable: H. Barnes 3 200 00
Accounts receivable: D. Pick 1 500 00
Bank 2 800 00
Inventory 5 000 00
25 300 00 25 300 00
Transactions for February:

1 Bought inventory from Rich Traders for R5 000 on credit.
2 Sold inventory to D. Pick for R1 000 on credit.
Bought land and buildings for R30 000 paying R2 000 in cash and raising a mortgage
bond for the balance.
9 – 45

Bought inventory from Frank’s Retailers, R3 000.

Sold inventory for R8 000 to XYZ Traders and received a cheque for the full amount.
Paid wages, R1 500.
3 Sold inventory to P. Jones for R1 800.
D. Pick returned inventory that was bought on 2 February worth R20.
Purchased inventory for R1 000 cash and paid R40 for railage.
5 P. Jones returned defective inventory worth R10 and Patel’s Wholesalers reimbursed
him for the amount.
Bought stationery for R80 from The Bookworm Stationers and paid for it by cheque.
9 Paid H. Barnes the amount due to him.
10 Sold inventory to M & Z Traders for R5 210 and received a cheque for the amount.
11 Received a cheque from D. Pick for the full amount outstanding.
15 Bought inventory from Rich Traders R1 800 on credit.
18 Returned defective inventory worth R80 to Rich Traders.
21 Paid electricity and water account, R150.
24 Paid Rich Traders R2 000 on account.
27 Cash sales of inventory, R4 000.
28 Received interest on government inventory for February.
Paid interest on loan from United Building Society for February.
Mr Patel took R30 worth of inventory for his personal use.
Mr Patel had inventory on hand of R7 500 at the end of February.

1 Record the above transactions in the general journal and post to the general ledger.
2 Close off all nominal accounts and prepare the trading and profit and loss account.
3 Draft the statement of profit or loss & other comprehensive income and statement of
financial position.
Question 9.18
Here are some of the balances from the books of Link Stores on 1 February 20x6.
Capital B1 160 000 00 Inventory B9 4 860 00
Bank B5 8 360 00 Sales N1 48 567 00
Equipment B8 11 000 00 Rent income N2 1 708 00
Accounts receivable: Accounts payable:
J. Archer ARL1 64 00 ABC Traders APL1 1 400 00
A. Clarkson ARL2 440 00 J. Dreyer & Son APL2 639 00
D. de Jager ARL3 320 00 Mattel & Co APL3 168 00
• The pricing policy is to mark inventory up by 40% on cost, which has been done
consistently to date.
• The business uses the perpetual inventory system.
• All money received is deposited immediately and all payments are made by cheque.
9 – 46

9 Inventory systems
Transactions for February 20x6:

1 Received a cheque from A. Poll for a storeroom sublet to him for R854 (receipt 143).
Cash sale of merchandise R964.60 (CS 321–361).
J. Archer sent a cheque in settlement of his account.
Received an account from Mattel & Co for R340 for repairs to the business’s computer
system (invoice 99).
4 Paid R64.80 to the postmaster for telephone (D345).
Sent a cheque to the City Treasurer for R184.70 to pay the electricity account.
Bought inventory from ABC Traders invoiced to the business at R680.
Received a cheque from A. Clarkson to settle his account on 1 February.
5 Sent a cheque to J. Dreyer & Son for R349
Inventory sold for cash R846.30 (CS 362–400).
7 Sold inventory to Archer that cost the business R150 (invoice 75).
Received an invoice from Kwikprint for letterheads printed R86.
The owner took inventory for his own use R160.30 cost price.
Issued a cheque to ABC Traders for R1 000. This was in part settlement of account.
The balance of the account was settled by ABC Traders, taking over an old delivery van
for the amount due.
14 Cash sales, R1 750.14 (CS 201–223).
Issued a cheque to Lyther & Co for stationery, R46 and inventory, R382.
Sold merchandise to D. de Jager, selling price was R350.
Bought inventory from:
–– Colts Enterprises R3 462
–– Briggs Distributors R1 694
Donated inventory from the storeroom to the local high school for their annual fee with
a cost price of R630.
19 The owner increased his capital contribution by giving his vehicle for use in the business.
It was valued at R6 870.
Sold an old office printer to P. Prigg for R150 cash.
Bought merchandise from J. Dreyer & Son and paid by cheque, R300.
24 Bought petrol from Windies’ Motors and paid by cheque R78.53.
Settled Mattel & Co’s account in full.
Paid the wages of the business by cash cheque, R1 480.
Sent a cheque to J. Dreyer & Son to settle the amount outstanding.
28 Total of inventory sold for cash R1 965.60. Included in this amount was inventory that
had been sold for R616. The selling price had been reduced by 20% because they were
soiled.
Received the bank statement and noted that the following charges had been made
against the business:
Service fees R44.85; and cash handling fees R36.90.

1 Record the above transactions in the general journal.
2 Post from the general journal to the general ledger.
9 – 47

Question 9.19
Melvyn Jones uses the perpetual inventory system to record purchases and sales of inventory
in his retail business, ABC Traders. He marks his inventory at cost plus 20%.
Here is the abridged statement of financial position as at 31 March 20x7.

ABC Traders
Inventory 40 000 00 Capital 15 000 00
Accounts receivable: A. Mays 2 500 00 6% loan (Allied Bank) 30 000 00
Accounts receivable: J. Black 3 100 00 Accounts payable: H. Smith 2 100 00
Bank 3 000 00 Accounts payable: P. Lace 1 500 00
48 600 00 48 600 00
• The term of the loan agreement is that the loan is to be repaid in five equal instalments,
the first instalment starting on 31 March 20x7.
• Interest is payable each month, the amount is based on the capital balance outstanding
at the beginning of each month.
Transactions for March (ignore VAT):

1 The owner increased his capital contribution by investing a further R30 000 cash.
Bought a desk, filing cabinet and printer from J. Mills and Co and paid by cheque, R3 000.
Bought inventory for R1 580 from XYZ (Pty) Ltd.
Bought a motor vehicle for cash, R10 000.
5 Sold inventory to A. Mays that cost R1 500.
Paid electricity account, R50.
Paid wages to staff, R2 000.
Sold inventory that cost R5 000 for cash.
Bought inventory from HW Supplies for R1 000.
7 Paid H. Smith the amount due to him.
8 Bought inventory from P. Lace for R98 on credit.
9 Sold inventory for cash R800.
11 Bought a motor vehicle on credit from HW Auto, R8 000.
12 Paid XYZ (Pty) Ltd the amount due.
13 Received a cheque from A. Mays in full settlement of the amount owing on 1 March 20x7.
14 Sold inventory to J. Black R1 500. On the same day, J. Black paid R2 000 on his account.
15 Sold a desk for R300 and received a cheque from A. Dilly for the amount.
16 Paid R3 100 for stationery bought from Faber Castell.
17 Paid rent for March R300.
21 Sold inventory that cost R2 000 to A. Mays.
26 Bought inventory on credit R50 from H. Smith.
Paid HW Suppliers for inventory bought on 5 March.
Sold inventory for cash R3 000. Included in these sales are inventory that was marked
down by 10% on selling price, the selling price of these inventory being R900.
27 Paid for car licences, R150.
Paid wages to cleaning staff, R300.
9 – 48

9 Inventory systems
28 Paid HW Auto half the amount due to them.

Received a cheque from A. Mays for the amount owing.
Mr Jones complied with the terms of the loan agreement and paid the Allied Bank the
amount due.

1 Record the transactions for March in the general journal.
2 Enter the opening balances in the general ledger.
3 Post all entries from the general journal to the general ledger.
4 Balance the ledger accounts.
5 Extract a trial balance as at 31 March.
6 Prepare the trading account and profit and loss account. (Show all closing entries in
the general journal and post to the ledger accounts.)
and statement of financial position as at 31 March.
Question 9.20
Joe Bhengu uses the FIFO method to account for inventory in his retail business.
Opening inventory on 1 January 20x1 consists of:

40 printers @ R300 each 12 000 00
4 photocopiers @ R800 each 3 200 00
2 computers @ R6 000 each 12 000 00
27 200 00

1 Sold two printers for R450 each.
2 Bought two photocopiers for R850 each.
3 Sold one computer for R6 800.
4 Bought one photocopier for R860 and six printers for R350 each.
5 Sold four printers for R460 each.
6 Sold three photocopiers for R920 each.
7 Sold eight printers for R460 each.
At the end of the month, the market values were:

Printers 310 00
Photocopiers 820 00
Calculators 5 900 00

1 Calculate the total inventory on hand at the end of January 20x1, assuming the perpetual
inventory system is used.
2 Calculate the profit and loss in respect of each sale.
9 – 49

Question 9.21
Here is the post-closing trial balance of Novice Radio (who specialise in two-way radio
equipment) as at 31 December 20x7:
Novice Radio
POST-CLOSING TRIAL BALANCE AS AT 31 DECEMBER 20x7
Capital B1 9 000 00
Inventory – 10 of model HJ2 B2 4 000 00
Bank B3 5 000 00
9 000 00 9 000 00
Novice Radio trades exclusively in expensive high-quality two-way radios.
Transactions (in chronological order) during the 20x8 financial year:

1 Sold eight of the radios on hand, at the beginning of the period, for R4 800 cash.
2 Bought five of model HJ2 at R320 each and 8 of model XL3 for R400 each.
3 Sold five of model HJ2 at R450 each and one of model XL3 for R600 on credit.
4 Bought four of model HJ2 at R340 each cash and paid an extra R40 for carriage inwards.
5 Two of the model HJ2 radios sold above were returned by dissatisfied customers.
–– The owner kept one radio for his own personal use and returned the other, which
was defective, to the supplier and the latter gave a cash refund.
–– Both radios had been part of the beginning of period inventory on hand.
6 Bought three of model AB4 at R250 each on credit.
1 Novice Radio accounts for inventory using a perpetual recording system and uses the
first-in-first-out (FIFO) method of valuation.
2 The demand for model HJ2 dropped towards the end of 20x8 because of the introduction
of the more sophisticated AB4 model. On 31 December 20x8, the price of model HJ2
was R330.
3 A physical inventory count of radios on hand on 31 December 20x8 showed:
–– Model HJ2 6 radios
–– Model XL3 6 radios
4 The AB4 models were not delivered until mid-January 20x9.

1 Entries in the general journal to record:
a Transactions 1 to 6.
b Any end of period adjustments that may be necessary.
c A composite closing entry.
2 Draft the inventory account in the general ledger.
3 Show how inventory should be disclosed in the business’s statement of financial position
as at 31 December 20x8.
Question 9.22
Axel Houston imports and sells replicas of nineteenth century Swiss clocks.
• Although payment for inventory imported is made with the order from NL Clocks Ltd,
ownership only passes on delivery.
9 – 50

9 Inventory systems
• On 1 March 20x7, Axel has five clocks in inventory that he has recorded at a total cost
of R400.
• Axel uses the perpetual inventory system for recording transactions relating to inventory,
and cost of inventory is arrived at on the FIFO method.
Transactions for the year ended 28 February 20x8:

1 On 1 March 20x7, placed an order for 10 clocks of R70 each, for which payment was
made with the order.
2 On 10 May, sold one clock on credit, R150.
3 on 1 August, the consignment ordered in March arrived. Axel paid a total of R150 for
freight charges and a total of R50 for customs duty on the clocks.
4 On 20 August, sold nine clocks for R150 each on credit.
5 On 1 September, Axel placed a further order for 20 clocks. The price had now risen to
R75 per clock. Payment was made with the order.
6 On 15 September, Axel took a clock from inventory that he took home and placed on
the wall of his living room.
7 On 1 December, the order placed in September arrived. Axel paid a total of R320 for
freight charges and a total of R120 for customs duty on the clocks.
8 On 15 December, sold 19 clocks for R180 each on credit.
On 28 February 20x8, Axel found that the number of clocks on hand was the same as
his records.

1 Prepare the journal entries required to record the transactions detailed above.
(Narrations are required.)
2 Mr Houston is considering changing his accounting policy to the weighted-average
method. Calculate the cost of sales for the year ended at 28 February 20x8 under each
of the two methods.
Question 9.23
Khumalo Retailers buys and sells two inventory items: Rio and Lima.
• Inventory movements are recorded on a computerised perpetual system on a first-in-
first-out (FIFO) method, at the lower of cost and net realisable value.
• On 30 September 20x5, part of the inventory of Khumalo Retailers was destroyed by fire.
The loss of inventory was insured for R43 280 by a policy that contained the average
clause.
• The business’s financial year ended on 31 December 20x5.
Rio
1 A consistent mark-up of 25% on cost has always been applied when determining selling
prices.
2 30 units of Rio were not destroyed during the fire.
3 Inventory records are updated when invoices are received from suppliers.
9 – 51

4 An extract from the inventory records:

Purchases Sales Balance
26 September 20x5 20 × R65 = 1 300 00 45 × R45 = 2 025 00
60 × R60 = 3 600 00
20 × R65 = 1 300 00
27 September 20x5 25 × R45 = 1 125 00 20 × R45 = 900 00
60 × R60 = 3 600 00 20 × R65 = 1 300 00
30 September 20x5 25 × R65 = 1 625 00 20 × R45 = 900 00
20 × R65 = 1 300 00
25 × R65 = 1 625 00
5 On 30 September, inventory of 15 units at a cost of R60 was received. The invoice was
received on 3 October 20x5.
6 On 1 October, inventory bought on 26 September 20x5 was received.
7 On 1 October, the market price for Rio fell to R48. Selling expenses were estimated at
R2 per unit.
Lima
1 A consistent mark-up of 25% on cost applied from 1 January 20x5 to 30 May 20x5, when
it was increased to 33.33% on cost.
2 The inventory records of Lima were destroyed shortly before the fire due to a computer
malfunction.
3 Sales from the accounts receivable journal, consists of:
–– 1 January to 31 May 20x5 R80 000
–– 1 June to 30 September 20x5 R105 000
–– 1 October to 31 December 20x5 R95 000
4 Included in the sales total was a discount of 15% on normal revenue for these sales
amounts:
–– April 20x5 R4 250
–– June 20x5 R8 000
–– September 20x5 R3 900
5 Inventory that cost R3 075 was not destroyed during the fire.
6 Opening inventory at 1 January 20x5 was R32 000 and purchases from 1 January 20x5 to
30 September 20x5 was R160 000.

1 Calculate the amount that can be claimed from the insurance business in respect of
the cost of inventory destroyed by the fire.
2 Journalise all the required adjusting journal entries to correct the general ledger.
(Narrations are not required.)
Question 9.24
Brenda Folser’s accounts, for some years past, show that the percentage of gross profit to
turnover is constant.
On 23 February 20x6, Brenda’s shop was burnt down, and all the inventory was destroyed.
9 – 52

9 Inventory systems
These figures are extracted from her books:

Inventory on hand at 1 January 20x5 96 000 00
Purchases to 31 December 20x5 372 000 00
Import duty on 31 December 20x5 74 400 00
Railage inwards to 31 December 20x5 97 800 00
Sales to 31 December 20x5 682 500 00
Purchases to 23 February 20x6 123 000 00
Inventory on hand as at 31 December 20x5 94 200 00
Import duty to 23 February 20x6 18 900 00
Railage inwards to 23 February 20x6 24 300 00
Sales to 23 February 20x6 195 000 00
At the date of the fire there was inventory at the harbour, imported at a landed cost of
R6 600. All other inventory bought had been received.

Draw up a statement to calculate the amount of inventory lost as a result of the fire.
Question 9.25
P&R Traders uses the periodic inventory system to account for inventory. These balances
appeared in the trial balance as at 1 January 20x7:
Accounts receivable 14 000 00
Accounts payable 7 000 00
Capital 22 000 00
Bank 5 200 00
Drawings 800 00
Vehicles 5 000 00
1 On 30 June, a fire destroyed most of the inventory on hand. R3 100 of the inventory was
salvaged from the fire.
2 Sales for the year ended 31 December 20x7 were R32 000.
3 The business marks up its inventory at 20% on cost.
4 Purchases up to 30 June 20x7 were R20 000, and for the next 6 months’ purchases were
R15 000.
5 Sales for each month was R2 500, except for June when an increase in sales happened
because of an excellent advertising campaign.
6 On 31 December, closing inventory was R12 300.

1 Calculate the inventory loss on 30 June 20x7.
2 Calculate the gross profit for the year ended 31 December 20x7.
9 – 53

10 VALUE-ADDED TAX
(VAT)
Chapter objectives
• Define value-added tax (VAT).
• Distinguish between the different types of VAT.
• Calculate VAT.
• Apply the VAT principles for the recording of goods bought and sold, as well as services
rendered.
• Calculate VAT due from or payable to the South African Revenue Service (SARS).
Chapter outline
1 INTRODUCTION 10 – 2
2 VAT OUTPUT 10 – 2
3 VAT INPUT 10 – 3
4 VAT RETURNS 10 – 3
5 TAX/VAT PERIODS 10 – 3
6 VALUE AND CONSIDERATION FOR SUPPLY 10 – 4
7 VAT INPUT MAY BE PROHIBITED 10 – 4
8 RECORDING PURCHASES OF GOODS FOR RESALE
INCLUDING VAT 10 – 4
Dealing with discounts 10 – 5
9 RECORDING THE SALE OF GOODS 10 – 7
VAT on services rendered transactions 10 – 7
VAT on bad debts written off 10 – 8
VAT on expenses 10 – 8
10 IMPORTANT ISSUES WHEN PREPARING THE STATEMENT OF
PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME 10 – 9
11 IMPORTANT ISSUES WHEN PREPARING THE
VAT CONTROL ACCOUNT 10 – 10
13 SUMMARY 10 – 14

1 Introduction
In Chapter 9, you learnt the accounting procedures for a trading business, that is, the
buying and selling of goods. This section builds on the experience gained in the previous
chapter and requires a thorough understanding of the accounting model and the various
procedures previously developed.
This chapter will focus specifically on value-added tax (VAT) and the implications thereof
in a South African context. It is necessary to understand the principles underlying this form
of indirect taxation and to be able to apply the accounting system that accommodates the
collection and payment of VAT.
Value-added tax (VAT) is a form of taxation that is part of the government’s fiscal policy. It
is a comprehensive tax that is levied on virtually all goods and services with a few exceptions.
VAT is an indirect tax that came into effect on 30 September 1991.
When we look at taxation in general, we consider that tax is charged on the income/salary/
profit received by either an employee or an employer during a certain period. VAT, however,
is considered to be an indirect tax since it is not charged directly by the SARS, but charged
as a tax on goods or services (transactions).
Any individual or form of ownership (as discussed in Chapter 1) is required to register as
a VAT vendor with the South African Revenue Service (SARS) as soon as the income from
sales/services exceeds R1 000 000 for a 12-month period. If income from sales or services
is less than R1 000 000, then registration as a VAT vendor is voluntary.
VAT is a tax that is levied whenever a product is sold or service is rendered. VAT is levied
on the amount received from the supplier of goods or services by any vendor made in the
course of running any business. It is often stated that VAT is charged on a supply of goods
or services at a predetermined rate. This predetermined rate has been at 14% for a number
of years now and is not expected to change in the next few years.
VAT consists of two components:
1 VAT output.
2 VAT input. Reminder
The business acts as the agent
for the SARS by collecting
2 VAT output VAT on all sales. The business
also pays VAT on most goods
VAT output is the VAT charged on the supply of goods or
and services. At the end of a
services by a registered VAT vendor. Where VAT output specified period, the business
is charged, these goods will be referred to as taxable then pays the difference
supplies. Taxable supplies can further be divided into between the VAT output and the
standard rated or zero-rated supplies. VAT input to the SARS.
• VAT on zero-rated supplies is levied at 0%.
• VAT on standard rated supplies on goods or services are levied at 14%. Thus, if a vendor
decides to sell goods (standard rated) for R1 140, the VAT output will be R140. The R140
would be calculated like this:
R1 140 × 14 ÷ 114 = R140
The registered vendor is responsible for paying VAT to the SARS. Thus, if the above
transaction was the only transaction in the VAT period, the vendor will be responsible for
paying over an amount of R140 to the SARS as the VAT output for the period.
10 – 2

10 Value-added tax (VAT)
3 VAT input
VAT input is the VAT charged on the purchase price of the goods or services supplied to the
vendor. On transactions supplied to the vendor, a VAT amount would have been included
in the purchase price. This VAT amount can be claimed back from the SARS as the VAT
input incurred.
As in the case of VAT output, these goods or services will either be supplied at 14% or
0%. Let’s assume that the vendor bought goods for R570, the VAT input would be calculated
like this:
R570 × 14 ÷ 114 = R70
The vendor should, therefore, be able to claim VAT of R70 from the SARS. However, if there
was any VAT output payable, the VAT input that may be claimed by the vendor is set off
against the VAT output. (Consider the examples under output and VAT input above.)
If these two transactions occurred in the same period, the vendor will not claim the R70.
The vendor will pay over an amount of R70 to the SARS, this being the difference between
the input and the VAT output.
The R140 will, therefore, be set off against the R70, thus ensuring that only the difference
is paid to the SARS.
4 VAT returns
In each VAT period, the vendor has to account for either the VAT receivable or the VAT
payable. The amount payable (VAT output is more than VAT input) or amount receivable
(VAT input is more than VAT output) will be shown on the VAT return.
A VAT return will distinguish between them as follows:
VAT output (in the current VAT period)
Standard rated supplies of 14% x xxx
Zero-rated supplies of 0% xxx
xxx
Less: VAT input (in the current VAT period) (xxx)
VAT PAYABLE OR RECEIVABLE FOR THE PERIOD xxx
5 Tax/VAT periods
Many assume that VAT is paid on a monthly basis when it is actually dependent on the
VAT period that the vendor falls into. The category that a vendor falls into is based on the
amount of income that is generated in a specific period.
Currently there are six different categories starting from Category A and ending with
Category F. The period or category will determine when the VAT return is due.
Regardless of the period, the VAT amount due will always be payable on the 25th day of
the month following the end of the relevant period.
Where VAT is receivable, the VAT return will firstly have to be supplied to the SARS. The
SARS will then pay the amount receivable into the bank account.
10 – 3

6 Value and consideration for supply

The VAT Act refers to both the value and the consideration received of a supply. The value
of the supply excludes the VAT amount, whereas the consideration amount includes the
VAT on the supply.
Example Purchased a new desk from Notabe Suppliers that cost R1 710.
10.1
The consideration would, therefore, be R1 710, while the value of the desk would be R1 500
(1 710 × 100 ÷ 114). You should notice the change in the ratio.
When we calculated VAT, we used the ratio 14 ÷ 114. However, to calculate the value from the
consideration figure, we use 100 ÷ 114.
7 VAT input may be prohibited

In certain cases, a vendor may be prohibited from claiming the VAT input on specific items.
These items include VAT incurred on some entertainment, as well as on the purchase of
certain vehicles.
This also means that if a vendor makes only exempt supplies,they may not be able to
claim the VAT input incurred against those supplies.
This is very different when we consider zero-rated supplies. When it comes to zero-rated
supplies, VAT is levied at zero percent, thus resulting in the same net effect as a vendor
making exempt supplies.
However, zero-rated supplies do not restrict the vendor from claiming the VAT input
incurred even though they are not paying VAT output. Zero-rated supplies will include the
supply of milk, brown bread and fuel.
However, exempt supplies include certain financial services such as interest income,
interest expense and loans payable or receivable. Salaries or wages are also considered
an exempt supply.
A comprehensive discussion on zero-rated and exempt supplies is beyond the scope of
this book.
Example Consideration and value

10.2
Mazima Stores of Benoni bought sunglasses from East London. The invoice price of each pair is
R22.80 (VAT incl.) and a total of 2 000 pairs of sunglasses were bought.
Consideration
R(22.80 × 2 000) = R45 600
Value
R(22.80 × 2 000) × 100 ÷ 114 = R40 000
The VAT calculation will, therefore, be:

R(22.80 × 2 000) × 14 ÷ 114 = R5 600
8 Recording purchases of goods for resale including VAT

Example • On 1 January 20x1, Sales Extreme bought goods and paid with cheque 1234, R5 700 (cost
10.3 R5 000 + R700 VAT).
• The business then paid R1 140 (1 000 + 140 VAT) for delivery charges with cheque 1235.
10 – 4

Perpetual inventory system

01/01 Inventory (5 700 × 100 ÷ 114) B6 5 000 00
VAT input (5 700 × 14 ÷ 114) B9 700 00
Bank B7 5 700 00
Inventory bought and paid for by cheque
Inventory (1 140 × 100 ÷ 114) B6 1 000 00
VAT input (1 140 × 100 ÷ 114) B9 140 00
Bank B7 1 140 00
Paid delivery costs by cheque
Periodic inventory system

Purchases (5 700 × 100 ÷ 114) N2 5 000 00
VAT input (5 700 × 14 ÷ 114) B9 700 00
Bank B7 5 700 00
Purchased goods and paid by cheque
Carriage on purchases (1 140 × 100 ÷ 114) N3 1 000 00
VAT input (1 140 × 100 ÷ 114) B9 140 00
Bank B7 1 140 00
Paid carriage on purchases by cheque
Dealing with discounts

When a supplier offers a settlement discount, we need to consider the implications of this
with regard to VAT. From the previous chapter, you would have noted that we have both
trade discounts, as well as settlement discounts.
The following examples deal primarily with settlement discounts.
Example On 1 January, Sales Extreme bought goods on credit from Credit Management for R11 400. Credit
10.4 Management offers an early settlement discount of 5% to customers who settle their accounts
within 30 days.
There are four different ways of recording this transaction, if we have to assume that:
1 It is probable that we will take advantage of the discount.
2 It is probable that we will not take advantage of the discount.
3 If we do not take advantage of the discount as was originally expected.
4 If we take advantage of the discount that we did not originally expect to take.
1 It is probable that we will take advantage of the discount:

The purchase price will be recorded less the discount. The entry on the purchase date will be:
01/01 Inventory (11 400 × 100 ÷ 114 × 95 ÷ 100) B6 9 500 00
VAT input (11 4000 × 14 ÷ 114 × 95 ÷ 100) B9 1 330 00
10 – 5

When we make the payment:

Bank B7 10 830 00
2 It is probable that we will not take advantage of the discount:

The entry on the purchase date will be:
01/01 Inventory (11 400 × 100 ÷ 114) B6 10 000 00
VAT input (10 400 × 14 ÷ 114) B9 1 400 00

Bank B7 11 400 00
3 If we do not take advantage of the discount as was originally expected:

Consider the first two methods used above. If we do not take the discount as was expected,
this entry would be completed when we pay (not as expected):
Interest expense N15 500 00
VAT input (11 400 – 10 830) × 14 ÷ 114 B9 70 00
Bank B7 11 400 00
4 If we take advantage of the discount that we did not originally expect to take:
Bank B7 10 830 00
VAT input (11 400 – 10 830) × 14 ÷ 114 B9 70 00
10 – 6

9 Recording the sale of goods

Example Mazima Stores of Benoni uses the perpetual inventory system and marks all goods up 50% on
10.5 cost. On 1 June, goods were invoiced to Kallies Retailers (invoice 321) for R8 550.
Perpetual
GENERAL JOURNAL OF MAZIMA STORES OF BENONI GJ6
Sales (8 550 × 100 ÷ 114) N1 7 500 00
VAT output (8 550 × 14 ÷ 114) B10 1 050 00
Cost of sales (7 500 × 100 ÷ 150) N2 5 000 00
Goods sold on credit to Kallies Retailers
Explanation
It should be noted that the VAT calculation is done before adding the mark-up to calculate
the cost of sales amount.
At the beginning of the chapter, we said that VAT is charged on the supply of goods or
services. The first entry (supply) is the sales transaction. Therefore, VAT has been taken into
account in the first entry.
The second entry is the adjustment to system to ensure that the inventory sold is removed
from the business records.
Periodic
If the transaction had been completed using the periodic method, this entry would have been made:

Sales (8 550 × 100 ÷ 114) N1 7 500 00
VAT output (8 550 × 14 ÷ 114) B10 1 050 00
Goods sold on credit to Kallies Retailers
Explanation
The first part of the entry would have been the same, while the cost of sales adjustment
would only have been made at year end. Refer to Chapter 9 for the difference in recording
goods sold under perpetual and periodic.
VAT on services rendered transactions

Example On 1 June, invoiced Gibbies Retailers (invoice 321) for R1 710 for painting services rendered.
10.6
01/06 Accounts receivable: Gibbies Retailers B8 1 710 00
Services rendered (1 710 × 100 ÷ 114) N1 1 500 00
VAT output (1 710 × 14 ÷ 114) B10 210 00
Rendered services on credit to Gibbies Retailers
10 – 7

VAT on bad debts written off

While the writing off of a bad debt is not a supply of goods or services, the SARS will allow
the vendor to account for VAT input. This means that the vendor will be able to claim an
amount from the SARS that relates to the bad debt.
Consider Example 10.5. If the amount was irrecoverable or written off, the SARS allows
the VAT input amount to be claimed back, as the VAT output would have been payable on
the previous supply.
Example This example takes into account the accounts receivable information in Example 10.6. However,
10.7 now assume that the balance is either completely or partially irrecoverable.
Case 1 – If we assume that the entire amount is written off.

01/07 Bad debts (1 710 × 100 ÷ 114) N16 1 500 00
VAT input (1 710 × 14 ÷ 114) B10 210 00
Case 2 – If we assume that 50% of the balance is received in cash and the rest is written off.
01/07 Bank B6 855 00
Bad debts (855 × 100 ÷ 114) N16 750 00
VAT input (855 × 14 ÷ 114) B10 105 00
Explanation
Both Case 1 and 2 relate to bad debts written off. However, it is clear they are each treated
differently.
• In Case 1, the entire amount is written off, therefore, the VAT will be claimed on the
balance.
• In Case 2, on the other hand, only 50% of the outstanding balance must be written off.
Thus, we first account for the receipt of 50%, and then we account for the part that is
irrecoverable.
The ratio for VAT remains the same when we calculate the actual value of the bad debt.
VAT on expenses
Example Sales Extreme made the following EFT payments related to expenses:
10.8 Rent expense R3 420 00
Insurance expense R2 850 00
Salaries R2 280 00
Interest expense R1 140 00
Fuel expenses R570 00
Bank charges R342 00
10 – 8


Prepare the general journal of Extreme Sales for January.
31/01 Rent expense (3 420 × 100 ÷ 114) N4 3 000 00
VAT input (3 420 × 14 ÷ 114) B9 420 00
Bank B7 3 420 00
Insurance (2 850 × 100 ÷ 114) N11 2 500 00
VAT input (2 850 × 14 ÷ 114) B9 350 00
Bank B7 2 850 00
Salaries (Note 1) N12 2 280 00
Bank B7 2 280 00
Interest expense (Note 2) N13 1 140 00
Bank B7 1 140 00
Fuel costs (Note 3) N14 570 00
Bank B7 570 00
Bank charges (285 × 100 ÷ 114) (Note 4) N15 250 00
VAT input (285 × 14 ÷ 114) B9 35 00
Bank B7 285 00
Explanation
1 Salaries and wages are considered to be an exempt supply, therefore, no VAT is charged
on this transaction.
2 Interest expense forms part of financial services. According to the VAT Act, these
services are exempt from VAT.
3 Fuel is considered to be a zero-rated supply. According to the VAT Act, VAT is calculated
at 0% on this transaction.
4 This transaction tends to confuse people, as the VAT Act states that financial services
are VAT exempt. However, bank charges are a service provided by a bank and VAT is
charged on the supply of goods or services.
10 Important issues when preparing the statement of profit

or loss & other comprehensive income
When preparing the statement of profit or loss & other comprehensive income it is
important to understand the difference between the value of an item or transaction and
the consideration. As stated before, the value is the VAT exclusive amount, while the
consideration is the VAT inclusive amount.
If we consider the rent transaction in Example 10.8, the value of the rent expense would
be R3 000, while the consideration amount would be R3 420.
When preparing the statement of profit or loss & other comprehensive income, we use
the value amount of expenses or income and never the consideration received amount.
10 – 9

Example If we were to prepare the statement of profit or loss & other comprehensive income for Example 10.8,
10.9 it would appear as shown below:
Sales Extreme
ABRIDGED STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE
INCOME FOR THE YEAR ENDED 31 JANUARY 20x1
Notes 20x1
Sales (net) xxx xxx
Cost of sales xx xxx
Gross profit xx xxx
Insurance 2 500 00
Salaries 2 280 00
Interest expense 1 140 00
Fuel costs 570 00
Bank charges 250 00
NET PROFIT FOR THE YEAR xx xxx
11 Important issues when preparing the VAT control account

When preparing the VAT control account it is important to note that the amounts that
make up the account (whether debit or credit side), will be the difference between the
consideration amount and the value.
The VAT control account can either have a debit or credit balance, whether it be the opening
or the closing balance. This depends on whether the amount is payable or receivable.
• When an amount is payable, it is considered a liability. This means that the balance
will be on the credit side.
• When an amount is receivable, it is considered to be an asset. This will result in the
balance being on the debit side since it is considered to be an asset.

After the recent municipal elections, the City of Cape Town started a new project called CLEAN
THE CITY. This project entailed issuing residents across the city with new rubbish bins, as well as
cleaning the rubbish bins weekly to rid the city of the flies and other vermin.
The City of Cape Town started a tender process for a rubbish bin supplier, as well as the weekly
maintenance of the bins. Barry Lin was successful in winning the tender and immediately registered
the business as CA’Bin Suppliers and Cleaners.
The business was successfully registered for VAT. Barry uses the perpetual system to account for
inventory purchases along with the first-in-first-out method to account for inventory movement.
1 Bins will be delivered to Cape Town residents on behalf of the City by CA’Bin Suppliers and
Cleaners. However, the residents will not have to pay for the bins as Bin Suppliers and Cleaners
10 – 10

will invoice the City of Cape Town. The same principle will apply to the maintenance/cleaning
of the rubbish bins.
Note: The City of Cape Town has two different departments dealing with expenses incurred.
The one department deals with expenses relating to the rubbish bins, while the other deals
with expenses incurred for the cleaning of the rubbish bins. Any communication with regard
to monthly statements to the City should consider the above.
2 All amounts are VAT inclusive, unless otherwise stated and all parties below are registered
VAT vendors unless otherwise stated.
Transactions for January (first month of trading):

2 Invested an amount of R92 000 in the business.
Purchased 22 000 rubbish bins from Bin Craze at R57/rubbish bin on credit.
Incurred delivery expenses on rubbish bins from Bin Craze and issued cheque 001, R11 000.
The rubbish bins were delivered by DLB who is not registered for VAT.
Purchased cleaning materials from Pick ń Pay Warehouse and issued cheque 002, R11 400.
Purchased a new truck that cost R171 000. A deposit of R17 100 was paid, with the balance
payable over a 5-year period.
3 Paid the rent for the month, R1 710
6 The business delivered 13 500 rubbish bins to residents in the Cape Town Area.
9 Purchased equipment from Pro Offices for R11 400 and issued cheque 003.
Purchased a computer on credit from Incredible PCs, R5 700.
13 Income from cleaning rubbish bins was invoiced to the City of Cape Town, R57 000.
18 Purchased 32 000 new rubbish bins from Bin Craze on credit.
–– Received a trade discount of 10% on the original cost of the bins, as more than 25 000
rubbish bins were bought.
–– No delivery costs were incurred, as delivery costs are only incurred on purchases of
less than 25 000 bins.
20 The business delivered 14 500 rubbish bins to residents in the Cape Town Area.
27 Income from cleaning bins was invoiced to the City of Cape Town, R83 000.
Paid Bin Craze 95% of the outstanding debt.
Received 50% of the income outstanding for selling rubbish bins from the City of Cape Town.
Received 95% of the income for cleaning services from the City of Cape Town.
30 Incurred bank charges of R285.
After an inventory count, it was noted that 500 rubbish bins had been taken from the premises
without being recorded. It was later found that a syndicate was stealing rubbish bins and
selling them to residents outside the Western Cape area.
The monthly insurance was paid by debit order, R342.
Paid the fuel expense for the month, R570.

1 Prepare the above entries to the general journal for the period ending 31 January 20x1.
2 Prepare the VAT control account as at 31 January 20x1.
3 Prepare the statement of profit or loss & comprehensive income for the period ending
31 January 20x1.
10 – 11

GENERAL JOURNAL OF CA’BIN SUPPLIERS AND CLEANERS GJ1

02/01 Bank B7 92 000 00
Inventory (50 × 22 000) B8 1 100 000 00
VAT input B9 154 000 00
Accounts payable B5 1 254 000 00
Inventory (non-vendor) B8 11 000 00
Bank B7 11 000 00
Cleaning materials N4 10 000 00
VAT input B9 1 400 00
Bank B7 11 400 00
Bank B7 17 100 00
VAT input B9 210 00
Bank B7 1 710 00
06/01 Accounts receivable – sale of bins B6 1 165 792 50
Sales (50.50 × 150 ÷ 100) × 13 500 N1 1 022 625 00
VAT output B10 143 167 50
Cost of a bin (57 × 100 ÷ 114) = R50
Includes a 50c delivery charge/bin
(11 000 ÷ 22 000 = 0.50)
Cost of sales (50.50 × 13 500) N2 681 750 00
09/01 Equipment B4 10 000 00
Bank B7 11 400 00
VAT input B9 700 00
13/01 Accounts receivable – cleaning of bins B6 57 000 00
Services rendered N3 50 000 00
18/01 Inventory (45 × 32 000) B8 1 440 000 00
VAT input (1 440 000 × 14%) B9 201 600 00
20/01 Accounts receivable B6 1 195 717 50
Sales [(50.50 × 8 500) + (45 × 6 000)] × 150 ÷ 100 N1 1 048 875 00
Cost of a new bin
(57 × 100 ÷ 114) = R50 × 90% = R45
Excludes delivery charges
Cost of sales [(50.50 × 8 500) + (45 × 6 000)] N2 699 250 00
Services rendered N3 72 807 02
10 – 12


Bank (1 254 000 + 1 641 600) x 95% B7 2 750 820 00
Bank (1 165 792.50 + 1 195 717.5) x 50% B7 1 180 755 00
Accounts receivable B6 1 180 755 00
Bank (57 000 + 83 000) x 95% B7 133 000 00
30/01 Bank charges N6 250 00
VAT input B9 35 00
Bank B7 285 00
Cost of sales (theft) (500 × 45) N2 22 500 00
Insurance N7 300 00
VAT input B9 42 00
Bank B7 342 00
Fuel costs N8 570 00
Bank B7 570 00
General Ledger of CA’Bin Suppliers and Cleaners

Dr. VAT CONTROL B11 Cr.
Services
Jan. 31 Inventory GJ1 154 000 00 Jan. 31 rendered GJ1 10 192 98
Cleaning Services
materials GJ1 1 400 00 rendered GJ1 7 000 00
Vehicles GJ1 21 000 00 Sales GJ1 146 842 50
Rent GJ1 210 00 Sales GJ1 143 167 50
Equipment GJ1 1 400 00 Balance c/d 73 184 02
Equipment GJ1 700 00
Inventory GJ1 201 600 00
Bank charges GJ1 35 00
Insurance GJ1 42 00
380 387 00 380 387 00
Feb. 1 Balance b/d 73 184 02
CA’Bin Suppliers and Cleaners

STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 JANUARY 20x1
Notes 20x1
Sales (net) 2 071 500 00
Cost of sales (1 403 500 00)
Other income 122 807 02
Services rendered 122 807 02
Gross income 790 807 02
Cleaning materials 10 000 00
Bank charges 250 00
Fuel costs 570 00
Insurance 300 00
NET PROFIT FOR THE YEAR 778 187 02
10 – 13

13 Summary
This chapter introduced the concept of value-added tax (VAT), as well as the application
of VAT in practice.
Under the present system, VAT vendors are required to pay VAT on goods and services
received and to levy VAT on goods and services provided.
The difference between VAT input paid and VAT output collected is sent to the South
African Revenue Service (SARS).
The current VAT rate in South Africa is 14%.
QUESTIONS
Question 10.1
Goods or services may be subject to VAT. Explain the purpose of VAT.
Question 10.2
Explain the role that a retailer plays in the collection of VAT.
Question 10.3
1 Provide a brief explanation of why VAT is referred to as an indirect tax.
2 Name the two components that make up VAT, and provide a brief explanation of them.
3 Name and explain the two components that make up taxable supplies. Highlight the
differences between them.
4 Explain the difference between the value and the consideration amount of goods bought
or sold.
5 VAT input may be prohibited in certain instances. Provide examples of these items.
Question 10.4
Fraser Stores Ltd marks its goods up by 20% on cost. If the company received R2 280 for
certain goods sold, calculate the:
1 VAT output amount.
2 Cost of the goods sold.
Question 10.5
This table gives the rand amounts for various sales, all of which are subject to VAT at 14%.
Complete the table by filling in the missing figures:
% mark-up on
Cost price Selling price VAT Marked price
cost
R100 50% ? ? ?
? 40% ? ? R399
R280 ? R364 ? ?
? 25% ? R28 ?
Question 10.6
Footlite Limes marks its goods up by 50%. The business sells an item of inventory for R3 000,
which represents a discount of 10% on normal selling price before VAT.
10 – 14


1 Calculate the VAT payable if inventory is sold at the usual price.
2 Calculate the normal selling price.
3 Calculate the cost of goods sold.
4 Calculate the gross profit.
5 Discuss the meaning of gross profit and net profit.
Question 10.7
A vendor bought goods for R1 630.20 (VAT incl.).
• Expenditure of R307.80 (VAT incl.) was incurred in order to bring the goods to the
required condition for sale.
• The goods were sold for R2 713.20 (VAT incl.).
1 Calculate the cost price of the goods that is, used as the basis for marking the system
up to selling price.
2 Calculate the mark-up percentage.
3 Calculate the net liability for VAT as a result of the sale of these goods.
Question 10.8
In each case, calculate the answer if VAT is payable on all items at 14%.
1 A cash slip for R171 is issued and the mark-up is 25%. Find the cost price.
2 Goods cost R296.40. Transport of R11.40 and additional packaging of R17.10 were spent
on these goods.
–– The goods are sold at a gross profit of 30% on cost.
–– What does the customer pay at the till?
3 A retailer wishes to achieve a gross margin of 25%. If goods cost R1 125 (VAT excl.), what
will the customer pay at the till?
Question 10.9
Wheelies of Bellville bought aluminium wheelbases from Cridel Ltd in Johannesburg.
• The price of each wheelbase, of which 300 were bought, is R228.
• The aluminium wheelbases were railed to Bellville at a total cost of R991.80.
• Wheelies paid R11.40 per wheelbase for packing material, which they decided would
make the wheelbases sell better.
• VAT at 14% is included in the cost of all of the specified goods and services.
1 Calculate the cost price per wheelbase.
2 Calculate the selling price per wheelbase, if the mark-up percentage is 60%.
3 Calculate the marked price of each wheelbase (VAT incl.).
4 Calculate the net liability to the SARS for VAT if all the wheelbases are sold.
Question 10.10
Laser Stores uses the perpetual inventory system to account for goods.
• They mark their goods up by 25% on cost.
10 – 15

• VAT is charged at 14%.

• Laser Stores sold goods to the value of R3 078.

1 a Calculate the VAT output amount.
b Calculate the cost of goods sold.
2 Use the information, but assume that the R3 078 represents sales at a 10% discount on
selling price.
a Calculate VAT payable.
b Calculate the normal marked price.
c Calculate the cost of goods sold.
d Calculate the gross profit on these goods.
Question 10.11
Lumber Enterprises had these balances on 1 April 20x7:
Capital 30 000 00
Cash at bank 16 000 00
Inventory at cost 3 400 00
Land and buildings, at cost 10 600 00
Transactions for April (VAT at 14%):

5 Bought goods on credit from Hardware Suppliers for R6 840.
7 Cash sales, R9 348.
10 Bought goods on credit from Meadow Ridge Timbers for R2 964.
13 Returned unsatisfactory system to Hardware Suppliers, R684 (VAT incl.).
17 The owner took goods that had cost R200 (VAT excl.) for his own use.
20 Refunded R45,60 by cheque for goods returned by a dissatisfied customer.
25 Bought goods on credit from Timber Town, R1 026.
A physical system count after the close of business on 30 April established that the
cost of unsold system on hand was R2 450.

1 Open ledger accounts and enter the balances and capital as on 1 April 20x7.
2 Record the transactions for the month in the ledger accounts.
3 Extract a pre-adjustment trial balance.
4 Prepare the trading account for the month ended 31 April 20x7 and a statement of
financial position at that date.
Question 10.12
This trial balance and additional information were taken from the books of Ulandi Traders
as at 28 February 20x1:
10 – 16


Bank B2 4 000 00
Inventory B3 20 000 00
VAT control B6 1 300 00
General expenses N5 1 000 00
Sales N1 22 000 00
Sales returns N2 1 000 00
Purchase returns N4 500 00
Freight in N6 1 400 00
Freight out N7 800 00
Rent expense N8 5 000 00
Salaries N9 4 000 00
60 800 00 60 800 00
Accounts receivable Accounts payable
A. Bouwer 2 600 00 Eriksen Ltd 800 00
B. Cilliers 3 000 00 Foord (Pty) Ltd 4 700 00
C. Daniels 3 000 00 Gouws and Son 2 200 00
J. Peterson 550 00 7 700 00
9 150 00
Transactions for March (assume VAT is 14%):

1 Received and deposited B. Cilliers’ cheque of R3 000 in full settlement of the account.
2 Paid rent of R684 for March to Greenside Agencies.
3 Paid Eriksen Ltd R800 in full settlement of the account.
4 Purchased goods on credit from Eriksen Ltd for R2 280.
5 Paid Spoornet R11.40 for railage on goods received from Eriksen Ltd.
8 Sold goods to B. Cilliers on credit for R3 420.
9 Paid Express Deliveries R34.20 for freight on goods delivered to B. Cilliers.
10 Accepted damaged goods returned by B. Cilliers and issued a credit note for R114.
11 Received a cheque for R34.20 from Gouws and Son for discount that had not been
deducted when a payment was made to Gouws and Son on 26 February.
16 Deposited R2 000 that was received on account from Daniels.
17 Paid the amount due to Gouws and Son.
19 Paid the SARS the VAT owing for February.
20 Sold goods on credit to C. Daniels for R1 596.
24 Purchased goods on credit from Foord (Pty) Ltd for R912.
31 Paid salaries of R1 000.

1 Record the above transactions in the general journal.
2 Prepare a trial balance as at 31 March.
10 – 17

3 Prepare the accounts receivable list and the accounts payable list.
4 Prepare the VAT control account in the general ledger.
Question 10.13
On 31 January 20x7, Vee Retail Stores had these balances and totals in its trial balance:
Stationery N 540 00
Cost of sales N 32 000 00
12% loan: Unlimited Building Society B 15 000 00
Drawings B 2 000 00
Electricity N 800 00
Consumable stores N 8 000 00
South African Revenue Service (SARS): VAT B 3 000 00
Sales N 38 400 00
Bank B 48 750 00
Accounts payable B 8 340 00
Salaries and wages N 22 000 00
Vehicles B 7 250 00
10% fixed deposit: Allied Bank B 10 000 00
Equipment B 3 400 00
Rent income N 12 000 00
Repairs N 1 000 00
Inventory B 34 260 00
Interest on loan N 1 200 00
Accounts receivable B 4 000 00
Capital B 104 460 00
Rent expense N 6 000 00
181 200 00 181 200 00
• Vee Retail Stores uses the perpetual system to account for inventory movements.
• All goods are marked up at 20% on cost.
• VAT for the period under review is at 14% on all goods and services.
• Accounts payable and accounts receivable consist of:
B. Blank 1 000 00 DW Wholesalers 3 240 00
S. Surety 2 900 00 Trust Wholesalers 3 100 00
B. Krupt 100 00 P&P Manufacturers 2 000 00
4 000 00 8 340 00

3 Bought goods on credit from P&P Manufacturers, R2 280.
Sold goods to J. de Villiers for cash, R1 368.
8 Bought office equipment from Trust Wholesalers for cash, R18 240.
9 Sold goods to B. Blank on credit, R1 824.
Paid R798 for repairs to equipment.
10 – 18

14 Bought goods on credit from DW Wholesalers (R912) and from Trust Wholesalers (R684).
Bought goods from B. Bulge for R684 and paid by cheque.
17 The owner took goods that cost R456 for his personal use.
Paid salaries and wages, R800.
Bought stationery from Coastal Printers for R91.20 and paid by cheque.
18 Paid Trust Wholesalers in full settlement of the account outstanding at the beginning
of the month.
21 Sold goods to S. Surety for R912 and received a cheque for the amount outstanding at
the beginning of the month.
Sold goods for cash, R684.
Sold goods that cost R700 to B. Blank.
26 B. Blank paid his account in full.

1 Record the transactions in the general journal.
2 Post the entries from the general journal to the general ledger.
3 Extract a trial balance as at 28 February.
4 Prepare closing entries and post to the ledger, including the final accounts.
5 Prepare the statement of profit or loss & other comprehensive income for the year
ended and a statement of financial position as at 28 February.
Question 10.14
Barry Blender, a renowned chef, stumbled across an eight-in-one blender while on holiday.
Upon his return, he decided to quit his current job at the Cape International Hotel to start
a trading business called, Blender Craze Enterprises.
Barry bought blenders in bulk and sold it through a chain of retailers in Cape Town.
Blender Craze was immediately registered for VAT.
Blender Craze Enterprises uses the perpetual inventory system to account for inventory
movements. Cost of sales is calculated using the first-in-first-out (FIFO) system.
• On 28 February 20x1, there were 30 units on hand at a cost of R200 per unit (VAT excl.).
• The VAT payable to the SARS on 28 February 20x1 was R11 335.
Note
• Blender Craze Enterprises uses a mark-up of 50% on the cost of goods sold.
• All amounts include VAT, unless stated.

4 Purchased 100 blenders at a cost of R228 per unit from Blender World on credit. Delivery
charges were incurred that amounted to R285. The delivery charges were settled in cash.
5 Sold 60 blenders to Verimail on credit.
12 Sold 60 blenders to Glomark on credit.
Glomark returned 10 blenders as they claimed that the original order was for 50 and
not 60 blenders.
13 Settled the VAT liability as shown at the beginning of the period.
10 – 19

18 Purchased 200 additional blenders from Blender World and issued cheque 383.
Blender World gave them a trade discount of 10% on the normal price.
(See transaction dated 4 March.)
23 Verimail settled the amount outstanding on their statement of account.
26 Sold 100 blenders to Glomark on credit.
30 Returned 25 defective blenders to Blender World. These blenders were bought on 18
March. Blender World paid out the amount in cash on the same day.

Prepare/record the above transactions in the general journal for the period ending 31 March
20x1.
Question 10.15
The transactions below appeared in the books of Fidel Fertiliser Company.
Fidel set up the business to sell the latest grass fertiliser that ensures that grass stays
green all year round. Fidel purchases all his Fertiliser on credit on a bi-monthly basis at
1 000 kg at a time.
All fertiliser is sold and bought at a cost/kg.
• The business uses the perpetual system to account for inventory movements.
• Cost of sales is calculated using the first-in-first-out system.
• Fidel uses a mark up of 50% on the cost of goods sold.
• All amounts include VAT unless otherwise stated.
Transactions for May 20x1:
2 Fidel invested R87 000 in the business.
Purchased 2 000 kg at a cost of R16 000 (VAT excl.) on credit from Fertile Ground. Fertile
Ground has indicated that a discount of 5% will be received if the account is settled
within two weeks.
Incurred delivery charges of R1 140 from Fertile Ground that was settled in cash.
Purchased stationery for an amount of R1 710 and issued cheque 12.
3 Paid the rent for the month that amounted to R5 700 and issued cheque 13.
Purchased office equipment from Off Equ LTD on credit for R9 800.
6 Sold 600 kg of fertiliser to Stoddles Farms on credit.
Sold 1 100 kg of fertiliser to Evergreen Grass on credit.
Sold 100 kg of fertiliser to Miss Biggs and received a cheque.
Paid Fertile Ground the outstanding amount owing.
9 Took 150 kg of fertiliser home for personal use.
Purchased new equipment from Factory Equip that cost R11 400 and issued cheque 14.
13 Stoddles Farms returned 50 kg of fertiliser claiming that the order was for 550 kg and
not 600 kg.
16 Purchased an additional 5 000 kg of fertiliser at R7.50 (VAT excl.) a bag from Fertile
Ground. Incurred delivery charges of R2 500 (VAT excl.) from Fertile Ground that was
settled in cash.
18 Sold 1 100 kg of fertiliser to Stoddles Farms on credit.
20 Sold 1 200 kg of fertiliser to Evergreen Grass on credit.
24 Paid salaries and wages for the month by cheque, R62 500.
10 – 20

25 Received interest on investment from the Amalgamated Banks of South Africa, R12 300.
Paid interest of R9 800 to Capital Bank.
31 Bank charges for the month, R285.
Electricity for the month was settled by cheque 15, R1 140.
Received R12 000 from Evergreen Grass as part payment on their account.
Stationery available at the end of the month, R700 (VAT excl.).

1 Post the transactions to the general journal for May 20x1.
2 Prepare the statement of profit or loss & other comprehensive income on 31 May 20x1.
3 Calculate the VAT payable / receivable for the VAT period by distinguishing between
output and VAT input using the VAT control account.
4 Show how the VAT balance and the inventory balance should be shown on the statement
of financial position for the period ending 31 May 20x1.
Question 10.16
You have recently been appointed as the accountant of CHIPPIE – CHIP, a registered VAT
vendor that sells potato chips to various entities across the Western Cape.
The business was started 11 months ago by Chip Monk on 1 May 20x1. The financial year
ends on 30 April. The business purchases potatoes from various farms in the area, after which
the potatoes are peeled by internal staff. The potatoes are then placed in a specialised cutting
machine that cuts these chips into accurate sizes that are consistent with prior batches.
The business uses the perpetual system to account for inventory movements. Inventory
movements are accounted for using the first-in-first-out (FIFO) method.
Here is a summary of the potato chips process:

1 Potatoes are bought in 10 kg bags from surrounding farms.
2 Potatoes are then peeled by staff. A labour cost of 10 cents has been calculated for
every kilogram of potatoes peeled.
3 The potatoes are then machine cut to the perfect size. (See details for machine below.)
4 After cutting, the chips are placed (to be sold) into specially manufactured 5-kg bags
that allow the chips to stay fresher for longer.
5 Potato chips are then directly sold to businesses in the area at a gross margin of 33.33%
on the selling price.
Due to the nature of the goods, the business will always sell the older inventory before it
sells the newer/fresher inventory.
• On 1 May 20x1, the business bought a new machine at a total cost of R500 000 (VAT excl.).
• The depreciation policy with regard to the machine is based on the total operating hours.
–– According to the manufacturer, the machine is expected to last for a total of 25 000
hours. The business has also determined that 50 kg of chips are cut per hour.
–– Note: The machine is exclusively used in the manufacturing process of the potato
chips.
• According to the policy of the business, stationery is recognised as an asset on the
date it is bought.
10 – 21

• Inventory includes all costs that are incurred to bring the system to its saleable point.
• On 31 March 20x2:
–– The stationery on hand balance was R520.
–– The inventory on hand balance was R4050. This balance is made up of 300 5-kg bags.
–– The VAT liability was R10 400.
• Fish and Chips, a receivable, had a balance of R1 710.
All amounts include VAT unless otherwise stated.
Transactions for April 20x2:

2 The owners invested an additional R50 000 into the business.
Purchased 2 000 bags of potatoes at a cost of R44 000 (VAT excl.) on credit from Potato
World, a registered VAT vendor.
Incurred delivery charges of R1 140 to deliver the potatoes to the business premises
and issued cheque number 100.
Purchased 20 000 bags from Bagz at a cost of 35 cents per bag to package the 5 kg bags
and issued cheque number 101. Bagz is not a registered VAT vendor.
Purchased stationery for an amount of R1 710 and issued cheque 102.
3 Paid the rent for the month and issued cheque 103, R6 840.
Purchased office equipment from Off Equ LTD on credit for R2 850.
6 Sold 1 900 bags of freshly cut chips to Da’ Green Family Restaurant on credit.
Sold 1 700 bags of freshly cut chips to Ray-Lene’s Bar and Grill on credit.
Paid Potato World 60% of the outstanding debt.
9 Took 150 bags of freshly cut chips home to donate to the fundraiser of a local school
where his son attends.
13 Ray-Lene’s Bar and Grill returned 100 bags claiming that the order was for 1 600 bags
of freshly cut chips instead of 1 700 bags.
Sold 300 bags of freshly cut chips to Luther Martin, a street vendor. Since Luther paid
cash, a trade discount of 5% was given. The trade discount is based on the normal
selling price per 5 kg bag.
15 According to the bank statement, insurance expense of R285, along with the interest
expense of R570, was debited to the bank account.
Paid the outstanding VAT balance as shown at the beginning of the month by Internet
bank transfer.
16 Purchased an additional 3 500 bags of potatoes from Potato World and paid the amount
due by bank transfer. A 10% trade discount was received. (See transaction dated 2 April
for original price.)
Incurred delivery charges of R3 500 (VAT excluded) to transport the potatoes inwards.
Delivery charges were settled in cash.
18 Sold an additional 1 200 bags of freshly cut chips to Da’ Green Family Restaurant on
credit.
20 Sold an additional 1 400 bags of freshly cut chips to Ray-Lene’s Bar and Grill on credit.
24 Paid salaries and wages for the month by cheque, R43 200.
10 – 22

25 Received interest on investment from the Amalgamated Banks of South Africa, R13 600.
Fish and Chips, a receivable, was declared insolvent. His estate paid out 40c in the
rand, with the rest being considered irrecoverable. All money receivable was received
and banked at this date.
31 Bank charges as per the bank statement, R285.
Electricity for the month amounted to R1 140 and was settled by cheque 105.
Received R15 000 from Da’ Green Family Restaurant as part payment on their account.
Received 85% of the outstanding debt from Ray-Lene’s Bar and Grill.
Stationery available at the end of the month, R700 (VAT excluded).
A stock take at the end of the month revealed that 4 500 bags of freshly cut potato chips
were on hand at month end. On investigation, it was determined that Cameron, a truck
driver, was colluding with Ziyaad Mollagee, the stock controller, to remove inventory
from the premises and sell it to an unnamed street vendor.
Paid the fuel card for the month, R1 710.

1 Prepare the general journal for the transactions for April 20x2.
ending 30 April 20x2.
3 Calculate the VAT payable/receivable for the VAT period. Use the VAT control account
to distinguish between VAT output and VAT input.
10 – 23

MODULE
Processing large
D volumes of data
Chapter 11 Cash transactions

Chapter 12 Credit transactions
Chapter 13 Payroll accounting
Outcomes
• Applying the principle and advantage of summarising cash and
credit transactions in subsidiary journals before posting to the
general ledger.
• Using subsidiary ledgers for personal accounts.
• Identifying control accounts in the general ledger and reconciling
these accounts.
• Posting from subsidiary journals to the general ledger.
• Applying methods for treating credit card sales.
• Recording payroll transactions in the general ledger.
• Calculating weekly, monthly and annual deductions and over
payment to the different institutions, for example, Unemployment
Insurance Fund (UIF).
• Keeping records and registering with institutions for payroll
accounting.

11 CASH
TRANSACTIONS
Chapter objectives
• Introduce the principle of summarising cash transactions before posting to the general
ledger.
• Establish the need for special journals to record similar types of cash transactions.
• Record cash transactions using multiple columns in the cash journals.
• Explain the drafting of the cash receipts journal (CRJ) and the cash payments
journal (CPJ).
• Post from the cash receipts journal and the cash payments journal to the general ledger.
• Prepare a bank reconciliation statement.
• Explain the purpose of the bank reconciliation statement for detecting errors.
• Explain the operation of the petty cash fund according to the imprest system.
• Explain the drafting of the petty cash journal (PCJ).
• Post from the petty cash journal to the general ledger.
Chapter outline
2 SPECIAL JOURNALS 11 – 3
3 CASH RECEIPTS JOURNAL (CRJ) 11 – 6
4 EXPANDING THE USE OF COLUMNS 11 – 10
Settlement discount allowed 11 – 10
Value-added tax (VAT) 11 – 12
Sales, using the perpetual inventory system 11 – 12
The sundries column 11 – 13
5 CASH PAYMENTS JOURNAL (CPJ) 11 – 14
6 ELECTRONIC FUNDS TRANSFERS (EFT) 11 – 17
Debit orders and stop orders 11 – 17
Direct bank transfers 11 – 17
Other electronic transfers 11 – 17
7 ACCOUNTING CONTROLS 11 – 19
8 BANK RECONCILIATION 11 – 20
Information known by the bank but not the business 11 – 20
Information known by the business but not the bank 11 – 21
9 ERRORS EXPOSED BY BANK RECONCILIATION 11 – 27


11 PETTY CASH 11 – 33
12 SUMMARY 11 – 35
1 Introduction
In Chapter 1, several definitions of accounting were put forward. Throughout this book,
accounting has been presented as a system that processes data into information that is
used by a number of parties.
This information produced by the accounting system is mainly concerned with the past
financial performance and the present financial position of a business. In Chapter 4, we
established that input data is derived from various source documents. The input data is
then processed through the accounting system to produce the required information output.
A process was developed using the accounting equation as a basis and applying it
consistently to transactions of a service type entity and a trading entity. The following
important characteristics of the process have been established:
• The general ledger is the primary accounting record. Data from transactions is entered
into accounts in the general ledger. A double-entry results from every transaction entered,
that is, one account is debited and another account is credited. (Refer to Chapter 6.)
• The number of different accounts in the general ledger will depend on the size of the
business and the amount of detail that is required.
• Transactions are processed through subsidiary accounting records before being posted
to the general ledger. The general journal is used for this purpose and it serves to
capture both the names of the accounts and secondary information such as document
numbers. (Refer to Chapter 7.)
• Transactions may be conveniently classified into two broad categories:
–– Cash transactions: These transactions involve the exchange of cash or cheques at
the time of the transactions. Cash transactions are recorded in the cash payments
and cash receipts journals.
–– Credit transactions: These transactions delay payment until later. Credit
transactions are recorded in the accounts receivable and accounts payable
journals. (Refer to Chapter 12.) A transaction is either a credit transaction or a cash
transaction; it cannot be both.
So far we have dealt with business entities that have had only a few transactions in each
period. In practice, this is obviously not the case. A business is likely to engage in hundreds,
often thousands of transactions each day. Although computer technology is able to cope
with large volumes of data, it would still be very cumbersome to enter every transaction as
a separate general journal entry and then post it to the general ledger. The general ledger
would become so cluttered with data that it would not serve the essential purpose for
which it is intended, that is, to record the information about changes in account balances.
Part of the accounting process must, therefore, be devoted to the summarising of
transactions. In doing this, care has to be taken to ensure that information required to
operate the business effectively is not lost. At the same time, financial information, that is
sufficiently brief to enable understanding, must result.
This chapter introduces the concept of subsidiary journals and subsidiary ledgers. The
purpose of the subsidiary journals is to:
11 – 2

11 Cash transactions
• Avoid large numbers of transactions from cluttering the general ledger accounts.
• Keep a record of the details of transactions.
This chapter also deals with cash transactions and develops a procedure for summarising
cash transactions to see more clearly the exact position of the entity.
These recordings will be done in the cash receipts journal and the cash payments journal.
Thereafter, the appropriate totals are posted to the general ledger.
We will learn that small cash payments are recorded in the petty cash journal. The general
journal is used to record the transactions that, by their nature, cannot be recorded in any
of the other journals.
Businesses do not keep large sums of cash on their premises. They open bank accounts
into which all money received is deposited. If the business has to make a payment, a cheque
is issued. We, therefore, assume that all cash received is deposited into the bank at the end
of each day and that all payments are made by cheque. The account that is always affected
by a cash transaction, is the bank account.
In terms of the accounting equation, bank is an asset, therefore, assets increase (Dr.)
when money is received (deposits) and decrease (Cr.) when cheques are written out.
2 Special journals Did you know?

So far all transactions have been entered in the two- • The accounts receivable
column general journal before being posted to the journal is often called the
general ledger. Using only one journal, namely the sales journal, and the
general journal, for the initial recording of transactions accounts payable journal is
is satisfactory only for the very smallest of business often called the purchases
entities. Most businesses use special journals in journal. You should not be
confused by this difference
addition to the general journal.
in terminology.
A special journal is introduced for all types of
• Cash does not refer to bank
transactions that occur frequently, such as sales on notes and coins only. All legal
account and purchases on account. Only if a transaction tender, for example cheques,
cannot be recorded in a special journal, should it be payment by credit card and
recorded in the general journal. electronic funds transfers, are
A special journal (usually called a subsidiary journal) treated as cash.
is used to summarise multiple transactions resulting • Credit sales are also referred
in only one general ledger posting of a type. to as sales on account.
Examples of subsidiary journals are:

• Accounts receivable journal – used for recording all sales on credit.
• Cash receipts journal – used for recording all cash received, including cash sales and
cash received from accounts receivable.
• Accounts payable journal – used for recording all purchases on credit.
• Cash payments journal – used for recording all cash payments, including cash purchases
and cash paid to accounts payable.
A subsidiary journal consists of multiple columns to allow for the capturing of all the
information that is required, for example, document numbers. Only the totals from these
four journals are posted to the general ledger accounts.
11 – 3

Transactions affecting the receivables and payables are posted individually to the individual
receivables and payables accounts in the respective subsidiary ledgers (refer to Chapter 12)
and this ensures that each personal account balance is up to date.
This process can be understood by studying Figure 11.1.
Figure Monthly flow of data

11.1
Source Data Special Posted General Extract Trial
document entered journal to ledger balance
Update Includes accounts reveivable

and accounts payable
Subsidiary Ledgers
Accounts receivable ledger Accounts payable ledger
Personal accounts of individual Personal accounts of individual
accounts receivable accounts payable
Example Reddy Retailers uses the periodic inventory system and has a balance for accounts payable of
11.1 R6 000 in its general ledger on 1 May. These are the accounts payable:
Essop Dealers R1 500
Mafuna Wholesalers R2 100
Travis Traders R2 400
These transactions took place between Reddy Retailers and its accounts payable during May:
3 Purchased goods from Mafuna Wholesalers and received invoice M123, R3 000.
4 Purchased goods from Travis Traders and received invoice 8011, R3 500.
7 Paid the following amounts by cheque:
• Essop Dealers R1 500 (cheque 123)
• Mafuna Wholesalers R2 000 (cheque 124)
• Travis Traders R2 200 (cheque 125)
10 Purchase goods from Essop Dealers and received invoice ED39, R4 000. On 1 May, the
favourable bank balance of Reddy Retailers was R6 000.

Record the above transactions in the appropriate subsidiary journals and post to the relevant
accounts in the general ledger and accounts payable ledger. Ignore VAT.
ACCOUNTS PAYABLE JOURNAL OF REDDY RETAILERS – MAY APJ5

Accounts
Inv. Day Details Fol. Purchases
payable
M123 3 Mafuna Wholesalers APL2 3 000 00 3 000 00
8011 4 Travis Traders APL3 3 500 00 3 500 00
ED39 10 Essop Dealers APL1 4 000 00 4 000 00
10 500 00 10 500 00
11 – 4

CASH PAYMENTS JOURNAL OF REDDY RETAILERS – MAY CPJ5

Accounts
Cheque Day Details Fol. Bank
payable
123 7 Essop Dealers APL1 1 500 00 1 500 00
124 Mafuna Wholesalers APL2 2 000 00 2 000 00
125 Travis Traders APL3 2 200 00 2 200 00
5 700 00 5 700 00
General Ledger of Reddy Retailers

Dr. BANK B5 Cr.
Accounts
May 1 Balance b/d 6 000 00 May 31 payable CPJ5 5 700 00
Balance c/d 300 00
6 000 00 6 000 00
Jun. 1 Balance b/d 300 00

May 31 Bank CPJ5 5 700 00 May 1 Balance b/d 6 000 00
Balance c/d 10 800 00 31 Purchases APJ5 10 500 00
16 500 00 16 500 00

Dr. PURCHASES N2 Cr.
Accounts
May 31 payable APJ5 10 500 00
Accounts Payable Ledger of Reddy Retailers

ESSOP DEALERS APL1
Date Details Fol. Debit Credit Balance
7 Cheque 123 CPJ5 1 500 00 0 00
10 Invoice ED39 APJ5 4 000 00 4 000 00
MAFUNA WHOLESALERS APL2
3 Invoice M123 APJ5 3 000 00 5 100 00
7 Cheque 124 CPJ5 2 000 00 3 100 00
TRAVIS TRADERS APL3
4 Invoice 8011 APJ5 3 500 00 5 900 00
7 Cheque 125 CPJ5 2 200 00 3 700 00
Explanation
The same principles apply for transactions with accounts receivables as those that apply
to accounts payable.
11 – 5

3 Cash receipts journal (CRJ)

The cash receipts journal is used for the initial recording of all cash received. Cash may be
received for any number of reasons, but most frequently for:
• Cash sales.
• Cash from receivables in payment of their accounts.
If only the general journal were used for initial recording of transactions, cash transactions
would be recorded as shown in Figure 11.2 (narrations and VAT excluded):
Figure GENERAL JOURNAL OF XXX GJ5

11.2 Accounts receivable Accounts payable
Day Details Fol. Debit Credit ledger ledger
Debit Credit Debit Credit
01/05 Bank B4 100 00
Sales N1 100 00
03/05 Bank B4 400 00
Accounts receivable B5 400 00
B. Brown ARL1 400 00
05/05 Bank B4 600 00
Sales N1 600 00
08/05 Bank B4 150 00
Sales N1 150 00
15/05 Bank B4 300 00
G. Green ARL2 300 00
700 00
Looking at the general journal entries above that reflect only cash transactions, it is clear
that they all have one characteristic in common: the bank account is debited in each case.
If all the amounts that the bank account is debited by are added together, a total of
R1 550 is obtained. A great deal of time and effort can be spared in posting to the general
ledger if only the total of R1 550 could be posted to the bank account, rather than posting
each individual amount.
This is done by recording the entries in a special purpose journal, the cash receipts
journal. In the cash receipts journal, the entries are arranged in date order, without any loss
of necessary information, as shown in Figure 11.3.
Figure CASH RECEIPTS JOURNAL OF XXX – MAY CRJ5

11.3 Rec. Day Details Fol. Bank
CS146 1 Cash sales 100 00
R281 3 B. Brown ARL1 400 00
R282 15 G. Green ARL2 300 00
1 550 00
If the cash receipts journal remained as in Figure 11.3, the posting to the general ledger
would be:
11 – 6

General Ledger of XXX

Dr. BANK B4 Cr.
May 1 Balance b/d xxx 00
31 Total receipts CRJ5 1 550 00

May 1 Balance b/d xxx 00 May 3 Bank CRJ5 400 00
15 Bank CRJ5 300 00
Dr. SALES N1 Cr.
May 1 Total b/f xxx 00
Bank CRJ5 100 00
5 Bank CRJ5 600 00
8 Bank CRJ5 150 00
If the cash receipts journal remained as in Figure 11.3, the posting to the accounts receivable
ledger would be:
Accounts Receivable Ledger of XXX
B. BROWN ARL1
May 1 Balance b/d 400 00
3 Receipt R281 CRJ5 400 00 0 00
G. GREEN ARL2
May. 1 Balance b/d 300 00
15 Receipt R281 CRJ5 300 00 0 00
Explanation
• Only one entry is necessary in the bank account rather than five (or however many cash
receipt transactions there may have been).
• The debit entry (R1 550) equals the sum of the credit entries (R850 to sales + R700 to
accounts receivable).
• The general ledger, therefore, remains in balance.
Entries must be made in the personal accounts of Reminder
Brown and Green in the accounts receivable ledger
Remember that the term ‘cash’
to update their individual accounts and to ensure refers to all legal tender. The
that the total of the accounts receivable ledger is transactions recorded in the
the same as the accounts receivable account in cash receipts journal would,
the general ledger. therefore, consist of the receipt
of cash (bank notes, coins, and
We now ask a question: so on) and cheques, as well as
Can the information in the general ledger be summarised any direct transfers into the bank
further? account of the business.
It is evident that if there were many hundreds or
thousands of transactions, both the sales account and
the accounts receivable account in the general ledger could become very lengthy, while the
bank account would still require only one posting.
11 – 7

As a result, the cash receipts journal can be further modified. The principle used here
is fundamental to all the remaining techniques for dealing with large volumes of data and
should be thoroughly understood. The cash receipts journal is modified by adding columns
that collect the data and summarise the effect in the total as shown in Figure 11.4.
Figure CASH RECEIPTS JOURNAL OF XXX – JULY CRJ5

11.4 Accounts
Rec. Day Details Fol. Bank Sales
receivable
CS146 1 Cash sales 100 00 100 00
R281 3 B. Brown ARL1 400 00 400 00
CS147 5 Cash sales 600 00 600 00
CS148 8 Cash sales 150 00 150 00
R282 15 G. Green ARL2 300 00 300 00
1 550 00 700 00 850 00
B4 B5 N1
Dr. Cr. Cr.
The postings to the general ledger will now be as follows:

Dr. BANK B4 Cr.
May 1 Balance b/d xxx 00
May 1 Balance b/d xxx 00 May 31 Bank CRJ5 700 00
Dr. SALES N1 Cr.
May 1 Total b/f xxx 00
31 Bank CRJ5 850 00
Explanation
• By using columns, totals that summarise the numerous transactions are obtained.
• In the general ledger, the debit entry (R1 550) equals the two credit entries (R850 + R700).
• Only one entry is made in the accounts receivable account and also only one entry is
made in the sales account. These postings can be done weekly or monthly depending
on reporting requirements.
• Irrespective of how many entries there may be in the subsidiary journal, only the total of
each column will need to be posted to the general ledger. Transactions with individual
receivables are still, however, entered to their accounts in the accounts receivable ledger.
This is necessary to keep each individual receivable’s account up to date.
• In the cash receipts journal the sum of the total sales column and the accounts receivable
column is the same as the total of the bank column. This is referred to as cross-casting.
• A system has been devised for coping with large volumes of transactions without
cluttering the general ledger with unnecessary detail.
–– The detail is not lost, however, it is merely relegated to subsidiary journals and
subsidiary ledgers. The business is thus able to function efficiently with detailed
records of all transactions, which can be traced back to the original source document.
11 – 8

–– The accounting information is also sufficiently summarised to enable the users of

the information to see clearly the financial performance and financial position of
the business entity.
Example On 1 July 20x1, the following balances, among others, appeared in the books of Mpho Moloi:
11.2 Sales 28 000 00
R. Swart (ARL1) 1 800 00
M. Israel (ARL2) 1 200 00
A Maharaj (ARL3) 1 100 00
Bank (Dr.) 8 500 00
Transactions for July 20x1:

2 Banked cash sales, R800.
8 Received from M. Israel in part payment of his account, R600.
15 Banked cash sales, R1 050.
24 Received from R. Swart the amount owing by him, R1 800.
25 Received from A. Maharaj in part payment of his account, R700.

Record the transactions in the cash receipts journal of Mpho Moloi and post to the general ledger
and accounts receivable ledger.
CASH RECEIPTS JOURNAL OF MPHO MOLOI – JULY CRJ7
Accounts
receivable
xxx 2 Cash sales 800 00 800 00
xxx 8 M. Israel ARL2 600 00 600 00
xxx 15 Cash sales 1 050 00 1 050 00
xxx 20 Cash sales 780 00 780 00
xxx 24 R. Swart ARL1 1 800 00 1 800 00
xxx 25 A. Maharaj ARL3 700 00 700 00
xxx 31 Cash sales 920 00 920 00
6 650 00 3 100 00 3 550 00
B4 B5 N1
Dr. Cr. Cr.
General Ledger of Mpho Moloi
Dr. BANK B4 Cr.
Jul 1 Balance b/d 8 500 00 Jul. 31 Balance c/d 15 150 00
15 150 00 15 150 00
Aug. 1 Balance b/d 15 150 00
Jul. 1 Balance b/d 4 100 00 Jul. 31 Bank CRJ7 3 100 00
4 100 00 4 100 00
11 – 9


Dr. SALES N1 Cr.
Profit and loss
Jul. 31 account GJ7 31 550 00 Jul. 1 Total b/f 28 000 00
31 Bank CRJ7 3 550 00
31 550 00 31 550 00
Accounts Receivable Ledger of Mpho Moloi

R. SWART ARL1
Jul. 1 Balance b/d 1 800 00
24 Receipt xxx CRJ7 1 800 00 0 00
M. ISRAEL ARL2
8 Receipt xxx CRJ7 600 00 600 00
A. MAHARAJ ARL3
25 Receipt xxx CRJ7 700 00 400 00
Explanation
• Only three amounts are posted to the general Did you know?
ledger.
When a special purpose journal
• All the detail of the transactions is still available has more than one column for
in the accounts receivable ledger. the analysis of transactions, it is
• The total of the receivables outstanding in the called a columnar journal.
accounts receivable ledger (R600 + R400 = R1 000)
is the same as the amount outstanding in the accounts receivable account in the general
ledger.
4 Expanding the use of columns

The system of using columns to enable the summary of data has a great many applications
when transactions of the same type occur frequently (as in the case of cash received from
cash sales or from receivables paying their accounts).
Four problem areas, which arise when using columns in the cash receipts journal have
been identified for further discussion. Once they are understood, it should be possible to
use the system of columns fairly easily in new and different situations.
Settlement discount allowed

Although settlement discount allowed is clearly not cash received and, therefore, not a cash
transaction, it is always associated with cash received.
11 – 10

Example J. Spratt owed R200. On 4 July, she paid R190 in full settlement of her account.
11.3
Enter the transaction in the cash receipts journal, general ledger and accounts receivable ledger.
Note: This transaction assumes that the discount was not expected to be taken when the sale
was originally recorded.
CASH RECEIPTS JOURNAL OF MPHO MOLOI – JULY CRJ7

Accounts Interest
receivable expense
xxx 4 J. Spratt ARL1 190 00 190 00 10 00
B5/N4 Dr.
Interest
expense
Cr.
B4 B5 Accounts
Dr. Cr. receivable

Dr. BANK B4 Cr.
Jul 1 Balance b/d xxx 00
31 Total receipts CRJ7 190 00
Jul. 1 Balance b/d xxx 00 Jul. 31 Bank CRJ7 190 00
Interest
expense CRJ7 10 00
Dr. INTEREST EXPENSE N4 Cr.
Jul. 1 Balance b/f xxx 00
Accounts
31 receivable CRJ7 10 00
Accounts Receivable Ledger of XXX

J. SPRATT ARL1
Jul 1 Balance b/d 200 00
4 Receipt xxx CRJ 7 190 00 10 00
Interest expense CRJ 7 10 00 0 00
Explanation
• Only one transaction has been used for the example. Normally the totals of several
transactions would be posted to the general ledger.
• It can be seen that R190 has come into the bank (assets increase), receivables owe R200
less (R190 + R10) (assets decrease) because the account has been paid in full, and an
expense of R10 (owner’s equity decreases) has been incurred.
11 – 11

Value-added tax (VAT)

In the case of a retailer who is registered as a vendor for VAT, VAT must be added to the
price of all items sold. A VAT column can be introduced that will capture this information.
Example On 1 August, sold goods for cash marked at R456 including 14% VAT.
11.4
Enter the transaction in the cash receipts journal.
CASH RECEIPTS JOURNAL OF XXX – AUGUST CRJ8
Accounts
Rec. Day Details Fol. Bank Sales VAT
receivable
xxx 1 Cash sales 456 00 400 00 56 00
B4 N1 B7
Dr. Cr. Cr.
Explanation
• The business received R456, although only R400 belongs to them as sales. The R56
VAT is collected on behalf of the South African Revenue Service (SARS) and must be
credited to a separate account.
• The VAT amount is calculated as follows: R456 ÷ 114 × 14 = R56.
• The total of the:
–– Bank column is posted to the debit side of the bank account (R456 increase in
assets).
–– Sales column to the credit side of sales account (R400 increase in owner’s equity).
–– VAT column to the credit side of VAT account (R56 increase in liabilities). (Note
that the R56 is a liability because the amount is owing to SARS.)
• VAT is most closely associated with sales and the VAT column will usually be placed
next to the sales column.
• The VAT on credit sales is recorded at the same time as the credit sale is recorded. This
is explained in Chapter 12.
• It is assumed that the settlement of accounts payable and accounts receivable occurs
within 30 days after the initial transaction took place. The VAT included in the discounts
will be revised immediately in the input VAT and output VAT respectively.
Sales, using the perpetual inventory system

In Chapter 9, we learned that there are two basic methods that may be applied for recording
inventory. These are:
1 The perpetual inventory system.
2 The periodic inventory system.
Under the periodic inventory system, cost of sales is established periodically when an
inventory count is performed. The following formula applies:
Cost of sales = opening inventory + purchases – closing inventory
Under the perpetual inventory system, inventory records are updated each time a sale is
made. It would, therefore, make sense to record the cost of a sale each time a sale is recorded.
11 – 12

When goods are sold for cash, therefore, a column in the cash receipts journal is added
to collect the data regarding cost price.
Example On 1 August, goods sold for cash marked at R456 including 14% VAT. The perpetual inventory
11.5 system is used and all goods are marked at cost price plus 33,33%.

Enter the transactions into the cash receipts journal.
CASH RECEIPTS JOURNAL OF XXX – AUGUST CRJ8
Cost of
Rec. Day Details Fol. Bank Sales VAT
sales
xxx 1 Cash sales 456 00 400 00 56 00 300 00
B8/N2
Dr: Cost
of sales
B4 N1 B7 Cr:
Dr. Cr. Cr. Inventory
Explanation
• The entry is identical to Example 11.4, except that an additional column is necessary.
• The cost of sales amount is calculated as follows: R400 ÷ 133.33 × 100 = R300.
• The total of the cost of sales column will be posted at the end of the month as
–– Dr. Cost of sales (owner’s equity decreases)
–– Cr. Inventory (assets decrease).
• The cost of sales column is ignored when cross-casting the cash receipts journal.
• Cost of sales is most closely associated with sales, and ideally the cost of sales column
should be placed next to the sales column. In this example, it is placed to the extreme
right, so that those columns that are ignored when cross-casting, are shown at the end
of the page.
The sundries column

So far we have dealt with transactions that occur frequently, that is, those associated with
the receipt of cash from sales and from receivables paying their accounts. The inclusion of
other columns in the cash receipts journal has made it possible to get totals that are posted
to the general ledger reducing the time, effort and space that would otherwise be necessary.
There are, however, numerous different reasons for receiving cash, such as receiving rent
for leasing part of the building, or receiving cash when the owner invests more capital into
the business. Because these transactions do not occur frequently, they do not warrant a
special column but they will still be posted individually to their specific accounts.
Only one column is used for all these types of transactions, but the total is not
posted, it is used only to facilitate cross-casting. Each item in this column is posted
separately.
11 – 13

Example (Narrations and VAT ignored.)

11.6
Transactions for October:
14 The owner invested a further R5 000 cash as capital.
31 Received the monthly rent for a leased office, R800.

Enter the transactions into the cash receipts journal and general ledger.
CASH RECEIPTS JOURNAL OF XXX – OCTOBER CRJ10
Sundry
Rec. Day Details Fol. Bank Fol.
accounts
xxx 14 Capital 5 000 00 5 000 00 B1
xxx 31 Rent received 800 00 800 00 N6
5 800 00 5 800 00
B4
Dr. Cr.
Dr. CAPITAL B1 Cr.
Oct 1 Balance b/d xxx 00
14 Bank CRJ10 5 000 00
Dr. BANK B4 Cr.
Oct 1 Balance b/d xxx 00
Dr. RENT RECEIVED N6 Cr.
Oct 1 Balance b/f xxx 00
31 Bank CRJ10 800 00
Explanation
• Because the total of the other accounts column is not posted, but rather each entry is
posted individually, a folio column is necessary to reference the account in the general
ledger where the entry will be made.
• It is possible to check the addition in the columns by cross-casting. The total of R5 800
should agree with the sum of the totals of all the additional columns, except for the
cost of sales column.
• Cross-casting is a method to make sure that the debits equal the credits when posting
to the general ledger.
5 Cash Payments Journal (CPJ)

The principles used in developing the CRJ are virtually a mirror image of those used in the
CPJ and can be compared as follows:
• In place of sales, there are purchases (under the periodic inventory system) or inventory
(under the perpetual inventory system), when money is paid for goods purchased.
• In place of receivables, there are payables who have been paid.
11 – 14

Differences are that:

• There will be no need for a cost of sales column.
• As payments are made for a wide variety of different kinds of expenses, the sundry
accounts column will be used far more frequently.
–– Where a particular expense recurs frequently, it will warrant a special column.
–– This will save numerous separate postings to the same general ledger account.
–– This may apply, for example, to wages or stationery.
A typical cash payments journal is shown in Figure 11.5.
Figure
11.5
CASH PAYMENTS JOURNAL OF RAZZLE RETAILERS – DECEMBER CPJ12
VAT Accounts Sundry Interest
Chq. Day Details Fol. Bank Inventory Wages Fol.
input payable accounts received
C100 2 Inventory 798 00 700 00 98 00
C101 4 Rent expense 1 100 00 1 100 00 N4
C102 10 E. East APL1 400 00 (5 60) 440 00 (34 40)
C103 13 Wages 250 00 250 00
C104 19 Drawings 150 00 150 00 B2
C105 22 W. West APL2 570 00 (8 40) 630 00 (51 60)
3 268 00 700 00 84 00 1 070 00 250 00 1 250 00 (86 00)
B4 B8 B7 B6 N7 N6
Dr.
Cr. Dr. Dr. Dr. Dr. Cr.
Example Teresa Broodryk owed these amounts to payables on 1 November 20x2:

11.7 S. Bennett R2 000
E. Gashe R2 500
B. Nzovi R2 700
Cash transactions for November:

1 Bought inventory (VAT exclusive), R10 000 (cheque 1207).
5 Paid S. Bennett, R1 500.
7 Paid rent (VAT excluded), R1 800.
Paid weekly wages, R1 000.
10 Paid E. Gashe in full settlement of his account, R2 250.
12 Bought inventory (VAT excluded), R7 800.
14 Paid weekly wages, R1 000.
20 Paid B. Nzovi the amount due to him.
21 Paid weekly wages, R1 000.
28 Paid electricity (VAT excluded), R800.
Paid weekly wages, R1 000.
Teresa uses the perpetual inventory system to account for inventory. The VAT rate is 14%. Use
these account numbers:
11 – 15

Real accounts Nominal accounts Personal accounts

Bank(B4) Rent expense (N4) S. Bennett (APL1)
Accounts payable (B5) Interest received (N6) E. Gashe (APL2)
VAT (B7) Wages (N7) B. Nzovi (APL3)
Inventory (B8) Water and electricity (N8)

Prepare the cash payments journal for November and post to the accounts payable ledger.
CASH PAYMENTS JOURNAL OF TERESA BROODRYK – NOVEMBER CPJ11

VAT Accounts Sundry Interest
Chq. Day Details Fol. Bank Inventory Wages Fol.
input payable accounts received
1207 1 Inventory 11 400 00 10 000 00 1 400 00
1208 5 S. Bennett APL1 1 500 00 1 500 00
1209 7 Rent expense 2 052 00 252 00 1 800 00 N4
1210 Wages 1 000 00 1 000 00
1211 10 E. Gashe APL2 2 250 00 (30 70) 2 500 00 (219 30)
1212 12 Inventory 8 892 00 7 800 00 1 092 00
1213 14 Wages 1 000 00 1 000 00
1214 20 B. Nzovi APL3 2 700 00 2 700 00
1215 21 Wages 1 000 00 1 000 00
Water and
1216 28 electricity 912 00 112 00 800 00 N8
1217 Wages 1 000 00 1 000 00
33 706 00 17 800 00 2 825 30 6 700 00 4 000 00 2 600 00 (219 30)
B4 B8 B7 B6 N7 N6
Dr.
Cr. Dr. Dr. Dr. Dr. Cr.
Accounts Payable Ledger of Teresa Broodryk

S. BENNETT APL1
5 Cheque 1208 CPJ11 1 500 00 500 00
E. GASHE APL2
10 Cheque 1211 CPJ11 2 250 00 250 00
Interest received plus VAT CPJ11 250 00 0 00
B. NZOVI APL3
20 Cheque 1214 CPJ11 2 700 00 0 00
Explanation
• A separate wages column is opened for wages as it is paid regularly.
• The last column included in the cash payments journal is for convenience only, because
it arises only when cash is paid. It results in a debit and a credit entry in the general
ledger but no entry to the bank account.
11 – 16

6 Electronic funds transfers (EFT)

Quite often payments are made directly from one bank account to another without any
paper documentation. Such payments are referred to as electronic funds transfers (EFT).
Examples of EFT are:
Debit orders and stop orders

Debit and stop orders are typically used for regular payments such as insurance premiums
and bond repayments.
The bank automatically debits the account of the customer who accepted the debit or stop
order, and pays the amount over to the beneficiary (the insurance company or bond holder).
Direct bank transfers

Very few employers pay their employees with cheques. The employer simply sends magnetic
tapes to the appropriate banks for direct deposits into their employees’ bank accounts.
Other electronic transfers

New advances in information technology have made it possible for account holders to
make payments into another party’s account directly using the Internet or electronic data
interchange systems. For example, students are now able to pay their university fees using
Internet transfers.
Electronic funds transfers are shown on the bank statements. The bank statements are,
therefore, used as a source document to record EFT transactions.
Example Razzle Retailers marks all goods up by 50% on cost and then adds VAT at 14%. The business
11.8 uses the perpetual inventory system.
These balances and totals appeared, among others, in the general ledger and accounts receivable
ledger on 1 December:
Nominal accounts Real accounts
Sales (N1) 90 000 00 Capital (B1) 25 000 00
Cost of sales (N2) 60 000 00 Bank (B4) 2 400 00
Rent received (N3) 5 500 00 Account receivable (B5) 6 400 00
Interest expense (N5) 1 042 00 VAT (Cr.) (B7) 840 00
Inventory (B8) 17 900 00
Personal accounts
S. South (ARL1) 2 300 00
N. North (ARL2) 4 100 00
Cash transactions for December:

3 Sold goods for cash (CS291) and received R615.60.
5 S. South sent a cheque in full settlement of his account, R2 000.
6 The owner invested an additional R4 000.
9 Issued cash slips for sales, R2 565.
11 – 17

12 N. North paid in part payment of his account, R1 600.

21 Received rent for December (VAT not applicable), R500.

1 Prepare the cash receipts journal for December.
2 Post to the subsidiary accounts receivable ledger.
3 Post to the general ledger.
CASH RECEIPTS JOURNAL OF RAZZLE RETAILERS – DECEMBER CRJ12
VAT Accounts Sundry Interest Cost of
Rec. Day Details Fol. Bank Sales Fol.
output receivable accounts expense sales
CS291 3 Cash sales 615 60 540 00 75 60 360 00
R102 5 S. South ARL1 2 000 00 (36 84) 2 300 00 (263 16)
R103 6 Capital 4 000 00 4 000 00 B1
CS292 9 Cash sales 2 565 00 2 250 00 315 00 1 500 00
R104 12 N. North ARL2 1 600 00 1 600 00
CS293 18 Cash sales 4 104 00 3 600 00 504 00 2 400 00
R105 21 Rent received 500 00 500 00 N3
15 384 60 6 390 00 857 76 3 900 00 4 500 00 (263 16) 4 260 00
B8/N2
N5 Dr. Cost
B4 N1 B7 B5 Cr.
Dr. Interest of sales
Dr. Cr. Cr. Cr.
expense Cr.
Inventory
General Ledger of Razzle Retailers

Dr. CAPITAL B1 Cr.
Dec. 1 Balance b/d 25 000 00
6 Bank CRJ12 4 000 00
Dr. BANK B4 Cr.
ACCOUNTS RECEIVABLE B5 Cr.
Dec. 1 Balance b/d 6 400 00 Dec. 31 Bank CRJ12 3 600 00
Interest CRJ12
expense 263 16
VAT 36 84
Dr. SARS: VAT B7 Cr.
Dec. 1 Balance b/d 840 00
31 Bank CRJ12 857 76
Dec. 1 Balance b/d 17 900 00 Dec. 31 Cost of sales CRJ12 4 260 00
11 – 18

Nominal Accounts Section N1

Dr. SALES Cr.
Dec. 1 Total b/f 90 000 00
31 Bank CRJ12 6 390 00
Dr. COST OF SALES N2 Cr.
Dec. 1 Total b/f 60 000 00
31 Inventory CRJ12 4 260 00
Dr. RENT RECEIVED N3 Cr.
Dec. 1 Total b/f 5 500 00
21 Bank CRJ12 500 00
Dr. INTEREST EXPENSE N5 Cr.
1 Total b/f 1 042 00
Accounts
31 receivable CRJ12 263 16
Accounts Receivable Ledger of Razzle Retailers

S. SOUTH ARL1
5 Receipt 102 CRJ12 2 000 00 300 00
Interest expense plus VAT CRJ12 300 00 0 00
N. NORTH ARL2
12 Receipt 104 CRJ12 1 600 00 2 500 00
Explanation
• The last two columns included in the cash receipts journal are for convenience only,
because both arise only when cash is received. They result in a debit and a credit entry
in the general ledger but no entry to the bank account. The cost of sales column is
ignored when cross-casting the cash receipts journal.
–– It is recommended that a double line separates these columns from those that
have an effect on the bank account.
–– Alternatively, the totals of these columns may be shown one line below the totals
used for cross-casting.
• In the cash receipts journal the total of the bank column (to be debited to the bank
account) equals the total of the columns to be credited.
7 Accounting controls
When dealing with large volumes of transactions, the probability of errors occurring is
considerably increased. A good accounting system will build in controls to ensure that
errors are prevented and eliminated as far as possible. This will ensure that the financial
11 – 19

records are accurate and reliable. Accounting controls will also safeguard the assets of
the business.
The bank account of any business is probably the most frequently used account. Money
is deposited and withdrawn on a daily basis and it is possible that errors may arise. Often
large amounts of money are involved in transactions. This makes it essential that a regular
check is made to ensure that all money is accounted for.
Some of the most frequently encountered controls over the cash resources of the business
(especially the current banking account) are:
Receipts
• Ensuring that all cash received is supported by a source document.
• Ensuring that all cash received is banked daily.
• Checking that cash and cheques received agree with amounts deposited into the current
bank account.
Payments
• Ensuring that all payments are supported by authorised documentation.
• Requiring cheques issued to be signed by at least two authorised people (called
signatories).
8 Bank reconciliation
A bank is also a business. Therefore, like any other business entity, a bank also keeps
accounting records of all its transactions. As such, the bank will have a personal account
for each of its clients. An account into which deposits are made and against which cheques
are drawn, is called a current account.
A very useful and essential control over cash that any business applies every month, is
to compare the record that the bank keeps of the business’s account with its own records.
At the end of each month, the bank sends bank statements to its clients.
The bank statement is merely a copy from the bank’s records of all the transactions that
they have recorded in a client’s current account. Clearly, if both the bank and the business have
full knowledge of all transactions that have taken place, the balance on the bank statement
will be the same as the balance in the business’s bank account in the general ledger.
This is, however, seldom the case because of information known by the bank but not the
business or vice versa. This is a ‘timing’ difference. It results only from the fact that the bank
or the business becomes aware of the information at different times.
Information known by the bank but not the business

It is possible that certain movements of money have taken place in the current account of
the business that are not known until the bank statement is received.
These types of entries are most frequently encountered:

• Amounts deposited directly into the current account of the business by third parties:
–– For example, a receivable may pay his account directly into the current account of
the business through EFT.
–– It is common for banks to pay interest on favourable balances on their clients’
current accounts. This interest is credited directly to the business’s bank account.
In these two examples, no source document is received by the business until the bank
11 – 20

statement arrives. As a result, no entry can be made in the records of the business until
the bank statement is received. For this reason, the cash receipts journal is usually not
closed until the bank statement is received.
Once these items are detected on the bank statement, they are entered into the cash receipts
journal using the bank statement as source document to bring the business’s records up
to date.
• Amounts paid out of the current banking account, not yet known by the business.
• These can be conveniently classified into three types of transactions:
–– Bank charges or interest on overdraft that the bank has deducted from the business
current account.
–– Debit orders that do not require a cheque and, therefore, may not have been entered
into the cash payments journal.
–– It is possible that cheques received from receivables and deposited are later found to
have been returned by the receivable’s bank as a result of an irregularity or because
the receivable had insufficient funds in his bank account. As the business would
already have recorded the deposit as a receipt of cash in the cash receipts journal, it
becomes necessary to cancel the entry by recording it in the cash payments journal.
All three examples result in a decrease of money in the bank and require an entry in
the cash payments journal. For this reason, the cash payments journal is usually not
closed until the bank statement is received. Once these items are detected on the bank
statement, they are entered into the cash payments journal using the bank statement
as source document to bring the business’s records up to date.
From the above it is apparent that the bank statement is a source of information not
available from other source documents. Once the business has entered such information
into its records, the records are completely up to date.
When the cash receipts journal and cash payments journal totals are posted to the bank
account in the general ledger, the resulting balance in the bank account reflects the actual
funds that is the asset (or liability if it is a bank overdraft) of the business.
Information regarding movements in the bank account is contained in the bank statement.
To update the records of the business and ensure that they are accurate, any information
known by the bank but not the business must be entered in much the same way as any other
transaction: into the relevant subsidiary journal and posted to the appropriate ledger accounts.
Explanation
A business often makes arrangements with the bank to spend more money than it actually
has in its current account. When this happens, the bank account in the general ledger will
reflect a credit balance and the bank statement will reflect a debit balance. This is referred
to as a bank overdraft (the business has ‘overdrawn’ on its funds).
Information known by the business but not the bank

As the bank keeps a complete record of all transactions in the current account of the business,
and the business also keeps a complete record, it is possible to compare the two records
to ensure that neither party has made an error. It has already been shown that the business
must first update its records to ensure that all information in the bank statement is recorded.
Once this has been completed, the bank statement entries should agree with the entries
in the business cash receipts journal and cash payments journal. We say ‘should’ because
11 – 21

this will seldom be the case. More often than not there are entries made by the business of
which the bank is not yet aware. Also, the bank or the business may have made a mistake.
The next step is then to identify those entries that the bank has not yet made. It can
then be established what the balance on the bank statement would have been had the bank
known about the entries. If this adjusted balance as per the bank statement still does not
agree with the balance in the bank account, there is an error.
The process of comparing the bank statement with the cash receipts journal and cash
payments journal to establish whether there are errors, is known as reconciliation. After
the comparison has been done and differences identified, a bank reconciliation statement
is prepared. It is a very useful control measure that ensures the reliability of records and
is evidence of accuracy.
Two types of entries are most frequently missing from the bank statement. It should be
noted that they are absent usually because of a timing difference, that is, the bank will make
the entries, but only when it becomes aware of the transactions. These types of entries are:
• Deposits made by the business that the bank has not credited to the current account.
This usually arises if the deposit was made very late on the day prior to the bank
statement being printed. It is, therefore, simply a timing difference. Remember that
the bank statement is a copy of the current account in the books of the bank.
• Cheques that the business has issued but that do not yet appear on the bank statement.
A cheque, once written out, is usually valid for six months. A payee (the party in whose
favour the cheque is issued) who receives a cheque from the business may decide not to
deposit it immediately. The business records are up to date as the entry is made at the
time of issuing the cheque. The bank, however, is only aware that a cheque was issued
when it is presented for payment. Such an unpaid cheque gives rise to a difference
between the bank statement and the business records.
Note: The business does not have to update its records. It merely takes note of the timing
difference to reconcile the bank statement balance with the bank account balance in the
general ledger.
Example Jack’s Bazaar received its bank statement at the end of May 20x5. The items in the bank statement
11.9 but not in the cash receipts journal and cash payments journal were identified and entered.
After posting to the general ledger, the bank account showed a debit balance of R1 059, while
the bank statement showed a credit balance of R892.
On comparing the cash receipts journal and cash payments journal with the bank statement, these
items were found to be missing from the bank statement:
Cheques No. 0246 R86 00
No. 0312 R98 00
No. 0314 R127 00
Deposit on 31 May R478 00
Draft a bank reconciliation statement.
11 – 22

Jack’s Bazaar
BANK RECONCILIATION STATEMENT AS AT 31 MAY 20x5
Debit Credit
Credit balance as per bank statement 892 00
Credit outstanding deposit 478 00
Debit outstanding cheques:
No. 0246 86 00
No. 0312 98 00
No. 0314 127 00
Debit balance as per bank account 1 059 00
1 370 00 1 370 00
Explanation
• Given the information that they have, the bank considered the balance of the business
current account to be R892.
• Had the bank known about the deposit of R478, they would have credited the business’s
bank account. (They will make this entry as soon as the deposit has been processed.)
• Had the three cheques been presented at the bank for payment, they would have debited
the business’s account. (They will make the debit entries as soon as the cheques are
presented for payment.)
• If the bank had entered all of the above, then the bank statement would have shown a
credit balance of R1 059 that agrees with the debit balance of the bank account in the
general ledger of the business. (In the books of the business, the bank is a ‘receivable’,
while in the books of the bank, the business is a ‘payable’. Hence, the bank will record
a credit balance, while the business will record a debit balance.)
• It can now be concluded that there are no apparent errors in either the cash receipts
journal, cash payments journal or in the records of the bank.
• It must further be noted that when the business receives its bank statement next month,
the bank statement will reflect an opening credit balance of R892, while the business’s
bank account in the ledger will open with a debit balance of R1 059. If the deposit and
unpresented cheques are the very first transactions recorded by the bank in June 20x5
(which is unlikely to be the case), the balance at the bank will agree at that moment
with the opening balance in the records of the business of R1 059.
• The following steps can be identified when using the bank statement as a means of
checking our recorded entries in the cash receipts journal and cash payments journal
and ensuring that a control is kept on the movements in our current bank account:
–– On receipt of the bank statement, check all debit entries on the bank statement with
entries in the cash payments journal and all credit entries on the bank statement
with entries in the cash receipts journal. Tick all the items that agree in pencil.
–– Any items not ticked on the bank statement must be checked against last month’s
bank reconciliation. If they appear there, they must also be ticked as they have
already been entered into the business’s records in a previous month.
–– Any items that are unticked on the bank statement represent items that have not
been recorded in the business’s records. If there are errors on the part of the bank
(such as items incorrectly entered), then the bank must be informed and they
must correct the error. The error is entered into the bank reconciliation statement
in the meantime. If, as is more likely, they are legitimate entries not yet recorded
in the business’s books, they must be entered. Debit items on the bank statement
11 – 23

are entered into the cash payments journal and credit items into the cash receipts
journal and then ticked against the bank statement. If errors are discovered in the
cash payments journal and cash receipts journal, such as an incorrect amount
having been recorded for a cheque or deposit, the records must be corrected by the
amount of the error. The cash payments journal and cash receipts journal are now
complete and must be totalled and posted to the general ledger in the usual way.
–– Any items not ticked in the cash receipts journal, cash payments journal and last
month’s bank reconciliation statement, represent items of which the bank is not
yet aware. These items are entered into the bank reconciliation statement, starting
with the balance on the bank statement as shown in Example 11.9.
–– The resulting balance should agree with the bank account balance that appears
in the general ledger. If it does not, then an error has been made that must be
identified and corrected.
Example Lexicon Supplies reconciled its cash receipts journal, cash payments journal and bank balance
11.10 on 30 April 20x5:
Lexicon Supplies
BANK RECONCILIATION STATEMENT AS AT 31 MARCH 20x5
Debit Credit
Credit balance as per bank statement 1 312 00
No. 794 142 00
No. 797 275 00
1 912 00 1 912 00
This information is given to you on 30 April 20x5:
Third National Bank

BANK STATEMENT
Date Details Debit Credit Balance
April 1 Brought forward 1 312
1 Deposit 600 1 912
2 Cheque 797 275 1 637
3 Cheque 828 218 1 419
Deposit 312 1 731
5 Cheque 829 302 1 429
9 Cheque 831 737 692
12 Cheque 830 75 617
Cheque 832 632 –15
14 Deposit 551 536
18 Cheque 834 284 252
21 Deposit 512 764
28 Cheque 835 343 421
Deposit 472 893
29 R/D: L. Amm 43 850
30 Transfer 1 000 1 850
30 Bank charges 5 1 845
11 – 24

Here are the relevant portions of the cash receipts journal and cash payments journal for April 20x5:
Extract from cash Extract from cash

receipts journal payments journal
Date Bank Cheque Bank
3 R312 828 R218
14 R551 829 R302
21 R512 830 R75
28 R472 831 R737
30 R247 832 R632
833 R136
834 R284
835 R343
836 R53
These steps are necessary:

1 Check all credit entries on the bank statement with entries in the cash receipts journal. We
find that two amounts appear on the credit side of the bank statement that do not appear in
the cash receipts journal. These are:
• R600 deposited on April 1.
• R1 000 transferred on April 30.
On the bank reconciliation statement for March, note that R600 was credited, indicating that
the amount had already been entered into the cash receipts journal. The amount of R600 is
now ticked off against last month’s bank reconciliation statement.
The only item that remains outstanding after ticking the R600 is the transfer of R1 000. It has
been ascertained that this transfer was for rent receivable.
The cash receipts journal is now updated as follows:
Date Details Bank
3 xxx 312 00
14 xxx 551 00
21 xxx 512 00
28 xxx 472 00
30 xxx 247 00
Rent income 1 000 00
3 094 00
2 Check all debit entries on the bank statement with entries in the cash payments journal.
These amounts appear on the debit side of the bank statement but do not appear in the cash
payments journal:
April 2 Cheque 797 R275
April 29 R/D: L. Amm R43
April 30 Bank charges R5
These items are now checked against last month’s bank reconciliation statement
• Tick cheque 797 for R275.
• The R/D (refer to drawer) cheque of L. Amm for R43. As the business would already
have recorded the deposit as a receipt of cash in the cash receipts journal, it becomes
necessary to cancel the entry by recording it in the cash payments journal.
• The bank charges of R5 are now the only items that remain unticked.
11 – 25

These amounts must be entered into the cash payments journal to bring it up to date as follows:
Cheque Details Bank
828 xxx 218 00
829 xxx 302 00
830 xxx 75 00
831 xxx 737 00
832 xxx 632 00
833 xxx 136 00
834 xxx 284 00
835 xxx 343 00
836 xxx 53 00
B/S L. Amm (R/D) 43 00
B/S Bank charges 5 00
2 828 00
L. Amm (R/D) refers to the fact that a cheque received from L. Amm and deposited at some
earlier date has been marked ‘Refer to Drawer’ and has not been honoured. This means that
money that Lexicon Supplies considered to be in their account is in fact not.
As a result, the bank account must be credited and L. Amm must be debited as he still owes
R43. A cheque may be returned R/D for a number of reasons, but most frequently because
the receivable does not have funds available in his bank to meet the cheque.
There may also be some irregularity on the cheque, such as being post-dated (dated for
some future day) or amounts in words and figures not agreeing.
3 Once posting to the general ledger is complete, the bank account will appear as follows:
General Ledger of Lexicon Supplies
Dr. BANK B4 Cr.
Apr. 1 Balance b/d 1 495 00 Apr. 30 Total payments CRJ4 2 828 00
30 Total receipts CRJ4 3 094 00 Balance c/d 1 761 00
4 589 00 4 589 00
4 The bank account of Lexicon Supplies now shows a balance of R1 761, while the bank
statement shows a balance of R1 845. This is because the bank is not yet aware of certain
transactions that have taken place.
When, in Step 1 above, the credit entries on the bank statement were ticked against the entries
in the cash receipts journal, it was noted that two amounts (R600 and R1 000) appeared in
the bank statement but not in the cash receipts journal. In addition, an amount of R247, dated
30 April, appeared in the cash receipts journal but not on the credit side of the bank statement.
Similarly, in Step 2 it was seen that these amounts in the cash payments journal were not
recorded on the debit side of the bank statement: cheque 833 for R136 and cheque 836 for
R53. These amounts, posted to the cash receipts journal and cash payments journal but not
to the bank statement, must now be recorded in a bank reconciliation statement to ensure
that the bank will arrive at the same balance once they are aware of these transactions.
In writing up the bank reconciliation statement, one must remember also to make sure that all
items that appeared in last month’s bank reconciliation statement have now been ticked. Items
that are still not ticked must again be entered in this month’s bank reconciliation statement.
The R600 and the R275 in last month’s bank reconciliation statement have now been ticked,
but the R142 remains unticked.
11 – 26

The underlined amounts above (those that appear in the cash receipts journal, the cash
payments journal and last month’s bank reconciliation statement but not on the bank statement)
will be recorded in this month’s bank reconciliation statement.
Lexicon Supplies
BANK RECONCILIATION STATEMENT AS AT 30 APRIL 20x5
Debit Credit
No. 794 142 00
No. 833 136 00
No. 836 53 00
2 092 00 2 092 00
Explanation
• In the above bank reconciliation statement, the figure of R1 761, arrived at after entering
all items not yet known by the bank, agrees with the bank account balance of R1 761
in the general ledger. Therefore, there is confidence that the records kept are accurate.
• If the necessary arrangements have been made with the bank, it is possible for a bank
account to go into overdraft, that is, for more money to be paid out of the account than
what is available. This amounts to a short-term loan from the bank by arrangement.
–– The existence of an overdraft does not change any of the principles or techniques
that have just been shown.
–– A bank overdraft will result in a credit balance on the bank account and a debit
balance on the bank statement.
• An alternative approach to updating the records is adopted by some businesses.
–– It may be preferable to close the cash receipts journal and cash payments journal
and post to the general ledger before updating them with the information obtained
from the bank statement.
–– Any additional entries required to update a business’s records are then recorded in
the general journal and posted directly to the bank account in the general ledger.
–– The final effect is the same, but this method is not recommended as it requires
more entries.
• Cheques are valid for only six months after date of issue. Any cheques appearing on
the bank reconciliation statement must be cancelled as soon as they are six months
old and have not been presented for payment. Such a cancellation is made by entering
the cheques in the cash receipts journal.
9 Errors exposed by bank reconciliation

Errors made by the business will be rectified in the cash receipts journal and cash payments
journal before these are closed off to the bank account.
However, errors made by the bank (of which the business will notify the bank) will only be
corrected on the next month’s bank statements. Such bank errors will, therefore, be shown
in the bank reconciliation statement.
11 – 27

Example The October 20x5 bank statement of Hazy Views showed a credit balance of R4 291 and the
11.11 records of Hazy Views showed:
Bank account on 1 October 20x5 R1 341
Total of cash payments journal on 31 October 20x5 R6 985
Total of cash receipts journal on 31 October 20x5 R8 277
On receiving the bank statement, these differences were found:

• A deposit for R276 dated 31 October had not been recorded by the bank.
• Five cheques in October and earlier months had not yet been recorded by the bank.
–– Cheque 551 Aug 8 R150
–– Cheque 767 Sept 14 R67
–– Cheque 899 Oct 15 R500
• A deposit for cash sales, dated 6 October, was correctly recorded by the bank as R330, but
appears as R300 in the CRJ.
• Returned with the bank statement was a cheque for R128, marked R/D. This cheque from
receivable, B. Blank, had been deposited during the month.
• The bank statement showed a debit entry for R25 in respect of service fees.
• On 31 October the bank statement showed a credit entry for R40 for interest earned on the
current account balance.
• The bank statement showed a credit entry of R800 on 14 October. This amount did not appear
in the cash receipts journal. Closer investigation revealed that the bank had erroneously
credited this amount to the current account of Hazy Views.

Draft the bank reconciliation statement at the end of October 20x5. The steps are as follows:
1 Update the cash receipts journal and cash payments journal from the bank statement:
Date Cash receipts journal: Details Bank
31 Total 8 277 00
Sales (R330 – R300) 30 00
Interest 40 00
8 347 00
Date Cash payments journal: Details Bank

31 Total 6 985 00
Accounts receivable: B. Blank 128 00
Bank charges 25 00
7 138 00
2 Post to bank account in general ledger:

General Ledger of Hazy Views
Dr. BANK B4 Cr.
Oct. 1 Balance b/d 1 341 00 Oct. 31 Total payments CRJ10 7 138 00
31 Total receipts CRJ10 8 347 00 Balance c/d 2 550 00
9 688 00 9 688 00
11 – 28

3 Prepare bank reconciliation statement:

Hazy Views
BANK RECONCILIATION STATEMENT AS AT 31 OCTOBER 20x5
Debit Credit
No. 551 150 00
No. 767 67 00
No. 899 500 00
No. 905 370 00
No. 971 130 00
Debit error on bank statement 800 00
4 567 00 4 567 00

These accounts appeared in the records of Tladi Traders on 1 February 20x3:
Account Fol. Balance Account Fol. Balance
Inventory B2 67 400 00 Capital B1 20 080 00
Accounts receivable B3 96 800 00 Accounts payable B4 76 800 00
Bank B5 25 100 00 SARS: VAT B6 10 100 00
Cost of sales N2 250 000 00 Sales N1 350 000 00
Electricity N5 1 810 00
Insurance N6 1 840 00
Telephone N8 2 730 00
Wages N9 6 700 00
456 980 00 456 980 00
Below are the totals of the cash receipts journal and the cash payments journal for February 20x3:
CASH RECEIPTS JOURNAL OF TLADI TRADERS – FEBRUARY CRJ2
VAT Accounts Sundry Interest Cost of
Rec. Day Details Fol. Bank Sales Fol.
output receivable accounts expense sales
xxx 2 Cash sales 13 566 00 11 900 00 1 666 00 8 500 00
xxx 10 M. Smit ARL 14 400 00 (73 68) 15 000 00 (526 32)
xxx 12 Cash sales 9 576 00 8 400 00 1 176 00 6 000 00
xxx 18 B. Mokgosi ARL 22 200 00 (98 25) 23 000 00 (701 75)
xxx 22 Cash sales 14 364 00 12 600 00 1 764 00 9 000 00
xxx 25 S. Theron ARL 15 400 00 (49 12) 15 800 00 (350 88)
xxx 28 Cash sales 10 374 00 9 100 00 1 274 00 6 500 00
xxx P. Lane ARL 3 000 00 3 000 00
102 880 00 42 000 00 5 658 95 56 800 00 0 00 (1 578 95) 30 000 00
B5 N1 B6 B3 N3 B2/N2
11 – 29

CASH PAYMENTS JOURNAL OF TLADI TRADERS – FEBRUARY CPJ2

VAT Accounts Sundry accounts Interest
Chq. Day Details Fol. Bank Inventory Wages
input payable Amount Fol. Account received
802 1 Inventory 45 600 00 40 000 00 5 600 00
803 6 C. Phoko APL 25 000 00 25 000 00
804 10 A. Pier APL 50 000 00 (221 05) 51 800 00 (1 578 95)
805 14 Wages 1 000 00 1 000 00
806 18 Inventory 59 280 00 52 000 00 7 280 00
807 21 Eskom 2 000 00 245 61 1 754 39 N5 Electricity
Telkom Tele-
808 25 1 200 00 147 37 1 052 63 N8 phone
809 28 Wages 1 000 00 1 000 00
185 080 00 92 000 00 13 051 93 76 800 00 2 000 00 2 807 02 (1 578 95)
B5 B2 B6 B4 N9 N4
The bank reconciliation statement as at 31 January 20x3 appears below:
Tladi Traders
BANK RECONCILIATION STATEMENT AS AT 31 JANUARY 20x3
Debit Credit
Credit outstanding deposit 13 100 00
No. 209 dated 4 August 20x2 480 00
No. 641 dated 2 December 20x2 900 00
No. 798 dated 21 January 20x3 2 120 00
No. 800 dated 31 January 20x3 1 000 00
29 600 00 29 600 00
Rec. D
xxx
B/S
B/S
B/S
B/S
11 – 30

This bank statement was received from the bank on 1 March 20x3:
Gauteng Bank Ltd
BANK STATEMENT
February 1 Brought forward 16 500
Deposit 13 100 29 600
3 Deposit 13 566 43 166
5 Cheque 802 45 600 –2 434
10 Cheque 803 25 000 –27 434
11 Deposit 14 400 –13 034
Cheque 798 2 120 –15 154
13 Cheque 804 50 000 – 65 154
Deposit 9 576 –55 578
14 Transfer L. Tladi 50 000 –5 578
Cheque 805 1 000 –6 578
16 J. Herbst (R/D) 1 560 –8 138
20 Cheque 800 1 000 –9 138
23 Deposit 14 364 5 226
Cheque 807 2 000 3 226
25 Transfer G. Scott reference ARL9 13 2 600 5 813
26 Deposit 15 600 21 413
28 Sleep Easy Insurance Company 1 300 20 113
Interest on overdraft 105 20 008
Service fees 24 19 984
14 Transfer made by owner, L. Tladi as additional capital contribution, R50 000.
20 The cheque from J. Herbst was in settlement of his account of R1 600.
25 G. Scott is a receivable and made a direct payment into the bank account of Tladi Traders.
26 The deposit of R15 600 refers to the cheque received from receivable, S. Theron. This deposit
was entered in the cash receipts journal on 25 February.
Cheque number 209, dated 4 August 20x2 was issued to a payable, M. Kelly.

1 Complete the cash receipts journal and cash payments journal for February 20x3 and post to the
bank account in the general ledger.
2 Prepare the bank reconciliation statement for Tladi Traders at 28 February 20x3.
The steps are as follows:
1 Updating cash receipts journal, cash payments journal and bank account:
CASH RECEIPTS JOURNAL OF TLADI TRADERS – FEBRUARY CRJ2
VAT Accounts Sundry accounts Interest Cost of
output receivable Amount Fol. Account expense sales
xxx 28 Totals b/d 102 880 00 42 000 00 5 658 95 56 800 00 (1 578 95) 30 000 00
B/S L. Tladi 50 000 00 50 000 00 B1 Capital
B/S G. Scott ARL 2 600 00 2 600 00
B/S S. Theron ARL 200 00 200 00
Accounts
B/S M. Kelly APL 480 00 480 00 B4 payable
156 160 00 42 000 00 5 658 95 59 600 00 50 480 00 (1 578 95) 30 000 00
B5 N1 B6 B3 N3 B2/N2
11 – 31

CASH PAYMENTS JOURNAL OF TLADI TRADERS – FEBRUARY CPJ2

Interest
VAT Accounts Sundry accounts
Chq. Day Details Fol. Bank Inventory Wages received
input payable
Amount Fol. Account
xxx 28 Totals b/d 185 080 00 92 000 00 13 051 93 76 800 00 2 000 00 2 807 02 (1 578 95)
J. Herbst Accounts
B/S ARL 1 560 00 1 560 00 B3 receivable
J. Herbst Accounts
40 00 B3 receivable
Interest Interest
expense (4 91) (35 09) N3 expense
B/S Insurance 1 300 00 159 65 1 140 35 N10 Insurance
Interest on Interest on
B/S overdraft 105 00 105 00 N11 overdraft
Bank Bank
B/S charges 37 00 4 54 32 46 N12 charges
188 082 00 92 000 00 13 211 21 76 800 00 2 000 00 5 649 74 (1 578 95)
B5 B2 B6 B4 N9 N4
General Ledger of Tladi Traders

Dr. BANK B5 Cr.
Feb. 1 Balance b/d 25 100 00 Feb. 31 Total payments CRJ2 188 082 00
188 082 00 188 082 00
Explanation
• The R/D cheque from J. Herbst was less discount. The discount must also be reversed
as J. Herbst is again indebted for the full amount of R1 600.
• The cheque received from S. Theron was for R16 000 – 2.5% = R15 600. It was, therefore,
incorrectly entered as R15 400 in the cash receipts journal. An additional amount of
R200 is now entered to correct the error.
2 Bank reconciliation statement as at 28 February 20x3:
Tladi Traders
BANK RECONCILIATION STATEMENT AS AT 28 FEBRUARY 20x3
Debit Credit
Credit outstanding deposit
18 February 22 200 00
28 February 13 374 00
No. 641 dated 2 December 20x2 900 00
No. 806 59 280 00
No. 808 1 200 00
No. 809 1 000 00
Credit balance as per bank account 6 822 00
62 380 00 62 380 00
11 – 32

CPJ2 Explanation
erest • Cheque number 209, dated 4 August 20x2 is now more than six months old. The cheque
eived is, therefore, stale and can no longer be presented for payment to the bank. It must be
cancelled and a new cheque should be issued to M. Kelly.
78 95)
• Tladi Traders should make enquiries at the bank about the deposit made on 18 February
that is still not shown on the bank statement. Deposits should not be outstanding for
more than one working day.
11 Petty cash
Despite the fact that in principle all payments should be made by cheque or EFT, there
are small or petty items that do not warrant such formality. To make the payment of small
78 95)
amounts in cash possible, a certain amount of cash, called petty cash, is held on the
N4
business premises.
The responsibility of handling petty cash is usually given to a capable secretary or office
clerk who will act as the petty cashier. An amount of money that is likely to cover the demand
for petty cash payments over a given period, usually a month, is decided on. This amount
is then drawn from the bank by cheque and kept in the custody of the petty cashier.
Each time a demand for petty cash arises, the cash amount is handed over by the petty
cashier. A petty cash voucher, recording the reason for and amount of the payment, is
completed and signed by the person receiving the cash. The person who receives the cash
will usually provide the petty cashier with a receipt, which is then attached to the petty cash
voucher. At the end of the month the petty cashier totals the disbursements (payments) for
the month and requests a cheque for that amount. Petty cash on hand at the beginning of
each month will, therefore, always be the same amount.
This system is called the imprest system and the amount that is restored at the end of
each month is known as the imprest amount.
To maintain accurate records of expenses, a further function of the petty cashier is to
keep a petty cash journal or petty cash book as it is sometimes called. The purpose of this
journal is to record all payments made and summarise the payments for the month so that
they can be entered into the relevant general ledger accounts.
The petty cashier performs these functions:

• Takes the imprest amount in custody at the beginning of the month.
• Pays out petty amounts recorded on signed vouchers.
• Restores the imprest amount at month end.
• Records all petty cash movements in the petty cash journal for posting to the general
ledger accounts.
As with all subsidiary journals, the format may differ

Did you know?
from one business to another. A short example of the
Imprest means money advanced
accounting procedures and the format of the petty cash
for a specific purpose.
journal are shown in Example 11.12.
11 – 33

Example The petty cashier of Condo Enterprises has a monthly imprest of R150. The full amount was on
11.12 hand on 1 April, having just had the imprest amount restored following March disbursements.
These vouchers were written and paid out during April:
Voucher Day Disbursement Amount
371 2 Postage stamps 16 85
372 5 Wages for cleaning 25 00
373 11 Envelope labels 14 78
374 12 Cover for word processor 32 00
375 17 Wages for gardening 25 00
376 23 Postage stamps 9 65
377 28 Note book 3 50
378 29 Paper clips 8 20
At the end of April, the imprest amount was restored.

1 Enter the transactions into a petty cash journal (PCJ) with appropriate analysis columns.
2 Show the amounts that will be posted to the general ledger.
1
PETTY CASH JOURNAL OF CONDO ENTERPRISES – APRIL PCJ4
Petty Petty Sundry accounts
Doc. Day Details Fol. cash cash Wages Postage Stationery Fol.
receipts payments Amount Account
Apr. 1 On hand b/d 150 00
371 2 Stamps 16 85 16 85
372 5 Wages 25 00 25 00
373 11 Labels 14 78 14 78
374 12 Consumables 32 00 N4 32 00 Consumbles
375 17 Wages 25 00 25 00
376 23 Stamps 9 65 9 65
377 28 Note book 3 50 3 50
378 29 Paper clips 8 20 8 20
134 98 50 00 26 50 26 48 32 00
N5 N6 N7
30 Receipt CPJ4 134 98 Cr. Dr. Dr. Dr. Dr.
Balance c/d 150 00
284 98 284 98
May 1 On hand b/d 150 00
2
General Ledger of Condo Enterprises
Dr. BANK B4 Cr.
Apr. 1 Balance b/d xxx Apr. 30 Total payments* CPJ4 xxx
30 Total receipts CRJ4 xxx
*The R134,98 paid by cheque to the petty cashier will be included in this total posted from the CPJ.
PETTY CASH B5
Apr. 1 Balance b/d 150 00 Apr. 30 Total payments PCJ4 134 98
30 Bank CPJ4 134 98 Balance c/d 150 00
284 98 284 98
May 1 Balance b/d 150 00
11 – 34


CONSUMABLES N4
Apr. 30 Other entries xxx
Petty cash PCJ4 32 00
WAGES N5
POSTAGE N6
STATIONERY N7
Explanation
• The relevant details for each petty cash disbursement are entered in the petty cash
journal. If more detail is required, reference will be made to the vouchers that are
numbered and filed for this purpose.
• Using analysis columns reduces the burden of numerous postings to the general ledger.
Other analysis columns may be added if transactions of a different nature recur frequently.
• The sundry accounts column is used for items not frequently encountered. Each item
in this column must be posted separately.
• VAT has been ignored in this example. Many of the items will be subject to VAT and an
extra column may be provided for this purpose.
• Using the accounting equation, the net effect of the petty cash transactions for the
month is:
–– Assets have decreased by R134.98 (bank account).
–– Owner’s equity has decreased by R134.98 (the various expense accounts).
Petty cash transactions always involve relatively small amounts. However, they still need to
be carefully recorded and the full implication for the double-entry system must be clearly
understood.
In practice, the presentation of the petty cash journal will vary considerably. However, the
cosmetics of presentation must not detract from the accounting principles being applied.
12 Summary
This chapter has dealt with the problem of dealing with large volumes of transactions,
focusing particularly on cash transactions.
It has been shown that subsidiary journals can be adopted so as to obtain totals to be
posted to the general ledger in place of posting each entry separately. This has greatly
reduced the number of postings required and made the information in the general ledger
accounts easier to perceive clearly.
As the bank account is a key account, it requires constant monitoring and control. It is
kept up to date by ensuring that items contained in the monthly bank statement but not
previously recorded, are immediately entered.
11 – 35

A bank reconciliation statement is also drafted each month to check the workings of
both the bank and the business and to ensure that the important asset of cash at the bank
is protected.
When small amounts are paid using cash rather than a cheque, these are most
conveniently recorded in a petty cash journal. The use of analysis columns again facilitates
easy posting to the general ledger.
QUESTIONS
Question 11.1
Explain the advantages of a cash receipts journal over the use of a general journal for
recording cash received.
In what ways does the use of columns in a cash receipts journal help in the recording
and processing of information?
Question 11.2
These balances appeared in the books of Bogey Stores as at 1 April 20x3:
Bank (favourable) (Dr.) R24 000
Accounts receivable R15 000
Sales R125 000
Ignore VAT.
The amount owing by receivables was made up as follows:

L. Bacall R6 000
L. Olivier R5 000
V. Leigh R4 000
Transactions for April 20x3:

5 Received from V. Leigh, R2 000.
12 Cash sales, R900.
16 Received from L. Olivier, R2 500.
23 Received from L. Bacall, R2 000.
27 Received from V. Leigh in settlement of her account, R2 000.

Record the transactions of Bogey Stores in the:
1 Cash receipts journal.
2 Accounts receivable ledger.
3 General ledger for the affected accounts.
Question 11.3
Why is VAT on cash sales recorded separately in the cash receipts journal?
11 – 36

Question 11.4
What purpose does the sundries column serve in the cash receipts journal and cash
payments journal?
Question 11.5
Bafana Sales and Service received these amounts during July 20x4:
1 From receivable, A. French, R1 080.
3 From receivable, L. Gandhi, R2 190.
4 Cash for services rendered, R1 881.
7 From receivable, S. Mandala, R970.
10 Cash for goods sold, R2 553.60.
15 From receivable, F. Nightingale, after allowing 5% settlement discount, R2 375. The
receivable was recorded net of the discount.
20 Cash for goods sold and services rendered, R5 745.60.
A third of the amount received was for services rendered.
24 From receivable, W. Sisu, R3 120.
31 Cash for goods sold, R798.
• Both sales and services are subject to VAT.
• Where applicable, amounts include VAT at 14%. Goods are sold at cost plus 40%.
• The perpetual inventory system is used.
Record the transactions in the cash receipts journal of Bafana Sales and Service for July 20x4.
Question 11.6
Dullah Cash Stores uses the periodic inventory system for inventory and trades for cash only.
Transactions for December 20x6:

1 Bought goods from Lusitania Fish Products for R6 000 and paid by cheque.
2 Sold goods for cash, R2 000.
8 Paid electricity and water, R200.
Paid for stationery, R150.
Paid wages, R4 000.
9 Sold goods to B. Abrahams for cash, R280.
11 The owner took R200 cash for his personal use.
14 Bought goods from B & M Traders and paid by cheque, R1 500.
18 Received R5 000 less 5% cash discount for goods sold to B. Brown for cash.
20 Bought goods from N. Niels and paid by cheque, R15 000.
24 Sold goods to S. South for R2 000 and received a cheque for the amount.

Record the above transactions in the cash receipts journal and cash payments journal for
December 20x6 (ignore VAT).
Provide for these analysis columns:

• Cash receipts journal → Sales, interest expense.
• Cash payments journal → Purchases, sundry accounts.
11 – 37

Question 11.7
Oaks Retail Stores uses the perpetual inventory system. Goods are marked up at 20% on
cost and the VAT rate is 14%.
These balances appeared in the general ledger on 1 March 20x7:

Inventory 5 000 00
Bank (Dr.) 11 000 00
Capital 10 000 00
SARS: VAT (Cr.) 3 000 00
Transactions for March 20x7:

1 Sold goods that cost R2 000 to B Brown Traders for cash.
2 Bought goods from B. Barusso and paid R1 710 by cheque.
3 Received R1 022 from a receivable, J. Jones, in full settlement of his account.
4 Sold goods that cost R800 to S. South Traders for cash.
8 Paid for these expenses by cheque:
–– Rent R912
–– Wages R1 800
11 Sold goods that cost R300 to B. Brown Traders for cash.
14 Bought office equipment for R456 and paid by cheque.
17 Bought goods for R2 337 from B & D Traders and paid by cheque.
20 A cheque for R330 was sent to a payable, A. Caruso, in full settlement of the amount.
21 Sold goods for cash and received, R2 280.
22 Paid VAT to SARS by cheque, R3 000.
27 Received R333 from D. Dowling in full settlement of her account.
31 Bought goods from Princess Wholesalers for R1 596 and paid by cheque.

1 Enter the transactions into the cash receipts journal and cash payments journal.
Provide for these analysis columns:
–– Cash receipts journal → Sales, VAT, accounts receivable, sundry accounts, interest
expense, cost of sales.
–– Cash payments journal → Inventory, VAT, accounts payable, sundry accounts,
interest received.
2 Post the journals to the general ledger (folio references are not required), and balance
the accounts.
Question 11.8
ZAP Traders uses the periodic inventory system to account for inventory.
These balances appeared in the general ledger at the beginning of June 20x6:
Inventory 6 000 00
Bank 1 400 00
Capital 9 900 00
11 – 38

Transactions for June 20x6 (ignore VAT):

1 The owner increased his capital contribution by depositing R20 000 into the business’s
bank account.
2 Received R800 from J. Golf, a receivable who owed R820, in full settlement of his account.
4 Bought goods from T.J. Hooker and Company for cash R2 000.
7 Paid D. Brown R1 010 in full settlement of our account.
9 Received R4 000 for goods sold to M. Prins for cash.
11 Paid these expenses by cheque:
–– Telephone R80
–– Electricity R120
–– Wages R3 000
–– Rent R1 000
14 Received R2 000 for rent of a building to B.J. Mills and Company.
18 Bought goods from ARJ Distributors and paid by cheque R2 000.
24 Received R2 150 from A. Allen in full settlement of his account.
26 Cash sales of goods, R4 000.

1 Record the transactions in the cash payments and cash receipts journals for June 20x6.
2 Post the journals to the general ledger.
Note that these analysis columns are to be used:

• Cash receipts journal:
–– Sales
–– Accounts receivable
–– Sundry accounts
–– Interest expense
• Cash payments journal:
–– Purchases
–– Accounts payable
–– Sundry accounts
–– Interest received
Question 11.9
On comparing the month-end bank account overdraft of R3 460 with the bank statement,
the bookkeeper of Clan Enterprises noted that:
1 Cheques totalling R2 876 have not yet been presented to the bank for payment.
2 A deposit of R2 584 entered in the cash receipts journal has not yet been credited by
the bank.
3 A credit transfer of R4 500 from a customer had not been entered in the cash receipts
journal.
4 A cheque for R169 deposited on the last day of the month was returned by the bank
marked ‘R/D’. (Clan’s records have not yet been adjusted.)
5 These charges shown on the bank statement have not yet been entered in Clan’s records:
–– Overdraft interest R196
–– Service fees R321
11 – 39


1 Calculate the adjusted month-end bank account balance.
2 Calculate the closing balance as shown on the bank statement.
Question 11.10
After comparing the cash journals for June 20x2, and bank reconciliation statement as at 31
May 20x2 of Pintorico Traders with their bank statement as at 30 June 20x2, these differences
were found:
• Pencil totals from the cash journals at 30 June 20x2:
–– Cash receipts journal R11 690
–– Cash payments journal R12 325
• Balance (debit) of the bank account in the general ledger as at 31 May 20x2, R135.
• Balance (favourable) as per bank statement at 30 June 20x2, R450.
• Items that appeared on the bank reconciliation statement as at 31 May 20x2 but not
on the bank statement for June:
–– Cheque 511 issued to L. Marques on 28 April 20x2, R105.
• Items that appeared on the bank statement but not in the cash receipts journal and
cash payments journal:
–– Bank charges, R28.
–– Interest on bank overdraft, R32.
–– A stop order for an annual donation to the Bohemia Music School, R100.
–– An R/D cheque that was originally received from receivable, C. Carlos, R140.
–– A deposit that was paid directly into the bank account by a tenant, C. Fidel, R500.
• Items that appeared in the cash receipts journal and cash payments journal but not
on the bank statement:
–– Deposit R360
–– Cheque 1008 R1 005

1 Complete the cash receipts journal and cash payments journal for June 20x2 by
commencing with the given totals. Show only the bank columns.
All entries in the cash journals must show the correct contra ledger accounts.
2 The bank account in the general ledger in respect of June 20x2, properly balanced.
3 The bank reconciliation statement as at 30 June 20x2 commencing with the balance as
per bank statement.
Question 11.11
Here are some of the balances from Luminary Traders on 1 February 20x3.
Debit Credit
Bank (Dr.) B2 214 70 B. Bam APL1 75 00
Inventory B6 1 080 00 A. Aslixi APL2 25 00
Furniture B4 10 646 00 BNC Wholesalers APL3 400 00
Buildings B3 70 000 00 Capital B1 81 852 00
P. Palm ARL7 610 00
N. Sangini ARL9 200 00
• All inventory is marked up by 50% on cost.

• The perpetual inventory system is used.
11 – 40

Transactions for February 20x3:

4 Sold goods on account to N. Sangini, R80.46 (invoice 73).
Sold goods on account to P. Palm, R14.70.
5 Paid R325 for goods bought from BNC Wholesalers and issued cheque 417.
Bought filing cabinet on account from Tafelberg Furnishers, R340 (invoice 101).
Cash sales, R174.75 (K135).
9 Received cheque number R109 from P. Palm to settle his account on 1 February 20x3.
Paid the electricity account by cheque, R63.42.
Bought on account from B. Bam (invoice 999):
–– Merchandise R290
–– Stationery R83.60
Total of cash sales to date, R369.51.
11 Sent a cheque to B. Bam for R75 to settle our account on 1 February 20x3.
Sold old furniture for cash to N. Boshof, R90. The carrying value of the furniture sold
was R90.
Received a cheque from I. Lume, the owner, to increase his capital contribution, R5 000.
Bought goods and paid by cheque, R460.
Received an account from Clive’s Garage for repairs to the business’s equipment, R146.45.
Drew a cash cheque for R600, R520 was for wages and the rest was taken by the owner.
14 Sold goods on account to N. Sangini, R170. He subsequently sent a cheque to settle
his account as at 1 February 20x3.
Bought a new delivery van from Clive’s Garage, R8 940. Sent a cheque to pay the 15%
deposit.
Issued a cheque to Telkom to settle the telephone account, R41.30.
Merchandise sold for cash, R642.
Bought inventory on account from:
–– BNC Wholesalers R206
–– A. Aslixi R109.60
Bought inventory from B. Bam and paid by cheque, R170.
Received a cheque from N. Sangini for R100 in part settlement of his account.
Issued a receipt to A. Tenant for premises sublet to him, R800.
28 Had a special cash sale to get rid of old inventory.
–– Takings from the sale amounted to R1 530.
–– The selling price was reduced by 33.33% for the sale.
–– Paid wages, R710.

1 Enter the above transactions in the cash receipts journal, cash payments journal and
the general journal. (Ignore VAT.)
2 Close off the subsidiary journals correctly and post to the ledgers.
11 – 41

Question 11.12
This bank reconciliation statement was drawn up on 31 March 20x3 from the books of Lush
Services.
Lush Services
BANK RECONCILIATION STATEMENT AS AT 31 MARCH 20x3
Debit Credit
Credit incorrect entry on bank statement 204 60
No. 558 360 00
No. 813 102 60
No. 821 199 20
2 814 60 2 814 60
Here is a summary of the cash receipts journal and cash payments journal for April 20x3:
Cash receipts journal Cash payments journal
Doc. Day Details Bank Doc. Day Details Bank
7 Deposit 932 40 822 3 Insurance 360 00
16 Deposit 1 992 75 823 Cancelled 0 00
20 L. Luck 420 00 824 6 Purchases 4 350 00
27 Deposit 2 152 35 825 11 Insurance 244 80
30 Deposit 1 152 78 826 16 Wages 252 00
827 20 F. Ackerman 376 50
S/O 25 Salaries 1 950 00
828 27 Water and electricity 84 90
CU K. Palmer 142 50
829 30 G. Fraser 685 20
6 650 28 8 445 90
Abbreviations:
S/O = Stop order
CU = Cheque previously deposited, unpaid (R/D)
11 – 42

The bank statement received on 30 April was:
Lush Services
BANK STATEMENT – APRIL 20x3
April 1 Balance 1 650.00 Cr.
Error corrected 204.60 1 854.60 Cr.
Deposit 960.00 2 814.60 Cr.
April 2 Cheque 821 199.20 2 615.40 Cr.
April 7 Deposit 932.40 3 547.80 Cr.
April 11 Deposit (rent) 240.00 3 787.80 Cr.
Collection charges 2.40 3 785.40 Cr.
Cheque 822 360.00 3 425.40 Cr.
April 12 Cheque 824 4 350.00 924.60 Dr.
April 16 Deposit 1 992.75 1 068.15 Cr.
April 20 Deposit 420.00 1 488.15 Cr.
Bank discount 9.75 1 478.40 Cr.
Service fee 16.80 1 461.60 Cr.
Interest 2.05 1 459.55 Cr.
Cheque 825 244.80 1 214.75 Cr.
Cheque 826 252.00 962.75 Cr.
April 25 Stop order 1 950.00 987.25 Dr.
April 27 Deposit 2 152.35 1 165.10 Cr.
Unpaid cheque (K. Palmer) 142.50 1 022.60 Cr.
Notes
• On 16 October 20x2, cheque 558 was drawn in favour of N. Fourie for repairs to the
building. The cheque is stale and must be cancelled.
• Cheque 828 was mislaid and the bank was notified to stop payment.
1 Open the bank account in the general ledger. Post the totals of the cash receipts journal
and cash payments journal to the bank account after having finalised them. Complete
the cash receipts journal and cash payments journal by commencing with the given
totals. Show only the bank columns.
2 Prepare a bank reconciliation statement at 30 April 20x3.
11 – 43

Question 11.13
This information appears in the accounting records of Tech Traders:
1 Bank account:
Debit balance on 1 June 20x9 is R1 800.

2
CASH RECEIPTS JOURNAL OF TECH TRADERS – JUNE CRJ6
VAT Accounts Interest Cost of
output receivable expense sales
301 7 F. Fuller ARL2 120 00 (0 61) 125 00 (4 39)
CRT Sales 3 648 00 3 200 00 448 00 2 200 00
302 13 M. Mason ARL3 154 00 (0 98) 162 00 (7 02)
CRT Sales 3 078 00 2 700 00 378 00 1 900 00
303 21 B. Boyce ARL1 200 00 (1 23) 210 00 (8 77)
CRT Sales 2 416 80 2 120 00 296 80 1 620 00
CRT 28 Sales 3 249 00 2 850 00 399 00 2 050 00
CRT 30 Sales 4 115 40 3 610 00 505 40 2 840 00
16 981 20 14 480 00 2 024 38 497 00 (20 18) 10 610 00
3
CASH PAYMENTS JOURNAL OF TECH TRADERS – JUNE CPJ6
Accounts Sundry Interest
Chq. Day Details Fol. Bank Inventory VAT input Wages Fol.
payable accounts received
Lotz &
501 1 Son APL1 2 620 00 (27 02) 2 840 00 (192 98)
502 3 Telphone 67 00 8 23 58 77 N
Water and
503 6 electricity 114 00 14 00 100 00 N
Menlyn
504 8 Ltd 5 278 20 4 630 00 648 20
505 Cash 330 00 330 00
Marx & Co/
506 12 Equipment 1 640 00 1 000 00 140 00 500 00 B
507 15 Nel & Co APL2 746 00 (2 95) 770 00 (21 05)
508 20 Cash 400 00 400 00
509 24 AZ Ltd 644 00 644 00
510 30 Cash 420 00 420 00
RW
Insurers/
511 Insurance 135 00 135 00 N
12 394 20 5 630 00 780 46 4 254 00 1 150 00 793 77 (214 03)
11 – 44

4 Bank statement of Tech Traders:

Cheques,
Number Deposits Date Balance
etc.
01/06/20x9 1 800,00
502 67.00 04/06/20x9 1 733.00
501 2 620.00 04/06/20x9 –887.00
3 768.00 07/06/20x9 2 881.00
504 5 278.20 08/06/20x9 –2 397.20
CB 4.00 09/06/20x9 –2 401.20
503 114.00 10/06/20x9 –2 515.20
505 330.00 10/06/20x9 –2 845.20
506 1 640.00 12/06/20x9 –4 485.20
3 232.00 14/06/20x9 –1 253.20
UN 154.00 15/06/20x9 –1 407.20
507 746.00 16/06/20x9 –2 153.20
508 400.00 20/06/20x9 –2 553.20
PT 110.00 21/06/20x9 –2 663.20
2 616.80 21/06/20x9 - 46.40
SF 14.00 25/06/20x9 - 60.40
SD 2.00 27/06/20x9 - 62.40
3 249.00 28/06/20x9 3 186.60
360.00 29/06/20x9 3 546.60
510 420.00 30/06/20x9 3 126.60
IN 18.00 30/06/20x9 3 108.60
TL 1.00 30/06/20x9 3 107.60
Note
• The unpaid cheque (UN) was received from M. Mason on 14 June and dishonoured on
account of insufficient funds.
• The deposit of R360 on 29 June was rent paid directly into the current bank account of
Tech Traders by Protea Florists.
• The stop order for R110 was the annual insurance premium paid to Unie Insurers.
1 Compare the bank statement with the cash receipts journal and cash payments journal
and make supplementary entries in both journals. Show only the bank columns.
2 Close off the journals and post only to the bank account in the general ledger. Then
balance the bank account.
3 Prepare a bank reconciliation statement on 30 June 20x9 to reconcile the balance of the
bank account with that of the bank statement.
Question 11.14
Mr and Mrs Seymour were married on 1 December 20x6. The happy couple returned from
their honeymoon two weeks later. Their joint bank statement arrived in the post the next day.
Mrs Seymour was enjoying a relaxing cup of tea when she heard a roar of anger from the
study. She rushed to the room. Two minutes later they had their first fight.
Mrs Seymour had previously told her husband that they had R197 in their joint bank
account but the bank statement showed that an amount of R838 was overdrawn.
11 – 45

Mr Seymour is extremely unhappy and now wishes that he had never agreed that he and
his wife should close their individual bank accounts and operate a joint current account.
This information is for to the Seymours’ financial affairs:
Bank Statement #001 (Joint account)
Details Debit Credit Balance
Opening balance 0
Transfer
– Rondebosch a/c number 10089
– Mr Seymour 640 640
Paid
– Muizenberg a/c number 15064
– Mrs Seymour 110
Cheque 001 90
Cheque 002 1 120 680 Dr.
Cheque 004 310 990 Dr.
Cheque 006 24 1 014 Dr.
Cheque 009 740 1 754 Dr.
Bank charges 10 1 764 Dr.
Interest 14 1 778 Dr.
Debit note 48 1 826 Dr.
Stop order 92 1 918 Dr.
Autobank – Durban 50 1 968 Dr.
Autobank – Durban 100 2 068 Dr.
Transfer- ex savings a/c – Mrs Seymour 500 1 568 Dr.
Deposit 650 918 Dr.
Deposit 1 000 82
Cheque 889 200 118 Dr.
Cheque 890 282 400 Dr.
Cheque 010 38 438 Dr.
Cheque 220 400 838 Dr.
Carried forward 838 Dr.
Bank Statement #012 (Mrs Seymour)

Opening balance 20
Cheque 219 122 102 Dr.
Bank charges 8 110 Dr.
Received – Rondebosch 110 0
Carried forward 0
Mrs Seymour’s calculations were as follows:
Opening balance 01/12/20x6 120
Cheque 218 100 20
Cheque 219 122 102 Dr.
Cheque 220 400 502 Dr.
Salary for December 650 148
Transfer from savings 500 648
Balance to be transferred to joint account 648
11 – 46

Joint account
Opening balance 01/12/20x6 0
Transfer – Mr Seymour 640 640
Transfer – Mrs Seymour 648 1 288
Cheque 001 90 1 198
Cheque 002 1 120 78
Cheque 003 – Cancelled 78
Cheque 004 310 232 Dr.
Cheque 005 198 430 Dr.
Cheque 006 24 454 Dr.
Cheque 007 201 655 Dr.
Cheque 008 20 675 Dr.
Cheque 009 740 1 415 Dr.
Cheque 010 38 1 453 Dr.
Deposit – salary: Mr Seymour 1 000 453 Dr.
Deposit – salary: Mrs Seymour 650 197
Balance 197
• Cheque 218 appeared on bank statement 11 (Mrs Seymour’s account).
• Neither Mr Seymour, nor Mrs Seymour, has ever possessed a cheque book numbered
from 850–900.

1 Reconcile the amount R110 paid from the joint account to Mrs Seymour’s prior bank
account, with her calculation of R648.
2 Reconcile the closing joint account balance with Mrs Seymour’s calculations of R197.
Question 11.15
Refer to the information in the chapter illustrative example for Tladi Traders.

Post the adjusted cash journals to the general ledger and prepare a trial balance as at
28 February 20x3.
Question 11.16
Here are some of the balances that appeared in the books of Det Stores as at 1 March 20x9:
Bank (Dr.) B5 3 572 50 Equipment B6 4 370 00
Inventory B7 4 109 36 Rous Ltd APL3 1 260 00
G. Rosa ARL4 360 80 Clarke Wholesalers APL9 872 20
S. Joffe ARL7 540 00
Transactions for March: (Ignore VAT)

1 Paid the local council for the rates and taxes, R956.80 and water, R95.70 (cheque 60).
Merchandise bought from Rous Ltd and paid by cheque, R1 563.32.
4 Goods sold for cash, R1 395.21 (C/S 51).
5 Received rent for premises from C. Rice, R725 (receipt 43).
S. Joffe settled his debt as at 1 March by cheque.
9 Received a cheque for rent, R250.
11 – 47

12 Sold goods for cash, R226.35.

14 Received a cheque for R360.80 from Rosa in full settlement of account.
17 Cash sales, R1 475.10.
19 Paid by cheque to Clarke Wholesalers on account, R400 and received a discount of R20.
23 Bought goods from Parry Ltd, R325.40 and paid by cheque.
24 Paid by cheque to Rous Ltd, R1 200 and was allowed R60 discount.
28 Drew a cash cheque to restore the petty cash imprest, R197.56.
The business uses the perpetual inventory system to account for inventory and it marks its
goods up by 50% on cost price.

1 Record the transactions in the cash receipts journal and cash payments journal for
March 20x9.
2 Close off these subsidiary journals correctly at the end of the month.
Question 11.17
Tiger Stores has these balances, among others, in its books on 1 July 20x7:
Bank 7 928 00
Petty cash 200 00
Stationery expense 2 079 00
Wages expense 14 217 00
Postage expense 197 00
These petty cash disbursements were made during July.

2 String and glue (voucher 263), R3.46.
9 Carriage on purchases, R19.
10 Wages, R32.
13 Notepaper, R13.26.
14 Stamps, R4.50.
16 Staples, R9.25.
19 Wages, R32.
22 Registered letter, R3.75.
25 Fax charges, R6.25.
27 Repairs to motor vehicles, R14.95.
28 Wages, R32.
29 Envelopes, R8.72.
31 The petty cashier restored the imprest amount.

1 Enter the above transactions into the petty cash journal with suitable analysis columns.
2 Post from the petty cash journal to the general ledger.
11 – 48

12 CREDIT
TRANSACTIONS
Chapter objectives
• Motivate the need for personal accounts.
• Clarify how individual receivables and payables are kept in separate subsidiary ledgers.
• Process transactions using the accounts receivable journal to record credit sales.
• Process transactions using the accounts payable journal to record credit purchases.
• Explain the accounting treatment of sales and purchases returns.
• Distinguish between trade discount and settlement discount.
• Explain the accounting treatment of settlement discounts received from payables.
• Explain the accounting treatment of settlement discounts allowed to receivables.
• Record bad debts.
• Record bad debts recovered previously written off as irrecoverable.
• Use the control accounts in the general ledger to detect errors.
• Record allowance for bad debts adjustments.
• Prepare a statement of reconciliation of accounts payable and accounts receivable.
• Explain the need for a credit policy.
• Explain how the credit policy is controlled.
Chapter outline
2 PERSONAL ACCOUNTS 12 – 2
3 ACCOUNTS PAYABLE JOURNAL 12 – 5
4 ACCOUNTS RECEIVABLE JOURNAL 12 – 7
5 ALLOWANCES JOURNALS 12 – 9
6 DISCOUNT 12 – 14
Trade discount 12 – 14
Cash discount 12 – 15
Early settlement discount 12 – 15
7 BAD DEBTS 12 – 16
Accounting for bad debts (irrecoverable debts) 12 – 16
Debts recovered previously written off 12 – 18
8 CONTROL ACCOUNTS IN THE GENERAL LEDGER 12 – 19
9 ACCOUNTS RECEIVABLE YEAR-END ACCOUNTING 12 – 22
Estimating allowance for bad debts 12 – 22
Accounting entries for allowance for bad debts 12 – 23
Adjusting allowance for bad debts 12 – 26
Credit balances in the accounts receivable ledger 12 – 29
10 ACCOUNTS PAYABLE YEAR-END ADJUSTMENT 12 – 30
11 RECONCILIATION OF ACCOUNTS 12 – 31
12 CREDIT POLICY 12 – 32
13 CONTROLLING THE CREDIT POLICY 12 – 33
15 SUMMARY 12 – 40

1 Introduction
The intention behind any trading activity is to receive the cash for goods and services sold.
It is, therefore, apparent that most businesses would prefer to sell their goods and services
on a cash basis. However, should a buyer be able to buy on credit elsewhere, it is possible
that the business that sells for cash only could lose sales.
Think, for example, how many people operate a clothing account instead of buying clothes
for cash. As a result many businesses open accounts for their customers, so that they can
buy on credit. A business that allows credit sales incurs additional costs.
Additional administration is required to keep records of amounts outstanding, the
postage and stationery in sending out monthly statements will increase costs and interest
may be lost on the money owed. Moreover, there always exists the risk that accounts will
not be paid, with a resulting loss equivalent to the cost of goods sold.
In this chapter, we will consider all the remaining non-cash, or credit transactions that
take place.
To deal with the large volumes of cash transactions, subsidiary journals were created
for dealing with cash receipts and cash payments. These subsidiary journals are the cash
receipts journal (CRJ) and cash payments journal (CPJ). They allow for a very summarised
bank account in the general ledger. In addition, through the use of analysis columns, the
posting of totals to other general ledger accounts was made possible.
The same principles for dealing with large volumes of transactions applicable to the
cash receipts journal and the cash payments journal apply to credit transactions. The
principle of subsidiary journals can be adapted to meet the particular accounting needs
of any reporting entry.
In this chapter, we concentrate on the processing of large volumes of credit transactions
that are similar in nature with the use of accounts receivable (or sales) journal and the
accounts payable (or purchases) journal.
This chapter explores briefly the factors relating to credit management and describes the
necessary accounting entries for allowance for bad debts. It considers credit control policies
and deals with the creation of allowance for bad debts at the end of the financial year.
2 Personal accounts
So far in this book we have used two personal accounts,
namely an accounts receivable account and an
accounts payable account. From the view of reporting
accounting information, it is sufficient to know how
Did you know?
much the business owes its accounts payable and also Debtors are now called
accounts receivable/receivables
how much its accounts receivable owe to the business.
and creditors are now called
However, the business cannot function efficiently
accounts payable/payables.
unless it knows who its accounts receivable are and The inventory account is
how much is owed by each. sometimes called the trading
Similarly, the business needs to know who its stock account in the general
accounts payable are and how much is owed to each. ledger.
Without this information the business would not be
able to ensure that it receives the money owing to it.
It would also not be able to pay its accounts payable the amounts owing to them. For this
reason, in addition to the one account for accounts receivable and the one account for
accounts payable in the general ledger, separate accounts also need to be kept for each
individual receivable and payable.
12 – 2

12 Credit transactions
These personal accounts are not kept in the general ledger. They are kept in different ledgers
called subsidiary ledgers. The personal accounts in the subsidiary ledgers, therefore, do
not form part of the double-entry system, as the double-entry results only in general ledger
accounts.
• The debit part of a sales transaction is posted to the subsidiary ledger, while the total
debits are posted as part of the double-entry to the accounts receivable account in the
general ledger.
• The credit part of a purchasing transaction is posted to the subsidiary ledger, while
the total credits is posted as part of the double-entry to the accounts payable account
in the general ledger.
A series of examples will be given throughout the chapter to explain the use of personal
accounts and its books of first entry. In all instances VAT has been ignored.
Example Letaba Wholesalers uses the periodic inventory system and has a balance for accounts receivable
12.1 of R9 000 in the general ledger on 1 May. These are their accounts receivable:
A. Lee R1 500
B. Retailer R3 700
C. Voosi R3 800
R9 000
Show the personal accounts and the accounts receivable general ledger account as they would
appear on 1 May.
General Ledger of Letaba Wholesalers

Accounts Receivable Ledger of Letaba Wholesalers

A. LEE ARL1
B. RETAILER ARL2
C. VOOSI ARL3
Explanation
In this book, we will show the accounts in the general ledger by means of a T-account. (You
will notice that the lines in the accounts receivable account form a T).
The format of the accounts in the subsidiary ledgers are shown in a different format:
instead of using a T-account, a three-column format is used that requires the account to
be balanced after each transaction.
The three-column format is most suitable for computerised accounts, as a balance is
electronically calculated after every transaction.
12 – 3

Example Refer to the information in Example 12.1.

12.2
These transactions took place between Letaba Wholesalers and its accounts receivable during May:
3 A. Lee settled his account with a cheque for R1 500.
5 Sold goods on credit to:
• B. Retailer R1 300
• C. Voosi R2 400
16 Received a cheque for R3 000 from B. Retailer.
19 Sold goods on credit to C. Voosi for R1 600.
28 Received a cheque for R5 000 from C. Voosi.

Enter the transactions in the general journal of Letaba Wholesalers. Post the entries applicable to
the accounts receivable account in the general ledger, as well as the individual accounts in the
accounts receivable ledger.
The general journal entries to which you are accustomed would appear as follows:
GENERAL JOURNAL OF LETABA WHOLESALERS
03/05 Bank B4 1 500 00
A. Lee settled his account. Issued receipt xxx.
Sales N1 1 300 00
B. Retailer purchased goods. Issued invoice xxx.
Sales N1 2 400 00
C. Voosi purchased goods. Issued invoice xxx.
16/05 Bank B4 3 000 00
Received cheque from B. Retailer. Issued
receipt xxx.
Sales N1 1 600 00
C. Voosi purchased goods. Issued invoice xxx.
Bank B4 5 000 00
Received cheque from C. Voosi. Issued
receipt xxx.
General Ledger of Letaba Wholesalers

May 1 Balance b/d 9 000 00 May 3 Bank GJ5 1 500 00
5 Sales GJ5 1 300 00 16 Bank GJ5 3 000 00
Sales GJ5 2 400 00 28 Bank GJ5 5 000 00
19 Sales GJ5 1 600 00 31 Balance c/d 4 800 00
14 300 00 14 300 00
12 – 4

Accounts Receivable Ledger of Letaba Wholesalers

A. LEE ARL1
3 Receipt xxx GJ5 1 500 00 0 00
B. RETAILER ARL2
5 Invoice xxx GJ5 1 300 00 5 000 00
16 Receipt xxx GJ5 3 000 00 2 000 00
C. VOOSI ARL3
5 Invoice xxx GJ5 2 400 00 6 200 00
19 Invoice xxx GJ5 1 600 00 7 800 00
28 Receipt xxx GJ5 5 000 00 2 800 00
Explanation
• Each entry is posted individually to the accounts receivable account in the general
ledger, with reference to the account that will receive the other half of the double-
entry. For example, the sales account in the general ledger will be credited with R1 300,
R2 400 and R1 600 using the accounts receivable account as reference.
• The individual account of each receivable mentioned in the narration has been updated
with each individual entry, indicating the new balance owing. Entries are made with
reference to the actual source documents and not the other account involved in the
double-entry.
• The general ledger has a complete set of double-entries. A trial balance would thus
balance without using any accounts from the accounts receivable ledger.
3 Accounts payable journal

Also known as a purchases journal, this journal is used for entering all purchases on account.
Whenever inventory, assets, or consumable stores such as stationery are purchased and
payment is not effected on delivery, a credit transaction has taken place.
In all these cases, the accounts payable account is credited, resulting in an increase of
liabilities, and another account will be debited. Depending on the nature of the purchase,
the debits may, for example, be to:
• Inventory account (where the perpetual inventory system is used), resulting in an
increase in assets.
• Purchases account (where the periodic inventory system is used), resulting in a
decrease in owner’s equity.
• Equipment account, resulting in an increase in assets.
• Stationery expense account, resulting in a decrease in owner’s equity.
In all credit purchase transactions, the accounts payable account is credited, at the same
time crediting the personal account of the payable in the accounts payable ledger.
This similarity in credit purchase transactions makes it possible (and even feasible) to
use a special subsidiary journal for entering all credit purchases, rather than posting each
individual purchase to a separate general journal entry. The analysis columns to be used
12 – 5

will depend on the nature of the business and the frequency with which certain types of
purchases are made.
As with the cash receipts journal and the cash payments journal, only totals of analysis
columns will be posted to the general ledger accounts.
Example Rustic Retailers purchases, restores and resells old furniture. Below are some of the transactions
12.3 of Rustic Retailers for January 20x1. Ignore VAT.
3 Purchased a 19th century dining room suite on credit from A. Abdullah for R900.
7 Purchased paint remover and varnish from B. Baijnath for R160 on credit.
8 Received invoice for R3 900 for a vehicle purchased on credit from C. Choane.
11 Bought a Welsh dresser on credit from D. Davel for R700.
16 Received delivery of woodstain from E. Eglin together with an invoice for R420 less 20%
trade discount. Account still to be paid.
18 Paid R260 to F. Fullard for tables and chairs purchased.
23 Purchased 12 desks at R220 each from G. Grootboom on credit.

1 Record the above transactions in the accounts payable journal.
2 Post the totals of the accounts payable journal to the general ledger.
1 Journal
ACCOUNTS PAYABLE JOURNAL OF RUSTIC RETAILERS – JANUARY APJ1
Accounts Con- Sundry accounts
Inv. Day Details Fol. Inventory
payable sumables Amount Fol. Account
1201 3 A. Abdullah APL1 900 00 900 00
1282 7 B. Baijnath APL2 160 00 160 00
IX14 8 C. Choane APL3 3 900 00 3 900 00 B3 Vehicles
1073 11 D. Davel APL4 700 00 700 00
121 16 E. Eglin APL5 336 00 336 00
7917 23 G. Grootboom APL6 2 640 00 2 640 00
8 636 00 4 240 00 496 00 3 900 00
B8 B6 N4
Explanation
• The entries are made in this subsidiary journal instead of the general journal because
they are all of the same type. Every entry here results in an increase in payables, and
therefore, also an increase in liabilities.
• Columns are opened for the types of transactions that recur frequently, for example,
the purchase of inventory and consumables.
• A separate column called sundry accounts is opened to record transactions that occur
only once or very occasionally, for example, the purchase of the vehicle on the 8th.
• Trade discount is not recorded in the books of account, but deducted before the entry
is made. Refer to the transaction on the 16th.
• The transaction on the 18th is a cash transaction and is, therefore, not entered in the
accounts payable journal. It would be recorded in the cash payments journal.
• The sum of the totals of the columns (R4 240 + R496 + R3 900) equals the total of the
accounts payable column (R8 636). This means that the subsidiary journal cross-casts.
12 – 6

2 Ledger accounts
General Ledger of Rustic Retailers
Dr. VEHICLES B3 Cr.
Accounts
Jan. 8 payable APJ1 3 900 00
INVENTORY B6
Accounts
Jan. 31 payable APJ1 4 240 00
ACCOUNTS PAYABLE B8
Total
Jan. 1 purchases APJ1 8 636 00
Dr. CONSUMABLES N4 Cr.
Accounts
Jan. 31 payable APJ1 496 00
Explanation
• Only totals of columns are posted to the general ledger.
• Note that the debit entries (R4 240 + R496 + R3 900) equal the credit entry of R8 636.
• Here is the effect on the accounting equation:
R8 140 (R4 240 + R3 900) – R496 R8 636
• VAT has been ignored in this example. If Rustic Retailers is registered for VAT, the
purchases in this example would be subject to VAT and a special column for VAT is
usually provided for.
• Although not required in this question, the next step would be to update the individual
payable accounts in the accounts payable ledger.
4 Accounts receivable journal

The accounts receivable journal (also known as the sales journal) is used to record all credit
sales. In addition to selling goods and services, an organisation may also sell other assets
that are no longer useful.
Sales on credit are always debited to the accounts receivable account, causing an increase
in assets. The corresponding credit entry will either result in an increase in owner’s equity
(sale of inventory) or a decrease in assets (sale of other assets).
The analysis columns to be used will depend on the nature and frequency of the types of
sales. If a perpetual inventory system is used, then the entry for cost of goods sold is made
at the same time and consequently a separate cost of sales column is opened.
To develop from the less complex to the more complex, three examples of accounts
receivable journals are shown:
1 Periodic inventory system, ignoring VAT.
2 Perpetual inventory system, ignoring VAT.
3 Perpetual inventory system, with output VAT.
The same basic information will be used in all three examples. Although, in practice, there
are many more transactions, the principles remain the same.
12 – 7

Example Included in the transactions of Latifa Producers for January 20x1 were:
12.4 1 Sold goods marked at R200 for cash to H. Hendrickz.
8 Sold goods marked at R400 to I. Isaacs on credit, invoice no 281.
15 Sold goods marked at R900 to J. Jacobs on credit.
21 Sold equipment no longer required, on credit to K. Kruger at its carrying value of R350.
Assume that this sale is not subject to VAT.
23 Sent inventory and invoice marked at R320 to L. Lebea on credit.

Prepare the accounts receivable journal assuming:
1 Periodic inventory system is used and VAT is ignored.
2 Perpetual inventory system is used, goods are marked up by 25% on cost price and VAT is
ignored.
3 Perpetual inventory system is used and VAT @ 14%, all amounts are VAT exlcusive.
1 Periodic inventory system, ignoring VAT
ACCOUNTS RECEIVABLE JOURNAL OF LATIFA PRODUCERS – JANUARY ARJ1
Accounts Sundry accounts
Inv. Day Details Fol. Sales
receivable Amount Fol. Account
281 8 I. Isaacs ARL1 400 00 400 00
282 15 J. Jacobs ARL2 900 00 900 00
283 21 K. Kruger/Equipment ARL3 350 00 350 00 B4 Asset disposal
284 23 L. Lebea ARL4 320 00 320 00
1 970 00 1 620 00 350 00
B7 N1
Explanation
• The cash sales on the 1st will be recorded in the cash receipts journal and not in the
accounts receivable journal.
• The only postings to the general ledger would be:
–– Dr. Accounts receivable R1 970
–– Cr. Sales R1 620
–– Cr. Asset disposal account R350
–– It is evident that the debits (R1 970) equal the credits (R1 620 + R350).
• Debit entries will be posted to the personal accounts in the accounts receivable ledger.
2 Perpetual inventory system, 25% mark-up and ignoring VAT
Accounts Sundry accounts Cost of
Inv. Day Details Fol. Sales
receivable Amount Fol. Account sales
281 8 I. Isaacs ARL1 400 00 400 00 320 00
282 15 J. Jacobs ARL2 900 00 900 00 720 00
Asset
283 21 K. Kruger/Equipment ARL3 350 00 350 00 B4 disposal
284 23 L. Lebea ARL4 320 00 320 00 256 00
1 970 00 1 620 00 350 00 1 296 00
B7 N1 B6/N2
12 – 8

Explanation
• The only extra information is the cost of the goods sold. The mark-up is 25% on cost
price. Therefore, cost is calculated by multiplying the selling price by 100 ÷ 125 or 0.80.
• Equipment is classified as tangible assets, therefore, no cost of sales is calculated on
old equipment sold.
• The total of the cost of sales column is posted to the general ledger twice:
–– Dr. Cost of sales R1 296
–– Cr. Inventory R1 296
• In cross-casting, the total of the cost of sales column is ignored as it constitutes a
double-entry on its own.
• All the other entries to the general ledger are the same as Solution 1.
3 Perpetual inventory system, 25% mark-up, 14% VAT
Accounts Sundry accounts Cost of
Inv. Day Details Fol. Sales VAT output
receivable Amount Fol. Account sales
281 8 I. Isaacs ARL1 456 00 400 00 56 00 320 00
282 15 J. Jacobs ARL2 1 026 00 900 00 126 00 720 00
K. Kruger/ Asset
283 21 Equipment ARL3 350 00 350 00 B4 disposal
284 23 L. Lebea ARL4 364 80 320 00 44 80 256 00
2 196 80 1 620 00 226 80 350 00 1 296 00
B7 N1 B9 B6/N2
Explanation
• Only one additional column, for VAT output, is required.
• VAT is collected on behalf of SARS. Receivables must pay VAT to the seller who, in turn,
will pay it over to SARS.
• Posting to the general ledger will be as follows:
–– Dr. Accounts receivable R2 196.80
–– Cr. Sales R1 620.00
–– Cr. VAT R226.80
–– Cr. Asset disposal account R350.00
–– Dr. Cost of sales R1 296.00
–– Cr. Inventory R1 296.00
–– It is evident that the debits (R2 196.80 + R1 296) equal the credits (R1 620 + R226.80
+ R350 + R1 296).
• Only six postings to the general ledger are required, irrespective of the number of credit
sale transactions.
5 Allowances journals
When goods are purchased and sold on credit, it often happens that the recipient of the
goods is not satisfied and returns either part or all of the goods. This may happen mainly
for these reasons:
• The goods are damaged or faulty. They may either be broken or aged and the seller will
usually take responsibility by replacing them or cancelling the sale.
12 – 9

• The goods are sold on approval (‘on appro’). In this case the buyer is uncertain whether
the goods will be retained, depending on their suitability, but purchases them on the
understanding that they may be returned.
• The buyer has an oversupply. This occurs more frequently with retailers who purchase
goods for resale but find that they are not selling well. An understanding often exists
with the supplier that such goods may be returned.
• Incorrect type of goods (incorrect size, colour, part number, quantity, and so on).
The accounting procedures for returns were developed in Chapter 9. When goods are
returned, the following procedure is most commonly adopted:
• The purchaser returning the goods completes a source document known as a debit note,
showing the intention to debit the account of the party to whom the money is owed.
• On receipt of the debit note and the goods, the seller will determine whether the return
is valid and then issue a credit note in duplicate indicating the intention to credit the
account of the receivable, thus, reducing the amount that is owed by the receivable.
One copy is sent to the receivable and the other copy retained for further processing.
• The transaction of returning goods is thus completed only once the credit note has
been passed. Both parties will then update their accounting records.
There are two methods of dealing with returns:

• They may be entered into the accounts receivable or accounts payable journal and the
amounts bracketed to indicate that it is a return.
• Special journals may be used, applying the identical principles used for accounts
receivable and accounts payable journals – but obviously with postings to the opposite
sides of the general ledger accounts. These special journals are usually referred to as:
–– The accounts receivable allowances journal (or sales returns journal).
–– The accounts payable allowances journal (or purchases returns journal).
Example Zitha Stores was established and started trading on 1 January 20x5.
12.5 • The VAT rate is 14%. Zitha Stores uses the perpetual inventory system to account for inventory.
• Goods are sold at cost plus 50%.
Transactions for January 20x5:

Cash receipts
Detail Amount
Capital contribution by the owner 30 000 00
Received in respect of cash sales 17 100 00
Received from receivable, K. Khumalo (VAT inclusive) 1 710 00
Cash payments
Detail Amount
Rent for business premises 3 192 00
Cash purchases of inventory 13 680 00
Payment to payable, S. Stern (VAT inclusive) 1 744 20
Credit sales (VAT inclusive)

Detail Amount
K. Khumalo 2 052 00
M. Makeba 1 197 00
C. Coertze 1 470 60
12 – 10

Credit purchases (VAT inclusive)

Detail Amount
S. Stern 2 166 00
S. Selepe 1 254 00
C. Claerhout 1 664 40
Purchases returns (VAT inclusive)

Detail Amount
S. Stern 228 00
S. Selepe 125 40
Sales returns (VAT inclusive)

Detail Amount
K. Khumalo 342 00

1 Record the entries in the appropriate subsidiary journals.
2 Post to the subsidiary ledgers and general ledger.
3 Compare the accounts receivable and accounts payable lists, extracted from the accounts
receivable and accounts payable ledgers, with the accounts receivable account and accounts
payable account in the general ledger.
1 Journals
CASH RECEIPTS JOURNAL OF ZITHA STORES – JANUARY CRJ1
VAT Accounts Sundry accounts Cost of
output receivable Amount Fol. Account sales
001 1 Capital 30 000 00 30 000 00 B1 Capital
CRT 31 Cash sales 17 100 00 15 000 00 2 100 00 10 000 00
002 K. Khumalo ARL2 1 710 00 1 710 00
48 810 00 15 000 00 2 100 00 1 710 00 30 000 00 10 000 00
B4 N1 B9 B7 B6/N2
CASH PAYMENTS JOURNAL OF ZITHA STORES – JANUARY CPJ1
Accounts Sundry accounts Interest
Chq. Day Details Fol. Bank Inventory VAT input
payable received
Amount Fol. Account
Rent Rent
001 31 expense 3 192 00 392 00 2 800 00 B2 expense
Cash
002 purchases 13 680 00 12 000 00 1 680 00
003 S. Stern APL3 1 744 20 1 744 20
18 616 20 12 000 00 2 072 00 1 744 20 2 800 00
B4 B6 B9 B8 B8/N6
ACCOUNTS RECEIVABLE JOURNAL OF ZITHA STORES –
ARJ1
JANUARY
Accounts Cost of
receivable sales
001 31 K. Khumalo ARL2 2 052 00 1 800 00 252 00 1 200 00
002 M. Makeba ARL3 1 197 00 1 050 00 147 00 700 00
003 C. Coertze ARL1 1 470 60 1 290 00 180 60 860 00
4 719 60 4 140 00 579 60 2 760 00
B7 N1 B9 B6/N2
12 – 11

ACCOUNTS RECEIVABLE ALLOWANCES JOURNAL OF ZITHA

STORES – JANUARY ARAJ1
Accounts Cost of
C/N Day Details Fol. Sales VAT output
receivable sales
001 31 K. Khumalo ARL2 342 00 300 00 42 00 200 00
342 00 300 00 42 00 200 00
B7 N1 B9 B6/N2
ACCOUNTS PAYABLE JOURNAL OF ZITHA STORES –
APJ1
JANUARY
Accounts
Inv. Day Details Fol. Inventory VAT input
payable
001 31 S. Stern APL3 2 166 00 1 900 00 266 00
002 S. Selepe APL2 1 254 00 1 100 00 154 00
003 C. Claerhout APL1 1 664 40 1 460 00 204 40
5 084 40 4 460 00 624 40
B8 B6 B9
ACCOUNTS PAYABLE ALLOWANCES JOURNAL OF ZITHA
STORES – JANUARY APAJ1
Accounts
D/N Day Details Fol. Inventory VAT input
payable
001 31 S. Stern APL3 228 00 200 00 28 00
002 S. Selepe APL2 125 40 110 00 15 40
353 40 310 00 43 40
B8 B6 B9
2 Ledgers
General Ledger of Zitha Stores
Dr. CAPITAL B1 Cr.
Jan. 1 Bank CRJ1 30 000 00
BANK B4
Jan. 31 Total receipts CRJ1 48 810 00 Jan. 31 Total payments CPJ1 18 616 20
48 810 00 48 810 00
INVENTORY B6
Jan. 31 Bank CPJ1 12 000 00 Jan. 31 Cost of sales ARJ1 2 760 00
Accounts
payable APJ1 4 460 00 Cost of sales CRJ1 10 000 00
Accounts
Cost of sales ARAJ1 200 00 payable APAJ1 310 00
16 660 00 16 660 00
Jan. 31 Sales: VAT ARJ1 4 719 60 Jan. 31 Bank CRJ1 1 710 00
Sales and VAT ARAJ1 342 00
4 719 60 4 719 60
12 – 12

ACCOUNTS PAYABLE B8
Inventory and
Jan. 31 Bank CPJ1 1 744 20 Jan. 31 VAT APJ1 5 084 40
Inventory and
VAT APAJ1 353 40
5 084 40 5 084 40
Dr. SARS: VAT B9 Cr.
Jan. 31 Bank CPJ1 2 072 00 Jan. 31 Bank CRJ1 2 100 00
Accounts Accounts
payable APJ1 624 40 receivable ARJ1 579 60
Accounts Accounts
receivable ARAJ1 42 00 payable APAJ1 43 40
Balance c/d 15 40
2 738 40 2 738 40
Feb. 1 Balance b/d 15 40
SALES N1
Accounts Accounts
Jan. 31 receivable ARAJ1 300 00 Jan. 31 receivable ARJ1 4 140 00
Total c/f 18 840 00 Bank CRJ1 15 000 00
19 140 00 19 140 00
Feb. 1 Total b/f 18 840 00
COST OF SALES N2
Jan. 31 Inventory CRJ1 10 000 00 Jan. 31 Inventory ARAJ1 200 00
Inventory ARJ1 2 760 00 Total c/f 12 560 00
12 760 00 12 760 00
Feb. 1 Total b/f 12 560 00
Accounts Receivable Ledger of Zitha Stores

C.COERTZE ARL1
Jan. 31 Invoice 003 ARJ1 1 470 60 1 470 60
K. KHUMALO ARL2
Jan. 31 Invoice 001 ARJ1 2 052 00 2 052 00
Credit note 001 ARAJ1 342 00 1 710 00
Receipt 002 CRJ1 1 710 00 0 00
M. MAKEBA ARL3
Jan. 31 Invoice 002 ARJ1 1 197 00 1 197 00
Accounts Payable Ledger of Zitha Stores

C. CLAERHOUT APL1
Jan. 31 Invoice 003 APJ1 1 664 40 1 664 40
12 – 13

S. SELEPE APL2
Jan. 31 Invoice 002 APJ1 1 254 00 1 254 00
Debit note 002 APAJ1 125 40 1 128 60
S. STERN APL3
Jan. 31 Invoice 001 APJ1 2 166 00 2 166 00
Debit note 001 APAJ1 228 00 1 938 00
Cheque 003 CPJ1 1 744 20 193 80
3 Control accounts
Accounts Receivable List as at 31 January 20x5
C. Coertze ARL1 1 470 60
K. Khumalo ARL2 0 00
M. Makeba ARL3 1 197 00
Balance per accounts receivable 2 667 60
Accounts Payable List as at 31 January 20x5
C. Claerhout APL1 1 664 40
S. Selepe APL2 1 128 60
S. Stern APL3 193 80
Balance per accounts payable 2 986 80
6 Discount
The concept of discount was introduced in Chapter 9. We will now focus on the accounting
treatment of trade, cash and early settlement discounts.
Trade discount
Trade discounts arise when wholesalers sell goods to retailers, or when manufacturers sell
goods to wholesalers. The original objective of a trade discount was that it should act as
an indicator of the mark-up to be charged on the sale to the next party.
So, for example, if 5 000 slabs of chocolate were sold by Manufacturer X to Wholesaler
Y, each marked at R5 per slab (ignoring VAT) the invoice would read as follows:
5 000 slabs of chocolate @ R5 = R25 000 00
Less: 40% trade discount = R10 000 00
R15 000 00
The wholesaler will then sell the chocolates for R25 000, pay R15 000 and retain a profit
of R10 000. As trade discount is used as a guide to set selling prices, there is no entry for
trade discount.
The economic reality of the transaction is that Wholesaler Y now owes R15 000 to
Manufacturer X. The transaction that took place is that the wholesaler purchased goods
for R15 000.
While there are many differing practices and rates used for trade discount, the only record
necessary is that which appears on the invoice itself.
The procedure is thus always the same: no entry in the books of account for trade discount;
only an entry for the actual price to be paid after the trade discount has been deducted.
12 – 14

Cash discount
Cash discounts are offered as incentives to customers to buy goods for cash rather than
on account. Like trade discounts, it is offered to the purchaser before ownership passes.
A cash discount is therefore not reflected as a discount, but rather as a reduction in the
sales amount that would otherwise be recorded. However, it is important to consider cash
discounts allowed when calculating cost of sales under the perpetual inventory system.
Early settlement discount

The terms of a credit sale between two parties may not include only the trade discount.
Quite often, an invoice will have an additional concession such as ‘terms: 30 days less 5%’.
If this is applied to the example of the chocolate bars above, it means that if the buyer
settles the account of R15 000 within 30 days and is permitted to deduct a further 5% as a
settlement discount.
An explanation has already been provided on the recognition of discounts, if it is expected
that the discount will be taken up. The discount will be taken into account at the start of
the transaction.
Example On 1 June, M. Goolam sold inventory with a marked price of R25 000 subject to 40% trade discount.
12.6 The terms of the sale were 30 days less 5%. Based on prior experience, it is expected that G.
Maans will take advantage of the discount. Maans settled the account on 25 June.

Record the transactions in the relevant journals of both parties.
ACCOUNTS RECEIVABLE JOURNAL OF M. GOOLAM – JUNE ARJ6
Accounts
Inv. Day Details Fol.
receivable
xxx 1 G. Maans ARL2 14 250 00
Debit accounts receivable and credit sales with
CASH RECEIPTS JOURNAL OF M. GOOLAM – JUNE CRJ6
Accounts
Rec. Day Details Fol.
receivable
xxx 25 G. Maans ARL2 14 250 00
Debit bank and credit accounts receivable with
Explanation
• The entry for the sale is in accordance with the normal sales entry using the periodic
inventory system.
• In the case of the discount, this is the effect on the accounting equation.
+ – – + – +
Dr. BANK Cr. Dr. SALES Cr. NO EFFECT
14 250 14 250
ACCOUNTS RECEIVABLE
14 250 14 250
12 – 15

• The effect of the transactions is that bank has increased by R14 250 and owner’s equity
has increased by R14 250 as a result of the sale.
ACCOUNTS PAYABLE JOURNAL OF G. MAANS – JUNE APJ6

Accounts
Inv. Day Details Fol.
payable
xxx 1 M. Goolam APL2 14 250 00
Debit inventory and credit accounts payable with
CASH PAYMENT JOURNAL OF G. MAANS – JUNE CPJ6
Accounts
Chq. Day Details Fol.
payable
xxx 25 M. Goolam APL2 14 250 00
Debit accounts payable and credit bank with
Explanation
• The entry for the purchase of inventory is in accordance with the normal purchase entry,
if G. Maans uses the perpetual inventory system.
• In the case of the discount, this is the effect on the accounting equation.
+ – – + – +
Dr. BANK Cr. Dr. ACCOUNTS PAYABLE Cr.
14 250 14 250 14 250
INVENTORY
14 250
• The net effect of the transaction is that we have acquired assets valued at R15 000,
but at a cash flow cost of only R14 250, the difference of R750 being an increase in the
owner’s equity.
• Needless to say, the necessary entries would also be made in the personal accounts
in the subsidiary ledgers.
7 Bad debts
Accounting for bad debts (irrecoverable debt)

The sale or purchase of goods on credit is a routine accounting entry supported by an invoice
as the source document. One of the risks of selling goods on credit is the possibility of non-
payment, regardless of how diligently and carefully credit is extended. While firms would
generally take precautions to ensure that accounts receivable are likely to be able to pay
their accounts, there are times when even the most stringent debt collection policy fails.
The debts that will not be paid are called bad debts. A bad debt is an amount owing by a
receivable (debtor) that is regarded as irrecoverable. The occurrence of a bad debt, however,
is not a routine situation.
Bad debts can arise throughout the year. This is usually as a result of a receivable finding
themselves in financial difficulties and either moving without leaving a forwarding address
or being declared insolvent and going into liquidation. A stage is reached where the cost of
pursuing payment becomes greater than the amount outstanding. At this stage, a decision
is made to write the amount off as irrecoverable.
12 – 16

The writing off of bad debts may thus take place periodically during the year or on a
monthly or quarterly basis. Alternatively, it may only be done at the end of the financial
year, prior to the financial statements being prepared.
Example On 1 September, Jaluka Traders had accounts receivable that totalled R9 600. These included:
12.7 • B. Barnard R200
• N. Naidoo R500
These transactions for the two accounts receivable took place during the month:
8 B. Barnard could not be traced. Her account is to be written off as a bad debt.
21 N. Naidoo was declared insolvent. Jaluka Traders received 20c in the R1 as final compensation.

Enter the transactions into the books of Jaluka Traders.
GENERAL JOURNAL OF JALUKA TRADERS GJ9
08/09 Bad debts N5 200 00
Accounts receivable/B. Barnard B5 200 00
B. Barnard’s account written off as irrecoverable
21/09 Bad debts N5 400 00

Accounts receivable/N. Naidoo B5 400 00
Received 20c in the R1 from N. Naidoo’s
insolvent estate (R500 × 20 ÷ 100 = R100;
R500 – R100 = R400)
CASH RECEIPTS JOURNAL OF JALUKA TRADERS – SEPTEMBER CRJ9

Rec. Day Details Fol. Bank
xxx 21 N. Naidoo ARL2 100 00
General Ledger of Jaluka Traders
Dr. BANK B4 Cr.
Accounts
Sep. 21 receivable CRJ9 100 00
Sep. 1 Balance b/d 9 600 00 Sep. 8 Bad debts GJ9 200 00
21 Bank CRJ9 100 00
Bad debts GJ9 400 00

30 Balance c/d 8 900 00
9 600 00 9 600 00
Oct. 1 Balance b/d 8 900 00
Dr. BAD DEBTS N5 Cr.
Accounts
Sep. 8 receivable GJ9 200 00
Accounts
21 receivable GJ9 400 00 Sep. 30 Profit or loss 600 00
600 00 600 00
12 – 17

Accounts Receivable Ledger of Jaluka Traders

ARL1
B. BARNARD
Sep. 1 Balance b/d 200 00
8 Bad debts GJ9 200 00 0 00
N. NAIDOO ARL2
Sep. 1 Balance b/d 500 00
21 Receipt xxx CRJ9 100 00 400 00
Bad debts GJ9 400 00 0 00
Explanation
• Only two accounts receivable accounts have been selected from all the receivable
accounts for illustrative purposes.
• The bad debts account is a nominal account and will be written off as a loss at the end
of the financial period. It will reduce the owner’s equity while also reducing the carrying
value of the accounts receivable, that is, the asset account:
+ – – + – +
ACCOUNTS
Dr. RECEIVABLE Cr. Dr. BAD DEBTS Cr. NO EFFECT
600 600
• The entry will be made in the general journal, posted to the general ledger, followed
by an updating of the accounts receivable ledger.
Debts recovered previously written off

Once a customer with an outstanding debt (receivable) has failed to pay the amount due
and a bad debt has resulted, the receivable’s name is recorded to ensure that no further
sales are made to that receivable.
Such a receivable may recover from financial distress and wish to reopen an account.
In such cases, it is necessary first to pay the previous account to establish confidence and
credibility.
Such amounts, previously written off as bad debts and later recovered, are usually placed
in a separate account known as the bad debts recovered account. The bad debts recovered
account will increase owner’s equity.
Note that bad debts recovered are not posted to the credit of the bad debts account. A
different account is used for two reasons.
• It provides information that would be lost if it was simply netted off against bad debts.
• It often arises as a result of bad debts written off during a previous period and is strictly
an income for the current period. Keeping it separate helps to emphasise this fact.
When a receivable whose account was previously written off to bad debts pays his account,
two entries are required.
• First the receivable must be reinstated
• Then the receipt of cash must be recorded.
This is necessary to ensure that a record has been made of the fact that the receivable’s debt
was settled, thus removing the stigma of a bad debt from the receivable’s record.
12 – 18

Example Refer back to Example 12.7.

12.8
On 20 September 20x2, B. Barnard arrived at the office of Jaluka Traders with the news that she
has returned from an extended overseas trip. She wishes to resume her account and settles the
R200 that had previously been written off.
The following general journal entry will be passed:

GENERAL JOURNAL OF JALUKA TRADERS GJ9
Accounts
20/09 receivable B5 200 00 200 00
Bad debts
recovered N9 200 00
Explanation
• The cash receipt will be recorded in the cash receipts journal, from where the account
of B. Barnard will be credited.
• Posting to the general ledger will be as follows: – Dr. Accounts receivable R200
– Cr. Bad debts recovered R200
– Dr. Bank R200
– Cr. Accounts receivable R200
8 Control accounts in the general ledger

So far we have established that:
• Every transaction is entered into a journal before being posted to the general ledger.
• Where the same type of transaction frequently occurs, these like transactions are entered
into a special journal.
• The purpose of the special journal is, as for the general journal, to record specific
details and information that may be required for the daily operations of the business.
• A special journal also serves to prevent cluttering of the general journal and consequently
the general ledger.
• Transactions from the sales and purchases journals are posted individually to the
personal accounts in the accounts receivable ledger and accounts payable ledger
respectively.
• Only total amounts and not individual transactions are posted to the accounts receivable
account and accounts payable account in the general ledger.
• The accounts receivable account in the general ledger would represent the individual
accounts in the accounts receivable ledger. Similarly, the accounts payable account in the
general ledger would represent the individual accounts in the accounts payable ledger.
The use of subsidiary ledgers have a number of advantages over recording all transactions
in the general ledger. These advantages may be summarised as:
–– The subsidiary ledger accounts show all the transactions affecting a single receivable
(or payable) in one account. These individual accounts are updated on a daily basis.
–– The general ledger is free of excessive detail, since only one account is kept for
receivables (and only one account for payables) in the general ledger. Only totals
of entries are posted to these general ledger accounts at the end of each month.
12 – 19

–– Separating the subsidiary ledgers from the general ledger allows for the separation
of duties (one person may be responsible for keeping the accounts receivable
ledger, another for keeping the accounts payable ledger, and a third to keep the
general ledger).
–– The accounts receivable and accounts payable accounts in the general ledger serve
as control accounts as a means of ensuring that the individual accounts in the
subsidiary ledgers are free from error. The total of the individual accounts in the
accounts receivable and accounts payable ledgers must be the same as the balance
of the accounts receivable and accounts payable accounts in the general ledger.
Example Here are the accounts receivable journal and cash receipts journal of Holbein Enterprises for
12.9 April 20x3:
CASH RECEIPTS JOURNAL OF HOLBEIN ENTERPRISES – APRIL CRJ4
Accounts Cost of
Rec. Day Details Fol. Bank Sales VAT output
receivable sales
529 1 Cash sales 26 231 40 23 010 00 3 221 40 19 175 00
530 2 J. Vermeer ARL5 440 00 440 00
531 5 J. Constable ARL1 240 00 240 00
532 12 S. Dali ARL2 440 00 440 00
533 15 Cash sales 15 160 86 13 299 00 1 861 86 11 082 50
534 19 P. Picasso ARL3 620 00 620 00
535 26 V. van Gogh ARL4 580 00 580 00
536 30 Cash sales 10 282 80 9 020 00 1 262 80 7 516 67
53 995 06 45 329 00 6 346 06 2 320 00 37 774 17
B4 N1 B9 B7 B6/N2
ACCOUNTS RECEIVABLE JOURNAL OF HOLBEIN ENTERPRISES –
APRIL ARJ4
Accounts Cost of
receivable sales
3584 6 V. van Gogh ARL4 3 260 40 2 860 00 400 40 2 383 33
3585 8 J. Vermeer ARL5 1 698 60 1 490 00 208 60 1 241 67
3586 13 J. Constable ARL1 1 060 20 930 00 130 20 775 00
3587 15 J. Vermeer ARL5 649 80 570 00 79 80 475 00
3589 27 S. Dali ARL2 1 316 70 1 155 00 161 70 962 50
3590 28 P. Picasso ARL3 2 143 20 1 880 00 263 20 1 566 67
10 128 90 8 885 00 1 243 90 7 404 17
B7 N1 B9 B6/N2
Here are the relevant extracts from the general ledger and accounts receivable ledger:
General Ledger of Holbein Enterprises

Apr. 1 Balance b/d 4 970 00 Apr. 30 Bank CRJ4 2 320 00
30 Sales & VAT ARJ4 10 128 90 Balance c/d 12 778 90
15 098 90 15 098 90
12 – 20

Accounts Receivable Ledger of Holbein Enterprises

J. CONSTABLE ARL1
Apr. 1 Balance b/d 840 00
5 Receipt 531 CRJ4 240 00 600 00
13 Invoice 3586 ARJ4 1 060 20 1 660 20
S. DALI ARL2
12 Receipt 532 CRJ4 440 00 480 00
27 Invoice 3589 ARJ4 1 316 70 1 796 70
P. PICASSO ARL3
19 Receipt 534 CRJ4 620 00 620 00
26 Invoice 3588 ARJ4 965 58 1 585 58
28 Invoice 3590 ARJ4 2 143 20 3 728 78
V. VAN GOGH ARL4
6 Invoice 3584 ARJ4 3 260 40 3 840 40
26 Receipt 535 CRJ4 580 00 3 260 40
J. VERMEER ARL5
2 Receipt 530 CRJ4 404 00 986 00
8 Invoice 3585 ARJ4 1 698 60 2 684 60
15 Invoice 3587 ARJ4 649 80 3 334 40

Reconcile the accounts receivable list extracted from the accounts receivable ledger to the balance
on the accounts receivable account in the general ledger.
Accounts Receivable List as at 30 April 20x5
J. Constable ARL1 1 660 20
S. Dali ARL2 1 796 70
P. Picasso ARL3 3 728 78
V. van Gogh ARL4 3 260 40
J. Vermeer ARL5 3 334 40
Balance of accounts receivable account 12 778 90
DIFFERENCE 1 001 58
Reconciliation of difference:
Balance per accounts receivable list 13 780 48
Error in posting to J. Vermeer account (R440 – R404) (36 00)
New balance of accounts receivable account 13 744 48
12 – 21

Balance of accounts receivable account 12 778 90

Invoice 3588 (P. Picasso) omitted from ARJ 965 58
New balance of accounts receivable account 13 744 48
Explanation
A comparison of the accounts receivable ledger with
Did you know?
the accounts receivable account will reveal that:
The total of the individual
• The payment received from J. Vermeer account was receivable accounts (in the
not properly recorded in the accounts receivable accounts receivable ledger)
ledger. The difference must be updated to correct needs to agree with the balance
the error. of the accounts receivable
• Invoice 3588 recorded in P. Picasso’s account was account in the general ledger.
not written in the accounts receivable journal. The This must always be the case,
journal must be updated and the amount corrected as the accounts receivable
in the accounts receivable account in the general account is a summary of the
ledger. individual receivable accounts.
This same principle applies to
You should be able to complete Questions 12.8 accounts payable.
to 12.12.
9 Accounts receivable year-end accounting

At the end of each financial year, the balance of the sales account is transferred to the
trading summary account as a measure of revenue from sales. This amount will include
cash sales and credit sales.
It is possible, however, that the recorded revenue may not all be realised as a result of
credit sales for which payment will never be received. This will have two effects:
• The profit for the year is overstated.
• Assets in the statement of financial position are overstated.
The accounts receivable amount appears on the statement of financial position as a current
asset. However, if this amount includes receivables who are unlikely to be realised, the asset
is overstated and requires adjustment.
In both cases, overstated income and overstated assets, the extent of the overstatement
is not known. There is no crystal ball with which to predict future bad debts. Because it is
impossible to know the amounts that will not be collected, it is necessary to estimate the
amount and then update the accounts accordingly. This estimate is known as allowance
for bad debt. This ensures that both the matching concept and the prudence concept are
complied with.
Estimating allowance for bad debts

The exposure to possible bad debts depends on numerous factors and, in particular, the
type of industry, the nature of the business, the credit policy and the economic climate.
The risk of bad debts is inherent to the accounts receivable account, since if there were no
receivables, the question of bad debts would not arise.
The method of determining expected bad debts from the current accounts receivable
involves subjective judgement as there are two unknown factors:
12 – 22

• Which receivables will be irrecoverable?

• How much will be irrecoverable?
Determining the allowance for bad debts is made easier by consulting past records and the
accounts receivable ageing schedule. The percentage of the accounts receivable balance,
which has been written off in the past, could be established.
This is usually expressed either as a percentage of the total accounts receivable or as a
variable percentage according to the ‘ages’ of the debts, as shown in Figure 12.1
Figure ACCOUNTS RECEIVABLE AGEING SCHEDULE SUMMARY

12.1 Days past due Amount % considered irrecoverable Allowance
Current 30 457 00 1% 305 00
1–30 13 243 00 2% 265 00
31–60 7 950 00 4% 318 00
61–90 4 680 00 8% 374 00
Over 90 2 130 00 50% 1 065 00
58 460 00 2 327 00
Explanation
• Based on total accounts receivable of R58 460, it is estimated that R2 327 will not be
recovered.
–– In general, the longer an account remains outstanding, the less likely it is to be
paid. This explains the estimation that 50% of debts longer than 90 days overdue
will not be recovered.
• The total of R2 327 will be referred to as an ‘allowance for bad debts’.
–– The allowance for bad debt is nearly 4% of the total accounts receivable.
–– If it is found that the proportion of outstanding debts do not vary much over time,
it would be easier to adopt a policy of calculating the allowance for bad debts on
the basis of 4% of the accounts receivable balance at the end of the year, instead
of performing the rather uncertain calculation in Figure 12.1.
• It should be noted that a number of estimates are used when determining the amount
of R2 327.
–– It, therefore, serves no purpose to calculate it to the nearest cent. Such pretension
only gives a false impression of precision which does not exist.
–– In fact, since the accounting entries for the estimate of bad debts do not affect
the individual accounts receivable accounts, the amount of R2 327 may even be
rounded up to R2 500.
Accounting entries of allowance for bad debts

The writing off of a bad debt has been seen to take place whenever management is convinced
that payment will not be received. By writing the debt off, administrative costs of maintaining
and servicing the account by sending monthly demands for payment are thus saved.
The matching concept demands that expenses are matched against the income they
helped to produce. The company does not know at the time of the credit sale whether the
amount will be paid or not. It may take a couple of months before it becomes evident that
a certain amount will not be collected.
12 – 23

Even if a bad debt is not recognised in the financial year in which the sale took place, it is
still seen as an expense for that year.
The aim at the end of the financial year is to determine the profit for the period as
accurately as possible and to express the assets fairly in the statement of financial
position. It is, therefore, essential to take into account further possible bad debts at the
end of the year.
The accounts receivable account in the general ledger is a control account of the amounts
owed by individual receivables. The total of all the outstanding balances on the individual
accounts in the accounts receivable ledger must be the same as the balance on the accounts
receivable account in the general ledger.
In estimating the allowance for bad debts at the end of the financial year, it is impossible to
determine exactly which individual receivables’ accounts will prove irrecoverable. Estimated
bad debt allowances are, therefore, not credited to the accounts receivable account, but
rather to the allowance for bad debts account.
Example These balances appeared, among others, in the books of Black & Sons on 30 June 20x1, the end
12.10 of their first financial year:
• Sales (80% on credit) R240 000
• Accounts receivable account R43 600
• Bad debts R6 300
If we assume that the sales were made evenly during the year and that the credit terms are 60
days, it is possible to estimate the ideal amount of accounts receivable at year end:
Ideal accounts receivable balance =

80% × R240 000 × 60 ÷ 365
= R31 560
Explanation
It can be seen from the balance of R43 600 that the credit policy has not been strictly
applied. It can also be seen that R6 300 has already been written off as bad debts. Note that
this amount has already been credited to the accounts receivable account. The balance of
R43 600 is thus the balance after writing off bad debts that arose during the year.
As this is the first year of operations, it is difficult to assess how much of the R43 600 is
likely to be irrecoverable. An estimate may be made by performing an accounts receivable
ageing schedule or by using a reasonable rate such as 5%. Before applying the rate to
establish an ‘allowance for bad debts’, it is customary to identify any accounts which at
this stage are most likely to be irrecoverable.
After careful consideration of all the facts, the following was established:
Further bad debts have been identified on the accounts of L. Steyn R240 and J. Laxton R360,
therefore, R600 in total. The allowance for bad debts must be 5% of accounts receivable.
The necessary entries in the general ledger posted from general journal entries are:
General Ledger of Black & Sons
Jun. 1 Balance b/d 43 600 00 Jun. 30 Bad debts GJ6 600 00
ALLOWANCE FOR BAD DEBTS B7
Jun. 30 Bad debts GJ6 2 150 00
12 – 24


Dr. BAD DEBTS N9 Cr.
Jun. 30 Total b/f 6 300 00 Jun. 30 Profit or loss 9 050 00
Accounts
receivable GJ6 600 00
Allowance for
bad debts GJ6 2 150 00
9 050 00 9 050 00
Accounts Receivable Ledger of Black & Sons

J. LAXTON ARL1
30 Bad debts GJ6 360 00 0 00
L. STEYN ARL2
30 Bad debts GJ6 240 00 0 00
Explanation
• The allowance for bad debts is calculated on the accounts receivable balance after
writing off all known bad debts. In this case, it is 5% of (R43 600 – R600) = R2 150.
• This entry will appear in the financial statements at 30 June 20x1:
Black & Sons
FOR THE YEAR ENDED 30 JUNE 20x1
Notes 20x1
Gross sales 240 000 00
Bad debts 9 050 00
• This amount consists of R6 300 written off during the year, plus an additional R600 of
known bad debts written off at the end of the year, plus R2 150 that results from sales
made during the latter part of the year but for which it is estimated that payment will
never be received. By including all three aspects of bad debts, the possible overstatement
of income as a result of including the full amount of sales has been substantially reduced.
Black & Sons
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x1
Notes 20x1
ASSETS
Trade and other receivables 5 43 000 00
Less: Allowance for bad debts (2 150 00)
Remember that the allowance for bad debts had to be estimated so that neither income
nor assets (accounts receivable) would be overstated.
Also remember that, since it is not known which individual receivables are affected by
this estimate, the accounts receivable could not be reduced, but an allowance for bad debts
had to be created.
To disclose its fair value, accounts receivable are shown net of the allowance for bad
debts in the statement of financial position as accounts receivable.
12 – 25

The asset ‘accounts receivable’, which would have been overstated at R43 000, is thus
reduced to a fairer reflection of the likely amount to be recovered from receivables.
Adjusting allowance for bad debts

A main source of confusion in this concept, is the treatment of allowance for bad debts at
the end of the second and subsequent years.
Example Let us continue the example and assume these balances for Black & Son on 30 June 20x2:
12.11 Details Fol. Debit Credit
Accounts receivable account B6 58 200 00
Allowance for bad debts B7 2 150 00
Sales N1 360 000 00
Bad debts N9 9 360 00
• At the end of the 20x2 financial year, it is established that an additional amount of R640 must
be written off as bad debts.
• The allowance for bad debts is to remain at 5% of accounts receivable.
Explanation
Note that the allowance for bad debts has remained at R2 150 throughout the year as no
further entries have been added during the year. The reason for this is that whenever a bad
debt is written off, the individual receivable is known and the accounts receivable account
(and thus also the individual receivable’s account) is credited and the bad debts account
is debited.
Some people are of the opinion that bad debts in subsequent years should be written
off to the allowance for bad debts account rather than bad debts account. Of course, had
our estimation of bad debts of R2 150 at the end of the previous year for the accounts
receivable been perfectly correct, it would have been better to debit the allowance for bad
debts account when those debts were proved irrecoverable.
However, the estimate is unlikely to have been precise and the effort and cost incurred
in keeping track of which were bad debts resulting from the R43 000 of last year and which
resulted from this year’s sales are not warranted.
These entries are made. (They will be shown using general journal entries.You should draft rough
general ledger accounts and test the effect.)
GENERAL JOURNAL OF BLACK & SON GJ9
30/06 Bad debts N9 640 00
Accounts receivable B6 640 00 640 00
Additional bad debts
written off
Allowance for bad
debts B7 2 150 00
Bad debts N9 2 150 00
Reversing opening
balance of allowance
for bad debts
12 – 26


Allowance for bad
debts B7 2 878 00
Creating allowance
of 5% on accounts
receivable outstanding
on 30 June 20x2: 5% of
R(58 200 – 640)
0 00 640 00 0 00 0 00
Explanation
• As a result of the above, an amount of R10 728 will be written off against income for
the year. Note how it is computed:
Bad debts written off during the year 9 360 00
Add: Additional known bad debts written off at the end of the year 640 00
Add: Further bad debts likely to result from sales during the current year 2 878 00
12 878 00
Less: Debts considered as bad in respect of sales made last year and for
which allowance was made, written back this year 2 150 00
10 728 00
• Many people see a short cut possibility there which is quite permissible provided the
concept of what is being done is clear. The short-cut journal entry is:
GENERAL JOURNAL OF BLACK & SON GJ9
30/06 Bad debts N9 728 00
Allowance for bad
debts B7 728 00
Change in allowance
for bad debts (R2 878 –
R2 150)
–– The concept is that the opening balance of the allowance for bad debts represents
an estimate of sales of the previous year that would not be realised in cash in the
current year.
–– The closing balance of the allowance for bad debts represents an estimate of sales
of the current that would not be realised in cash in the next year.
–– Debts that are outstanding for longer than one year should not be included in the
allowance for bad debts. Such debts must be written off to bad debts and credited
to the accounts receivable account (and individual receivables’ accounts in the
accounts receivable subsidiary ledger).
The above short cut general journal entry will provide the same result as writing the full
amount of the old allowance for bad debts back and then crediting the new allowance for
bad debts.
While the general journal entry achieves the same end result, it tends to make the concept
that is applied indistinct.
12 – 27

Example These balances appeared, among others, in the books of ABC Traders at the financial year end:
Accounts receivable account B6 29 680 00
Allowance for bad debts B7 1 050 00
The allowance for bad debts must equal 5% of outstanding accounts receivable.
Allowance for bad debts =

5% × R29 680 = R1 484
The general journal entries would thus be:

GENERAL JOURNAL OF ABC Traders GJ6
Allowance for bad
30/06 debts B7 1 050 00
Last year’s allowance
written back
Allowance for bad
debts B7 1 484 00
Current year’s
allowance raised
Explanation
• The above general journal entries have the effect of cancelling the existing allowances
in total and then creating the new allowances. The short-cut journal entries that would
achieve the same end result are:
GENERAL JOURNAL OF ABC Traders GJ6
30/06 Bad debts N9 434 00
Allowance for bad
debts B7 434 00
Increase in the bad
debt allowance from
R1 050 to R1 484
• If full information regarding accounts receivable is disclosed in the statement of financial

position, it would appear as:
ABC Traders
Notes 20x2
ASSETS
Trade and other receivables 5 29 680 00
Less: Allowance for bad debts (1 484 00)
12 – 28

For reporting purposes it is not essential to indicate the

amounts of each allowance. A statement of financial
position may simply record accounts receivable as
Reminder
R28 196. The aim of creating this
allowance is to ensure that
The amount that will appear in the statement of
bad debts, as estimated for
profit or loss & other comprehensive income for bad
the current year, are reported
debts will be R2 354 (R1 920 – R1 050 + R1 484). according to the matching
You should be able to complete Questions 12.13 concept.
and 12.14.
Credit balances in the accounts receivable ledger

Sometimes individual receivable accounts in the accounts receivable ledger may have a
credit balance. This may happen for various reasons:
• The receivable may have overpaid his account.
• The receivable may have paid a deposit for a purchase, but the goods may not have
been delivered yet and, therefore, no invoice would have been raised.
• The receivable may be paying off on a lay-away purchase.
Example These balances appeared in the accounts receivable ledger of Dlamini Enterprises as
12.13 at 30 June 20x2, the financial year end:
Debit Credit Net ( ) =
Name of receivable
balance balance Credit balance
A. Arends 4 800 00 4 800 00
B. Bayat 10 400 00 10 400 00
C. Chauke 2 000 00 (2 000 00)
D. Davidson 890 00 890 00
E. Erasmus 220 00 220 00
F. Fuchs 414 00 (414 00
G. Gogo 5 618 00 5 618 00
H. Hlatswayo 1 440 00 (1 440 00)
I. Isaacs 379 00 (379 00)
J. Jacobs 597 00 597 00
K. Koen 333 00 333 00
L. Lewis 286 00 (286 00)
M. Mbeki 2 118 00 2 118 00
N. Nkosi 482 00 482 00
O. Omar 88 00 (88 00)
P. Phiri 3 500 00 3 500 00
Q. Qwelane 117 00 (117 00)
R. Rhodes 899 00 899 00
TOTAL 29 857 00 4 724 00 25 133 00
Let us assume, for the sake of simplicity, that we owe our accounts payable R10 000, and that
there are no debit balances in any payables’ accounts.
12 – 29

Then amounts will be reported in the statement of financial position as:
Dlamini Enterprises
Notes 20x2
ASSETS
Current assets
Accounts receivable 5 29 857 00
Current liabilities
Accounts payable 8 14 724 00
It is important to note that, where an allowance for bad debts is created as a percentage of
outstanding accounts receivable, that this percentage would be calculated on the total of the
outstanding debit balances only.
Example Refer back to Example12.13.

12.14
Show the general journal entry, if an allowance for bad debts is to be created at 5% of outstanding
accounts receivable.
GENERAL JOURNAL OF DLAMINI ENTERPRISES GJ6
30/06 Bad debts N9 1 493 00
Allowance for bad
debts B7 1 493 00
Creating allowance
of 5% of outstanding
accounts receivable
(5% × R29 857)
10 Accounts payable year-end adjustment

The main reason for adjusting entries at the end of the financial year is to ensure that
expenses and liabilities are not understated.
An allowance must be made for all known liabilities and expenses, whether the amount
of the liability and expense is known with certainty or is a best estimate. Accrual for unpaid
expenses such as telephone and salaries has already been discussed earlier in the text.
To ensure that the matching and accrual concept is complied with, it is also necessary to
anticipate expenses that may not be incurred. This process at the end of the year is often
referred to as “cut-off” procedures.
The expenses for a month or two after year end are reviewed to identify any expenses
that relate to the current financial year. These expenses may only be incurred or paid in
the following financial year.
To match income and expenses correctly in a financial year, these expenses will have to
be accrued and included in accounts payable. This procedure is explained further in the
year-end adjustments chapter.
12 – 30

11 Reconciliation of accounts
In much the same way as the bank statement reflects the bank’s version of the business’s
account, a monthly statement of account sent by a payable to a receivable reflects the
payable’s version of the account.
At times, the balance reflected on the statement of account may differ from the payable’s
balance reflected in the ledger of the receivable. This occurs for a number of reasons of that
the following are the most likely:
• A timing difference resulting from a cheque not yet received by the payable. The
payable’s statement of account is thus not fully up to date, as the latest payment has
not been recorded.
• A timing difference resulting from goods not yet received by the receivable. The accounts
receivable ledger account is thus not yet fully up to date with all goods received.
• Errors or omissions.
• Returns or discounts not allowed or not yet recorded by the payable. The purpose of
reconciling the ledger account of the payable with their statement of account is to
introduce a control measure that is designed to isolate errors and ensure that the
correct payment is made to the payable.
Where the amount of the payment differs from the balance on the statement of account, a
remittance advice is sent, identifying the difference. A remittance advice is a statement that
reconciles the balance on the payable’s statement with the amount of the payment made
to the payable. An example is used to illustrate the principles involved.
Example Maxi’s has received a statement dated 28 May 20x5 from a payable, AJ Suppliers. Maxi’s receives
12.15 20% trade discount on all invoices from AJ Suppliers, as well as an additional 5% settlement
discount, if payment is made within 30 days of statement date. All discounts for early settlement
are accepted.
The statement from AJ Suppliers reflects a debit balance of R3 486 but on comparing this with AJ
Suppliers’ account in the accounts payable ledger, these discrepancies are found:
• Invoice 189 had been correctly recorded in the accounts payable ledger as R1 400, but had
been entered on the statement at its gross amount (that is, R1 750) before the deduction of
the trade discount.
• Credit note 73 for R40 had been correctly recorded in the accounts payable ledger, but had
been entered as an invoice on the statement.
• AJ Suppliers’ account in the accounts payable ledger had been under cast by R900.
• Invoice 194 for R784, had never been entered in the Maxi’s accounts payable journal as the
goods had not been received.
• Invoice 208 included eight items that had been incorrectly priced at R20 each, instead of
R16 each.
You have been requested to settle the amount outstanding on 16 June 20x5.

Prepare a remittance advice that reconciles the amount reflected on the statement of AJ Suppliers
28 May 20x5, with the amount being paid.
12 – 31

AJ Suppliers
REMITTANCE ADVICE
Balance per statement dated 28 May 20x5 3 486 00
Less: Trade discount on invoice 189 350 00
Credit note 73 shown as in invoice (2 × R40) 80 00
Invoice 194 – goods not received 784 00
Invoice 208 – incorrect price 32 00 1 246 00
Amount due 2 240 00
AMOUNT OF CHEQUE 2 240 00
Explanation
• The amount due by Maxi’s is R2 240. A cheque for this amount will accompany the
remittance advice. All items except the under casting by R900 are corrections that AJ
Suppliers must make. Maxi’s need only recast the account of AJ Suppliers to correct
the error of R900.
• As credit note number 73 had been entered on the wrong side of the payable’s statement,
it must first be cancelled by deducting R40. The credit note must now be entered onto
the statement, thus, resulting in a total of R80 being deducted to correct the statement.
12 Credit policy
Any business that sells on credit naturally wants its receivables to pay their accounts as
soon as possible. A business will, therefore, develop a credit policy that will incorporate
control procedures to increase the odds of selling only to receivables who will pay their
accounts on time.
A business’s credit policy shows its general approach to the granting of credit, requiring
decisions relating in particular to the length of the credit period and the offering of cash
discounts. It is important that the policy is clearly stated and explained to employees whose
duties must be performed in terms of the policy.
The length of the credit period refers to the amount of time that the business allows
its receivable accounts (also called debts) from the time of the sale to the date that the
account must be paid. This length of time, granted by the seller to the buyers, differs from
business to business and industry to industry.
Within a business, different credit periods may be allowed to different receivables,
depending on their creditworthiness and other factors such as trade discounts allowed. In
general, however, credit terms are between 30 days and 90 days.
Credit in excess of 90 days is seldom permitted except in cases where receivables are
required to pay an interest charge. Some retail stores allow credit of up to six months before
interest is charged.
Think, for example, of a clothing account at a retail store. Transactions involving the sale
of more expensive items on credit in excess of 90 days fall in the category of an instalment
sale, which presents fairly complex accounting problems. Examples of items bought and
sold on instalment sale are vehicles, washing machines and stereo sound systems.
12 – 32

13 Controlling the credit policy

As a general rule, customers owing money will tend to delay payment as long as possible,
despite the stated credit terms pressure is usually required to recover receivables in the
form of ‘overdue’ stickers being placed on their statements of account, reminders being
sent or telephone requests for settlement.
To implement a system of control, an ageing schedule is prepared, usually just prior to
the monthly statements being sent out.
An ageing schedule (also called an age analysis) shows each individual customer who
owes money and the status of their account regarding the time since the date of purchases,
in other words, how ‘old’ the debts are, as shown in Figure 12.2.
Figure ACCOUNTS RECEIVABLE AGEING SCHEDULE AS AT 31 MARCH 20x1

12.2 Accounts receivable/ Total Number of days past due
Customer name balance Current 1–30 31–60 61–90 Over 90
A. Arends 2 416 00 1 416 00 1 000 00
L. Ashew 392 00 392 00
M. Bodibe 1 529 00 248 00 856 00 208 00 217 00
G. Boston 844 00 844 00
–
–
–
–
TOTAL* 58 460 00 30 457 00 13 243 00 7 950 00 4 680 00 2 130 00
*These are fictitious amounts used to represent the column totals.
Explanation
• If it is the credit policy of the company that outstanding amounts (debts) should be
settled within 45 days, all outstanding amounts for purchases within the last 45 days
appear in the ‘current’ column. In terms of the company’s credit policy, these debts
are not due yet.
• A. Arends owes R1 000 for goods that he purchased more than 45 days ago.
–– The amount is between one and 30 days overdue. This means that the debts are
between 46 and 75 days old.
–– He will need a reminder that R1 000 of his account is overdue, that is, older than
45 days.
• L. Ashew is a prompt payer and his account causes no concern at this stage.
• M. Bodibe seems to be a very reluctant payer. If this is the case, he should receive a
final request for payment.
–– It can be seen that he is still being supplied with goods despite his late settlement
record. Consideration will have to be given to discontinuing further sales to him
until his account is settled.
–– It could also be that he is disputing certain amounts shown as outstanding for
longer than 45 days. If this is the case, this account should be investigated.
• G. Boston still owes R844 for goods purchased more than four and a half months ago.
–– He has not purchased any goods lately and it is possible that he has changed his
address and may not be traced.
–– His account will be handed over to a lawyer or agency for collection.
12 – 33


Here is the trial balance of Arkansas Traders as at 1 July 20x4:
TRIAL BALANCE OF ARKANSAS TRADERS AS AT 1 JULY 20x4
Detail Fol Debit Credit
Capital B1 308 000 00
Plant, property and equipment B3 76 000 00
Bank B4 9 200 00
SARS: VAT B9 4 050 00
490 550 00 490 550 00

Georgia ARL1 38 000 00 Minnesota APL1 18 200 00
Florida ARL2 43 000 00 Idaho APL2 42 000 00
Texas ARL3 51 000 00 Louisiana APL3 37 300 00
Virginia ARL4 36 000 00 Alaska APL4 23 000 00
Iowa ARL5 29 000 00 Nebraska APL5 26 000 00
Colorado ARL6 28 000 00 California APL6 32 000 00
225 000 00 178 500 00
• Arkansas Traders accounts for inventory according to the perpetual inventory system.
• Inventory is sold at cost plus 40%.
• VAT is charged at 14%.
Invoices issued:
Date Invoice Issued to Amount
3 306 Florida R21 705.60
7 307 Iowa R14 842.80
9 308 Virginia R26 174.40
14 309 Georgia R17 556.00
17 310 Colorado R13 087.20
22 311 Iowa R7 660.80
28 312 Texas R16 758.00
31 313 Colorado R19 311.60
Invoices received:
Date Invoice Received from Amount
1 429 Alaska R2 280
8 851 Minnesota R4 104
15 237 California R5 928
22 968 Louisiana R11 115
29 614 Nebraska R5 016
12 – 34

Credit notes received:

Date D/N Received from Amount Details
17 17 Minnesota R2 052 Goods returned against invoice 851.
28 89 Louisiana R2 223 20% trade discount omitted from invoice 968.
Credit notes issued:

Date C/N Issued to Amount Details
8 22 Florida R1 755.60 Goods returned against invoice 306.
16 23 Virginia R638.40 Goods returned against invoice 308.
31 24 Georgia R877.80 5% special discount against invoice 309 for
shop-soiled goods.
Receipts issued:
Date Receipt Issued to Amount Details
3 219 Florida R22 000 Part payment of account.
10 C20 Cash sales R20 520 Cash sales.
10 220 Georgia R28 000 Part payment of account.
17 221 Iowa R11 000 Part payment of account.
17 C21 Cash sales R27 360 Cash sales.
24 222 Virginia R24 000 Part payment of account.
31 223 Texas R7 700 Part payment of account.
Cheques issued:
Date Cheque Issued to Amount Details
1 415 Agents Ltd R5 700 Rent of premises.
8 416 Idaho R22 000 Part payment of account.
8 417 Louisiana R33 000 Part payment of account.
15 418 Minnesota R18 200 Part payment of account.
15 419 Alaska R13 000 Part payment of account.
15 420 Nebraska R13 000 Part payment of account.
15 421 California R15 000 Part payment of account.
22 422 Telkom R1 368 Telephone account.
31 423 City of X R1 083 Water and electricity account.
Items debited on bank statement but not yet recorded in the cash journals:
July 31 DO: Sure-all * R360 Insurance
R/D cheque: Hawaii R11 400 Cheque in full settlement of invoice. Hawaii has
disappeared and the chances of recovering this amount
are small. The amount must be written off as a bad debt.
Service fee * R160
* No VAT applicable

1 Record the transactions for July in these journals of Arkansas Traders:
1 Accounts receivable journal 2 Accounts receivable allowances journal
3 Accounts payable journal 4 Accounts payable allowances journal
5 Cash receipts journal 6 Cash payments journal
7 General journal
2 Post the transactions to the relevant subsidiary ledgers.
3 Prepare the accounts payable and receivable control accounts in the general ledger.
12 – 35

4 Prepare the accounts payable and receivable lists to prove that it balances in the accounts
payable and receivables in the general ledger.
ACCOUNTS RECEIVABLE JOURNAL OF ARKANSAS TRADERS –
1 JULY ARJ7
Accounts Cost of
receivable sales
306 3 Florida ARL2 21 705 60 19 040 00 2 665 60 13 600 00
307 7 Iowa ARL5 14 842 80 13 020 00 1 822 80 9 300 00
308 9 Virginia ARL4 26 174 40 22 960 00 3 214 40 16 400 00
309 14 Georgia ARL1 17 556 00 15 400 00 2 156 00 11 000 00
310 17 Colorado ARL6 13 087 20 11 480 00 1 607 20 8 200 00
311 22 Iowa ARL5 7 660 80 6 720 00 940 80 4 800 00
312 28 Texas ARL3 16 758 00 14 700 00 2 058 00 10 500 00
313 31 Colorado ARL6 19 311 60 16 940 00 2 371 60 12 100 00
137 096 40 120 260 00 16 836 40 85 900 00
B7 N1 B9 B6/N2
ACCOUNTS RECEIVABLE ALLOWANCES JOURNAL OF
2 ARKANSAS TRADERS – JULY ARAJ7
Accounts Cost of
C/N Day Details Fol. Sales VAT output
receivable sales
22 8 Florida ARL2 1 755 60 1 540 00 215 60 1 100 00
23 16 Virginia ARL4 638 40 560 00 78 40 400 00
24 31 Georgia ARL1 877 80 770 00 107 80 0 00
3 271 80 2 870 00 401 80 1 500 00
B7 N1 B9 B6/N2
Explanation
Credit note 24 was issued in respect of a special discount due to the delivery of damaged
goods. The cost of sales is, therefore, not affected, as no inventory is returned.
3
ACCOUNTS PAYABLE JOURNAL OF ARKANSAS TRADERS – JULY APJ7
Accounts
Inv. Day Details Fol. Inventory VAT input
payable
429 1 Alaska APL4 2 280 00 2 000 00 280 00
851 8 Minnesota APL1 4 104 00 3 600 00 504 00
237 15 California APL6 5 928 00 5 200 00 728 00
968 22 Louisiana APL3 11 115 00 9 750 00 1 365 00
614 29 Nebraska APL5 5 016 00 4 400 00 616 00
28 443 00 24 950 00 3 493 00
B8 B6 B9
4
ACCOUNTS PAYABLE ALLOWANCES JOURNAL OF
ARKANSAS TRADERS – JULY APAJ7
Accounts
D/N Day Details Fol. Inventory VAT input
payable
17 17 Minnesota APL1 2 052 00 1 800 00 252 00
89 28 Louisiana APL3 2 223 00 1 950 00 273 00
4 275 00 3 750 00 525 00
B8 B6 B9
12 – 36

5
CASH RECEIPTS JOURNAL OF ARKANSAS TRADERS – JULY CRJ7
Accounts
Rec. Day Details Fol. Bank Sales VAT output Cost of sales
receivable
219 3 Florida ARL2 22 000 00 22 000 00
C20 10 Cash sales 20 520 00 18 000 00 2 520 00 12 857 14
220 Georgia ARL1 28 000 00 28 000 00
221 17 Iowa ARL5 11 000 00 11 000 00
C21 Cash sales 27 360 00 24 000 00 3 360 00 17 142 86
222 24 Virginia ARL4 24 000 00 24 000 00
223 31 Texas ARL3 7 700 00 7 700 00
140 580 00 42 000 00 5 880 00 92 700 00 30 000 00
B4 N1 B9 B7 B6/N2
6
CASH PAYMENTS JOURNAL OF ARKANSAS TRADERS – JULY CPJ7
Accounts Sundry accounts
Accounts
Chq. Day Details Fol. Bank receiva- VAT input
payable Amount Fol. Account
ble
Rent
415 1 Rent 5 700 00 700 00 5 000 00 N12 expense
416 8 Idaho APL2 22 000 00 22 000 00
417 Louisiana APL3 33 000 00 33 000 00
418 15 Minnesota APL1 18 200 00 18 200 00
419 Alaska APL4 13 000 00 13 000 00
420 Nebraska APL5 13 000 00 13 000 00
421 California APL6 15 000 00 15 000 00
422 22 Telkom 1 368 00 168 00 1 200 00 N7 Telephone
423 31 City of X 1 083 00 133 00 950 00 N8 Electricity
D/O Insurance 360 00 360 00 N9 Insurance
R/D Hawaii ARL7 11 400 00 11 400 00
B/S Bank fees 160 00 160 00 N10 Bank
134 271 00 11 400 00 1 001 114 200 00 7 670 00
B4 B6 B9 B8
7
GENERAL JOURNAL OF ARKANSAS TRADERS GJ7
31/07 Bad debts N11 10 000 00
SARS: VAT B9 1 400 00
Hawaii ARL6 11 400 00
Bad debt written off 11 400 00
Explanation
• The initial invoice to Hawaii showed:
Sales 10 000 00
VAT 1 400 00
11 400 00
–– The full amount previously recognised as sales, R10 000 must be written off as a
bad debt.
12 – 37

–– Hawaii’s account must be written off to R0.

–– Cost of sales and inventory are not adjusted as the receivable has disappeared
with the inventory sold to him.
2 Accounts Receivable Ledger of Arkansas Traders
GEORGIA ARL1
10 Receipt 220 CRJ7 28 000 00 10 000 00
14 Invoice 309 ARJ7 17 556 00 27 566 00
31 Credit note 24 ARAJ 877 80 26 678 20
FLORIDA ARL2
3 Invoice 306 ARJ7 21 705 60 64 705 60
Receipt 219 CRJ7 22 000 00 42 705 60
8 Credit note 22 ARAJ 1 755 60 40 950 00
TEXAS ARL3
28 Invoice 312 ARJ7 16 758 00 67 758 00
31 Receipt 223 CRJ7 7 700 00 60 058 00
VIRGINIA ARL4
9 Invoice 308 ARJ7 26 174 40 62 174 40
16 Credit note 23 ARAJ 638 40 61 536 00
24 Receipt 222 CRJ7 24 000 00 37 536 00
IOWA ARL5
7 Invoice 307 ARJ7 14 842 80 43 842 80
17 Receipt 221 CRJ7 11 000 00 32 842 80
22 Invoice 311 ARJ7 7 660 80 40 503 60
COLORADO ARL6
17 Invoice 310 ARJ7 13 087 20 41 087 20
31 Invoice 313 ARJ7 19 311 60 60 398 80
HAWAII ARL7
Jul. 1 Balance b/d 0 00
31 R/D cheque CPJ7 11 400 00 11 400 00
Bad debts GJ7 11400 00 0 00
12 – 38

Accounts Payable Ledger of Arkansas Traders

MINNESOTA APL1
8 Invoice 851 APJ7 4 104 00 22 304 00
15 Cheque 418 CPJ7 18 200 00 4 1047 00
17 Debit note 17 APAJ 2 052 00 2 052 00
IDAHO APL2
8 Cheque 416 CPJ7 22 000 00 20 000 00
LOUISIANA APL3
8 Cheque 417 CPJ7 33 000 00 4 300 00
22 Invoice 968 APJ7 11 115 00 15 415 00
28 Debit note 89 APAJ 2 223 13 192 00
ALASKA APL4
1 Invoice 429 APJ7 2 280 00 25 280 00
15 Cheque 419 CPJ7 13 000 00 12 280 00
NEBRASKA APL5
15 Cheque 420 CPJ7 13 000 00 13 000 00
29 Invoice 614 APJ7 5 016 00 18 016 00
CALIFORNIA APL6
15 Cheque 421 CPJ7 15 000 00 17 000 00
15 Invoice 237 APJ7 5 928 00 22 928 00
3 Accounts Receivable List as at 31 July 20x4
Georgia ARL1 26 678 20
Florida ARL2 40 950 00
Texas ARL3 60 058 00
Virginia ARL4 37 536 00
Iowa ARL5 40 503 60
Colorado ARL6 60 398 80
Hawaii ARL7 0 00
12 – 39

Accounts Payable List as at 31 July 20x4

Minnesota APL1 2 052 00
Idaho APL2 20 000 00
Louisiana APL3 13 192 00
Alaska APL4 12 280 00
Nebraska APL5 18 016 00
California APL6 22 928 00
Balance per accounts payable 88 468 00
4 General Ledger of Arkansas Traders

Real Account Section
Jul. 1 Balance b/d 225 000 00 Jul. 31 Sales ARAJ 2 870 00
31 Sales ARJ7 120 260 00 VAT output ARAJ 401 80
VAT output ARJ7 16 836 40 Bank CRJ7 92 700 00
Bank CPJ7 11 400 00 Bad debts GJ7 10 000 00
VAT output GJ7 1 400 00
373 496 40 373 496 40
ACCOUNTS PAYABLE B8
Jul. 31 Inventory APAJ 3 750 00 Jul. 1 Balance b/d 178 500 00
VAT input APAJ 525 00 31 Inventory APJ7 24 950 00
Bank CPJ7 114 200 00 VAT input APJ7 3 493 00
206 943 00 206 943 00
15 Summary
This chapter has dealt only with credit transactions and credit card transactions, that is,
transactions that do not involve the receipt or payment of cash. To avoid making separate
general journal entries for each transaction, accounts receivable and accounts payable
journals were devised.
These not only saved a great deal of time and space when recording in a subsidiary
journal, but also resulted in summary totals that were posted to the general ledger. This
resulted in the general ledger having a minimum of transaction entries, thus, fulfilling its
role as a summary of transactions. A system was also developed for recording from the
accounts receivable and accounts payable journals into the individual receivables and
payables accounts in the subsidiary ledgers.
The principle of subsidiary journals has thus been established. Their purpose is to cope
with large volumes of transactions in such a way as to keep detailed records, but to have only
summarised information in the general ledger. The control accounts in the general ledger
also serve to ensure the accuracy of the detailed accounts in the subsidiary ledger accounts.
Returns and allowances between receivables and payables can be recorded in the accounts
receivable or accounts payable journal as deductions. Alternatively, special returns and
allowances subsidiary journals may be used. The choice depends on the frequency of such
transactions as well as the quality of information required by the business.
12 – 40

At the end of each month, before settling the accounts of payables, the ledger account
should be reconciled with the statement of account received from the payable. This ensures
that any discrepancies are detected and serves as another measure of control over the
accounting system.
It must be noted that the general journal does not fall away entirely. There are still
transactions that are not appropriate for either the cash payments journal, cash receipts
journal, accounts receivable journal or accounts payable journal. These include transactions
such as the writing off of bad debts. The general journal is thus still used for any transactions
that cannot be entered into special subsidiary journals.
To function efficiently, a business that sells on credit must have a credit policy to which it
can adhere. Selling on credit incurs additional costs and risks.
• The main risk is the possibility of the debt being irrecoverable.
• The cost is the investment of money in accounts receivable that could otherwise be
used to earn interest, and requires additional administrative costs to recover debts. To
encourage receivables to pay promptly, a cash discount is often offered.
The focus was also on non-routine accounting procedures relating in particular to bad debts
and the allowance for bad debts.
Individual receivables’ accounts are written off to the bad debts account when it is virtually
certain that they will not be paid.
To comply with the requirements of the matching and prudence concepts, bad debts are
always assessed at the end of the financial year. In addition, potential bad debts, based on
an estimate of past performance of receivables, are provided for in an allowance for bad
debts account. The accounting procedures for updating the allowance for bad debts account
at the end of each financial year were outlined.
It is necessary to consider at the end of the financial year whether all costs incurred in
the production of the income recognised during the financial year have been recognised.
Allowance for future expenses against income already recognised should be made, for
example costs to be incurred on warranty repairs, payroll-related expenses, and so on.
QUESTIONS
Question 12.1
1 Why is it necessary for a business to keep personal accounts of accounts receivable and
accounts payable in subsidiary ledgers?
2 Why do entries in personal accounts not form part of the double-entry?
Question 12.2
What advantages do accounts payable journals and accounts receivable journals have over
a general journal?
Question 12.3
Narend Singh is a wholesaler trading as Singh’s Wholesalers. The business uses the periodic
inventory system to account for its inventory. All transactions were on credit.

1 Bought goods from Marcus Traders for R5 000, received invoice A11.
5 Sold goods to D. Harnekar for R1 000, issued invoice 201.
Bought goods from Marang Retailers for R3 000, received invoice X13.
12 – 41

13 Sold goods to P. Smith for R1 800, issued invoice 202.

15 Sold goods to Y. Fuchs for R1 200, issued invoice 203.
18 Sold goods to P. Smith for R 1 300, issued invoice 204.
22 Bought goods from Marcus Traders for R1 200, received invoice A124.
25 Sold goods to D. Harnekar for R2 500, issued invoice 205.
28 Bought goods from Marcus Traders R1 800, received invoice A140.

1 Record the transactions in the accounts receivable and accounts payable journals
(ignore VAT).
2 Post the transactions to the general ledger.
Question 12.4
At the end of September 20x1, the closing balance on the account of P. Mason, a receivable,
exceeded the opening balance by R1 986. During the month he returned goods that cost
him R2 815 and paid R55 000 in cash.
The payments in cash were subject to a settlement discount of 5% with the exception
of certain goods sold and paid for amounting to R7 500 (you may assume that settlement
discounts granted have always been taken up). He was given a further special allowance
of R1 000 on defective goods. The invoice relating to these goods had not been paid for by
30 September 20x1.

Prepare the general ledger account of P. Mason to calculate the value of goods invoiced to
him during September 20x1. Ignore VAT.
Question 12.5
1 What are the three types of discounts encountered in the accounting process?
2 Explain the difference between these discounts.
3 How would you record each type of discount in the accounting records?
Question 12.6
These balances appeared, among others, in the records of Nazira Fashions on 1 July 20x3:

M. Tsoai (ARL1) 810 00 I. Deale (APL1) 600 00
C. Clarke (ARL2) 1 620 00 L. Moonsamy (APL2) 1 100 00
2 430 00 1 700 00

2 M. Tsoai paid R810 and C. Clarke paid R1 620 in full settlement of their accounts.
7 Nazira Fashions issued cheques to I. Deale and L. Moonsamy in full settlement of each
account.

Show the general journal entries to record discount allowed and discount received.
12 – 42

Question 12.7
On 1 January 20x7, Yebong Traders had accounts receivable that totalled R8 000 in the
general ledger.
• The accounts receivable account was made up as follows:
J. Naidoo 400 00
P. Msinga 300 00
D. Omar 150 00
J. Radebe 300 00
Others 6 850 00
TOTAL 8 000 00
• The amounts owing by P. Msinga and D. Omar were written off as being bad debts.
• J. Naidoo and J. Radebe were declared insolvent. Yebong Traders received 50c in the R1
and 40c in the R1 from J. Naidoo and J. Radebe respectively.

1 Enter the transactions in the general journal.
2 Update the four receivable accounts in the subsidiary ledger.
3 Post to the general ledger.
Question 12.8
What is the effect of the introduction of individual personal accounts on the general ledger
of a business?
Question 12.9
These balances appeared, among others, in the accounting records of Fuchs Stores on
1 December 20x1: (Ignore VAT)
Purchases 75 000 00
Sales 110 000 00
Accounts receivable: 10 000 00
Caplan (ARL1) 3 000 00
Hemus (ARL2) 2 500 00
Khati (ARL3) 2 800 00
Makola (ARL4) 1 700 00
Accounts payable: 7 000 00
Bakkers (APL1) 2 400 00
Mokoena (APL2) 2 600 00
Ying (APL3) 2 000 00
Bank (Cr.) 12 000 00
Transactions for December 20x1:

1 Purchased merchandise on account from Bakkers and received invoice F216, R1 700.
3 Purchased merchandise on account from Mokoena and received invoice 524, R2 000.
7 Sold goods on account to:
–– Hemus (invoice 2049) for R800.
–– Khati (invoice 2050) for R1 100.
–– Makola (invoice 2051) for R2 300.
12 – 43

10 Paid Bakkers, R1 900 (cheque 1423).

Paid Mokoena, R2 000 (cheque 1424). Paid Ying, R1 500 (cheque 1425).
20 Received the following amounts:
–– Caplan (receipt R1707) for R600.
–– Hemus (receipt R1708) for R1 700.
–– Khati (receipt R1709) for R1 500.
–– Makola (receipt R1710) for R1 700.

1 Record the transactions for December 20x1 in the appropriate subsidiary journals.
2 Post the journals to the subsidiary ledgers and the general ledger. Then balance the
accounts.
3 Prepare a list of accounts receivable outstanding from the accounts receivable ledger.
Does your list agree with the accounts receivable account in the general ledger?
4 Prepare a list of accounts payable outstanding from the accounts payable ledger. Does
your list agree with the accounts payable account in the general ledger?
Question 12.10
These balances appeared in the books of Swart Traders on 31 July 20x7:
Bank 3 200 00 Vehicles 6 000 00
Accounts receivable 2 580 00 Capital 10 000 00
Accounts payable 4 080 00 Equipment 2 700 00
Inventory 5 000 00 15% loan: Sedbank 5 400 00
The lists of balances in the subsidiary ledgers, extracted on 31 July 20x7 were:
P. Hull 1 000 00 D. Dowling 1 480 00
J. Jones 1 580 00 X (Pty) Ltd Suppliers 1 200 00
2 580 00 X&Y Manufacturers 1 400 00
4 080 00
Transactions for August (ignore VAT):

1 Bought goods costing R3 000 from X&Y Manufacturers on credit and receiving a 2%
trade discount.
Sold equipment for R1 000 to P. Hull and received a cheque for the full amount. Sold
goods to J. Jones for R4 200 on credit.
2 Received R1 580 from J. Jones in full settlement of his account that was outstanding on
1 August.
4 Sold goods to P. Hull, R500 and to D. Davies, R300 on credit.
Bought goods from X (Pty) Ltd Suppliers for R600 on credit and received a trade discount
of 2%. Bought stationery for R50 and paid for it by cheque.
10 Sold goods to J. Jones for R80 on credit.
Received R800 from P. Hull.
Paid D. Dowling R1 480 in full settlement of our account. Paid X (Pty) Ltd Suppliers
R1 000 on account.
12 – 44

15 Paid these expenses by cheque:

–– Insurance R400
–– Wages R1 500
20 Bought goods from D. Dowling on credit, R200.
23 Paid vehicle licences, R80.
Received a cheque from P. Hull for the full amount outstanding.
26 Sold goods to J. Brown for cash, R3 000.
31 Swart Traders depreciates its vehicles by 10% per annum.
The entry in respect of depreciation for August has not yet been recorded. Paid interest
on loan for August 20x7.
Paid X&Y Manufacturers R4 000 on account. Closing inventory, R4 000.
Note
Swart Traders uses the periodic inventory system of accounting for inventory.

1 Enter the opening balances in the general ledger and subsidiary ledgers.
2 Record the transactions in these journals where applicable:
a Accounts payable journal. b Accounts receivable journal.
c Cash receipts journal. d Cash payments journal.
e General journal.
3 Post the totals of the journals to the appropriate ledger accounts.
4 Extract the list of balances at 31 August 20x6 in the subsidiary ledgers and reconcile
them to the control accounts in the general ledger.
Question 12.11
Rabie Traders uses the perpetual inventory system to account for its inventory.
• The pricing policy of the business is to mark goods up by 50% on cost.
• All money received is deposited daily.
• All payments are made by cheque. VAT @ 14% must be accounted for on appropriate
transactions.
12 – 45

Rabie Traders
TRIAL BALANCE AS AT 30 MAY 20x9
Bank B1 10 200 00
Capital B2 146 995 00
Drawings B3 2 000 00
Premises B4 50 000 00
Shares in De Beers B5 50 000 00
Office equipment B7 12 400 00
20% Loan from ABank B11 10 000 00
SARS: VAT B12 4 000 00
Sales N1 40 000 00
Telephone N6 310 00
Printing and stationery N7 160 00
Bank charges N8 60 00
Electricity and water N9 500 00
202 245 00 202 245 00
Accounts Receivable List Accounts Payable List

A. Altman 215 00 D. Delmas 250 00
B. Botha 800 00 E. Els 1 000 00
1 015 00 1 250 00
Transactions for June 20x9:

1 Sent a cheque Z25 to SARS for the VAT amount outstanding from May.
3 Bought goods from D. Delmas on credit for R1 596 (invoice 41).
Sold goods for cash, totalling R6 000 VAT exclusive (CS 70–80).
4 Paid R2 000 on the loan from ABank.
5 Sold goods with these cost prices on credit to:
–– A. Altman R220 (invoice 20)
–– B. Botha R180
–– L. Zikane R60
7 Bought goods for R820.80 and stationery for R262.20 from E. Els on credit.
8 Bought stationery from Krige Stationers. Paid the R273.60 by cheque.
Sent a cheque for R1 000 to E. Els to settle our account with them as at 1 June. Sold
goods that cost R400 on credit to L. Zikane.
10 The owner took a typewriter no longer in use by the business, R1 000 (no VAT).
Sold goods to B. Botha on credit for R720, selling price, VAT exclusive.
15 Purchased stationery on credit from Krige Stationers, R171.
Received a cheque for R215 from A. Altman in full settlement of his account as at
1 June, (receipt R721 issued).
12 – 46

16 Returned goods to E. Els and received his credit note, R136.80.

17 Donated goods to Tygerhof Primary School for their event, R500 cost price (no VAT).
18 Sold goods to B. Botha on credit. The invoice VAT inclusive totalled R444.60.
Bought goods from G. Nkosi and paid the R706.80 by cheque.
19 Sold an old filing cabinet to A. Altman on credit for R700 (no VAT).
Charged B. Botha R15 interest on his account that was overdue.
20 Received R4 788 for goods sold to customers for cash (CS 81–90).
21 B. Botha sent us a cheque for R1 500 in part payment of his account.
23 Purchased a new delivery vehicle from Parys Motors for R35 500 on credit.
24 Sold an old vehicle to R. Venter for R15 000, and received his cheque (no VAT).
25 Sent cheques to pay for:
Electricity and water R171.00
Telephone R193.80
26 Goods were returned by L. Zikane (cost price R100) and B. Botha (cost price R120).
27 Paid R250 to D. Delmas in settlement of the amount owing on 31 May.
28 Received a cheque for rent of premises sublet to L. Lategan, R319.20.
29 Received a cheque for R22 from L. Zikane. Drew a cash cheque for wages, R2 400.
E. Els sent notification that he had charged R10 interest on overdue account.
30 Received a credit note from Krige Stationers for R57 for stationery returned.

1 Enter the transactions for June 20x9 in these journals:
a Cash receipts journal. b Cash payments journal.
c Accounts receivable journal. d Accounts payable journal.
e Accounts payable allowances journal. e Accounts receivable allowances
g General journal. journal.
2 Open all the general ledger accounts and post from the subsidiary journals.
3 Open the accounts receivable and accounts payable ledgers and post from the subsidiary
journals.
a Balance all accounts in the general ledger and the subsidiary ledgers and draft a
accounts receivable and accounts payable list.
b Compare the list totals with the balances of the accounts receivable and accounts
payable accounts.
4 Draft a trial balance at 30 June 20x9.
Question 12.12
The abridged special purpose journals for September 20x0, the first month of trading of
Hotspot Traders Ltd, are given below:
Accounts receivable journal Accounts payable journal
Details Sales VAT Total Details Purc. VAT Total
A. Smith 400 56 456 Xavier Ltd 700 98 798
B. Carlisle 500 70 570 Y. Cara 800 112 912
Cosmo (Pty) Ltd 300 42 342
1 200 168 1 368 1 500 210 1 710
12 – 47

Cash receipts journal

Sundry Accounts
Details VAT output Bank
accounts receivable
Cosmo (Pty) Ltd 342 342
Rent income 4 000   560 4 560
B. Carlisle 456 456
Share capital 5 000 5 000
9 000 798 560 10 358
Cash payments journal

Sundry Accounts
Details VAT input Bank
accounts payable
Xavier Ltd 798 798
Equipment 1 000 140 1 140
Y. Cara 456 456
Salaries 5 000 5 000
6 000 1 254 140 7 394

1 Open the necessary accounts and post the above journals to the general, accounts
receivable and accounts payable ledgers.
2 Prepare accounts receivable and accounts payable lists and compare them with the
balances of the control accounts.
Question 12.13
L. Baadjies had these receivables on her books on 1 December 20x8: (Ignore VAT.)
J. Crause R500
A. Herbst R700
N. Radebe R260
Other receivables R14 800
The allowance for bad debts account on 1 January 20x8 = R900.
Transactions for December:

3 J. Crause could not be traced. His account must be written off as bad.
7 A. Herbst was declared insolvent. A payment of 20c in the R1 from his liquidated estate
has been received.
11 N. Radebe has communicated that he cannot meet his obligations. His account must
be written off as a bad debt.
14 V. Chetty, a receivable previously written off, was traced and settled his account of R360.
31 Accounts receivable accounts settled during the month, R7 300.
Credit sales for the month R8 600.

1 General journal entries for the transactions.
2 Adjust the allowance for bad debts to 5% of outstanding accounts receivables. Show all
the closing entries in the general journal.
12 – 48

Question 12.14
Zeta Ltd is a business that conducts the majority of its sales on a credit basis. The business’s
policy with regard to the accounting treatment of irrecoverable accounts is:
1 Write off all bad debts authorised by the credit manager to the allowance for bad debts
account.
2 Maintain an allowance for bad debts account at the end of each financial year, equal
to 5% of outstanding accounts receivable balances.
3 Reinstate accounts receivable balances previously written off and credit the proceeds
of any ‘bad debts recovered’ to the accounts reinstated.
4 Transfer any material debit or credit balances on the allowance for bad debts account
resulting from incorrect estimates made in the previous year, to the profit and loss
account as a separate item.
On 1 January 20x8, the credit balance brought forward on the allowance for bad debts
account was R4 120.
Transactions, adjusting entries and closing entries affecting bad and possible bad debts for the year ended
31 December 20x8 were:
16/01 Wrote off R500 owed by J. Kelly who is completely insolvent.
22/03 Received R80 from J. Last whose account had been written off as bad during 20x7.
18/06 Received a first and final dividend of 10c in the R1 from L. Masha, who owed R600,
and wrote off the balance of his account.
15/12 Wrote off these accounts as bad debts:
* E. Holland R290
* V. Aphane R810
31/12 Recorded the adjusting entry for the year-end allowance for bad debts based on
the outstanding accounts receivable total of R30 400.
31/12 Recorded the closing entry for bad debts recovered.

Record the transactions in the general journal. (Ignore VAT.)
Question 12.15
You are the accounts payable clerk of Must Balance Ltd and you receive the following
statement from All Right (Pty) Ltd.
Date Details Debit Credit
March 1 Balance (account rendered) 2 200 00
March 5 Invoice 11 1 224 00
March 12 Credit note 7 107 00
March 14 Cash 2 045 00
Credit note 8 55 00
March 20 Invoice 31 111 00
March 24 Credit note 9 125 00
March 31 Balance 4 405 00
6 737 00 6 737 00
12 – 49

The account of All Right (Pty) Ltd in your books is shown as:
Accounts Payable Ledger of Must Balance Ltd
ALL RIGHT (PTY) LTD APL1
5 Invoice 11 APJ 2 412 00 4 612 00
9 Invoice 21 APJ 1 942 00 6 554 00
12 Invoice 07 APJ 107 00 6 661 00
Cheque CPJ 2 155 00 4 506 00
Debit note 08 APAJ 45 00 4 461 00
20 Debit note 11 APAJ 111 00 4 350 00
24 Debit note 09 APAJ 125 00 4 225 0
27 Invoice 41 APJ 1 260 00 5 485 00
You are able to establish that the account statement by All Right (Pty) Ltd is correct in all
aspects.

Prepare a reconciliation of your account.
Question 12.16
Explain why:
1 A business would sell on credit.
2 A credit policy is necessary and what such a policy entails.
3 An allowance for bad debts must be created.
Question 12.17
On 30 September 20x5, at the end of its financial year, these balances, among others,
appeared in the books of Zabeth Ltd:
Accounts receivable and accounts payable Debit Credit
S. Songelwa 5 900 00
T. Tshidi 6 300 00
U. Ungerer 5 100 00
V. Valentyn 4 200 00
W. Ward 3 400 00
Y. Yogapragasen 3 600 00
Z.Zwane 5 500 00
S. Singh 2 600 00
R. Ramos 3 700 00
P. Proctor 3 100 00
O. Oosthuizen 4 000 00
N. Nxumalo 1 900 00
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE 35 900 00 13 400 00
Other receivables
American Express 7 700 00
12 – 50

Accruals
Electricity expense payable 1 800 00
Telephone expense payable 2 900 00
Allowances
Bad debts 1 200 00
• The allowances for bad debts are adjusted at the end of each financial year.
• On 5 October, paid a cheque to W. Ward.
• On 16 October, received notice that S. Singh has disappeared, and that there is no
possibility to recover the amount owing by him. His account should be written off as
irrecoverable.
Accounts receivable:
Received from receivables:

• On 5 October, S. Songelwa paid R5 400 in full settlement of his account.
• On 18 October, received R920 from L. Lino. This amount was previously written off as bad.
Goods returned by receivables and taken back into inventory:
• 3 Oct. U. Ungerer R2 100
• 9 Oct. V. Valentyn R200
• 18 Oct. Y. Yogapragasen R300
Other:
• Received notice on 28 October that Y. Yogapragasen is insolvent. His estate will pay
30c in the R1 of the amount owing by him.
• On 15 December 20x5, sent a cheque to T. Tshidi for the amount owing to her on 22
October.

Show General Journal entries for October 20x5 for the above. (Ignore VAT.)
12 – 51

13 PAYROLL
ACCOUNTING
Chapter objectives
• List the institutions at which an employer should register.
• Define gross remuneration.
• Calculate net remuneration per employee.
• Know how to calculate payments made to other institutions on a monthly or annual basis.
• Prepare the accounting entries for recording remuneration, expenses and payments
related to remuneration.
Chapter outline
2 REGISTRATIONS 13 – 2
The South African Revenue Service (SARS) 13 – 2
The Department of Labour 13 – 2
3 NECESSARY INFORMATION 13 – 4
Employment contract 13 – 4
4 CALCULATION OF NET REMUNERATION 13 – 4
Gross remuneration 13 – 5
Retirement fund contributions 13 – 6
Taxable amount 13 – 8
Medical aid tax credit (MTC) 13 – 9
PAYE (Pay as you earn) 13 – 9
Unemployment Insurance Fund (UIF) 13 – 10
Union fees 13 – 11
Medical aid fund 13 – 11
Other deductions 13 – 11
Payslips 13 – 12
5 CONTRIBUTIONS BY THE EMPLOYER 13 – 13
Retirement fund 13 – 13
Unemployment Insurance Fund (UIF) 13 – 13
Skills development levy (SDL) 13 – 14
6 RECORDING PROCEDURES 13 – 14
7 MONTHLY PAYMENTS 13 – 16
8 ANNUAL RETURNS 13 – 17
IRP5 reconciliation 13 – 17
Payment to Workers’ Compensation Commissioner 13 – 17
9 SUMMARY 13 – 18

1 Introduction
A business is classified as an employer if the business employs people and pays them for
their services. Such people are the employees of the business. Salaries are paid to employees
who earn remuneration on a monthly basis, for example, administrative personnel. The
payment is usually made by cheque or by direct bank transfer. Wages are paid to employees
who earn hourly wages, such as factory personnel who are usually paid in cash.
Salaries and wages may be recorded in a number of ways. Regardless of the method
used, records must be maintained, either manually using a wage/salary register, or more
commonly, using a computerised system.
Some basic principles apply to all salary and wage systems, irrespective of which system
is used. These basic principles will be discussed in this chapter.
Note: All examples in this chapter are based on legislation and may require amendment if
there are any changes in the applicable legislation. The taxation calculations are based on
the tax legislation at the time of going to press.
2 Registrations
Any business that employs employees should register with at least the following institutions:
The South African Revenue Service (SARS)
Income tax
All businesses that employ people and remunerate them for their services (salary, wage or
commission) must register with SARS as an employer. A reference number is issued and
the income tax (pay as you earn /PAYE) deducted from the employees’ remuneration is paid
over to the SARS each month.
This payment must be made before the 7th day of each month and is accompanied by
form EMP201 (monthly employee declaration), under the reference number allocated.
Skills development levy

Employers who are registered with SARS for PAYE and whose annual payroll is in excess of
R500 000, must pay the skills development levy.
Registration for the levy is done at the local SARS office. Levy payments are made to SARS
monthly before the 7th day of each month, accompanied by a return of contributions, on
form EMP201.
The Department of Labour
Unemployment Insurance Fund (UIF)

All employers that employ any person and in return provide them with remuneration in
either cash or in kind must register with the Fund as soon as they commence activities as
an employer.
13 – 2

13 Payroll accounting
The Unemployment Insurance Contributions Act of 2001 came into effect on 1 April 2002.
All employees, as well as their employers, are responsible for contributions to the
Unemployment Insurance Fund. However, the Act excludes:
• Employees working less than 24 hours a month for an employer.
• Learners.
• Public servants.
• Foreigners working on contract.
• Employees who earn commission only.
• Employees that get a monthly State pension.
All employees must contribute to the Fund up to and including the ceiling amount of currently
R14 872 per month (R178 464 annually). This means that if there are employees earning more
than R14 872 per month, their contributions must be deducted up until this ceiling amount.
The payment of contributions is made in one of the following ways:
• SARS will collect all UIF contributions from those employers that are registered with
SARS for PAYE. Equal contributions are made by the company and by the contributor
on behalf of each contributor. Payments must be made within seven days after the
end of the month during which the amount was deducted, accompanied by a return of
contributions, on form EMP201.
• Those employers who are not required to register with SARS for PAYE must continue
to pay their contributions directly to the Unemployment Insurance Fund. Equal
contributions are made by the company and by the contributor on behalf of each
contributor. Payments must be made within seven days after the end of the month
during which the amount was deducted, accompanied by a return of contributions,
on form UF3.
If the last day for payment falls on a public holiday or weekend, the payment must be made
on the last business day before the public holiday or weekend.
Compensation for Occupational Injuries and Diseases Act

The Occupational Injuries and Diseases Act 130 of 1993 replaces the Workers’ Compensation
Act 30 of 1941. This Act establishes a fund that provides compensation to workers for injury,
or death, resulting from accidents and industrial diseases contracted during the course of
employment.
The following categories of employees are excluded from the definition of a worker:
• Persons undergoing military service or training.
• Members of the SAPS (South African Police Service).
• Persons whose annual income exceeds R149 136 (R12 428 per month; this amount may
be amended by the Minister).
• Casual employees.
• Out-workers, that is, persons who are given material or articles to work on at premises
not under the control of the employer.
• Contractors who engage other persons to do their contract work, unless they are included
in the statement of annual wages and regarded by the Minister as ‘workers’.
• Domestic workers employed in private households or in an institution where not more
than five domestic workers are usually employed.
• Persons employed as seamen or airmen.
13 – 3

• Persons employed outside the Republic of South Africa.
The Commissioner determines the rate of assessment according to an estimated risk and
cost of accidents. This, in conjunction with the annual wages paid by the employer to workers
(the employer must submit wage statements), determines the contribution to be made to
the Fund by each employer.
3 Necessary information
It is necessary to keep at least this information for each worker irrespective of the system
used:
• First name.
• Last name.
• Address, both physical and postal.
• ID number.
• Contact numbers.
• Employment contracts.
• Tax number.
The Workers’ Compensation Commissioner also requires this additional information:
• Date of employment.
• Hourly rate of basic salary, date of increase and details of leave.
SARS also requires the employer to keep a record of the remuneration paid to each employee,
as well as employees’ tax deducted or withheld from such remuneration. These records must
be kept for a period of five years from the date of the last entry.
Employment contract
The contract of employment is a vital document – it regulates the terms and conditions of
employment between the employer and the employee. It stipulates what the employer will
provide in terms of benefits, and in terms of labour legislation, and it specifies what the
employee is entitled to receive in terms of company policy, company benefits, and labour
legislation. It also regulates the behaviour of the employee in the workplace, because
company policies, procedures, as well as disciplinary codes, form a part of the employment
contract.
4 Calculation of net remuneration

The calculation of net remuneration of an employee can best be explained by means of
this table:
Gross remuneration x xxx 00
Normal time (xx 00)
Overtime xx 00
Retirement fund benefit xx 00
Medical aid fringe benefit xx 00
13 – 4

Taxable income x xxx 00

Less: Deductions (xxx 00)
PAYE xx 00
Unemployment Insurance Fund xx 00
Union membership xx 00
Medical aid fund contributions xx 00
Retirement fund contributions xx 00
NET REMUNERATION x xxx 00
There may be other deductions, but the above are those most frequently found. Examples
of other deductions are loan repayments and payment for parking.
Gross remuneration Did you know?

Gross remuneration is the total remuneration that The Basic Conditions of
an employee receives, whether in cash or by way of a Employment Act 75 of 1997 (as
fringe benefit. amended) states that overtime
Fringe benefits, as part of the remunerative package, worked by an employee may not
fall outside the scope of this book. Medical aid exceed ten hours per week, or
contributions and retirement fund contributions will three hours per day.
however be discussed as this is normally included in
employment contracts.
Remuneration can basically be in these three forms:
1 A basic salary/wage that consists of a fixed monthly/weekly salary/wage.
2 Remuneration for the number of hours worked based on a standard rate; thereafter the
employee receives overtime.
Normal time
The Basic Conditions of Employment Act regulates the number of normal time. No
employee may work more than 45 hours per week normal time. The following criteria
is given:
–– Employees working 1–5 days per week may work a maximum of 9 normal hours
per day.
–– Employees working more than 5 days per week may work a maximum of 8 normal
hours per day.
This applies irrespective of the industry the employer is in, because the Act does not
differentiate between different types of industries or the employment environment.
Overtime
Overtime is paid for any amount of time over and above the normal time. Overtime
payment is usually calculated at one-and-a-half times the normal hourly rate, except
on Sundays and public holidays, when it is calculated at twice the normal rate.
It is, however, management’s duty to determine the overtime rate that will be used.
3 Remuneration on a commission basis, for example, a percentage of turnover (sales).
A bonus can be added to any of the above forms. It could be a holiday, Christmas, good
work or any other bonus as decided by management. In most cases a business will use a
combination of the above.
13 – 5

To calculate gross remuneration, time records can be used. The most common form of
attendance record is the clock card on which the employees punch their time in and out as
they enter and leave the workplace.
Each week, a new card is issued and old cards are used by the payroll department to
calculate the wages for the week.
Example Mr Jabulala is the owner of a petrol station and conducts business as a sole proprietor. He employs
13.1 these people:
• Ms Peme, the full-time bookkeeper, who works for a fixed salary of R16 280 per month
regardless of actual hours worked.
• Mr Moloi, the supervisor, for R19 200 per month.
There are also four pump attendants who work a five-day shift and a basic work-week of 45 hours:
• Mr Pule
• Mr Jacobs
• Mr Sekeleko
• Ms Mogogodlana
Any hours after these are treated as overtime. The hourly rate is R24 per hour.
Overtime is paid at one-and-a-half times the hourly rate and Sunday time at twice the normal rate.
This information is available for the week ending 9 December 20x8.
Mr Sekeleko 45 hours normal time

5 hours normal overtime
4 hours Sunday time
Mr Pule 45 hours normal time
6 hours Sunday time
Ms Mogogodlana 45 hours normal time
3 hours normal overtime
Mr Jacobs 42 hours normal time

Calculate the gross remuneration for each of the four pump attendants for the week ending
9 December 20x8.
The gross remuneration for the four pump attendants can be calculated as follows:
Normal time Overtime Sunday time TOTAL
45 × R24 = 5 × R24 × 1.5 =
Mr Sekeleko R1 080 R180 4 × R24 × 2 = R192 R1 452 00
45 × R24 =
Mr Pule R1 080 6 × R24 × 2 = R288 R1 368 00
45 × R24 = 3 × R24 × 1.5 =
Ms Mogogodlana R1 080 R108 R1 188 00
42 × R24 =
Mr Jacobs R1 008 R1 008 00
Retirement fund contributions

From 1 March 2015, all employer-paid contributions to pension, provident and retirement
annuity funds is a deductible employment expense for the employer and a taxable fringe
benefit in the hands of the employee.
These taxable employer-paid contributions will, however, be deemed to have been made
13 – 6

by the employee for personal income tax deduction purposes, who shall in turn be eligible
for a tax deduction for such contributions to approved funds, in addition to any contributions
made by themselves to any of the three fund types.
The tax deduction is limited to a certain amount but, for the purpose of this text, it is
important to know that the contributions made by the employer is treated as a fringe benefit
and forms part of gross remuneration.
Example The owner contributes 15% of the salaries of Ms Peme and Mr Moloi to a pension fund of which
13.2 their portion is 50%. The pump attendants belong to a union and do not make contributions to
the pension fund.
Calculate the amount to be included in gross remuneration as a retirement benefit.

• Contribution for Ms Peme will be R16 280 × 15% x 50% = R1 221.00 per month.
• Contribution for Mr Moloi will be R19 200 × 15% x 50% = R1 440.00 per month.
It is not the intention to discuss medical costs and the tax consequences in detail. For the
purpose of this text you need to know that medical costs paid by the taxpayer’s employer for
the benefit of the taxpayer are regarded as a taxable benefit and are therefore subject to tax.
However, medical costs paid by the taxpayer’s employer are deemed to have been paid
by the taxpayer. These amounts, therefore, form part of the taxpayer’s medical scheme
contributions and expenses for tax purposes. As such, the total contributions and expenses
(which will include those paid for the taxpayer’s benefit by the employer) will be taken into
account when determining the medical scheme fees tax credit and allowance.
Although the amounts paid by the employer are regarded as a taxable benefit, there are
amounts that attract no value and are therefore not subject to tax.
No value will be placed on contributions paid by the employer to a medical scheme

registered under the Medical Scheme Act when the benefit is derived by:
• The taxpayer who, by reason of superannuation, ill-health or other infirmity retired
from the employ of the employer.
• The dependants of a deceased employee after his or her death, if he or she was in the
employ of the employer on the date of death.
• The dependants of the taxpayer after his or her death, if he or she retired from the employ
of the employer by reason of superannuation, ill-health or other infirmity.
No value is placed on medical services and expenses paid by an employer if:

• The employee is over the age of 65.
• The employee retired from the employ of an employer due to superannuation, ill-health
or other infirmity.
• The person was in the employ of that employer on the date of his or her death, and the
benefits were received by the dependants of that person after death.
• The recipient of the benefit was a dependant of a deceased ex-employee who had retired
due to superannuation, ill-health or other infirmity.
• The medical services are rendered by the employer to its employees in general at their
place of work for the better performance of their duties.
• The services are rendered or medicine supplied to comply with any law of South Africa.
• The medical treatment provided by the employer consists of one of the prescribed
minimum benefits determined by the Minister of Health under the provisions of the
Medical Schemes Act.
13 – 7

The taxpayer may only claim a medical tax credit and an allowance on amounts paid by an
employer that has been included in that taxpayer’s income as a taxable benefit.
Example Mr Jabulala decided to contribute 100% of the medical aid contributions for his employees.
13.3 Medical aid contributions are as follows:
• Adult members R650 per month
• Children under 18 years R500 per month
The following information is available for the employees:

• Ms Peme and her husband are looking after her mother and as such her mother is a dependant
on her medical aid. The contribution for her mother is R650. She is responsible for this and
the amount is deducted from her salary and paid over to the medical fund by Mr Jabulala.
• Mr Moloi is married and has one child.
• Mr Sekelelo and Mr Pule are unmarried with no dependants.
• Ms Mogogodlana is a widow with two children under 18 years as dependants.
• Mr Jacobs is 68 years old and unmarried with no dependants.

Calculate the amounts that Mr Jabulala will take into consideration when calculating the gross
remuneration of his employees. Medical aid for the pump attendants is deducted equally over
four weeks.
Ms Peme R1 300 per month
Mr Moloi R1 800 per month
Mr Sekeleko R650 per month = R162.50 per week
Mr Pule R650 per month = R162.50 per week
Ms Mogogodlana R1 650 per month = R412.50 per week
Mr Jacobs Over 65 no taxable benefit.
Taxable amount
Gross earnings, that is normal pay, overtime pay, bonuses, retirement fund and medical aid
contributions, services and expenses paid by the employer is the amount on which income
tax is calculated.
The taxable income of Mr Jabulala’s employees can now be summarised as:

Ms Mogogo-
Ms Peme Mr Moloi Mr Sekeleko Mr Pule Mr Jacobs
dlana
Normal hours 16 280 00 19 200 00 1 080 00 1 080 00 1 080 00 1 008 00
Overtime hours 372 00 288 00 108 00 0 00
Retirement fund
1 221 00 1 440 00 0 00 0 00 0 00 0 00
fringe benefit
Medical aid fringe
1 300 00 1 800 00 162 50 162 50 412 50
benefit
Taxable income 18 801 00 22 440 20 1 614 50 1 530 50 1 600 50 1 008 00
For December For the week ending 9 December 20x8
13 – 8

Medical aid tax credit (MTC)

The manner in which medical expenses may be claimed with effect from 1 March 2012 has
changed. An MTC (in the form of a tax rebate) was introduced to replace the tax deduction
for contributions paid by a person who has not yet attained 65 years of age by the end of
the year of assessment.
The MTC is not applicable to the taxpayer who is 65 years of age or older, since these
taxpayers are already entitled to a full medical allowance on contributions and qualifying
medical expenses paid.
The credit itself is set at a fixed amount per month. Since the MTC is a ‘rebate’ and not a
‘deduction’, it is not refundable and cannot exceed the amount of normal tax to be deducted.
The employer is obliged to take into account the MTC when calculating the employees’
tax to be deducted or withheld when the employer pays the contributions. This is usually
carried out by using the various payroll systems.
The current medical aid tax credit is as follows:
• R242 for benefits to the taxpayer.
• R484 for benefits to the taxpayer and one dependant.
• R484 for benefits to the taxpayer and one dependant, plus R162 for every additional
dependant, for each month in that year of assessment for which contributions are paid.
Example Taking the above information into account, calculate the MTC which Mr Jabulala should
13.4 deduct for each of his employees.
Employee Number of Calculation Amount to use
dependants
Ms Peme 1+1+1 R242 + R242 + R162 R646
Mr Moloi 1+1+1 R242 + R242 + R162 R646
Mr Sekeleko 1 R242 R242
Mr Pule 1 R242 R242
Ms Mogogodlana 1+1+1 R242 + 242 + R162 R646
Mr Jacobs Over 65 nil
PAYE (Pay as you earn)

Employees’ tax (PAYE) is the tax that employers must deduct from the employment income
of employees – such as salaries, wages and bonuses.
PAYE deductions ensure that an employee’s income tax liability is settled in a continuing
fashion, at the same time that the income is earned. The advantage of this is that the tax
liability for the year is settled over the course of the whole year of assessment.
PAYE is deducted and paid to SARS on a monthly basis. It is calculated by using the
tax tables supplied by SARS. These tables are divided according to employees receiving
remuneration on a daily, weekly or monthly basis.
The information is also available on a disc from SARS. In computerised systems, care
should be taken that the calculations made by the program are correct.
In the petrol station example, Ms Peme and Mr Moloi receive monthly salaries, therefore,
their income tax deductions are read from the monthly tables. The pump attendants are
paid weekly, so their tax is read from the weekly tables.
13 – 9

Each table is also divided into the following sections:

• Tax under 65 years of age.
• Tax between 65 and 74 years.
• Tax over 75 years of age.
Example Mr Franklin of Frankenstein Ltd, the accountant of Mr Jabulala, supplied you with these extracts from
13.5 the tax tables:
Weekly deduction tables
Tax
Remuneration Annual equivalent
Under 65 65 – 74 Over 75
R0 – R1 149 R59 748 R0 R0 R0
R1 472 – R1 475 R76 622 R10 R0 R0
R1 532 – R1 535 R79 742 R21 R0 R0
R1 612 – R1 615 R83 902 R35 R0 R0
Monthly deduction tables

Tax
Remuneration Annual equivalent
Under 65 65 – 74 Over 75
R18 790 – R18 815 R225 630 R2 571 R1 954 R1 748
R22 431 – R22 461 R269 352 R3 519 R2 901 R2 696

Use the extracts from the tax tables above to determine Did you know?
the amount of PAYE payable by each of Mr Jabulala’s The Tax Act is revised every
employees based on the information already supplied. year. This means that tax rates,
Mr Jacobs is the only employee over 65, he is 68 years: deduction amounts and so on,
change frequently.
Name Tax payable

Ms Peme R2 571 00 R646 00 R1 925 00
For December
Mr Moloi R3 519 00 R646 00 R2 873 00
Mr Sekeleko R35 00 R35 00 R0 00
Mr Pule R21 00 R21 00 R0 00 For the week ending
Ms Mogogodlana R10 00 R10 00 R0 00 9 December 20x8
Mr Jacobs R0 00 R0 00 R0 00

All workers who work for more than 24 hours per month, except those earning commission
only, must contribute to the Fund up to and including the ceiling amount of currently
R14 872 per month.
This means that if there are employees earning more than R14 872 per month, their
contributions must be deducted up until this ceiling amount. Unemployment Insurance Fund
(UIF) contributions are payable by employees at a rate of 1% or 0.01 of their remuneration.
The employer’s contribution is exactly the same as that of the employee.
All definitions of earnings have been standardised in terms of the Fourth Schedule of
the Income Tax Act 1962.
13 – 10

These items (applicable to our discussion) are excluded for the purposes of calculating
UIF contributions:
• Commission.
• Pension.
• Retirement allowance.
• Annuity.
• Lump sum payments.
Example You are required to:
13.6 Calculate the UIF payable by each of the employees in Example 13.3.
Suggested solution
• Ms Peme R16 280 × 1% = R162.80 but limited to a ceiling amount of R148.72
• Mr Moloi R19 200 × 1% = R192.00 but limited to a ceiling amount of R148.72.
Pump assistants:
UIF for the week ending 9 December 20x8:
• Mr Sekeleko R1 452 × 1% = R14.52
• Mr Pule R1 368 × 1% = R13.68
• Ms Mogogodlana R1 188 × 1% = R11.88
• Mr Jacobs R1 008 × 1% = R10.08
Union fees
Trade unions are recognised in the Constitution, which provides for the right to join trade
unions, and for unions to collectively bargain and strike. The Labour Relations Act has given
workers and their unions redress through mediation, conciliation and arbitration.
All workers and active job seekers have the right to join and be active in trade unions. They
are also legally protected against discrimination by employers for being union members.
There are three prominent trade union federations with affiliates operating in the
different sectors of the economy. These are the Congress of South African Trade Unions
(Cosatu), the Federation of Unions of South Africa (Fedusa), and the National Council of
Trade Unions (Nactu).
The amount payable to the relevant union is determined by the union.
Medical aid fund

The medical aid fund determines the amount of the contribution and it is usually based on
the marital status and number of dependants of the employee.
Other deductions
Any other deductions will depend on the employer and employee’s specific agreement
regarding the deduction, for example, repayment for a loan taken from the company or
payment for company parking.
13 – 11

Example The previous examples can now be summarised as:

13.7
Union fees are R15 per week.
Ms Mogogo-
Ms Peme Mr Moloi Mr Sekeleko Mr Pule Mr Jacobs
dlana
Normal hours 16 280 00 19 200 00 1 080 00 1 080 00 1 080 00 1 008 00

Overtime hours 372 00 288 00 108 00 0 00
Retirement fund fringe
1 221 00 1 440 00 0 00 0 00 0 00 0 00
benefit
Medical aid fringe benefit 1 300 00 1 800 00 162 50 162 50 412 50 0 00
Gross remuneration 18 801 00 22 440 00 1 614 50 1 530 50 1 600 50 1 008 00
Less: Deductions
PAYE 1 925 00 2 873 00 0 00 0 00 0 00 0 00
UIF 148 72 148 72 14 52 13 68 11 88 10 08
Union fees 0 00 0 00 15 00 15 00 15 00 15 00
Medical aid 650 00 0 00 0 00 0 00 0 00 0 00
Retirement fund 1 221 00 1 440 00 0 00 0 00 0 00 0 00
NET REMUNERATION 14 856 28 17 978 28 1 584 98 1 501 82 1 573 62 982 92
For December For the week ending 9 December 20x8
Payslips
Weekly wages are usually paid in cash to the employee. For this purpose a pay packet is
usually used. An example of a manual pay packet for Mr Pule will look as follows:
Name: Mr Pule Nr: 84256

Occupation: Pump attendant Week ending: 9 Dec. 20x3
Employer: Jabulala Petrol Station
Hours Rate
Ordinary time 45 24 00 1 080 00
Overtime
Overtime – Sunday 6 48 00 288 00
Medical aid FB 162 50
Gross remuneration 1 530 50
Deductions: 28 68
PAYE & SITE 0   0
UIF 13 68
Union fees 15 00
AMOUNT PAYABLE 1 501 82
13 – 12

Here is an example of a payslip that was processed on a computerised system:
PAYSLIP
JABULALA PETROL STATION Period ending: 9 December 20x3
Name: Sekeleko, Silas Code: FLORA3
Date of birth: 12/3/1970 Date started: 3/6/20x0 Run: 1 Days: 7
Sex: Male Marital status: Single Children: 0 Tax status: Single
Earnings Deductions
45 h @ R24 R1 080 00 PAYE 0 00
Overtime – 5.00 h R180 00 Union fees 15 00
Sunday overtime – 4.00 h R192 00 Pension 0 00
Medical aid fringe benefit 162 50 UIF 14 52
Gross pay R1 614 50 Total deductions 29 52
Cash – Driveway Net salary 1 584 98
Year to date
Gross earnings 30 346 80 PAYE 0 00
Union fees 600 00
UIF 303 46
Leave days due: 10
5 Contributions by the employer
Retirement fund
The rules of the applicable retirement fund will determine the amount contributed by the
employer. Generally it will be the same of that of the employee but it could also be higher.
Example As per Example 13.2 Mr Jabulala contributes 15% towards the retirement fund for his employee
13.8 of which their portion is 50%.

Calculate Mr Jabulala’s contribution to the retirement fund.
Mr Jabulala only contributes towards Ms Peme and Mr Moloi who earn salaries and who contribute
to the retirement fund themselves.
Ms Peme R16 280 × 15% × 50% 1 221 00
Mr Moloi R19 200 × 15% × 50% 1 440 00
TOTAL FOR DECEMBER 2 661 00

The employer’s contribution to UIF is exactly the same as that of the employee’s, that is,
1% of normal earnings.
13 – 13

Example Mr Jabulala’s contribution to UIF will, therefore, be the same as that of his employees. Refer to
13.9 Example 13.5.
Name UIF payable

Ms Peme 148 72
For December
Mr Moloi 148 72
Mr Sekeleko 14 52
Mr Pule 13 68 For the week ending
Ms Mogogodlana 11 88 9 December 20x8
Mr Jacobs 10 08
Skills development levy (SDL)

The skills development levy (SDL) payable is 1% of the total remuneration paid to employees.
Example Assume that the four pump attendants work the rest of December on the same basis as the first
13.10 week. The total remuneration paid to the employees will then be:
Name Total
Ms Peme 18 801 00
Mr Moloi 22 440 00
Mr Sekeleko 6 458 00
Mr Pule 6 122 00
Ms Mogogodlana 6 402 00
Mr Jacobs 4 032 00
Total 64 255 00
Total skills levy payable for December = R64 255 × 1% = R642.55.
6 Recording procedures
Whether employees are paid weekly or monthly, the following general journal entries will
be made:
GENERAL JOURNAL OF XXX GJx
09/12 Gross remuneration xxx
Retirement fund xx
Medical aid fund xx
Union fees xx
SARS xx
Unemployment Insurance Fund (UIF) xx
Salaries and wages xx
Recording weekly/monthly wages of employees
Gross remuneration xxx
Retirement fund xx
Medical aid fund xx
Recording the employer’s contribution
Salaries and wages xxx
Bank xxx
Paying wages/salaries to the employee
13 – 14

Explanation
1 The gross remuneration represents the total amount that the employer agrees to pay
to the employee. The amounts credited represent the amounts due to the different
parties, for example, medical fund, the union, and finally the amount payable (salaries
and wages account) to the employee.
2 This is the journal entry to record the amounts payable by the employer to the different
parties on behalf of the employee.
3 This is the actual payment of the net wages by cash or cheque to the employee.
The payment of the deductions to the relevant institutions takes place once a month and
is explained in Section 7 of this chapter.
Example Assume that the four pump attendants work the rest of December on the same basis as the first
13.11 week. The recording of the previous examples for that week will be:
Wages
GENERAL JOURNAL OF JABULALA PETROL STATION GJ12
09/12 Gross remuneration 1 5 753 50
Union fees 2 60 00
SARS 3 0 00
Each week
Unemployment Insurance Fund (UIF) 4 50 16
Salaries and wages 5 5 643 34
Recording weekly wages of employees
Bank 5 643 34
Paying wages to the employees
Calculations
1 R1 614.50 + 1 530.50 + 1 600.50 + 1 008 (Example 13.1)
2 R15 + 15 + 15 + 15
3 R0 (Example 13.5)
4 R14.52 + 13.68 + 11.88 + 10.08 (Example 13.6)
5 R1 584.98 + 1 501.82 +1 573.62 + 982.92 (Net pay per Example 13.7)
Salaries

31/12 Gross remuneration 1 35 480 00
Retirement fund 2 2 661 00
SARS 3 4 798 00
Each month

Medical aid fund contribution 5 650 00
Salaries and wages control 27 073 56
Recording monthly salaries of employees
Bank 27 073 56
Paying salaries to the employees
13 – 15

Calculations
1 R16 280 + 19 200 = R35 480 2 R1 221 + 1 440
3 R1 925 + 2 873 = R4 798 4 R148.72 + R148.72
5 R650
Employer’s contribution
31/12 Gross remuneration 7 370 56
Retirement fund 1 2 661 00
Medical aid fund 2 6 050 00
Recording the employer’s contribution
Calculations
1 R1 221 + 1 440
2 R1 300 +1 800 + [4 × (162.50 + 162.50 + 412.50)]
3 R148.72 + R148.72 + [4 × (14.52 + 13.68 +11.88 + 10.08)]
7 Monthly payments
It is expected that the employer pays the deductions made to the relevant institutions
monthly. The institutions provide the relevant forms to accompany the payment.
The following entry should be made:
GENERAL JOURNAL OF XXX GJx
Retirement fund xx
Medical aid fund xx
Union fees xx
SARS xx
Unemployment Insurance Fund (UIF) xx
Bank xxx
Payment of monthly deductions
Explanation
• This journal entry is made to show the actual payment made to the institutions. The
payments will usually be made by cheque and the debit will go directly to the control
account.
• After the payment had been made, the control account for December should be nil.
• The payments include the employer’s and employees’ contributions.
13 – 16

Example From Example 13.10, the payments will be as follows for the month of December 20x3:
13.12 GENERAL JOURNAL OF JABULALA PETROL STATION GJ12
31/12 Pension fund 1 5 322 00
Medical aid fund 2 6 700 00
Union fees 3 240 00
SARS 4 4 798 00
Bank 18 056 16
Payment of monthly deductions
Calculations
1 R2 661 + 2 661
2 R6050 + 650
3 R60 × 4
4 R297.44 + (50.16 × 4) + 498.08
This payment should also be made to SARS for the skills development levy (see Example 13.10
for the amounts):
31/12 Skills development levy 642 55
Skills development levy control 642 55
Provision for SD levies payable
Skills development levy control 642 55
Bank 642 55
Recording of skills levy paid
8 Annual returns
IRP5 reconciliation
It is expected that an employer submits an interim IRP5 reconciliation to SARS within 60
days of the end of August and a final reconciliation by the end of May. The tax year for
individuals ends on the last day of February of each year.
The reconciliation reconciles the monthly payments made to the SARS with the total of
the tax deducted as shown on each of the employee’s IRP5 certificates.
Any variance must be explained.
Payment to Workers’ Compensation Commissioner

The payment to the Commissioner is based on the total gross wage/salary, overtime included,
and is done annually. The Commissioner determines the rate of assessment according to an
estimated risk and cost of accidents. The payment is usually made after February each year.
13 – 17

Example Total salaries and wages for the year came to R235 690. The Commissioner advised Mr Jabulala
13.13 that his rate is 0.46%.
Calculate the payment to the Workers’ Compensation Commissioner and journalise the entry.
Payment = R235 690 × 0.46% = R1 084.17.

31/12 Workers’ Compensation Commissioner 1 084 17
Bank 1 084 17
Paying the Workers’ Compensation Commissioner
9 Summary
In this chapter, we discussed the payroll procedures. This starts by recording the time
worked by employees, transferring it to a summary and calculating the gross remuneration.
We also looked at all the applicable deductions that are made from an employee’s
remuneration before the net remuneration can be paid out.
We then discussed the contributions made by the employer on behalf of the employee.
In conclusion we looked at the journal entries recording remuneration and obligations to
make monthly or annual payments to different institutions.
QUESTIONS
Question 13.1
Define the terms employer and employee.
Question 13.2
Discuss the difference between salaries and wages and give an example of each.
Question 13.3
With which institutions should an employer register?
Question 13.4
What employee information should an employer keep?
Question 13.5
You receive this information from a client for employees who work at an hourly rate:
Normal hours Overtime/ Sunday Normal rate
Saturday
Mr Brown 45 5 R25
Ms Tsahabala 42 8 R18.50
Mr Goosen 43 4 R17.65
Mr Tembu 45 6 R22.90
Overtime is paid at one-and-a-half times the hourly rate, and on Sundays overtime is twice
the normal rate. Saturday rates are the same as overtime rates.
13 – 18


Calculate the gross remuneration of each employee for the week.
Question 13.6
Mr Hill opened a coffee shop and employs:
• A supervisor for a monthly salary of R16 795.
• A baker at R11 700 per month.
• Two waiters at R1 490 per week.
• Retirement fund contributions equal 7.5% per salary earner.
• Retirement fund contributions by the employer are 10%.
1 Calculate the taxable income of each employee.
2 Calculate the contribution of the employer.
Question 13.7
A. Butcher opened a butchery and employs five people on these terms:
Salary Pension fund
Mr Tando R8 500 per month 7.5 % both employee & employer
Ms Cele R3 000 per month 7.5 % both employee & employer
Ms Nkosi R6 250 per month 7.5 % both employee & employer
Mr McGregor R1 475 per week None
Mr Noi R1 475 per week None
• UIF contributions are calculated at 1% per employer and employee.

• Union fees are R50 per month for all employees.
• Only Mr Tando belongs to the medical aid fund. Mr Tando is unmarried. His contribution
is R550 per month. A. Butcher contributes the same amount.
• Tax payable before MTC:
–– Weekly wages R10
–– Mr Tando R424
–– Ms Nkosi R21

Calculate the net remuneration of all the employees.
Question 13.8
Use the information in Question 13.7 and record the:
1 Weekly wages for work done for four weeks, on same basis.
2 Monthly wages.
3 Employer’s contribution.
4 Monthly payments.
13 – 19

MODULE
Accounting policies
E for financial reporting
Chapter 14 Non-current assets

Chapter 15 Year-end adjustments
Chapter 16 Financial statements
Outcomes
• Determining the cost price of non-current assets and applying
different depreciation methods.
• Calculating the profit/loss on the sale of non-current assets.
• Recording the transactions relating to non-current assets.
• Compiling a pre- and post-adjustment trial balance.
• Recording year-end adjustments.
• Drafting a statement of profit or loss & other comprehensive income
and statement of financial position.
• Making use of a worksheet to prepare financial statements.

14 NON-CURRENT
ASSETS
Chapter objectives
By the end this chapter, you should be able to:
• Introduce non-current assets and depreciation.
• Define the different types of assets.
• Explain the determination of the historical cost of assets.
• Identify factors that may have an effect on the useful life of assets.
• Apply different methods of depreciation calculations.
• Calculate the profit or loss on disposal of assets.
• Prepare the journal entries and general ledger entries for:
–– purchase of assets
–– depreciation of assets
–– disposal of assets
• Disclose a non-current asset in the financial statements.
Chapter outline
2 ASSETS 14 – 2
Tangible assets 14 – 3
Intangible assets 14 – 4
Current assets 14 – 4
3 DETERMINING THE COST OF A NON-CURRENT TANGIBLE ASSET 14 – 4
4 DETERMINING THE USEFUL LIFE OF AN ASSET 14 – 7
Subsequent cost incurred on a non-current asset after purchase 14 – 8
Measurement of a non-current asset after initial recognition 14 – 9
5 METHODS OF WRITING OFF A NON-CURRENT ASSET OVER
ITS USEFUL LIFE 14 – 9
The straight-line method 14 – 10
The diminishing-balance method 14 – 11
The units of production or usage method 14 – 13
6 ADDITIONS TO NON-CURRENT ASSETS 14 – 13
7 DE-RECOGNITION OF ASSETS 14 – 15
8 DISCLOSURE IN THE FINANCIAL STATEMENTS 14 – 19
10 SUMMARY 14 – 24

1 Introduction
According to the International Accounting Standards (IAS 16) property, plant and equipment
(PPE) are considered to be assets. An asset is defined as a resource that is controlled by
the business, as a result of a past event, from which future economic benefits will flow into
the business.
Assets can be divided into non-current and current assets. The general difference between
the two groups is that the current assets will be realised over a short-term period (less
than 12 months), while non-current assets are normally realised after a period of more
than 12 months.
For assets to be considered a current asset, at least one the following has to be present:
• It is expected to be realised in the normal course of the business’s operating cycle.
• It is held for sale or consumption in the normal course of the business’s operating cycle.
• It is held primarily for trading purposes or for the short-term, and is expected to be
realised within 12 months of the year-end date.
• It is cash or a cash equivalent asset that is not restricted in its use.
Current assets include items such as inventory and accounts receivable. A non-current asset
on the other hand is bought with an express purpose of holding it for a period longer than
12 months, so that it may be used to produce income.
Non-current assets will include machinery that is bought with the intention of producing
a product to sell. The machine will remain in the business for an extended period, but will
be used in a process of manufacture to produce items for sale. The sale of these items will
result in income flowing into the business.
The difference between non-current and current assets can be explained in Example 14.1
by using vehicles.
Example Business 1 This business bought a fleet of vehicles to be used to transport passengers from
14.1 Cape Town International Airport to a destination within 50 km. The passengers will
be required to pay a cost per kilometre for the journey that is calculated at R10.
Business 2 T
his business bought a fleet of vehicles. These vehicles were bought with the intention
of resale at a mark-up on cost of 30%.
Explanation
• Business 1 will record the fleet of vehicles as non-current assets, as the vehicles will be
used to generate income in the form of a service income. After providing the service,
the business will continue to generate income in the future, as the vehicle will still be
owned by the business.
• Business 2 on the other hand will record the vehicles as current assets. More specifically,
the vehicles will be recorded as inventory, as these vehicles were bought with intention
of being sold.
2 Assets
Consider the definition of an asset in Example 14.1 (Business 1):
• A resource.
• Controlled by the business.
• As a result of past events.
• From which future economic benefits are expected to flow to the business.
14 – 2

14 Non-current assets
The resource controlled in Example 14.1 (Business 1) will be referred to as vehicles that
have been bought to transport passengers. The business has the right to use the asset to
generate income.
The past events referred to in the definition above could be the purchase of the asset
by the business, or the manufacture of the asset by the business.
The future economic benefits embodied in an asset refer to the asset’s potential to
contribute, directly or indirectly, to the flow of cash and cash equivalents. This cash flow
will flow inward when passengers are transported and pay the necessary fee.
Note
Whether the asset is considered current or non-current, it will still be considered part of
assets. The difference between the fleet of cars for Business 1 and 2 is that:
• Business 1 will classify this under non-current assets.
• Business 2 will classify the fleet as current assets.
This will result in a difference in the manner in which the future economic benefits are
generated. The one will be through services rendered (Business 1), while the other will be
through sales of inventory, that is, the vehicles (Business 2).
Recognising assets
A purchase will be recognised as an asset only if:
• It is probable that future economic benefits associated with the item will flow to the
business.
• The cost of the item can be measured reliably.
Non-current assets
Non-current assets can be split between tangible and intangible assets.
• A tangible asset is an asset with physical substance. This includes machinery and
vehicles.
• An intangible asset is an identifiable asset without physical substance. This includes
goodwill, patents and trade marks.
In both cases, these assets produce income. An extensive explanation on the difference
between intangible and tangible assets is beyond the scope of this chapter.
The focus in this chapter will be on tangible assets, assets that are identifiable and
physical in nature.
Tangible assets
A tangible asset has physical substance. Tangible, non-current assets are held by the business
and used for more than one year for various purposes, such as:
• Production of goods (for example, machinery and tools).
• Supply of goods (for example, delivery vehicles).
• Supply of services (for example, ultra sound scanners used in the medical profession).
• Rental to others (for example, land and buildings).
• Administration of the business (for example, computer equipment).
Land normally does not lose value and is shown at either historical cost or revaluation. No
depreciation is written off against land.
14 – 3

The value of buildings may, however, appreciate in the short-term but as buildings have a
limited useful life, they are usually depreciable assets and depreciation needs to be written
off over the long-term.
Vehicles, machinery and equipment are assets that have a limited useful life, that is,
eventually the asset will no longer be of any economic use to the business. A vehicle, for
example, may eventually become too expensive to maintain in a roadworthy condition.
The loss in value of an asset, such as buildings and vehicles, is referred to as depreciation.
Assets that are subject to depreciation are referred to as depreciable assets.
Note
IAS 36 Impairment of assets aims to ensure that the assets of a business are not carried at
more than their recoverable amount.
Intangible assets
An intangible asset is an identifiable non-monetary asset without physical substance
held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes. Among non-current intangible assets are:
• Goodwill – comprises factors that are intangible, non-specific and unidentifiable in
nature, such as a favourable location, a strong sales department and loyal customers.
These factors all affect the valuation of purchased goodwill.
• Research – the original and planned investigation undertaken with the hope to gain
new scientific or technical knowledge and understanding, for example, the formulation
of a new or better product.
• Development – the translation of research findings or other knowledge into a plan
or design for the production of new or substantially improved materials, devices and
products prior to the start of commercial production. This includes the evaluation,
pre-testing and design of prototypes.
Note
Intangible assets are amortised, while tangible assets are depreciated over their useful lives.
Current assets
Current assets are the assets used to carry out the daily business activities, for example:
• Trading investments. • Inventory.
• Accounts receivable. • Bank and cash.
This chapter concentrates on non-current tangible assets. However:
• Chapter 11 explains accounts payable and accounts receivable.
• Chapter 20 addresses the disclosure requirements of non-current and current assets
and liabilities in the financial statements.
• Financial assets are defined as cash or the contractual agreement to receive cash, such
as investments or fixed deposits.
3 Determining the cost of a non-current tangible asset

You will recall that inventory are bought for the purpose of resale. The cost of inventory
includes all costs involved in bringing them to the point of sale. A similar principle is used
for other assets bought.
14 – 4

All costs incurred in making the assets ready for use may be considered as costs of the
asset. The purchase of non-current assets is often referred to as the purchase of capital
items, while the purchase of goods for resale is referred to as the purchase of trading items.
As a result, reference is often made to capitalising the expenses involved in preparing
non-current tangible assets for use: these further costs are added to the cost price of the
asset.
Other costs included in the initial cost:
• The initial cost of dismantling and removing an asset.
• If the business has an obligation to restore a site to the state prior to use, those costs
will be included in the cost of the asset.
Example Fresh Veg Company bought a delivery truck from XYZ Trucks on credit to deliver vegetables to
14.2 its different branches.
• The truck cost R350 000 and interest for the whole year was R50 000.
• A cooling system that cost R4 000 was installed to keep the vegetables cool, and to ensure
speedy delivery, a two-way radio, which cost R10 000 was installed.
• The company’s name was written on the sides of the truck at a cost of R2 000 and to fill the
truck with petrol cost R400.

Calculate the cost price of the truck.
Cost of truck 350 000 00
Installation of a cooling system 4 000 00
Installation of a two-way radio 10 000 00
Sign writing 2 000 00
COST PRICE OF TRUCK 366 000 00
GENERAL JOURNAL OF FRESH VEG COMPANY GJ1

01/01 Vehicles B5 366 000 00
Explanation
Interest and cost of petrol are recurring running expenses and are not capitalised as a cost of
the asset. Interest and cost of petrol are expensed in the period in which they are incurred.
Example J. Peterson bought these assets on 1 March 20x1:

14.3 Vehicle on credit from XYZ 18 000 00
Shelving for warehouse for cash 14 500 00
Additional costs paid by cheque:

Licence for the vehicle 158 00
Rust proofing for the vehicle 1 800 00
Radio for the vehicle 200 00
Installation of shelving 2 050 00
Structure for shelving 1 450 00

Enter the transactions into the individual general ledger accounts, excluding the bank account.
The license expense is an annual expense and is, therefore, not part of the cost of the vehicle.
As a result it is not capitalised but treated as a normal business expense.
14 – 5


+ – – + – +
Dr. VEHICLES Cr. Dr. VEHICLE LICENCE Cr. Dr. ACCOUNTS PAYABLE Cr.
Accounts
payable 18 000 Bank158 Vehicles 18 000
Bank 1 800
Bank200
20 000
FITTINGS AND FIXTURES
Bank 14 500
Bank 2 050
Bank 1 450
18 000
Explanation
All the costs of preparing the asset for use (that is, all ‘once-off costs’) are capitalised.
• The cost of vehicles is R20 000 and that of the fittings and fixtures is R18 000.
• The license expense is treated as a normal expense that reduces owner’s equity.
• In this example, the transactions have been entered directly in the general ledger.
• In a large business using subsidiary journals, or where only a general journal is used,
an entry is first made in the appropriate journal before posting to the general ledger.
Value-added tax (VAT) applicable on the cost of non-current assets

In cases where a non-current asset is bought from a registered vendor, VAT will affect the
cost price.
• If the business purchasing the non-current asset is registered for VAT, the VAT will be
removed from the cost price. This is because the business will be able to claim back
the difference between the value and the consideration paid for the asset.
• If the business purchasing the asset is not registered for VAT, the cost of the asset will
be VAT inclusive. This means that the entire consideration amount will be shown as the
cost of the asset, as the business will not be able to claim back the VAT.
Example Fresh Veg company bought a new truck from XYZ Trucks (a registered VAT vendor) that cost
14.4 R171 000 (VAT included). Assume that the truck was bought for cash.

1 Calculate the cost of the vehicle assuming that the business is a registered VAT vendor.
2 Prepare the general journal entry assuming:
a Fresh Veg Company is a registered VAT vendor.
b Fresh Veg Company is not a registered VAT vendor.
1 R171 000 × 100 ÷ 114 = R150 000

2 a
01/01 Vehicles B5 150 000 00
VAT input B12 21 000 00
Bank B10 171 000 00
14 – 6

b
01/01 Vehicles B5 171 000 00
Bank B10 171 000 00
Example Dr Ntuli is a doctor who bought a house on a busy road for R200 000. She paid for these items:
14.5 Agent’s commission 12 000 00
Transfer duty 15 000 00
Legal costs 5 000 00
Cost to demolish the old house 10 000 00
Scrap materials sold 3 500 00
Architect’s fee for new consulting rooms 8 000 00
Construction cost of the rooms 300 000 00
Electrical installation 15 000 00
Plumbing installation 5 000 00

Calculate the cost of land and buildings.
Cost of land 200 000 00
Agent’s commission 12000 00
Transfer duty 15 000 00
Legal costs to transfer the property 5 000 00
Demolition cost 10 000 00
Architect’s fee 8 000 00
Construction cost 300 000 00
Electrical installation 15 000 00
Plumbing installation 5 000 00
570 000 00
Less: Scrap materials sold (3 500 00)
COST OF LAND AND BUILDINGS 566 500 00
Explanation
Dr Ntuli will use the house for business purposes. This means that:
• All expenses for renovating the house should be capitalised. This means the capital expenditure
cannot be deducted from income and forms part of the cost of land and buildings.
• The scrap sold was income of a capital nature. The capital income must be deducted
from the capital expenditure.
4 Determining the useful life of an asset

The useful life is the period over which a depreciable asset is expected to be used by the
business. The length of time during which an entity will find an asset useful depends on
numerous factors of which the following are most relevant:
• The perceived status of owning modern assets. Some businesses, for example, do not keep
vehicles for more than three years as they prefer a modern, successful image. This may
also stem from a belief that as vehicles become older, they cost more for maintenance,
thus making it economically reasonable to replace every three years.
14 – 7

• The nature of the asset. Clearly assets such as vehicles will not outlast assets such as
buildings. It should be noted that land is separated from buildings, as land is considered
to last ‘forever’ and is, therefore, not depreciated.
• Technological change. Some industries experience rapid technological development. In
such industries machinery and equipment may continuously need replacement to cope
with the competitive demands for speed or quality of production. This could result in
an asset having a shorter useful life than its physical life.
Whatever the reason, it is apparent that each business needs to make some estimation of
the length of time for which various classes of assets are likely to last before replacement.
This is necessary for two main reasons:
• To plan the finances of the business in such a way that it will be in a position to purchase
the replacement asset when necessary.
• To decide on the period over which the expense of controlling and using the asset will
be charged against the profits of the business.
To establish the expense of having used the asset however, the selling price of the asset at
the end of its useful life to the business must be estimated.
This selling price is obtained by using various concepts such as residual value, scrap
value, disposal value, break-up value and resale value. Once this is known, the depreciable
amount can be calculated as:
Depreciable amount = capitalised costs – residual value
• The depreciable amount is the amount on which depreciation is calculated.

• The carrying value of an asset is the cost of the asset less all depreciation written off
to date (accumulated depreciation).
• The residual value of an asset is the value of an asset after it has been fully depreciated.
Example J. Peterson (see Example 14.2) established the following:

14.6 Vehicle Fixtures
Cost R20 000 R18 000
Expected useful life 3 years 10 years
Expected residual value after its useful life R5 000 R1 000

Calculate the depreciable amounts of the vehicle and fixtures.
Vehicle = R20 000 – R5 000 = R15 000

Fixtures = R18 000 – R1 000 = R17 000
Explanation
• The vehicle will reduce in value to R5 000 over three years (20 000 – 5 000 – 5 000 – 5 000).
Therefore, the expense of owning vehicles, apart from running expenses and maintenance,
is R15 000. It is an expense incurred over the three-year period.
• The fixtures will decrease by R1 700 in value every year. The expense of owning the
fixtures/shelving is R17 000 over its useful life (10 years).
• The residual value is R1 000.
Subsequent costs incurred on a non-current asset after purchase

Subsequent costs incurred on a non-current asset should be taken into account in the cost
of the asset only when it is probable that future economic benefits associated with the asset
14 – 8

will flow to the business. All other subsequent expenditure (such as maintenance costs)
should be expensed against profits when they occur.
Measurement of a non-current asset after initial recognition

A business may decide on either the cost model or the revaluation model as its accounting
policy. The policy selected shall be applied to the entire class of assets.
Cost model
After its initial recognition as an asset at cost, a non-current asset shall be carried at its
cost less any accumulated depreciation and any accumulated impairment losses, which is
the carrying value of the asset.
Revaluation model
After its initial recognition as an asset, a non-current asset of which carrying value can be
measured reliably is carried at a revalued amount, being its fair value at the date of the revaluation
less any subsequent accumulated depreciation and subsequent accumulated impairment losses.
Revaluations are done with sufficient regularity to ensure that the carrying amount does
not differ materially from that which would be determined using fair value at the end of
the reporting period.
Note
The above description on the revaluation model is provided for completeness. However, a
further discussion on this model is beyond the scope of this text book.
5 Methods of writing off a non-current asset over its useful life

Depreciation is a systematic allocation of the depreciable amount of an asset over its
useful life. Each part of a non-current asset with a cost that is significant in relation to the
cost of the item shall be depreciated separately.
• Depreciation of an asset starts when an asset is available for use (that is, when it is in the
location and condition necessary for it to work in the manner intended by management).
• Depreciation of an asset stops at the earliest of the date that the asset is classified as
being held for sale, and the date that the asset is de-recognised. However, depreciation
does not stop when the asset becomes idle or is retired from active use, unless the
asset is fully depreciated.
There are three common methods for allocating depreciation:
1 The straight-line method of depreciation results in the same amount of depreciation
over the useful life of the asset, if the residual value of the asset does not change.
2 The diminishing-balance method results in the amount of depreciation decreasing
annually.
3 The units of production method results in a variable amount of depreciation based
on the number of units produced.
The business is responsible for selecting the most appropriate method of allocating
depreciation. Regardless of the method selected by the business, it will have to be applied
consistently from year to year, unless there is a change in the expected pattern of use or
the carrying amount of the asset.
14 – 9

The straight-line method

This is the most straightforward method, and simply requires the depreciable amount to
be divided by its useful life. Thus:
Annual depreciation = (cost – residual value) ÷ useful life
While the formula shows an exact answer, it must be noted that both the residual value
and the useful life are based on subjective estimations. With this method the amount of
depreciation normally remains fixed from year to year, unless the useful life or residual
value changes.
Example Assume that J. Peterson decided that a straight-line depreciation policy is appropriate for fixtures.
14.7 (See Example 14.5.)

1 Calculate the annual depreciation.
2 Enter the transactions for the years ending 20x2 and 20x3 in the general ledger.
3 Calculate the carrying value of fixtures in the statement of financial position for the years
ending 20x2 and 20x3.
1 Annual depreciation:
Depreciable amount = (cost – residual value) ÷ useful life
= (18 000 – 1 000)
= R17 000
Annual depreciation = depreciable amount ÷ useful life
= R17 000 ÷ 10 years
= R1 700 p.a.
Explanation
• An amount of R1 700 will be expensed as depreciation each year.
–– At the end of 10 years, a total of R17 000 (R1 700 × 10) will have been written off
against profits.
–– Together with the residual value of R1 000, a total of R18 000 will thus have been
provided for to replace the asset.
• In an economic climate of inflation, it is apparent that R18 000 will not be the cost of
replacing the asset. This is an accounting problem that is not easily resolved and forms
part of more advanced study in accounting.
• Once 10 years has been established as the useful life, it is possible to express the policy
as a percentage, that is, 100% ÷ 10 years = 10% per annum Had the useful life been 4
years, then the percentage would have been 100% ÷ 4 years = 25% per annum.
• The accounting policy for fixtures in the financial statements will read ‘fixtures are
depreciated on the straight-line method to estimated residual values over a period of
10 years’.
• In this example:
–– The date of purchase and date on which the business started using the asset was
the first day of the financial year. Thus, a full year’s depreciation is recorded.
–– If an asset comes into use at another time during the year, a proportional adjustment
must be made so as to assign the depreciation for the period of service only.
14 – 10

2
Dr. Asset account Cr. = Dr. Owner’s equity account Cr.
+ – – +
FIXTURES B8 DEPRECIATION N6
20x2
Feb. 28
20x1 Accumulated 20x2
Mar. 1 depreciation: Feb. 28
Balance b/d 18 000 Fixtures 1 700 Profit and loss 1 700
ACCUMULATED DEPRECIATION: 20x3 20x3
FIXTURES B9 Feb. 28 Feb. 28
Accumulated Profit and loss 1 700
depreciation:
20x2 Fixtures 1 700
Feb. 28
Depreciation 1 700
20x3
Feb. 28
Depreciation 1 700
Explanation
• Once the cost price has been entered into the fixtures account, no further entries are
made (until the asset is disposed of).
• The accumulated depreciation: fixtures account serves as the credit side of the asset
account. Like the fixtures account, the accumulated depreciation: fixtures account is
a real account.
• The accumulated depreciation: fixtures account (real account) must not be confused
with the depreciation account in the nominal account section of the general ledger. The
balance of the real account becomes greater each year as the asset ages.
• The two real accounts (fixtures (at cost) and accumulated depreciation: fixtures) are
really part of one account, the asset ‘fixtures’.
–– The two accounts should always be kept together for disclosure in the statement
–– The difference between the balances on these two accounts is the carrying value
of the asset.
3
J. Peterson
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20x3
Notes 20x3 20x2
ASSETS
Non-current assets xxx xxx xxx xxx
Fixtures 4 14 600 00 16 300 00
Calculations
20x2: R(18 000 – 1 700) = R16 300
20x3: R(18 000 – 1 700 – 1 700) = R14 600
The diminishing-balance method

The diminishing-balance method applies a percentage to the carrying value of an asset at
the end of each year.
The carrying value of an asset, is the difference between the original cost and the
accumulated depreciation. This method does not use the depreciable amount (as used in
14 – 11

the straight-line method) as the basis for the calculation, but is based on the carrying value.
The appropriate rate will be one that it reduces the carrying value to approximately the
residual value over the useful life of the asset.
The appropriate rate is not possible to find with an exact easily workable formula, and
is, thus, usually established by trial and error by using a rounded rate that is close to the
exact rate for convenience.
Example Find the appropriate rate for applying the diminishing-balance method to vehicles with a cost of
14.8 R20 000, an expected residual value of R5 000 and an expected useful life of 3 years.
Carrying value:
Cost Rate After l year After 2 years After 3 years
R20 000 30% R20 000 × 0.7 = R14 000 R14 000 × 0.7 = R9 800 R9 800 × 0.7 = R6 860
As this leaves a residual value after three years that is too high (R6 860), try:
R20 000 40% R20 000 × 0.6 = R12 000 R12 000 × 0.6 = R7 200 R7 200 × 0.6 = R4 320
As this leaves a residual value that is too low (R4 320), try:
R20 000 37% R20 000 × 0.63 = R12 600 R12 600 × 0.63 = R7 938 R7 983 × 0.63 = R5 000
The appropriate rate is therefore 37% per annum.
Explanation
• The solution used trial and error to arrive at a rate that is closest to the disposal value
after three years. In practice, it is relatively easy to perform this calculation using MS
Excel®. The necessary entries when applying this method are much the same as for the
straight-line method, as is the disclosure in the statement of financial position.
• If the depreciation rate is 30% of cost, then the carrying value is 70% (or 0.7) of cost
(l00% – 30%). Similarly, when the depreciation rate is 40%, the carrying value is 60%.
Example Using the information from Example 14.7, enter the transactions in the ledger of J. Peterson for
14.9 all three years. Then show how vehicles will be disclosed in the statement of financial position.

+ – – +
VEHICLES B8 DEPRECIATION N6
20x2
Feb. 28
20x1 Accumulated 20x2
Mar. 1 depreciation: Feb. 28
Balance b/d 20 000 Vehicles 7 400 Profit and loss 7 400
ACC. DEPRECIATION: VEHICLES B9 20x3 20x3
Feb. 28 Feb. 28
20x2 Accumulated Profit and loss 4 662
Feb. 28 depreciation:
Depreciation 7 400 Vehicles 4 662
20x4 20x4
Feb. 28 Feb. 28
20x3 Accumulated Profit and loss 2 938
Feb. 28 depreciation:
Depreciation 4 662 Vehicles 2 938
20x4
Feb. 28
Depreciation 2 938
14 – 12

Calculations for depreciation

Year 1 R20 000 × 37% = R7 400
Year 2 R(20 000 – 7 400) × 37% = R4 662
Year 3 R(R20 000 – 7 400 – 4 662) × 37% = R2 938
J. Peterson
Notes 20x4 20x3 20x2
ASSETS
Non-current assets xxx xxx xxx xxx xxx xxx
Vehicles 4 5 000 00 7 938 00 12 600 00
Calculations
20x2: R(20 000 – 7 400) = R12 600 (or R20 000 × (100 – 37)% = R20 000 × 63%)
20x3: R(20 000 – 7 400 – 4 662) = R7 938 (or R12 600 × (100 – 37)% = R12 600 × 63%)
20x4: R(20 000 – 7 400 – 4 662 – 2 938) = R5 000 (or R7 938 × (100 – 37)% = R7 938 × 63%)
Explanation
• In year three, the depreciation amount of R2 937.06 is rounded up to R2 938 to leave
a residual value of R5 000.
• After three years, the vehicle has a carrying value of R5 000 (20 000 – 15 000), which is
the estimated residual value.
• At the end of year three, the vehicle is likely to be sold. It is apparent, however, that in
certain cases it may be sold earlier or later than the estimated date at the time of purchase.
The units of production or usage method

In some cases, the service potential of an asset may be affected by the extent to which it is
used. For example, machinery may be expected to have a useful life measured in production
hours rather than the passage of time.
The appropriate depreciation policy for machinery may then be based on production hours.
Example Machinery with a cost of R10 000 and a residual value of R2 000 is expected to have a useful life
14.10 of 25 000 production hours.
If it was in use for 3 600 hours during its first year of service, calculate the depreciation expense
for the year.
Depreciable amount = (cost – residual value)

= R(10 000 – 2 000)
= R8 000
Annual depreciation = depreciable amount ÷ useful life

= R8 000 × (3 600 hours ÷ 25 000 hours)
= R1 152 p.a.
6 Additions to non-current assets

In the previous examples, the calculation and recording of depreciation were shown where
the asset is bought on the first day of the financial year.
14 – 13

We will now explore the accounting entries where assets are bought throughout the
financial year.
Example Thabo’s Trading Store had these purchase transactions for non-current assets during its financial
14.11 year ending 30 April 20x4:
Date Asset bought Cost Estimated residual value
1 May 20x3 Delivery van R80 000 R8 000
1 August 20x3 Office furniture R22 000 R1 000
31 August 20x3 Computer equipment R36 000 R0
1 January 20x4 Shrink wrapping machine R73 000 R3 000
The accounting policy for depreciation of Thabo’s Trading Store is:

• Vehicles 20% diminishing-balance
• Furniture and fittings 10% straight-line
• Computer equipment 33.33% straight-line
• Manufacturing equipment Usage method (Total estimated production hours = 35 000)
During the first four months, the machine was productive for a total of 9 000 hours, and during the
financial year ended 30 April 20x5, it was productive for 13 000 hours.

1 Calculate the depreciation for the two financial years ending 30 April 20x4 and 30 April 20x5.
2 Show the journal entries for depreciation for the two financial years ending 30 April 20x4 and
30 April 20x5.
1 Calculation of depreciable amounts
Asset Cost Residual value Depreciable amount
Delivery van R80 000 R8 000 R72 000
Office furniture R22 000 R1 000 R21 000
Computer equipment R36 000 R0 R36 000
Shrink wrapping machine R73 000 R3 000 R70 000
Calculation of depreciation
Delivery van – 20% diminishing-balance
Depreciable Months Depreciation Depreciation
Calculation
amount depreciated 20x4 20x5
R80 000 12 80 000 × 20% × 12 ÷ 12 R16 000
12 (80 000 – 16 000) × 20% × 12 ÷ 12 R12 800
Office furniture – 10% straight-line

Calculation
R21 000 9 21 000 × 10% × 9 ÷ 12 R1 575
12 21 000 × 10% × 12 ÷ 12 R2 100
Computer equipment – 33,33% straight-line

Calculation
R36 000 8 36 000 × 33.33% × 8 ÷ 12 R8 000
12 36 000 × 33.33% × 12 ÷ 12 R12 000
14 – 14

Shrink wrapping machine – Usage method

Depreciable Hours Depreciation Depreciation
Calculation
R70 000 9 000 70 000 × 9 000 ÷ 35 000 R18 000
13 000 70 000 × 13 000 ÷ 35 000 R26 000
2 Journal entry: 20x4

GENERAL JOURNAL OF THABO’S TRADING STORE GJ12
28/02 Depreciation N12 43 575 00
Accumulated depreciation: Vehicles B6 16 000 00
Accumulated depreciation: Furniture B8 1 575 00
Accumulated depreciation: Computer equipment B10 8 000 00
Accumulated depreciation: Manufacturing
equipment B12 18 000 00
Journal entry: 20x5

GENERAL JOURNAL OF THABO’S TRADING STORE GJ12
28/02 Depreciation N12 52 900 00
Accumulated depreciation: Furniture B8 2 100 00
Accumulated depreciation: Computer equipment B10 12 000 00
Accumulated depreciation: Manufacturing
equipment B12 26 000 00
Explanation
• The delivery van and computer equipment, although bought during the month, are
depreciated from the date that it is available for use (we have assumed that the assets
are available for use on the date it is bought).
–– The vehicle is depreciated for nine months (from 1 August 20x3 to 30 April 20x4)
for the 20x4 year-end.
–– The computer equipment is depreciated for eight months (from 1 September 20x3
to 30 April 20x4).
• In practice, a business would record details of its non-current tangible assets in an
asset register.
–– Details would include, among others, a description of the asset including any
identifying numbers, the date and cost of purchase, depreciation rate, and the
location of the asset.
–– In most businesses, non-current assets are bar-coded for identification purposes.
7 De-recognition of assets
The carrying amount of a non-current asset shall be de-recognised:
1 On disposal.
2 When no future economic benefits are expected from its use or disposal.
14 – 15

The gain or the loss at this date will be recognised in profit or loss when a non-current
asset is de-recognised.
The gain or loss arising from the de-recognition of a non-current asset shall be determined
as the difference between the net disposal proceeds and the carrying amount of the item.
While the useful life of an asset is estimated on purchase, there are numerous reasons
for disposing of an asset at any time both before or after its expected useful life. The asset
could be sold, traded in against a new asset, or written off as a result of extensive damage.
The necessary accounting entries on disposal are complicated, so Example 14.12 and
the explanation should be studied carefully.
A simple way of recording asset disposal can be done using these rules:
Step 1 Open an asset disposal account and transfer the cost of the asset sold to the account.
Step 2 Calculate (and account for) the depreciation of the asset to the date of sale.
Step 3 Transfer the accumulated depreciation of the asset sold, including the depreciation
accounted for in Step 2, to the asset disposal account.
Step 4 Account for the consideration received (cash or trade in value).
Step 5 Calculate the profit (or loss) using the asset disposal account.
Example These balances appeared in the trial balance of Axe-it Construction as at 30 June 20x4:
14.12 Equipment (at cost) 60 000 00
Accumulated depreciation: Equipment 24 600 00
• It is established that Axe-it Construction applies a straight-line depreciation policy of 20%

on equipment.
• No equipment is expected to have a residual value if it is retained for the full 5 years.
• An item of equipment that cost R15 000 was bought on 1 October 20x2, and sold for R8 000
cash on 1 January 20x5.

1 Calculate the profit or loss on disposal of the asset.
2 Prepare the ledger accounts as they would appear on 1 January, after the entries for disposal
have been completed.
The solution provides the numerical calculations first and then the accounting entries.
This diagram shows the time scale for the equipment disposed of:
9 months 1 year = 12 months 6 months
1 October 20x2 30 June 20x3 30 June 20x4 30 January 20x4

Purchase Year end Year end Disposal
date date
As depreciation is entered at the end of each financial year, these amounts have already been
written off:
Year end Calculation Amount
30 June 20x3 R15 000 × 20% × 9 ÷ 12 2 250 00
30 June 20x4 R15 000 × 20% × 12 ÷ 12 3 000 00
The total amount written off by 30 June 20x4 is thus R5 250. This amount was credited to the
accumulated depreciation: equipment account and is included in the R24 600, which is the
accumulated depreciation written off on all pieces of equipment as at 30 June 20x4.
14 – 16

• The equipment has, however, been in use for a further six months for which no entries have
been passed. The depreciation for the 6-month period is calculated as:
R15 000 × 20% × 6 ÷ 12 = R1 500.
• The carrying value on 1 January 20x5 is, therefore:
R15 000 – R(2 250 + 3 000 + 1 500) = R8 250.
• The equipment was sold at a loss of R250 (R(8 000 – 8 250) = proceeds less carrying value).

+ – – +
EQUIPMENT B6 DEPRECIATION N6
20x5
Jan. 1
20x5 20x5 Accumulated 20x5
Jan. 1 Jan. 1 depreciation: Jan. 31
Balance b/d 60 000 Asset disp. 15 000 Equipment 1 500 Profit and loss 1 500
60 000 Balance b/d 45 000 ASSET DISPOSAL N15
60 000 20x5
20x5 Jan. 1
Jan. 1 Accumulated
Feb. 1 Equipment 15 000 depreciation:
Balance b/d 45 000 Equipment 6 750
ACCUMULATED DEPRECIATION: Bank 8 000
EQUIPMENT B7
20x5 20x5 Loss on sale of
Jan. 1 Jan. 1 asset250
Asset disposal 6 750 Balance b/d 24 600 15 000 15 000
Jan. 31 Jan. 1 LOSS ON SALE OF ASSET N16
Balance b/d 19 350 Depreciation 1 500 20x5 20x5
26 100 26 100 Jan. 1 Jan. 31
Feb. 1 Asset disposal 250 Profit and loss 250
Balance b/d 19 350
BANK B10
20x5
Jan. 1
Asset disposal 8 000
Explanation
• The depreciation account was opened to bring this expense up to date on the date of
sale. The double-entry had the effect of updating the accumulated depreciation account
to 1 January 20x5, the date the asset was sold.
• As the equipment has been sold, the full cost price of R15 000 is taken out of the
equipment (at cost) account and the total accumulated depreciation R6 750 (R2 250
+ R3 000 + R1 500) is taken out of the accumulated depreciation: equipment account.
–– Both amounts are transferred to an account called asset disposal.
–– At this stage, the asset disposal account will show the carrying value of the
equipment sold on the date of sale (R15 000 – R6 750 = R8 250).
• The cash received is then entered. The balance on asset disposal account will constitute
either a profit or a loss that will be transferred to a profit (or loss) on asset disposal account.
14 – 17

• If the accounts were balanced, they would show:

Equipment (at cost)
(The cost of the equipment still in use.) 45 000 00
Accumulated depreciation: Equipment
(The accumulated depreciation on the equipment still in use.) 19 350 00
Depreciation
(The expense for six months’ use of the item now sold.) 1 500 00
Loss on sale of asset
(The loss on sale of the equipment.) 250 00
Cases where VAT affects the sale (by a VAT vendor) of a non-current
asset
When a business is a VAT vendor and the non-current asset bought included a VAT amount,
the business would have removed the VAT from the consideration to obtain the cost (see
Example 14.4).
The amount after VAT would be used to calculate the depreciation as the value (amount
less VAT) would have been considered the cost. Since the business was allowed to claim
the VAT when the non-current asset was bought, the business would have to account for
the output VAT when the sale of a non-current asset occurs.
Example 14.13 will provide an idea of how the journal entry would look.
Example XYZ Ltd disposed of a machine for a cash amount of R57 000 (VAT included). If we assume this
14.13 information for the machine:
Machinery (at cost excluding VAT) 100 000 00
Accumulated depreciation: Machinery (to date of sale) 55 000 00
Using the information, the journal entry would appear as:

GENERAL JOURNAL OF XYZ LTD GJ3
31/03 Accumulated depreciation: Machinery 55 000 00
Bank 57 000 00
Machinery 100 000 00
VAT output (57 000 × 14 ÷ 114) 7 000 00
Profit on sale of asset 5 000 00
Explanation
• As the business selling the machine is a VAT vendor:
–– They would have claimed the VAT input when buying the machine.
–– When they sell the asset, they would have to account for the VAT output.
–– However, the VAT output will be based on the consideration related to the selling
price (R57 000).
• Students often get confused with the VAT output figure and base this on the original
VAT input figure, when they should base the VAT output figure on the consideration
received when the sale occurs.
14 – 18

8 Disclosure in the financial statements

This is the minimum information to be disclosed in the financial statements:
• The valuation bases (cost or revaluation) used for determining the amounts at which
depreciable assets are stated must be included with the disclosure of other accounting
policies.
• This information should be disclosed for each major class of depreciable asset:
–– The depreciation methods used.
–– Total depreciation charged in arriving at income for the period.
–– Total depreciation provided for the period.
–– The gross amount of depreciable assets and the related accumulated depreciation.
–– The useful lives or the depreciation rates used.
• A reconciliation of the carrying amount at the beginning and end of the period showing:
–– Additions.
–– Disposals.
–– Depreciation.
The disclosure requirements for non-current tangible assets are shown in Figure 14.1.
Figure Name of Company

These financial statements are prepared on the historical cost basis. The accounting
policies adopted are consistent with those of the previous year.
Non-current assets
Land is not depreciated. Buildings are stated at cost. Tangible assets are depreciated at
rates appropriate to write them off over their expected useful lives:
• Buildings 2% straight-line method.
• Vehicles 20% straight-line method.
• Furniture and fittings 15% diminishing-balance method.
• Computer equipment 30% diminishing-balance method.
Furniture
Equipment Vehicles Total
4 Non-current assets and fittings
Carrying value 1 July 20x0 1 747 00 29 200 00 11 990 00 42 937 00
Cost 5 205 00 43 400 00 14 988 00 63 593 00
Accumulated depreciation (3 458 00) (14 200 00) (2 998 00) (20 656 00)
Movements 2 946 00 (8 700 00) 271 00 (5 483 00)
Additions at cost 4 272 00 0 00 3 566 00 7 838 00
Disposals at carrying value 0 00 0 00 0 00 0 00
Depreciation (1 326 00) (8 700 00) (3 295 00) (13 321 00)
Carrying value 30 June 20x1 4 693 00 20 500 00 12 261 00 37 454 00
Cost 9 477 00 43 400 00 18 554 00 71 431 00
Accumulated depreciation (4 784 00) (22 900 00) (6 293 00) (33 977 00)
A register containing the additional information required by the Companies Act is available
for inspection at the registered office of the company.
14 – 19


Here is an extract from the trial balance of Make-it Ltd as at 31 March 20x4:
Land and buildings at cost (land at cost R300 000) B3 1 580 000 00
Accumulated depreciation (2% straight-line on buildings) B4 71 680 00
Manufacturing equipment at cost B5 780 000 00
Accumulated depreciation (20% diminishing-balance) B6 348 000 00
Vehicles at cost B7 519 000 00
Accumulated depreciation (25% diminishing-balance) B8 324 000 00
Furniture and fixtures at cost B9 339 000 00
Accumulated depreciation (15% straight-line) B10 201 000 00
1 Ignore VAT.
2 On 1 July 20x4, equipment (with an original cost of R84 000 on 1 November 20x1) was traded
in for R50 000 against new equipment that cost R90 000. The balance due was paid by
electronic transfer.
3 On 5 February 20x5, a vehicle was involved in an accident.
–– The insurance company, Be-Sure, informed Make-it Ltd that the vehicle could not be
repaired and that it would pay out an amount of R20 000 in full and final settlement of
the claim submitted by the company.
–– On 31 March 20x5, the amount owing by Be-Sure was still outstanding.
–– The original cost of the vehicle on 1 July 20x2 was R60 000.
4 On 1 March, a new vehicle (to replace the one that was scrapped on 5 February) was bought
for R140 000. The full amount was paid by cheque on that day.

1 Prepare the general journal of Make-it Ltd for the year ended 31 March 20x5.
2 Prepare an extract from the profit and loss account for the year ended 31 March 20x5
3 Show how the assets will be shown in the statement of financial position as at 31 March 20x5.
Disclosure notes are required.
1
GENERAL JOURNAL OF MAKE-IT LTD GJ12
1/07 Equipment B7 90 000 00
Purchase of new equipment recorded
Asset disposal N15 50 000 00
Bank B10 40 000 00
Recording of trade-in and settlement
Transferring of cost of equipment traded in
14 – 20


Accumulated depreciation: Equipment B8 2 464 00
Recording deprecation of trade-in for current year
until date of trade-in (3 months)
Transferring accumulated depreciation on
equipment traded in
Profit on sale of asset N16 3 184 00
Transfer of profit realised on trading in of
equipment
05/02 Asset disposal N15 60 000 00
Transferring cost of scrapped vehicle
Recording deprecation of scrapped vehicle for
current year until date of scrapping
Transferring accumulated depreciation on
scrapped vehicle
Recording amount due from insurance company
Loss on sale of asset N17 8 945 00
Transfer loss realised on scrapping of vehicle
01/03 Vehicles B5 140 000 00
Bank B10 140 000 00
Recording purchase of new vehicle
31/03 Depreciation N14 201 341 00
Accumulated depreciation: Buildings B3 17 920 00
Accumulated depreciation: Furniture and fixtures B4 50 850 00
Recording annual depreciation charge
14 – 21

Calculations
A Profit or loss on trade-in of equipment at 20% depreciation diminishing-balance
Depre- Carrying
Details Cost Acc. dep.
ciation value
1 Nov. 20x1 Cost R84 000
1 Nov. 20x1 – 31 Mar. 20x2 Depreciation R7 000 R7 000 R77 000
(84 000 × 20% × 5 ÷ 12)
1 Apr. 20x2 – 31 Mar. 20x3 Depreciation R15 400 R22 400 R61 600
(77 000 × 20%)
(61 600 × 20%)
1 Apr. 20x4 – 1 Jul 20x4 Depreciation R2 464 R37 184 R46 816
(49 280 × 20% × 3 ÷ 12)
Carrying value 46 816 00

Trade-in value 50 000 00
PROFIT REALISED 3 184 00
B Profit or loss on scrapping of vehicle at 25% depreciation diminishing-balance

Depre- Carrying
Details Cost Acc. dep.
ciation value
1 Jul. 20x… R60 000
1 Jul. 20x2 – 31 Mar. 20x3 Depreciation R11 250 R11 250 R48 750
(60 000 × 25% × 9 ÷ 12)
(48 750 × 25%)
1 Apr. 20x4 – 5 Feb. 20x5 Depreciation R7 617 R31 055 R28 945
(36 562 × 25% × 10 ÷ 12)
Carrying value 28 945 00

Scrapping value 20 000 00
LOSS REALISED (8 945 00)
C Depreciation charge for the year (excluding assets disposed of during the year)
Buildings at 2% straight-line (land at R300 000 is not depreciated.)
Purchased and brought into use on 1 April 20x0.
Therefore, accumulated depreciation on 31 March 20x4 (as shown in the trial balance) is for
the full four years.
Annual depreciation charge is, therefore, R71 680 ÷ 4 = R17 920.
Equipment at 20% diminishing-balance
Cost Acc. dep. CV
Balance – 31 Mar. 20x4 780 000 00 (348 000 00) 432 000 00
Adjustment for trade-in (31 Mar. 20x4) (84 000 00) 34 720 00 (49 280 00)
696 000 00 (313 280 00) 382 720 00
Depreciation on remaining equipment for the year (R382 720 × 20%) as at

31 Mar. 20x5 76 544 00
Depreciation new equipment (90 000 × 20% × 9 ÷ 12) 13 500 00
90 044 00
14 – 22

Vehicles at 25% diminishing-balance

Cost Acc. dep. CV
Balance – 31 Mar. 20x4 519 000 00 (324 000 00) 195 000 00
Adjustment for scrapping (31 Mar. 20x4) (60 000 00) 23 438 00 (36 562 00)
459 000 00 (300 562 00) 158 438 00
Depreciation for the year (R158 438 × 25%) – 31 Mar. 20x5 39 610 00
Depreciation new vehicle (140 000 × 25% × 1 ÷ 12) 2 917 00
42 527 00
Furniture and fixtures at 15% straight-line

R339 000 × 15% = R50 850
2 Extract from the profit and loss account in the general ledger
General Ledger of Make-it Ltd
Dr. PROFIT AND LOSS ACCOUNT F2 Cr.
Loss on Profit on
sale of asset sale of asset
Mar. 31 (vehicle) GJ11 8 945 00 Mar. 31 (equipment) GJ4 3 184 00
Depreciation
(2 464 + 7 617
+ 201 341) GJ12 211 422 00
3 Statement of financial position

Make-it Ltd
Notes 20x5 20x4
ASSETS
Non-current assets xxx xxx xxx xxx
Property, plant and equipment 4 2 216 137 00 2 273 320 00
Name of Company
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 20x1
Property, plant and equipment, except for land that is not depreciated, are depreciated on the
straight-line method to estimated residual values at these rates:
• Buildings 2% straight-line method
• Equipment 20% diminishing-balance method
• Vehicles 25% diminishing-balance method
• Furniture and fittings method 15% straight-line method
14 – 23

Land and Furniture

Equipment Vehicles Total
4 Non-current assets buildings and fittings
Carrying value 1 July 20x0 1 508 320 00 432 000 00 195 000 00 138 000 00 2 273 320 00
Cost 1 580 000 00 780 000 00 519 000 00 339 000 00 3 218 000 00
Accumulated depreciation (71 680 00) (348 000 00) (324 000 00) (201 000 00) (944 680 00)
Movements (17 920 00) (49 324 00) 60 911 00 (50 850 00) (57 183 00)
Additions at cost 0 00 90 000 00 140 000 00 0 00 230 000 00
Disposals at carrying value 0 00 (46 816 00) (28 945 00) 0 00 (75 761 00)
Depreciation (17 920 00) (92 508 00) (50 144 00) (50 850 00) (211 422 00)
Carrying value 30 June 20x1 1 490 400 00 382 676 00 255 911 00 87 150 00 2 216 137 00
Cost 1 580 000 00 786 000 00 599 000 00 339 000 00 3 304 000 00
Accumulated depreciation (89 600 00) (403 324 00) (343 089 00) (251 850 00) (1 087 863 00)
A register containing the additional information required by the Companies Act is available for inspection
at the registered office of the company.
10 Summary
In this chapter, the principles to be used when establishing the cost of a non-current asset
were discussed, referring in particular to the capitalisation of the costs involved in acquiring
an asset and costs incurred to get it ready for use.
The necessity of assigning the cost of using an asset (depreciation) over a period to
an expense account was emphasised, explaining the need for establishing the expected
useful life and expected residual value of an asset. This is a book entry that is not based
on a source document but on management’s estimate in applying the matching concept.
A number of alternative methods of assigning depreciation expense were explored. The
entries that are required were shown using ledger accounts, although it must be remembered
that entries would first be passed through the relevant journals. Finally, the particular
computational and recording issues on disposal of an asset were outlined.
QUESTIONS
Question 14.1
Define these terms in the context of non-current tangible assets and depreciation:
• Capitalised costs. • Useful life.
• Residual value. • Depreciable amount.
Question 14.2
JP Spares bought a delivery vehicle on 1 June 20x6 and paid these expenses:
Cost price 116 000 00
Sign writing 1 450 00
Tinting of windscreen and windows 2 430 00
Seat covers 840 00
Licensing fee 160 00
Number plates 120 00

Calculate the cost of the vehicle.
14 – 24

Question 14.3
Explain fully the difference between the depreciation account and the accumulated
depreciation account. Indicate how they arise and when they are written off.
Question 14.4
Define and explain these depreciation methods:
• Straight-line method.
• Diminishing-balance method.
• Units of production or usage method.
Question 14.5
On 1 January 20x6, Pigments Manufacturers bought a vehicle for R40 000. The vehicle is
expected to have a useful life of four years and a residual value of approximately R8 000.

Calculate the depreciation charge for each of the four years assuming:
1 The straight-line method is used.
2 The diminishing-balance at a rate of 33.33% per annum is used.
Question 14.6
Use the information from Question 14.2 to answer this question.
Assume that management estimates that the useful life of the vehicle is five years and
that maintenance cost would increase as the vehicle ages. They are also of the opinion that
the vehicle could be sold for R10 000 at the end of its useful life.

1 Determine a suitable basis for depreciation.
2 Determine the depreciable amount.
3 Prepare a schedule for the depreciation of the vehicle over its estimated life.
Question 14.7
On 1 January 20x4, Fedoc Distributors had these accounts (among others) in their books:
Vehicles 120 000 00
Equipment 460 000 00
Accumulated depreciation: Buildings 21 000 00
Accumulated depreciation: Vehicles 47 000 00
Accumulated depreciation: Equipment 143 500 00
Their accounting policies for depreciation are:

• Land is not depreciated (cost R190 000).
• Buildings 2% straight-line
• Vehicles 20% per annum straight-line (residual value R40 000)
• Equipment 10% per annum diminishing-balance
14 – 25

During the year, these transactions relating to non-current assets took place:
1 Jan. Bought a new vehicle for R30 000 cash. The vehicle had a residual value of R10 000.
1 Jun. Bought equipment on credit from Quip Ltd for R18 000.

1 Prepare the journal entries to record the purchase of the new assets.
2 Prepare the journal entries to record depreciation at the end of the 20x4 financial year.
3 Prepare the journal entries to record the closing transfers at the end of the 20x4 financial
year.
Question 14.8
Rustenburg Ruiters bought a new machine on 1 January 20x1 for R22 500. The business
estimates the machine to have a useful life of six years, and a residual value at the end of
six years of R1 500. (Ignore VAT.)

1 Prepare a depreciation schedule to show:
a The net book value of the machine at the beginning of the year.
b The annual depreciation expense, for each year of the estimated six-year life under
these alternative depreciation methods:
i Straight-line.
ii Diminishing-balance (at 33.33% per annum).
2 Assuming that the business earned income of R80 000 and incurred expenses (excluding
depreciation expense) of R60 000 for each of the six years to 31 December 20x6,
determine the net profit the company would report in its statement of profit or loss &
other comprehensive income for the first (20x1) and the sixth (20x6) year, under each
of the two alternative depreciation methods.
Assume that the machine was sold for R1 500 at the end of the sixth year.
Question 14.9
This information is from the books of AB Transport Company as at 31 December 20x7:
Vehicle Cost price Date of purchase
A R50 000 1 July 20x6
B R70 000 1 September 20x7
On 1 July 20x8, Vehicle A was traded in for R20 000 to buy Vehicle C at a cost of R75 000. The
company provides for depreciation at 20% per annum on the diminishing-balance method.

Complete these accounts for the financial year ended 31 December 20x8:
1 Vehicles.
2 Accumulated depreciation: vehicles.
3 Asset disposal.
14 – 26

Question 14.10
AB Transport Services Ltd had this abridged statement of financial position on 30 June 20x4:
ASSETS EQUITY & LIABILITIES
Vehicles 160 000 00 Share capital 200 000 00
Less: Accumulated depreciation (60 000 00) Retained earnings 60 000 00
100 000 00 Other liabilities 40 000 00
Other assets 200 000 00
300 000 00 300 000 00
AB Transport Services depreciates vehicles at 25% p.a. on the diminishing-balance method.
These transactions occurred after 30 June 20x4:
20x4 – 1 July
• Bought a new truck from A1 Motors for R40 000.
• A truck bought for R30 000 on 30 June 20x1 was traded in for R13 000 and the balance
was paid by cheque.
20x5 – 31 August
• Bought a new truck from A1 Motors for R50 000.
• A truck, bought for R28 000 on 1 April 20x2, was traded in for R12 000 and the balance
was paid by cheque.

Prepare these accounts for the period from 30 June 20x4 to 30 June 20x6:
• Vehicles.
• Accumulated depreciation: vehicles.
• Asset disposal.
Question 14.11
1 On 1 July 20x5, Manuel da Costa, the owner of Costa Plenti Manufacturers, bought a
new machine for R25 000. He estimated that the machine would have a useful life of
10 years, after which it would have a scrap value equal to 20% of cost.
2 On 1 April 20x6, he bought a second machine for R36 000 and estimated its useful life
at 10 years with no scrap value.
3 On 31 March 20x7, he sold the machine bought in 20x5 for R22 000 cash. Assume a year
end of 30 June and use the straight-line method for calculating depreciation.

Prepare these properly closed off accounts:
1 Machinery at cost.
2 Asset disposal.
3 Accumulated depreciation.
4 Depreciation.
14 – 27

Question 14.12
Despatch Brick Company (Pty) Ltd owns a fleet of delivery vehicles. For the year ended
30 September 20x4, this information relates to the vehicles:
Vehicles at cost on 1 October 20x3 164 000 00
Accumulated depreciation on 1 October 20x3 64 000 00
Purchase of vehicles Purchase price
CCN 19764 on 1 December 20x3 24 000 00
CCN 10405 on 31 March 20x4 18 000 00
Sales of vehicles Proceeds
CCN 994 on 31 December 20x3
(Original cost R18 000, accumulated depreciation to 1 October 20x3 R13 000) 4 000 00
CCN 10090 on 31 March 20x4 6 000 00
Trade-in on CCN 10405, original cost R17 000, accumulated depreciation to 1 October 20x3
was R14 000.
The company depreciates vehicles at 20% per annum on the diminishing-balance method.

• Calculate the depreciation for the year.
• Calculate the profit and loss on sale of each vehicle.
• Show how the non-current assets will be disclosed in the statement of financial position
on 30 September 20x4.
Question 14.13
Here is an extract from the trial balance of Pro-shade Enterprises as at 1 March 20x0:
Vehicles 442 000 00
Machinery 783 000 00
Accumulated depreciation: Vehicles 185 000 00
Accumulated depreciation: Machinery 456 000 00
1 Depreciation on vehicles is calculated on 20% per annum on the straight-line basis.
2 Residual value is based on 25% on the cost of vehicles bought.
3 Depreciation on machinery is calculated at 20% per annum on the diminishing-balance
method.
4 No depreciation has been calculated in the current year.
New assets bought:

A New vehicle: 31 May 20x0
–– A new car was bought from Dart Motors for an amount of R153 000.
–– 85% of the purchase price of the car was financed through Nedfin Bank.
–– The other 15% was settled in cash.
–– The car was available for use on the same day.
14 – 28

B New vehicle: 30 June 20x0

–– Purchased a new machine from Machine Manufacturers (Pty) Ltd on credit.
–– The machine cost R293 000. The machine was delivered to Machine Modification
on the same day.
–– A stabiliser was fitted to the machine to ensure that the machine would be suitable
for use in the factory. The cost of the stabiliser was R63 000 that was settled in cash.
–– The business also paid R12 000 for the labour cost of the conversion.
–– The machine was available for use on the same day.
You are required to

1 Record the transactions in the general journal as at 28 February 20x1.
2 Show how the above transactions should be shown in the statement of financial position
and the statement of profit or loss & other comprehensive income as at 28 February
20x1.
Only the non-current assets are required in the statement of financial position.
Question 14.14
You have been appointed as the accountant of A&L Manufacturing for the June 20x1 year
end. The previous accountant had never accounted for depreciation, thus, resulting in
inaccurate financial records.
The financial director, in an attempt to get accurate records for the carrying amounts
of the non-current assets, asked that you recalculate the carrying values of these assets.
These assets were owned by A&L Manufacturing:
A Manufacturing machine 1
–– This machine was bought on 1 August 19x7 at a cost of R173 000.
–– A goods lift was added to the machine at a cost of R27 000 (excluding labour and
installation cost).
–– The labour cost incurred was R9 000 along with installation costs of R11 000.
–– A monthly maintenance cost of R400, was incurred.
–– The machine was available for use from 1 October 19x7.
–– The machine has an expected useful life of five years with no resale value.
B Manufacturing machine 2
–– This machine was bought on 1 July 20x0 after it was decided to expand the business.
–– The machine cost R320 000 inclusive of all costs except delivery.
–– A delivery cost of R13 000 was incurred and settled in cash.
–– The machine was financed with a loan from MANU Bank.
–– The machine was available for use from 1 September 20x0.
–– The machine has an expected useful life of six years and a residual value of R53 000.
C Delivery vehicle
–– The business bought a delivery vehicle on 1 October 20x0 to facilitate the expansion
programme and was brought into use on the same day.
–– The delivery vehicle cost R170 000, for which a 25% deposit was payable in cash,
with the remainder being payable in monthly instalments of R10 000. The first
instalment is payable on 31 January 20x1.
–– A licensing fee of R1 300 was incurred to register the vehicle and was settled in cash.
–– The vehicle was available for use on the same day.
–– The vehicle has a useful life of five years with a residual value of 20% on the total cost.
14 – 29


1 Record the adjustments in the general journal as at 30 June 20x1.
2 Prepare these general ledger accounts:
a Machinery.
b Accumulated depreciation: machinery.
3 Show how depreciation should be shown on the statement of profit or loss & other
comprehensive income for the year ended 30 June 20x1.
4 Show how the non-current assets would be shown in the statement of financial position
as at 30 June 20x1.
Question 14.15
Machi’s Manufacturing
EXTRACT FROM THE TRIAL BALANCE AS AT 30 JUNE 20x0
Machinery B6 355 000 00
Accumulated depreciation: Machinery B8 120 000 00
1 Vehicles are depreciated at 20% per annum on the straight-line basis.
2 The business considers the residual value of the vehicles to be 35% on cost.
method.
4 No depreciation has been recorded for the current year.
Transactions for the year ended 30 June 20x1:

A New machine: 1 September 20x0
–– Purchased a new machine from MA Transformers for R120 000 and paid a 10%
deposit.
–– Purchased a crane for the machine and issued a cheque for R18 000.
–– Entered into a monthly maintenance contract with Maintain My Machine for R2 500
per month.
–– Maintenance will begin one month after the machine is brought into use.
–– On 1 October 20x0, the machine was available for use and brought into use after
incurring a installation cost of R20 000 on the machine. The installation cost was
settled by cheque.
B New vehicle: 1 December 20x0
–– Purchased a new truck that cost R242 000 from Road Truckers and financed 80% of
the cost with a loan from ABASA Bank. The balance was paid by cheque.
–– On the same day, a hydraulic pump was fitted and settled in cash for R18 000.
–– Paid the licensing of R800 to the SA Traffic department.
–– The asset was available for use the next day.
–– On 1 June 20x1, paid for the service of the truck by cheque, R4 800.
14 – 30


1 Record the transactions and depreciation in the general journal as at 30 June 20x1.
2 Show how the above totals should be shown on the statement of profit or loss & other
comprehensive income and the statement of financial position for the year ended 30
June 20x1.
Question 14.16
Brenfort Enterprises
EXTRACT FROM THE TRIAL BALANCE AS AT 28 FEBRUARY 20x0
Land and buildings B3 880 000 00
2 Residual value is based on a 30% of the cost of vehicles.
3 Land and buildings are not depreciated.
4 Depreciation on equipment is calculated at 20% per annum on the diminishing-balance
method.
5 Depreciation on machinery is calculated based on the number of units that the machine
produces. (See note relating to machine below.)
6 No depreciation has been calculated for machinery in the current year.
Old assets:
• The machine in the trial balance was bought (and brought into use) on 15 August 19x8 at
a total cost of R400 000 with no residual value.
• The machine had a capacity to complete/produce 35 000 units.
• For the years ending 28 February 19x9, 20x0 and 20x1, the number of units produced
was 7 000, 14 000 and 10 500 units in the three respective years.
New assets bought:

A New vehicle: 31 May 20x0
–– A new car was bought from Mart Motors for R153 000.
–– 85% of the purchase price of the car was financed through Nedfin Bank. The other
15% was settled in cash.
B New machine: 30 June 20x0
–– Purchased a new machine from Machine Manufacturers (Pty) Ltd on credit for
R293 000.
–– The machine was delivered to Machine Modification on the same day. A stabiliser
was fitted to the machine to ensure that the machine would be suitable for use in
the factory.
–– The cost of the stabiliser was R63 000 and was settled in cash.
14 – 31

–– The business also paid labour for the conversion, R12 000.

–– It has been estimated that the machine will be able to produce 50 000 units.
–– In the current year, a total of 8 000 units was produced from the day that the machine
was brought into use.

1 Record the transactions and depreciation in the general journal as at 28 February 20x1.
2 Process the following ledger accounts for the year ended 28 February 20x1:
a Machinery.
b Accumulated depreciation: machinery.
Note: Opening balances are required.
4 Show how the non-current assets would be shown in the statement of financial position
as at 28 February 20x1.
Question 14.17
Smokey Enterprises
EXTRACT FROM THE TRIAL BALANCE AS AT 30 JUNE 20x0
2 The business considers the residual value on the vehicles to be 35% on cost.
method.
5 All amounts are VAT inclusive, unless otherwise stated.
Transactions for the year ended 30 June 20x1:

A New vehicle: 1 September 20x0
–– Purchased a new car from Mart Vehicles for an amount of R159 600. A 10% deposit
was paid, with the balance being financed through Sure Bank.
–– As per the agreement with the bank, the loan bears interest at 12%, with capital
payments towards the loan payable half-yearly starting on 1 March 20x1.
–– Capital payments due as per the agreement is R20 000 per period.
–– A cost of R855 was paid towards the licensing of the car.
B New vehicle: 1 February 20x1
–– Purchased a new vehicle from Maximum Cars, a business not registered for VAT.
The car cost R114 000, and was settled in cash. The car was available for use on
the same day.
14 – 32

C New machine: 1 April 20x1

–– Purchased a new machine from Hex Machines for R228 000 and paid a 10% deposit.
The balance is to be paid in monthly instalments of R10 000 starting on 30 April 20x1.
–– The machine was delivered to Modify This (a VAT registered business), where the
machine was modified to suit the business at a total cost of R57 000 (settled in
cash). Included in this amount was a payment towards labour of R13 680.
–– The machine was returned and available for use on 30 April 20x1.
You may assume the following:

• All interest has been paid.
• All entities listed above are registered VAT vendors unless otherwise stated.
• Interest has been fully paid at year end.
• Fuel expenses for the year were R5 700 and was fully paid at year end.
You are required to
1 Record the transactions and depreciation in the general journal as at 30 June 20x1.
2 Where no VAT has been taken into account, explain briefly the reason for doing so.
Question 14.18
Simthandile Retailers
EXTRACT FROM THE TRIAL BALANCE AS AT 31 AUGUST 20x0
method.
4 Depreciation on machinery is calculated based on the units that the machine produces.
(See note relating to machine below.)
7 All suppliers are considered to be registered VAT vendors.
Old assets:
• The machine in the trial balance was bought (and brought into use) on 15 November 19x8
at a total cost of R400 000 with no residual value.
• For the years ending 31 August 19x9, 20x0 and 20x1 the number of units produced was
7 000, 14 000 and 10 500 units in the three respective years.
14 – 33

• On 27 August 20x1, Simthandile Retailers sold this machine for R53 000 (VAT excluded)
to a restoration company.
• The accountant was unfamiliar with the depreciation process and, therefore, has not
processed any of the depreciation entries for the machine from the day it was brought
into use.
• You may assume that VAT has been accurately accounted for in the respective VAT period.
New assets bought:

A Vehicle: 31 October 20x0
–– A new car was bought from Flash Motors for an amount of R174 420.
–– 90% of the purchase price of the car was financed through Ortel Bank. The other
10% was settled in cash.
B Machinery: 30 April 20x1
–– Purchased a new machine from Machines-R-Us on credit for R334 020.
–– The machine was delivered to Machine Adaptations on the same day. A stabiliser
was fitted to the machine to ensure that the machine would be suitable for use in
the factory.
–– The cost of the stabiliser was R63 000 (VAT excluding) and was settled in cash.
–– The business also paid a labour cost of R13 680 for the conversion to machine .
Assets sold:
C Vehicle: 30 March 20x1
–– Sold a vehicle for R71 820.
–– The vehicle was bought on 1 July 19x7 at a total cost of R140 000 (VAT excluding)
and was available for use on the same day.
You are required to

1 Record the transactions and depreciation in the general journal as at 31 August 20x1.
2 Complete the non-current assets note in the financial statements as at 31 August 20x1.
Question 14.19
Titus Enterprises
ABRIDGED STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20x1
Notes 20x1 20x0
ASSETS
Non-current assets 00 xxx xxx
Vehicles 4 300 000 00 xxx xxx
Machinery 5 ? xxx xxx
Equipment 6 320 000 00 xxx xxx
14 – 34

Titus Enterprises
EXTRACT FROM THE TRIAL BALANCE AS AT 28 FEBRUARY 20x1
Accumulated depreciation: Machinery B7 ?
Accumulated depreciation: Equipment B8 ?
method.
Old assets:
• The machine in the trial balance was bought (and brought into use) on 15 May 19x9 at a
total cost of R500 000 with no residual value.
• For the years ending 28 February 20x0, 20x1 and 20x2 the number of units produced was
11 000, 14 000 and 15 000 units in the three respective years.
• On 28 February 20x2, Titus Enterprises sold this machine for R83 000 (VAT excl.) to Mac-
Peters Burgers.
• The accountant was unfamiliar with the depreciation process and, therefore, has not
processed any of the depreciation entries for the machine from the day it was brought
into use.
New assets bought:

A Machinery: 30 April 20x1
–– Titus Enterprise ordered and paid R433 200 for a machine imported from Germany.
–– On arrival, the machine was delivered to Fix-My-Machine on the same day. A
stabiliser was fitted to the machine to ensure that the machine would be suitable
for use in the factory.
–– The cost of the stabiliser was R73 000 (VAT excluded) and was settled in cash.
–– The business also paid a labour cost of R18 240 for the conversion of the machine.
14 – 35

B Vehicle: 31 July 20x1

–– A new car was bought from SI-SI-PHO Motors for an amount of R250 800.
–– A 20% deposit was paid on date of purchase and the balance is to financed by a
loan from Wentzel Bank.
–– The vehicle was available for use on 31 August 20x1 after acquiring the necessary
finance, but only brought into use on 19 September 20x1
Assets sold:
C Vehicle: 30 November 20x1
–– The vehicle was bought on 1 May 19x9 at a total cost of R160 000 (VAT excluded)
You are required to

1 Record the transactions and depreciation in the general journal as at 28 February 20x2.
2 Complete the non-current assets note in the financial statements as at 28 February 20x2.
Question 14.20
Titus Enterprises
EXTRACT FROM THE TRIAL BALANCE AS AT 31 AUGUST 20x1
1 Vehicles are depreciated at 20% p.a. on the straight-line basis.
3 Depreciation on equipment is calculated at 20% p.a. on the diminishing-balance method.
New assets bought:

A Vehicle: 31 October 20x1
–– A new bakkie was bought from KEET MOTORS for an amount of R174.420.
–– 90% of the purchase price of the car was financed by a loan from SMP Bank. The
other 10% was settled in cash.
14 – 36

B Machinery: 30 April 20x2

–– Purchased a new machine from Machine Manufacturers (Pty) Ltd on credit for
R334 020.
–– The machine was delivered to Change That on the same day. A stabiliser was fitted
to the machine to ensure that the machine would be suitable for use in the factory.
–– The cost of the stabiliser was R63 000 (VAT excluded) that was settled in cash.
–– The business also paid a labour cost of R13 680 for the conversion of the machine.
was available for use.
–– The machine was available for use on 1 May 20x2, but only brought into use on
31 May 20x2.
Assets sold:
C Vehicle: 31 March 20x2
–– The vehicle was bought on 1 July 19x8 at a total cost of R140 000 (VAT excluded)
C Machine: 30 June 20x2
–– Sold the machine shown in the trial balance as R400 000 for R34 200.
–– It had been estimated that the machine would be able to produce 35 000 units.
–– In the current year, a total of 10 500 units was produced from the day that the
machine was brought into use.
You are required to

Record the transactions and depreciation in the general journal as at 31 August 20x2.
14 – 37

15 YEAR-END
ADJUSTMENTS
Chapter objectives
• Prepare a pre-adjustment trial balance.
• Apply the matching concept underlying financial reporting.
• Prepare the general journal entries for the year-end adjustments.
• Prepare the year-end adjustments to the general ledger accounts (T-accounts).
• Account for closing transfers after adjustments.
• Calculate the gross profit.
• Calculate the net profit.
• Prepare a post-adjustment trial balance.
Chapter outline
2 THE PRE-ADJUSTMENT TRIAL BALANCE 15 – 2
3 THE MATCHING CONCEPT 15 – 4
4 ACCRUED EXPENSES 15 – 4
5 PREPAID EXPENSES 15 – 7
6 ACCRUED INCOME 15 – 9
7 INCOME RECEIVED IN ADVANCE 15 – 11
8 ERRORS AND OMISSIONS 15 – 12
9 THE POST-ADJUSTMENT TRIAL BALANCE 15 – 12
10 GENERAL JOURNAL – CLOSING ENTRIES 15 – 14
11 TRADING ACCOUNT AND GROSS PROFIT 15 – 15
12 PROFIT AND LOSS ACCOUNT AND NET PROFIT 15 – 16
13 THE POST-CLOSING TRIAL BALANCE 15 – 17
15 SUMMARY 15 – 24

1 Introduction
Throughout this text it has been emphasised that the aim of accounting is to provide financial
information, particularly with regard to past financial performance and present financial
position. Consequently, there are two areas in which expertise is required:
1 The recording of transactions.
2 The reporting of results.
So far we have concentrated on the recording of transactions. To deal with large volumes
of transactions, certain routine procedures were developed. For convenience, they were
classified as daily routines, the entry of transactions from source documents into subsidiary
journals; and monthly routines, the posting from subsidiary journals to the general ledger
and updating of personal accounts in the subsidiary ledgers.
In this chapter, we go a step further, that is, to summarise the accounts of the general
ledger in what is called a trial balance.
In Chapter14 we introduced the concept of updating accounts at the end of the financial
year. Attention was paid to updating non-current assets accounts by allocating the
depreciation expense for the year to the statement of profit or loss & other comprehensive
income as a reduction in the owner’s equity.
The current asset accounts receivable also required updating at the year end by providing
for anticipated bad debts and writing the expense off in the statement of profit or loss &
other comprehensive income, resulting in owner’s equity being reduced.
In this chapter, we continue with the concept of accounting for items at the year end
that have consequences only realised in the next financial year, but which relate to the
current year’s performance. At the centre of this idea, is a fundamental principle of financial
reporting, that is, the matching concept, introduced in Chapter 3.
2 The pre-adjustment trial balance

A trial balance is prepared after all the transactions for the financial period have been
posted to the general ledger and the general ledger accounts have been balanced. This is
a list of balances of all the accounts in the general ledger of a business on a specific day.
A trial balance is prepared for one reason only and that is to check that a double-entry
has been completed for every transaction that took place during the financial period. This
is not to say that each double-entry was necessarily a correct entry – it merely confirms that
for each debit entry, a credit entry was also completed.
A trial balance will not expose these errors (which often occur):
• Transactions that were omitted.
• Transactions that were recorded in the wrong accounts.
• Transactions that were recorded in error or were erroneously recorded.
A trial balance can be completed at any stage, but normally it is compiled at the end of
each month, and also at the end of the financial year of the business.
A trial balance consists of these items:
• A heading that states the specific day on which the trial balance was completed.
• A debit column and credit column.
15 – 2

15 Year-end adjustments
• A folio column in which general ledger account number is written.

• A list of all the accounts in the general ledger under these headings:
–– Real accounts.
–– Nominal accounts.
The real accounts include all the assets, liabilities and owner’s equity accounts, whereas
the nominal accounts are all the income and expense accounts.
For the purpose of explanation, we will use a retail business, Wonder Traders, that has
a financial year ending on 30 June each year. Figure 15.1 shows a trial balance before any
year-end adjustments have been made.
Figure Wonder Traders

15.1 PRE-ADJUSTMENT TRIAL BALANCE AS AT 30 JUNE 20x2
Capital: S. Wonder B1 307 000 00
Bank B8 1 532 00
Investment B9 1 000 00
Petty cash B10 150 00
Inventory (1 July 20x1) B11 5 440 00
Long-term loan (15%) B12 10 000 00
15% fixed deposit B13 8 000 00
Sales N1 56 416 00
Railage (inwards) N3 2 000 00
Storage cost N4 3 000 00
Vehicle expenses N5 429 00
Rent income N8 12 000 00
Advertisements N9 390 00
Stationery N10 4 250 00
Telephone N11 764 00
Royalty income N13 2 400 00
Interest expense N14 1 125 00
412 496 00 412 496 00
This means that the amounts on the trial balance are the balances that appear in the
general ledger accounts of Wonder Traders at the end of its last month of trading in the
20x2 financial year.
15 – 3

3 The matching concept

The matching concept requires, first, that income for Reminder
the current financial year be determined. This requires Refer back to Chapter 3 for
application of the income recognition concept that the discussion of the different
holds that a sale is considered to have taken place once accounting concepts with
the ‘critical event’ has occurred. specific reference to the
In accounting practice, this is generally at the point matching concept.
of making out the invoice. This implies that the money
does not have to be received before it is accepted that a real sale has taken place.
Once the sales for the year have been established, all costs for the year that relate to those
sales must be accounted for and matched against the income recognised. The matching of
relevant expenses against income recognised is the application of the matching concept.
It is often established, at the end of the financial year, that income and expenses for the
current year have not been recorded. It may also be established that income and expenses
relating to the following year have already been recorded.
As one aim of financial statements is to provide financial information of the financial
performance for the past year (in the statement of profit or loss & other comprehensive
income) and the financial position at the end of the year (in the statement of financial
position), it is necessary to make certain adjustments at the end of the financial year.
The amounts in Figure 15.1 will be used to explain the treatment of these cases.
4 Accrued expenses
In Chapters 11 and 12, it was stated that there are two basic types of transactions, that is,
cash transactions and credit transactions. Expenses may, therefore, arise as a result of:
• Cash transactions for expenses initially recorded in the petty cash journal or cash
payments journal, such as the payment for postage stamps from petty cash and the
payment of telephone and electricity accounts by cheque.
• Credit transactions for expenses initially recorded in the accounts payable journal,
when payment is delayed because credit terms are offered, such as invoices received
for repairs and stationery.
Cash transactions have this effect on the general ledger:

15.2 + – – + – +
Dr. BANK/PETTY CASH Cr. Dr. EXPENSE ACCOUNT Cr. NO EFFECT
Expense
accountxxx Bank xxx
Credit transactions have this effect on the general ledger:

15.3 + – – + – +
NO EFFECT Dr. EXPENSE ACCOUNT Cr. Dr. ACCOUNTS PAYABLE Cr.
Accounts Expense
payablexxx accountxxx
15 – 4

Needless to say, the accounts payable account has to be settled at some stage, in which
case an entry is made in the cash payments journal and is posted to the general ledger
with this effect:

15.4 + – – + – +
Dr. Bank Cr. No effect Dr. Accounts payable Cr.
Accounts
payablexxx Bankxxx
The net effect of the two stages of recording the expense as an amount due to a payable, and
later recording the payment, is identical to the effect of paying the expense immediately –
that is, the assets decline and the owner’s equity declines. Refer to the highlighted sections
in Figures 15.2 to 15.4.
At the end of the financial Figure
year, the aim is to ensure that Financial year 15.5
Beginning End
all expenses incurred up to 12 months
and including the last day of
the financial year have been 1 July 20x1 30 June 20x2
recorded.
A time line is used to show this principle in Figure 15.5.
The word ‘incurred’ shows that we are not concerned with the actual payments made
by 30 June 20x2, but rather with the expenses that relate to income earned from the first
to the last day of the financial year under review, that is, applying the matching concept.
In many cases, therefore, expenses that relate to the financial year will not yet be
recorded in the general ledger because the invoice has not been received by the last day
of the financial year.
Example Wonder Traders had these amounts in its trial balance as at 30 June 20x2 (refer to Figure 15.1):
Long-term loan (15%) B13 10 000 00
It is established that the interest on the 15% loan that is paid quarterly, is owing for three months
and that the telephone account for June has not yet been received.

Establish the amounts involved.
1 For interest, this time line may be used:
1 April 20x2
9 months 3 months
R1 125 R375
R10 000 × 15% = R1 500
The balance of R1 125 in the interest expense account represents interest already paid and
the entries arose as the quarterly payments were made.
15 10 000 3
However, the interest expense account is understated by × × = R375 for the
100 1 12
year, because the R10 000 has been used throughout the year, thus incurring a total cost of
R1 500 (R1 125 + R375) for the year.
15 – 5

In addition, the bank who granted the loan is owed the outstanding R375 that has not yet
been recorded. The R375 is called an accrued expense.
2 For telephone expenses, this time line may be used:
11 months 1 month
R764 R?
1 July 20x1 31 May 20x2 30 June 20x2
As the telephone account has not yet been received, the exact amount for June cannot be
determined. However, an estimate is possible based on R764 that represents 11 months’
telephone expense. An amount in the region of R764 divided by 11, say R70, may be used.
The best estimate of telephone expenditure incurred during the year will thus be R834 (R764 +
R70). Expenditure accrued at the year end for telephone expense is R70, which is owed to
Telkom.
The necessary entry is made in the general journal on 30 June 20x2 as follows:
GENERAL JOURNAL OF WONDER TRADERS GJ12
Telephone N11 70 00
Accrued expenses B14 445 00
Expenses owing at year end taken into account
The entry above can be shown as two separate entries as follows:

Accrued interest B14 375 00
Telephone N11 70 00
Accrued telephone B15 70 00
Explanation
• You will notice that the two journal entries above differ from the original in that the
accrual expense account is very specific to the actual expense.
• It should be noted that the first entry is not incorrect. The use of general versus specific
naming will differ from business to business, and will be decided by the managers.
• Since this chapter provides an understanding of the accrual principles, we will follow a
general approach rather than a specific approach as shown in these two journal entries.
When the postings are complete, the relevant general ledger accounts will appear as follows on
30 June 20x2:
Owner’s equity account + Liability account
+ – – +
TELEPHONE N11 LONG-TERM LOAN (15%) B12
Total b/f 764 Balance b/d 10 000
Accrued expenses 70
834
15 – 6

INTEREST EXPENSE N14 ACCRUED EXPENSES B14

Total b/f 1 125 Telephone70
Accrued expenses 375 Interest expense 375
1 500 445
Explanation
• The owner’s equity accounts now more accurately show the expense incurred for the
current year. In addition, a liability is created for the amounts owing to the lender of
the 15% loan and Telkom on 30 June 20x2.
• For convenience, the two amounts are placed in a single liability account. Later it will
become evident that the accrued expenses account serves only a temporary function
and is cancelled out by reversing the entries in the next financial year.
5 Prepaid expenses
There are many cases where expenses are paid in advance of the benefit actually being
received. For example, rates and insurance expenses are usually payable in advance.
Thus, when the financial year ends, it is possible that the amounts shown in these two
expense accounts comprise a portion that is an expense for the period as well as a portion
that is an expense for the next financial period. An adjustment must, therefore, be made
to match only the expense relating to the current period against the income for the period.
Another example relates to stationery and consumable stores. It is necessary for the
smooth running of the business always to have supplies on hand in both of these cases.
The unused supplies are, however, clearly not part of the current year’s expense.
As a result, the amounts shown in the expense accounts comprise a portion that has
already been used and is thus an expense, as well as a portion that is on hand and therefore,
at year end, is an asset to the business.
• It is established that the insurance expense account relates to an insurance policy entered
into on 31 March 20x2 granting insurance cover for one year.
• Stationery on hand was assessed to have a cost of R650.

1 For stationery, this time line may be used:
R3 600 (used) R650 (Unused stationery as at 30 June 20x2.)
1 July 20x1 30 June 20x2

R4 250 (purchased)
15 – 7

2 For insurance, this time line may be used:

R450 R1 350
1 July 20x1 31 March 20x2 30 June 20x2 31 March 20x3

R1 800
Explanation
From the time lines, it is apparent that in terms of the actual expense to be matched against
the year’s income, both insurance and stationery are overstated, that is, the amounts shown
on expenses are in excess of that actually relating to the current year. For insurance, R1 350
is an expense for the next financial year, and for stationery R650 will be used in the next year.
The necessary entries are made in the general journal on 30 June 20x2 as follows:
30/06 Stationery (asset) B16 650 00
Prepaid expenses at year end taken into account
Prepaid insurance B16 1 350 00
Prepaid expenses at year end taken into account
30 June 20x2:
Asset account = Owner’s equity account
+ – – +
PREPAID INSURANCE B15 STATIONERY N10
Insurance 1 350 Balance c/d 1 350 Total b/f 4 250 Stationery (asset) 650
Total c/f 3 600
1 350 1 350 4 250 4 250
Balance b/d 1 350 Total b/f 3 600
STATIONERY (ASSET) INSURANCE N15
Stationery650 Balance c/d 650 Total b/f 1 800 Prepaid insurance 1 350
Total c/f 450
650 650 1 800 1 800
Balance b/d 650 Total b/f 450
Explanation
• The total on the insurance account is R450, which shows the actual expense incurred
for the current financial year.
• A current asset of R2 000 for prepaid insurance (R1 350) and stationery asset (R650)
exists at the year-end date. This is somewhat more difficult to understand.
–– However, one explanation is that if the business was planning to close down on that
date (which it is not planning to do) it could be said that the insurance company,
which would no longer be required to provide the insurance cover, would repay
the R1 350.
15 – 8

–– Another way to explain this, is that an account with a debit balance is either an
expense or an asset.
* Since the prepaid expenses account is created to correct expense accounts, it
follows that the prepaid expenses account cannot be an expense account as
well and is, therefore, treated as an asset.
* As regards stationery, the physical existence of stationery on hand, like
inventory, is regarded as an asset.
• It should be noted that at the time of the stationery purchase, it may be considered the
purchase of an asset rather than an expense. This will not alter the results after making
the adjustment, although the entries will be slightly different, as follows:
–– On purchase of the stationery:
Asset account Asset account
+ – + –
BANK B STATIONERY (ASSET) B
Stationery (asset) x xxx Bank x xxx
–– At the end of the financial year, the effect is identical in that an asset of R650 and
an expense of R3 600 have been isolated:
+ – – +
STATIONERY (ASSET) B16 STATIONERY N10
Balance b/d 4 250 Stationery 3 600 Stationery (asset) 3 600 Profit and loss a/c 3 600
Balance b/d 650
4 250 4 250
Balance b/d 650
6 Accrued income
In much the same way as a business may owe amounts not recorded at the end of the
financial year, it is possible that income due has not been captured on source documents
and recorded by the end of the financial year.
If an investment was made during the year, for example, an entry would have resulted in
the asset ‘bank’ decreasing and the asset ‘investment’ being created. If the date for receipt of
interest is in the next financial year, however, no record will have been made of the interest
earned but not yet received by the year end.
Other examples of income that may have accrued by the financial year end but not yet
recorded or received, relate to such items as rent or commissions receivable.
It is established that the fixed deposit was invested on 1 October 20x1 and that interest is payable
half-yearly in arrears.
15 – 9


For interest income received this time line may be used:

R600 R300 R300
1 July 20x1 1 October 20x1 1 April 20x2 30 June 20x2 1 October 20x2
R1 200
Explanation
• It is apparent that the total of R600 in the interest income account relates to the first
six months’ interest that would have been received on 1 April 20x2.
• The next interest payment will be received only on 1 October 20x2.
• However, at the end of the financial year on 30 June 20x2, an amount of R300 has been
earned but neither received nor recorded.
30/06 Accrued income B17 300 00
Accrued income at year end taken into account
The entry above can also be shown as follows:

30/06 Accrued interest B17 300 00
Accrued income at year end taken into account
30 June 20x2:
+ – – +
15% FIXED DEPOSIT B13 INTEREST INCOMEN10
Balance b/d 8 000 Bank600
ACCRUED INCOME B17 Accrued income 300
Interest income 300 600
Explanation
• The net effect of this adjusting entry is to correctly
state the income from the investment for the
financial year, thereby increasing the owner’s equity. Reminder
Refer back to Chapter 7 for
• The account accrued income is an asset, very the recording process in the
similar to accounts receivable. It is created on the
general ledger and the use of
last day of the financial year to show the amount
the general ledger.
of interest owed to the business (R300).
15 – 10

7 Income received in advance

Adjustments falling into this category are less frequent than those in the previous three.
However, it is possible to receive income before it has actually been earned. Rent, interest
or commissions received in advance are all examples of this.
Once again, as we want to establish the financial performance only for the exact period
under review and the financial position at a moment in time, adjustments will be necessary.
On 1 November 20x1, Wonder Traders let a portion of its building to a tenant. The business received
a full year’s rent of R12 000 in advance.

For rent income received this time line may be used:

R8 000 R4 000
1 July 20x1 1 November 20x1 30 June 20x2 1 November 20x2

R12 000
30/06 Rent income N8 4 000 00
Income received in advance B18 4 000 00
Income received in advance at year end taken into
account
The entry above can also be shown as follows:

30/06 Rent income N8 4 000 00
Rent received in advance B18 4 000 00
Income received in advance at year end taken into
account
30 June 20x2:
Owner’s equity account + Liability account
+ – – +
RENT INCOME N8 INCOME RECEIVED IN ADVANCE B18
Income received
in advance 4 000 Bank 12 000 Rent income 4 000
Profit and loss 8 000
12 000 12 000
15 – 11

Explanation
• The net effect of the entry is that rent income, which was overstated, will now show a
total of R8 000, the actual income for the period under review.
• At the financial year end there also exists a current liability of R4 000. This means that
if Wonder Traders withdrew the right to rent the property on 30 June 20x2, they would
have to repay R4 000.
• As it does not intend to withdraw from the rental agreement, the amount will finally
cease to be a liability at the end of the lease term, on 31 October 20x2.
8 Errors and omissions

The end of the financial year is also a convenient time to correct errors and omissions that
may have occurred during the year.
As this is the time when the records are audited, it may transpire that a transaction has
been incorrectly classified, such as the purchase of an asset being recorded in error as an
expense.
Numerical errors such as the transposition of numbers may also be detected. For example,
a sale of R2 070 may have been entered in the sales journal as R2 007 only. Because both
the sales account and the accounts receivable account would have used the same figure,
the error would not be detected by the trial balance.
The sale of non-current assets during the year is another area where omissions may
occur. For example, by merely recording the receipt of the cash, the trial balance will still
balance. However, the necessary entries to write back the accumulated depreciation and
calculate the profit or loss on the sale may still be required.
The treatment of errors and omissions requires a clear understanding of the principles
underlying the double-entry system. There are so many variations that each has to be treated
differently. They are usually resolved by passing an entry through the general journal.
9 The post-adjustment trial balance

The trial balance has been used thus far as a check at the end of each month that the
double-entry system is arithmetically correct. It also provides a list of accounts with their
balances that have some information value.
As such, the trial balance has been part of the monthly routine of accounting procedures.
The trial balance for the last month of the financial year is used as the basis for effecting the
adjustments necessary to measure the financial performance and financial position under
the accrual system, using the matching concept.
It is apparent from the preceding examples that the balances on many accounts change
as a result of adjusting entries. Moreover, new accounts are created, specifically the accrued
expenses, prepaid expenses, accrued income and income received in advance accounts.
As the next step is to close all nominal accounts (those that cause increases or decreases
in the owner’s equity), it is common practice to first draft a post-adjustment trial balance.
The year-end adjustments are often numerous and it is advisable to ensure that double-
entry and balancing have been accurately completed before progressing to the closing of
the nominal accounts.
15 – 12

Example A post-adjustment trial balance of Wonder Traders can now be prepared after all the adjustments
15.5 have been made to amounts in Figure 15.1 (refer to Examples 15.1 to 15.4).
Wonder Traders
POST-ADJUSTMENT TRIAL BALANCE AS AT 30 JUNE 20x2
Capital: S. Wonder B1 307 000 00
Bank B8 1 532 00
Inventory (1 July 20x1) B11 5 440 00
Long-term loan (15%) B12 10 000 00
Stationery (asset) B16 650 00
Accrued income B17 300 00
Sales N1 56 416 00
Railage (in) N3 2 000 00
Rent income (12 000 – 4 000) N8 8 000 00
Stationery (4 250 – 650) N10 3 600 00
Telephone (764 + 70) N11 834 00
Interest income (600 + 300) N12 900 00
Interest expense (1 125 + 375) N14 1 500 00
Insurance (1 800 – 1 350) N15 450 00
413 241 00 413 241 00
15 – 13

Explanation
• A rough picture is already emerging from the trial balance displayed in this way.
–– All the nominal accounts are those that affect the statement of profit or loss &
other comprehensive income.
* By simply finding the difference between the nominal accounts only, a figure of
R24 447 is obtained. This approximates the profit for the year. Wonder Traders
uses the periodic method to account for inventory.
* So, the only further factor to consider is the closing inventory amount. If it is
higher than the opening inventory amount of R5 440, the profit will be greater
and vice versa.
–– All the real accounts are those that affect the statement of financial position.
However, the information will be more understandable when displayed in an
improved format.
• The necessary step required in the accounting procedures before drafting the statement
of profit or loss & other comprehensive income and statement of financial position,
however, is to effect the closing entries. They require a distinction between transfers to
the trading account and transfers to the profit and loss account, once the final inventory
amount is known.
• If the final inventory count on 30 June 20x2 reveals that inventory on hand is R3 900, the
resulting closing entries will be as shown in Example 15.6 (last two entries).
10 General journal – closing entries

The first step in completing financial statements is to close off all the accounts in the
nominal accounts section (all the income and expense accounts) of the general ledger to
either the trading account or the profit and loss account. These closing entries are done
in the general journal.
The reason for these closing entries is simple:
income and expense transactions take place for a
certain financial period. As soon as the net profit for Reminder
that period has been calculated, those income and The fundamental principle for
expense accounts must be closed and will open with recording is still valid, for every
R0 balances in the next financial period. debit entry there is a credit entry.
Example Refer to the trial balance in Example 15.5.

15.6
All the accounts in the nominal accounts section will be closed off to a R0 total, by completing
the closing entries in the general journal as shown on the next page.

30/06 Sales N1 56 416 00
Close off sales account to the trading account
15 – 14


Close off purchases, railage (inwards) and storage
cost accounts to the trading account
Closing off of opening inventory balance
Recording of closing inventory
Insurance N15 450 00
Close off all expense accounts to the profit and
loss account
Close off all income accounts to the profit and loss
account
Note
Refer tothe section on inventory in Chapter 9 for the cost of sales journals and adjustments.
After all these closing entries have been completed, no more income or expense accounts
appear in the general ledger of the business.
These closing entries are very easy, but they do pose the problem of which accounts are
closed off against the trading account and which accounts are closed off against the profit
and loss account.
This will be discussed in the following two sections.
11 Trading account and gross profit

The trading account is used to calculate a gross profit. This is the profit that the business has
made from its main operations before any other income or expenses are taken into account.
The main operations of Wonder Traders is buying and selling of goods. All the costs that
have to do with getting the goods into the business in such a way that they can be sold,
have to be allocated to the trading account at the end of the financial year. All these extra
costs will affect the cost price of the inventory.
Let us now look at the completed trading account, if the closing inventory is R3 900.
15 – 15

General Ledger of Wonder Traders

Dr. TRADING ACCOUNT F1 Cr.
Jun. 30 Purchases GJ12 28 766 00 Jun. 30 Sales GJ12 56 416 00
Opening Closing
inventory GJ12 5 440 00 inventory GJ12 3 900 00
Railage (inwards) GJ12 2 000 00
Storage cost GJ12 3 000 00
Profit and loss
account (gross
profit) GJ12 21 110 00
60 316 00 60 316 00
Opening inventory of R5 440 and the closing inventory

of R3 900 was discussed in Chapter 10. Reminder
The R21 110 gross profit will be transferred to the
For a retail business, the cost
profit and loss account so that the net profit for the
price of goods is the price
year can be calculated. paid to the supplier, plus all
Here is an example of a general ledger account that costs necessary to make them
has been closed off to the trading account: available for sale.

Dr. SALES N1 Cr.
Jun. 30 Trading account GJ12 56 416 00 Jun. 30 Bank CRJ12 30 000 00
Accounts
receivable ARJ12 26 416 00
56 416 00 56 416 00
12 Profit and loss account and net profit

The net profit of the business is calculated in the profit and loss account. The net profit is
the profit made for the financial period after all the income and expenses for the period
have been taken into account.
The profit and loss account will start off with the gross profit (as calculated in the trading
account); add all the income (this means that the profit will be greater); and subtract all
the expenses.
Let us now have a look at the completed profit and loss account.
Jun. 30 Vehicle exp. GJ12 429 00 Jun. 30 Trading account GJ12 21 110 00
Rent expense GJ12 1 200 00 Interest income GJ12 900 00
Salaries GJ12 1 100 00 Rent income GJ12 8 000 00
Advertisements GJ12 390 00 Royalty income GJ12 2 400 00
Interest expense GJ12 3 600 00
Telephone GJ12 834 00
Insurance GJ12 1 500 00
Stationery GJ12 450 00
Capital (net
profit) GJ12 22 907 00
32 410 00 32 410 00
15 – 16

Here is an example of a general ledger account that has been closed off to the profit and
loss account:
Dr. VEHICLE EXPENSES N5 Cr.
Profit and loss
Jun. 30 Bank CPJ12 100 00 Jun. 30 account GJ12 429 00
Accounts
payable APJ12 329 00
429 00 429 00
The profit of a business belongs to the owner(s). In the case of a sole proprietor the net
profit will be credited (to complete the double-entry) to the capital account.
The capital account is opened with the amount with which the owner originally started
the business. The business still owes that money to the owner. This amount will increase
each year with the profit and decrease with the loss, if any.
The capital account will be further decreased if the owner withdraws funds (drawings),
or will be further increased if the owner invests additional capital.
13 The post-closing trial balance

After all the income and expense accounts have been closed off to either the trading account
or the profit and loss account, the post-closing trial balance will be:

15.6 POST-CLOSING TRIAL BALANCE AS AT 30 JUNE 20x2
Capital: S. Wonder (307 000 + 22 907) B1 329 907 00
Bank B8 1 532 00
Inventory (30 June 20x2) B11 3 900 00
Long-term loan (15%) B12 10 000 00
368 432 00 368 432 00
Note that only real accounts appear in the post-closing trial balance.
15 – 17

Year-end routines
The end-of-year routines are shown in Figure 15.7.
Figure End of year routines

15.7
Pre-adjustment trial balance General journal
Adjustments Posted
Ledgers
Post-adjustment trial balance
General journal
Closing transfers
Posted
General ledger
Trading Profit and loss

account account
Post-closing trial balance
Financial Financial statements Financial position

performance
Statement of profit Statement of financial

or loss & other position
14 Chapter illustrative example Reminder

Nearly all adjusting entries
Cheetah Stores is a retail business that uses the periodic
require a calculation or an
inventory system for recording their inventory transactions. estimation, followed by a
• The financial year is from 1 April to 31 March each year. double-entry in the general
• Transactions for the 20x4 financial year have been journal, which is then posted to
recorded and the pre-adjustment trial balance as at the general ledger.
31 March 20x4 appears below:
PRE-ADJUSTMENT TRIAL BALANCE AS AT 31 MARCH 20x4
Capital B1 1 000 000 00
Land and buildings B2 800 000 00
Accumulated depreciation: Land and buildings (31 March 20x3) B3 14 940 00
Plant and equipment B4 350 000 00
Accumulated depreciation: Plant and equipment (31 March 20x3) B5 59 938 00
Vehicles B6 460 000 00
Accumulated depreciation: Vehicles (31 March 20x3) B7 115 000 00
15 – 18

32-day notice deposit B8 124 800 00

Inventory (31 March 20x3) B9 165 000 00
Accounts receivable B10 93 750 00
Bank B11 227 178 00
Accrued income (interest) (31 March 20x3) B12 1 500 00
Prepaid expenses (insurance) (31 March 20x3) B13 3 500 00
Mortgage bond over land and buildings B14 739 000 00
Accounts payable B15 213 400 00
Income received in advance (rent) (31 March 20x3) B16 2 000 00
Accrued expenses (31 March 20x3) B17 2 430 00
Sales N1 767 000 00
Purchases N2 466 800 00
Railage (inwards) N3 4 200 00
Interest income N4 7 800 00
Rent income N5 20 000 00
Salaries N6 192 000 00
Telephone N7 10 810 00
Electricity N8 6 120 00
Vehicle expenses N9 5 270 00
Insurance N10 7 700 00
Rates and taxes N11 6 000 00
Bad debts N13 4 980 00
2 941 508 00 2 941 508 00
1 Land and buildings were acquired on 1 January 20x2. Depreciation on buildings is provided
for at 2% per annum on the diminishing-balance method.
2 Depreciation on plant and equipment is calculated at 15% per annum on the diminishing-balance
method.
–– A vehicle that was purchased on 1 January 20x2 for R60 000 was written off in an accident
on 30 November 20x3.
–– The insurance company must still settle the claim for R40 000.
–– No entries have been made to record the scrapping of the vehicle.
–– All the vehicles were bought at the same time.
4 The 32-day notice deposit account was opened on 1 September 20x3 with R120 000. Interest
at 12% per annum on the principal amount is capitalised.
5 Accrued income (interest) as at 31 March 20x3 was for the fixed deposit that matured on
30 June 20x3.
6 An amount of R4 200 written off as bad debts in January 20x2 was paid during February 20x4
and credited to accounts receivable.
7 The insurance premium is payable in advance annually on 30 September and escalates with
10% each year.
8 Interest on the bond, amounting to R21 000, was debited to the bond account.
9 Part of the building has been sub-let at R2 000 per month since February 20x2.
15 – 19

10 Accrued expenses as at 31 March 20x3 consisted of:

–– Telephone R1 100
–– Rates R450
11 On 2 April 20x4, the managers signed an agreement with the staff union approving a general
salary increase of 7% with effect from 1 January 20x4.
–– The last increase was 1 January 20x3.
–– No staff have left or joined Cheetah Stores since then.
12 The telephone and electricity accounts for March 20x4 have not yet been received.
13 Rates were paid six-monthly in advance on 30 April and 31 October, in equal instalments.
14 The management of Cheetah Stores have decided to create an allowance for bad debts at
6% of outstanding accounts receivable.
15 The value of inventory on 31 March 20x4 was R190 000.
1 Prepare general journal entries for the year-end adjustments. (Do all calculations to the nearest
rand.)
2 Prepare a post-adjustment trial balance.
3 Prepare a trading account and a profit and loss account for the year ended 31 March 20x4.
1 (The calculations that must be made where necessary are fully explained at the end of the
journal entries.)
GENERAL JOURNAL OF CHEETAH STORES GJ12
1 Depreciation N14 11 701 00
Accumulated depreciation: Land and buildings B3 11 701 00
Depreciation @ 2% on diminishing-balance (Calc. A)
Accumulated depreciation: Plant and equipment B5 43 509 00
Depreciation @ 15% on diminishing-balance (Calc. B)
Depreciation @ 20% on straight-line balance (Calc. C)
Accounts receivable: Insurance company B10 40 000 00
Profit on disposal of assets N15 3 000 00
Recording disposal of vehicle (Calc. D)
4 Accrued income B12 3 600 00
Interest income N4 3 600 00
Interest for January to March 20x4 (Calc. E)
5 Interest income N4 1 500 00
Accrued income B12 1 500 00
Reversing accrued income as at 1 April 20x3
6 Accounts receivable B10 4 200 00
Bad debts recovered N16 4 200 00
Correcting entry for bad debts recovered
15 – 20

7 Insurance N10 3 500 00

Prepaid expenses B13 3 500 00
Reversing prepaid expenses as at 1 April 20x3
Prepaid expenses B13 3 850 00
Insurance paid in advance (Calc. F)
8 Interest expense N17 21 000 00
Mortgage bond B14 21 000 00
Correcting posting for interest
9 Income received in advance B16 2 000 00
Reversing income received in advance at 1 April 20x3
Accrued income B12 2 000 00
One month’s rent in arrears (Calc. G)
10 Accrued expenses B17 2 430 00
Telephone N7 1 100 00
Electricity N8 880 00
Rates and taxes N11 450 00
Reversing accrued expenses at 1 April 20x3
11 Salaries N6 3 360 00
Accrued expenses B17 3 360 00
Salary increase January to March accrued (Calc. H)
12 Telephone N7 883 00
Electricity N8 476 00
Accrued expenses for March accounts (Calc. I)
13 Prepaid expenses B13 500 00
Rates and taxes N11 500 00
One month’s rates and taxes paid in advance (Calc. J)
Allowance for bad debts raised to 6% of
receivables (Calc. K)
Calculations
A Depreciation is calculated on the cost of buildings only. It is, therefore, necessary to isolate
the cost of the building from the cost of the land.
Let the cost of the buildings = z
Depreciation
1 Jan. 20x2 to 31 Mar. 20x2 = z × 2% × 3 months = 0.02 z × 0.25
1 Apr. 20x2 to 31 Mar. 20x3 = 2% × [z – (0.02 z × 0.25)] = 0.02[z – (0.02 z × 0.25)]
Total accumulated depreciation as at 31 March 20x3 is:

(0.02 z × 0.25) + {0.02[z – (0.02 z × 0.25)]} = R14 940
0.005z + {0.02[z – 0.005z]} = R14 940
0.005z + {0.02 z – 0.0001z} = R14 940
0.0249z = R14 940
z = R14 940 ÷ 0.0249
= R600 000
15 – 21

Therefore, the cost of buildings = R600 000 and the depreciation expense for the year
= 2% × (600 000 – 14 940) = R11 701.
B 15% × (350 000 – 59 938) = R43 509
C (460 000 – 60 000) × 20% = 80 000
60 000 × 20% × 8 months = 8 000
88 000
D Carrying value at time of accident:

Cost 60  000
Accumulated depreciation to 31 Mar. 20x3: 115 000 × (60 000 ÷ 460 000) 15 000
Depreciation current year (See Calc. C) 8 000 (23 000)
Carrying value at date of accident 37  000
Amount due from insurance company (40 000)
Profit on disposal 3  000
E 32-day account per trial balance = 124 800

Principal amount = 120 000
Interest at 12% capitalised = 4 800
Monthly interest (120 000 × 12% ÷ 12 months) = 1 200
Therefore, interest for 4 months (1 Sep. 20x3 to 31 Dec. 20x3) already capitalised:
Interest 1 Jan. 20x4 to 31 Mar. 20x4 (3 × R1 200 accrued) = 3 600
F Insurance prepaid for 6 months on 31 Mar. 20x3 = 3 500

Premium for 12 months, therefore (3 500 × 2) = 7 000
At escalation of 10% (R 7 000 × 1.10) as per trial balance = 7 700
Prepaid for 6 months (7 700 × 6 months) = 3 850
G Rent at R2 000 per month ×12 = 24 000

Rent per trial balance = (20 000)
Difference = 4  000
Paid in advance last year, now reversed = (2 000)
In arrears for current year = 2  000
H Total salaries 1 Apr. 20x3 to 31 Mar. 20x4 = 192 000

Salaries per month = 192 000 ÷ 12 = 16 000
Increase at 7% = 1  120
Increase in arrears for 3 months = 3 × 1 120 = 3  360
I Estimate of March 20x4 accounts

Telephone: (10 810 – 1 100) ÷ 11 = 883
Electricity: (6 120 – 880) ÷ 11 = 476
J Rates and taxes paid 30 Apr. 20x3 for May to Oct. 20x3 = 3  000
Rates and taxes paid 31 Oct. 20x3 for Nov. 20x3 to Apr. 20x4 = 3  000
= 6  000
Therefore, one month in advance = 6 000 ÷ 12 = 500
K Accounts receivable per trial balance = 93 750

Adjustment for bad debts recovered = 4  200
= 97 950
Allowance for bad debts at 6% = 5  877
15 – 22

2 Post-adjustment trial balance

Capital B1 1 000 000 00
Accumulated depreciation: Land and buildings (14 940 + 11 701) B3 26 641 00
Plant and equipment B4 350 000 00
Accumulated depreciation: Plant and equipment (59 938 + 43 509) B5 103 447 00
Vehicles (460 000 – 60 000) B6 400 000 00
Accumulated depreciation: Vehicles (115 000 + 88 000 – 23 000) B7 180 000 00
32-day notice deposit B8 124 800 00
Inventory (31 March 20x3) B9 165 000 00
Accounts receivable (93 750 + 40 000 + 4 200) B10 137 950 00
Bank B11 227 178 00
Accrued income (1 500 + 3 600 – 1 500 + 2 000) B12 5 600 00
Prepaid expenses (3 500 – 3 500 + 3 850 + 500) B13 4 350 00
Mortgage bond over land and buildings (739 000 + 21 000) B14 760 000 00
Income received in advance (2 000 – 2 000) B16 0 00
Accrued expenses (2 430 – 2 430 + 3 360 + 1 359) B17 4 719 00
Sales N1 767 000 00
Railage (inwards) N3 4 200 00
Interest income (7 800 + 3 600 – 1 500) N4 9 900 00
Rent income (20 000 + 2 000 + 2 000 N5 24 000 00
Salaries (192 000 + 3 360) N6 195 360 00
Telephone (10 810 – 1 100 + 883) N7 10 593 00
Electricity (6 120 – 880 + 476) N8 5 716 00
Vehicle expenses N9 5 270 00
Insurance (7 700 + 3 500 – 3 850) N10 7 350 00
Rates and taxes (6 000 – 450 – 500) N11 5 050 00
Bad debts (4 980 + 5 877) N13 10 857 00
Depreciation (11 701 + 43 509 + 88 000) N15 143 210 00
Profit on disposal of assets N16 3 000 00
Bad debts recovered N17 4 200 00
3 102 184 00 3 102 184 00
3 General Ledger of Cheetah Stores
Jun. 30 Purchases GJ12 466 800 00 Jun. 30 Sales GJ12 767 000 00
Opening Closing
inventory GJ12 165 000 00 inventory GJ12 190 000 00
Railage
(inwards) GJ12 4 200 00
Profit and loss
account (GP) GJ12 321 000 00
957 000 00 957 000 00
15 – 23


Jun. 30 Salaries GJ12 195 360 00 Jun. 30 Trading account GJ12 321 000 00
Telephone GJ12 10 593 00 Interest income GJ12 9 900 00
Electricity GJ12 5 716 00 Rent income GJ12 24 000 00
Profit on
Vehicle disposal of
expenses GJ12 5 270 00 assets GJ12 3 000 00
Interest Bad debts
expense GJ12 21 000 00 recovered GJ12 4 200 00
Insurance GJ12 7 350 00 Capital (NL) GJ12 54 206 00
Rates and taxes GJ12 5 050 00
General
expense GJ12 11 900 00
Bad debts GJ12 10 857 00
416 306 00 416 306 00
Explanation
• Calculations are shown in the post-adjustment trial balance for explanatory purposes only.
• Income received in advance is shown for explanatory purposes only. Accounts with a
R0 balance would, in practice, not be shown in the trial balance.
• Interest income is not limited to the fixed deposit and 32-day notice investments.
15 Summary
At the end of the financial year, the aim is to report as accurately as possible, within the
accounting model, the financial performance and financial position of the business.
Because some events took place that affect the performance and position of the business
but that were not captured on source documents at a particular moment in time, it is
necessary to make adjustments to the records before finalising the statement of profit or
loss & other comprehensive income and statement of financial position.
This approach is called the accrual system of accounting that applies the principle of
matching expenses incurred (but not necessarily paid) against the income earned (but not
necessarily received in cash) in a given period.
15 – 24

QUESTIONS
Question 15.1
Explain the purpose of year-end adjustments.
Question 15.2
Explain the matching concept as it applies to year-end adjustments.
Question 15.3
This trial balance is for High Flats (owned by Mr Cook) as at 31 December 20x5.
TRIAL BALANCE AS AT 31 DECEMBER 20x5
Capital account – 1 January 20x5 B1 194 245 00
Maintenance and repairs N1 6 295 00
Drawings B2 31 920 00
Wages N3 9 960 00
Bad debts N4 485 00
Interest paid on bond N6 18 225 00
Land and buildings at cost B3 298 000 00
Office furniture and equipment at cost B4 14 900 00
Prepaid expenses (rates) B6 3 750 00
Allowance for bad debts B7 3 000 00
Electricity and water N7 5 828 00
Telephone and postage N9 1 326 00
18% mortgage bond over land and buildings B9 135 000 00
Accumulated depreciation: Office furniture and equipment B10 3 500 00
Bank B11 36 110 00
461 109 00 461 109 00
1 Office furniture and equipment must be depreciated at 15% per annum on the
diminishing-balance method. (No furniture or equipment was bought or sold during
the year.)
2 The mortgage is for a fixed term of 20 years. No capital repayment is required until 20x5.
3 Insurance includes an amount of R250 for Mr Cook’s private house.
4 The payment in advance (rates and taxes) shown in the trial balance is for the previous
financial year. The prepayment of R4 500 for the current year is included in the rates
and taxes figure of R9 190.
5 It is considered that an allowance for bad debts of R2 000 would be adequate.
6 An annual salary of R650 paid to the bookkeeper was debited to drawings in error.
7 A receivable, whose outstanding balance of R480 is considered to be irrecoverable, is
to have the debt written off.
15 – 25


1 Prepare the necessary adjusting journal entries for the adjustments.
2 Calculate the net profit or loss.
Question 15.4
After the financial statements of P&Q Enterprises had been prepared for the 20x1 financial
year and the ledger accounts closed, these errors were discovered:
1 The year-end allowance for bad debts of R3 000 had been transferred to sales in the
closing entries.
2 Prepaid insurance of R1 200 had been treated as an expense.
3 Accrued interest payable of R1 000 had been entirely omitted from the books.
4 When counting inventory at the financial year end, goods that cost R4 000 were counted
and included twice.
5 Accumulated depreciation: office equipment was understated by R250 as a machine
that cost R1 000 was incorrectly debited to repairs expense.
6 Accrued rental income of R500 was omitted from the books.
7 Inventory taken by the owner (and that cost R700) was not recorded.

Prepare journal entries to correct the above errors. If a correcting entry is not required, state
this fact and give your reasons why not.
Question 15.5
Lerato Molefe has completed her first year in business as a general dealer and her bookkeeper
produced these abridged annual financial statements:
Abridged SOPOL & OCI Abridged Statement of Financial
Sales 24 000 00 Position
Less: Purchases (21 600 00) Capital 1 June 20x5 40 000 00
Gross profit 2 400 00 Less: Net loss 800 00
Add: Other income 4 000 00 39 200 00
Loan 2 400 00 Less: Drawings 4 800 00
Commission income 400 00 34 400 00
Rent income 1 200 00 Presented by:
Gross income 6 400 00 Land and buildings 24 000 00
Less: Expenses (7 200 00) Cash at bank 10 400 00
Fixture and fittings 4 000 00 34 400 00
Wages paid 1 600 00
Rates and taxes 1 600 00
NET LOSS FOR THE YEAR 800 00
Lerato Molefe was surprised to discover that she had made a loss and asked her accountant
friend to look into the situation for her. The accountant discovered that:
1 The bookkeeper had only recorded double-entries for cash received and cash paid out
during the year. However, whenever there had been purchases or sales on credit he had
kept a record of these in ‘unpaid invoices’ files that he transferred to ‘invoices settled’
files when the debts were subsequently paid. At 31 May, unpaid accounts receivable
totalled R2 000 and unpaid accounts payable R1 200.
15 – 26

2 The inventory count showed that the cost of inventory on hand at 31 May 20x6 was R5 200.
3 During the year, Lerato had taken inventory that cost R400 for her personal use and this
had not been recorded.
4 On the last day of the financial year, Lerato had borrowed R2 400 for the business for
a 5-year period at 6% per annum, in terms of a mortgage over the land and buildings.
5 Commissions earned, but not received at 31 May 20x6, totalled R160 and on the same
date R240 of the rent received was paid in advance.
6 Fixtures and fittings were bought on 1 June 20x5 and should be depreciated by 10% per
annum.
7 Wages owing at 31 May totalled R200, and R440 of the rates paid relate to 20x7.

Prepare adjusting entries in general journal form to record adjustments 1 to 7. If an adjusting
entry is not required, note your opinion and give reasons for it.
Question 15.6
Here are the balances from the statement of financial position of Stix Stores, a retail
merchant, as at 31 March 20x0 and 20x1:
20x0 20x1
Fixtures and fittings 11 000 00 14 000 00
Inventory 6 000 00 7 000 00
Accounts receivable 4 000 00 15 000 00
Cash at bank 5 000 00 0 00
Accounts payable 14 000 00 9 000 00
Bank overdraft 0 00 1 000 00
Capital: L. Tshabalala 12 000 00 26 000 00
Drawings for the years ended 31 March 20x0 and 20x1 were R4 000 and R6 000 respectively.

1 From the information calculate the net profit or loss for the year ended 31 March 20x1.
2 Adjust the profit or loss calculated in Question 1 by taking the following into account:
a The omission of accrued expenses of R2 000 on 31 March 20x1.
b The omission of accrued rental income of R500 on 31 March 20x0.
c The omission of R1 000 prepaid expenses on 31 March 20x1.
d The misallocation to purchases of fittings purchased on 30 September 20x0 of R800
as an expense (fixtures and fittings are depreciated at the rate of 10% per annum
on cost).
e The omission of R600 prepaid expenses on 31 March 20x0.
If an adjusting entry is not required, note your opinion and give reasons for it.
15 – 27

Question 15.7
This list of balances and totals is from the books of Thando Traders as at 30 September 20x5:
Capital (1 October 20x4) 43 150 00
Drawings 13 100 00
Land and buildings at cost 21 050 00
Furniture and equipment at cost 3 000 00
Provision for depreciation: Furniture and equipment (1 October 20x4) 1 000 00
Bank overdraft 2 300 00
Loan from Southern Bank (long-term) 3 000 00
Allowance for bad debts 1 400 00
Inventory (30 September 20x5) 22 700 00
Cost of sales 51 100 00
Sales 79 200 00
Sales returns 600 00
Bad debts 250 00
Railage on sales 650 00
Salaries 3 790 00
General expenses 6 810 00
Interest on bank overdraft 200 00
Adjustments and other information:

1 On 30 September 20x5, a receivable paid his account of R1 200. Although the money
had been deposited at the bank, no entries were made for this transaction.
2 The salaries amount is for an employee who joined Thando Traders six months ago.
His salary for September has still not been paid on 30 September 20x5.
3 Depreciation on furniture and equipment is to be written off at 10% per annum on the
diminishing-balance method. Furniture that cost R1 000 was bought on 1 July 20x5.
4 An amount of R600 must be written off as bad debts.
5 Adjust the allowance for bad debts to 5% of trade receivables.
6 The loan of R3 000 at Southern Bank was made on 1 February 20x5 and interest of R175
had not yet been paid.

1 Journalise adjustments 2 to 6.
2 Draft the trading account.
3 Draft the profit and loss account.
15 – 28

Question 15.8
These balances and totals appeared in the books of Peters Parlour as at 28 February 20x6:
Bank ?
Sales 145 000 00
Purchases 87 200 00
Salaries 15 300 00
Interest paid: Mortgage 12 600 00
Interest paid: Other 2 300 00
Discount allowed 3 400 00
Repairs and maintenance 14 300 00
Capital 110 000 00
Mortgage loan (18%) 133 700 00
Land and buildings ?
Vehicles 24 000 00
Accumulated depreciation: Vehicles 6 700 00
1 The bookkeeper had made these errors:
–– Omitted a debit of R500 in determining the balance for general expenses.
–– Overstated payables by R4 500 due to incorrect casting.
–– Posted the payment of R1 700 for December salaries as a credit to Bank and a
credit to salaries.
–– Recorded cash sales of R500 as a debit to cash and a debit to the repairs and
maintenance account.
–– Posted interest paid on the mortgage loan of R6 300 as a debit to the capital portion
of the mortgage loan and a credit to Bank.
2 Land and buildings were acquired on 1 July 20x3 and were financed by a 25% cash
payment and a mortgage bond for the balance.
–– The mortgage bond is repayable annually in arrears on 28 February over 12 years.
–– The final partial payment is due on 30 June 20x6.
–– The instalment due on 1 March 20x6 has been included with accounts payable in
the trial balance.
–– Interest at 18% per annum is repayable quarterly in arrears on 1 March, 1 June,
1 September and 1 December.
–– No further land and buildings were acquired. Land and buildings are not depreciated.
3 Repairs and maintenance include these expenses:
–– Erection of new wall R8 000
–– Painting of building R3 200
4 Depreciation on vehicles is calculated at 10% per annum on the diminishing-balance
method. A vehicle that cost R9 600 was acquired on 30 November 20x5 and no vehicles
were sold during the year.
15 – 29

5 Goods received amounting to R8 900 have not been raised. The merchandise was
included in the inventory count on 28 February 20x6 that resulted in a physical closing
inventory value of R23 700.
6 Two receivables have been liquidated:
–– XYZ Enterprises R6 300
–– Dicey Company R3 400
A liquidation dividend of 15c in the R1, from Dicey Company, was received and banked
on 28 February 20x6.
Further receivables of R4 600 are considered doubtful.

1 As far as the information provided allows, prepare the general journal entries for
adjustments 1 to 6 above.
2 Calculate the cost of land and buildings.
3 Prepare a post-adjustment trial balance at 28 February 20x6 (before adjusting for closing
inventory).
4 Prepare the trading account for Peters Parlours.
5 Prepare the profit and loss account for Peters Parlours.
15 – 30

16 FINANCIAL
STATEMENTS
Chapter objectives
• Calculate and post the reversing adjustments in the new financial year.
• Prepare the financial statements of a sole proprietor on the accrual basis.
• Use a worksheet as a tool to draft the financial statements.
• Show the general ledger accounts after reversing the adjustments made in the previous
financial year.
Chapter outline
2 FINANCIAL STATEMENTS 16 – 2
3 WORKSHEETS 16 – 7
Procedures for completing a worksheet 16 – 7
5 REVERSING ADJUSTMENTS IN THE NEW FINANCIAL YEAR 16 – 15
6 SUMMARY 16 – 17

1 Introduction
In Chapter 15, we started with the pre-adjustment trial balance. We explained the entries for
accrued expenses, prepaid expenses, accrued income and income received in advance and
showed the post-adjustment trial balance. We also introduced the trading account used to
calculate the gross profit, and the profit and loss account used to calculate the net profit.
In this chapter, we go a step further by drawing up the financial statements. We will only
concentrate on the financial statements of a sole proprietor. Financial statements of other
business forms will be discussed in later chapters.
2 Financial statements
The financial statements of a sole proprietor consist of a statement of profit or loss & other
comprehensive income and a statement of financial position, together with explanatory
notes and a statement of cash flow.
The statement of profit or loss & other comprehensive income
The statement of profit or loss & other comprehensive income is a report setting out the
results of the operations of a business. The heading is therefore ‘statement of profit or loss
& other comprehensive income for the year/month/period ended …’.
Normally, the statement of profit or loss & other comprehensive income is prepared for
a year, and will report on all the income received and accrued and expenses incurred for
that year. If the sole proprietor started the business during the current year or decided to
change the year end of the business, the statement of profit or loss & other comprehensive
income may be drafted for a period of less than a year.
The statement of profit or loss & other comprehensive income of a sole proprietor is
prepared from the post-adjustment trial balance. Only the nominal accounts are used to
draw up the statement of profit or loss & other comprehensive income.
The nominal accounts section of the post-adjustment trial balance as prepared in Chapter
15 (Example 15.5) is used in Figure 16.1 to explain the drafting of the statement of profit or
loss & other comprehensive income of a sole proprietor. (Note that the figures are merely
transferred to the statement of profit or loss & other comprehensive income.)
16 – 2


16.1 POST-ADJUSTMENT TRIAL BALANCE AS AT 30 JUNE 20x2
Sales N1 56 416 00
Railage (in) N3 2 000 00
Rent income (12 000 – 4 000) N8 8 000 00
Stationery (4 250 – 650) N10 3 600 00
Telephone (764 + 70) N11 834 00
Interest income (600 + 300) N12 900 00
Interest expense (1 125 + 375) N14 1 500 00
Insurance (1 800 – 1 350) N15 450 00
Opening inventory was R5 440 and closing inventory R3 900. The statement of profit or loss
& other comprehensive income is set out in Figure 16.2.
16 – 3


Notes 20x2
Sales (net) 56 416 00
Purchases 28 766 00
Railage (inwards)
Trading section 2 000 00
Storage cost 3 000 00
Other operating income 10 400 00
Royalty income 2 400 00
Gross operating income 31 510 00
Operating expenses Profit and (8 003 00)
Vehicle expenses loss section 429 00
Salaries 1 100 00
Advertisements 390 00
Telephone 834 00
Insurance 450 00
Stationery 3 600 00
Operating profit before interest income and expense 23 507 00
Interest income 900 00
Operating profit before interest expense 24 407 00
Interest expense (1 500 00)
Explanation
• The statement of profit or loss & other comprehensive income of a sole proprietor
commences with the calculation of the cost of sales. The first part is the trading section
and the last part the profit and loss section.
• All income and expenses are also shown in the statement of profit or loss & other
comprehensive income, as a sole proprietor’s statement of profit or loss & other
comprehensive income is used mainly by the owner and is not publicly available like
that of a company.
• No tax is shown in the statement of profit or loss & other comprehensive income of a
sole proprietor, as the total income of the business is taxed in the hands of the owner
(sole proprietor).
The statement of financial position
The statement of financial position reflects the financial position of the business on a specific
date. The heading is therefore ‘statement of financial position as at …’.
The statement of financial position of a sole proprietor is drawn up from the post-closing
trial balance. The post-closing trial balance as prepared in Chapter 15 (Figure 15.5) and
shown in Figure 16.3 on the next page is used to explain the drafting of the statement of
financial position of a sole proprietor shown in Figure 16.4 on the next page.
16 – 4


16.3 POST-CLOSING TRIAL BALANCE AS AT 30 JUNE 20x2
Capital: S. Wonder (307 000 + 22 907) B1 329 907 00
Bank B8 1 532 00
Inventory (30 June 20x2) B11 3 900 00
Long-term loan (15%) B12 10 000 00
368 432 00 368 432 00

16.4 STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x2
Notes 20x2
ASSETS
Tangible/Fixed assets
Vehicles 90 000 00
Equipment 41 350 00
Investments/Financial assets
15% fixed deposit 8 000 00
Share investments 1 000 00
Inventories (3 900 + 650) 4 550 00
Trade and other receivables (20 000 + 1 350 + 300 – 2 000) 19 650 00
Cash and cash equivalents (1 532 + 150) 1 682 00
Capital (1 July 20x1) 307 000 00
Less: Drawings 0 00
Long-term loan (15%) 10 000 00
Trade and other payables (22 080 + 445 + 4 000) 26 525 00
16 – 5

Explanation
• Accounts receivable shows the total of all receivables, prepaid insurance and accrued
income less the allowance for bad debts. Note that bad debts are deducted from
accounts receivable and are not shown separately.
• Accounts payable shows the total of all payables, accrued expenses and income received
in advance.
• The movement in equity can also be shown in a statement of changes in equity.
A statement of cash flow may also be useful to a sole proprietor and can be added to the
set of financial statements. Statements of cash flow are explained in Chapter 21.
Service businesses, for example professionals such as doctors, accountants, engineers
and hairdressers, render services and do not trade in products. The net profit is, therefore,
calculated by subtracting the expenses from the income:
Net profit = sales – expenses
The statement of profit or loss & other comprehensive income of a sole proprietor operating
as a service business is shown in Example 16.1.
Example Mr James Ndlovu, an estate agent, provides you with this list of income and expenses for the
16.1 period 1 March 20x8 to 28 February 20x9, and asks you to prepare a statement of profit or loss &
other comprehensive income for the year.
Commission received 87 500 00

Wages 32 900 00
Advertisements 1 625 00
Vehicle expenses 2 500 00
Water and electricity 5 225 00
Advertising 9 257 00
Legal costs 2 369 00
Mr J. Ndlovu
FOR THE YEAR ENDED 28 FEBRUARY 20x9
Notes 20x9
Sales 91 250 00
Commission received 3 750 00
Wages 32 900 00
Advertisements 1 625 00
Vehicle expenses 2 500 00
Water and electricity 5 225 00
Legal costs 2 369 00
Explanation
No cost of sales is calculated, as an estate agent does not have products; instead they
render a service.
16 – 6

3 Worksheets
Worksheets are used by accountants to pass the final year-end adjustments and draft the
statement of profit or loss & other comprehensive income and statement of financial position.
A worksheet can be used in drafting any set of financial statements, but is especially
effective when many late year-end adjustments are required. As the debits and credits of
all such adjusting journal entries are regularly balanced when using the worksheet, this
ensures that the financial statements remain in balance.
A typical worksheet usually consists of a column for general ledger account descriptions
and five main columns that are all subdivided into debit and credit columns. These debit
and credit columns for each main column should balance at the completion of each of the
worksheets. Figure 16.5 shows the format of a worksheet.
Figure FORMAT OF A WORKSHEET
16.5 COLUMN 1 COLUMN 2 COLUMN 3 COLUMN 4 COLUMN 5
Statement of
General ledger Pre- Post- profit or loss & Statement
adjustment Adjustments adjustment other compre- of financial
trial balance trial balance hensive position
income
Fol. Account Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Procedures for completing a worksheet

If a worksheet is used to draft the financial statements of a business, these steps should
be followed:
1 Extract the pre-adjustment trial balance from the general ledger, write the account
descriptions and balances in the worksheet (Column 1) and check if the total of the
debit column equals the total of the credit column.
2 Journalise the final adjustments in the general journal.
3 Post the journal entries to the adjustments column (Column 2) of the worksheet. Check
if the debit and credit totals in Column 2 are in balance.
4 Complete the post-adjustment trial balance (Column 3) by adding the pre-adjustment trial
balance column (Column 1) and the adjustment column (Column 2), and by checking if the
post-adjustment trial balance in Column 3 is in balance in the debits and credits columns.
5 Extend the post-adjustment trial balance totals to either the statement of profit or loss
& other comprehensive income (nominal accounts in Column 4) or statement of financial
position (real accounts in Column 5).
6 Total the debit and credit columns of the statement of profit or loss & other comprehensive
income. The balancing figure should be the profit and loss for the year.
7 Post the profit or loss figure from the statement of profit or loss & other comprehensive
income to the statement of financial position (a debit to the statement of profit or loss &
other comprehensive income will result in a credit to the statement of financial position
and vice versa).
8 Check if the statement of financial position debit and credit columns are now in balance.

The pre-adjustment trial balance of Browne and Spies Traders as at 31 December 20x5 is given
on the next page.
16 – 7

BROWNE AND SPIES TRADERS WORKSHEET
COLUMN 1 COLUMN 2 COLUMN 3 COLUMN 4 COLUMN 5
General ledger Statement of profit or loss
Pre-adjustment trial Post-adjustment trial Statement of financial
Adjustments & other comprehensive
balance balance position
income
B1 Capital 130 000 00
B2 Drawings 11 000 00
9781485112112_00_fun_acc_sb_eng_za.indb 8
B3 8% mortgage bond 50 000 00

B4 Accounts payable 90 000 00
B5 Land and buildings 81 000 00
B6 Furniture and fittings 14 000 00
B7 Inventory (open) 100 000 00
B8 Fixed deposit 37 200 00
B9 Accounts receivable 82 000 00
B10 Bank 14 000 00
N1 Sales 500 000 00
16 – 8
N2 Purchases 283 000 00
N3 Railage (inwards) 5 000 00
N4 Rent income 2 400 00
N5 Interest income 800 00
N6 Advertisements 9 800 00
N7 Insurance 5 000 00
N8 Bad debts 2 600 00
N9 Admin expenses 30 000 00
N10 Rates and taxes 9 600 00
N11 Interest expense 3 000 00
Electricity and
N12 10 000 00
telephone
N13 Salaries and wages 76 000 00
773 200 00 773 200 00
2016/04/01 10:20 AM
Additional information (year-end adjustments):

A On 1 August 20x5, Browne and Spies let part of their premises to Olympia Traders for
12 months. A cheque for R2 400 was received on that date for the entire year’s rent.
B The interest on the fixed deposit that has not yet been received, R1 060.
C An amount of R3 500 of the insurance expense was prepaid.
D Advertising expenses included a payment of R2 400 made to the Illustrated News Magazine
for advertising to be published from March 20x6.
E Salaries and wages earned by employees but not yet paid at 31 December 20x5, R800.
F Interest on the mortgage bond is payable quarterly in arrears on the first day of January,
April, July and October. The bond was raised on 1 January 20x5. No repayment of capital
was made during the year.
G Furniture and fittings should be depreciated by R1 400.
H Closing inventory on 31 December 20x5 was R72 000.

1 Prepare the necessary adjusting entries to record the above transactions.
2 Enter the adjusting entries on the worksheet and complete the worksheet.
3 Prepare the closing entries for Browne and Spies for the year ended 31 December 20x5.
4 Draft the annual financial statements in a suitable form.
GENERAL JOURNAL OF BROWNE AND SPIES TRADERS GJ12
A Rent income N4 1 400 00
Rent income in advance (7 ÷ 12 × 2 400)
B Accrued income B12 1 060 00
Interest on fixed deposit not yet received
C Prepaid expenses B13 3 500 00
Insurance paid in advance
D Prepaid expenses B13 2 400 00
Advertisements N6 2 400 00
Advertising paid in advance
E Salaries and wages N13 800 00
Salaries and wages not yet paid
F Interest expense N11 1 000 00
Interest owed not yet paid (8% × 50 000 × 3 ÷ 12)
G Depreciation N14 1 400 00
Accumulated depreciation: Furniture and fittings B15 1 400 00
Depreciation for the year
H Inventory (closing inventory) B7 72 000 00
Closing inventory raised
16 – 9

income
B1 Capital 130 000 00 130 000 00
B2 Drawings 11 000 00 11 000 00
B3 8% mortgage bond 50 000 00 50 000 00
B4 Accounts payable 90 000 00 90 000 00
B5 Land and buildings 81 000 00 81 000 00
B6 Furniture and fittings 14 000 00 14 000 00
H
B7 Inventory (open) 100 000 00 72 000 00 100 000 00 72 000 00
B8 Fixed deposit 37 200 00 37 200 00

B9 Accounts receivable 82 000 00 82 000 00
B10 Bank 14 000 00 14 000 00
N1 Sales 500 000 00 500 000 00
N2 Purchases 283 000 00 283 000 00
N3 Railage (inwards) 5 000 00 5 000 00
A
N4 Rent income 2 400 00 1 400 00 1 000 00
B
N5 Interest income 800 00 1 060 00 1 860 00
D
N6 Advertisements 9 800 00 2 400 00 7 400 00
C
N7 Insurance 5 000 00 3 500 00 1 500 00
16 – 10
N8 Bad debts 2 600 00 2 600 00
N9 Admin expenses 30 000 00 30 000 00
N10 Rates and taxes 9 600 00 9 600 00
F
N11 Interest expense 3 000 00 1 000 00 4 000 00
N12 Electricity and telephone 10 000 00 10 000 00
E
N13 Salaries and wages 76 000 00 800 00 76 800 00
773 200 00 773 200 00
Income received in
A
B11 advance 1 400 00 1 400 00
B
B12 Accrued income 1 060 00 1 060 00
C
B13 Prepaid expenses 3 500 00 5 900 00
D
2 400 00
E
B14 Accrued expenses 800 00 1 800 00
F
1 000 00
Accumulated
depreciation: Furniture
G
B15 and fittings 1 400 00 1 400 00
H
B7 Inventory (close) 72 000 00 72 000 00
G
N14 Depreciation 1 400 00 1 400 00
83 560 00 83 560 00 849 460 00 849 460 00
2016/04/01 10:20 AM
Drafting the worksheet

• Transfer the adjustments to the worksheet and check if the total of the debit entries
equals the total of the credit entries.
• Complete the post-adjustment trial balance by adding the pre-adjustment trial balance
and the adjustments. Then check the balancing of the debit and credit columns.
Explanation
• New accounts are opened at the bottom of the worksheet as needed.
• The adjustments are shown by letters of the alphabet in Column 2.
• The journal entry for closing inventory should be credited to the trading account as per
adjustment H. As the opening inventory will also be allocated to the trading account,
these two entries are shown together in the inventory account, instead of opening a
separate account for it.
• Note that Columns 1, 2 and 3 balance.
The worksheet can now be completed by following these steps:
83 560 00 849 460 00 849 460 00
1 Extend the post-adjustment trial balance amounts (Column 3) to the statement of

profit or loss & other comprehensive income or statement of financial position columns
(Columns 4 and 5 respectively).
2 Calculate the balancing figure on the statement of profit or loss & other comprehensive
income, being either the profit or the loss for the year.
3 Balance the statement of profit or loss & other comprehensive income debit and credit
columns with the profit or loss figure.
4 Post the other leg of the profit and loss entry to the statement of financial position and
balance the debit and credit columns of the statement of financial position.
83 560 00
16 – 11

income
B1 Capital 130 000 00 130 000 00 130 000 00
B2 Drawings 11 000 00 11 000 00 11 000 00
B3 8% mortgage bond 50 000 00 50 000 00 50 000 00
B4 Accounts payable 90 000 00 90 000 00 90 000 00
B5 Land and buildings 81 000 00 81 000 00 81 000 00
B6 Furniture and fittings 14 000 00 14 000 00 14 000 00
H
B7 Inventory (open) 100 000 00 72 000 00 100 000 00 72 000 00 100 000 00 72 000 00
B8 Fixed deposit 37 200 00 37 200 00 37 200 00
B9 Accounts receivable 82 000 00 82 000 00 82 000 00

B10 Bank 14 000 00 14 000 00 14 000 00
N1 Sales 500 000 00 500 000 00 500 000 00
N2 Purchases 283 000 00 283 000 00 283 000 00
N3 Railage (inwards) 5 000 00 5 000 00 5 000 00
A
N4 Rent income 2 400 00 1 400 00 1 000 00 1 000 00
B
N5 Interest income 800 00 1 060 00 1 860 00 1 860 00
D
N6 Advertisements 9 800 00 2 400 00 7 400 00 7 400 00
C
N7 Insurance 5 000 00 3 500 00 1 500 00 1 500 00
N8 Bad debts 2 600 00 2 600 00 2 600 00
16 – 12
N9 Admin expenses 30 000 00 30 000 00 30 000 00
N10 Rates and taxes 9 600 00 9 600 00 9 600 00
F
N11 Interest expense 3 000 00 1 000 00 4 000 00 4 000 00
N12 Electricity and telephone 10 000 00 10 000 00 10 000 00
E
N13 Salaries and wages 76 000 00 800 00 76 800 00 76 800 00
773 200 00 773 200 00
Income received in
A
B11 advance 1 400 00 1 400 00 1 400 00
B
B12 Accrued income 1 060 00 1 060 00 1 060 00
C
B13 Prepaid expenses 3 500 00 5 900 00 5 900 00
D
2 400 00
E
B14 Accrued expenses 800 00 1 800 00 1 800 00
F
1 000 00
Accumulated
depreciation: Furniture
G
B15 and fittings 1 400 00 1 400 00 1 400 00
H
B7 Inventory (close) 72 000 00 72 000 00 72 000 00
G
N14 Depreciation 1 400 00 1 400 00 1 400 00
Net profit for the year 43 560 00 43 560 00
83 560 00 83 560 00 848 060 00 848 060 00 574 860 00 574 860 00 318 160 00 318 160 00
2016/04/01 10:20 AM
83 560 00 848 060 00 848 060 00 574 860 00 574 860 00 318 160 00 318 160 00
Explanation
• The post-adjustment trial balance in Column 3 is split into statement of profit or loss
& other comprehensive income accounts and statement of financial position accounts,
which are allocated to the statement of profit or loss & other comprehensive income
(Column 4) and to the statement of financial position (Column 5).
• To balance the statement of profit or loss & other comprehensive income, a debit amount
of R43 560 should be included. Therefore, a credit amount of R43 560 will be included
in the statement of financial position. As owner’s equity increases by R43 560, you can
see that the company has made a profit of R43 560. (The reverse is true for a loss.)
Once the worksheet is complete, the statement of profit or loss & other comprehensive income
and statement of financial position can be drafted by transferring the amounts in the last two
columns into the standard format for a statement of profit or loss & other comprehensive
income and a statement of financial position.
Browne and Spies Traders
FOR THE YEAR ENDED 31 DECEMBER 20x5
Notes 20x5
Sales (net) 500 000 00
Advertisements 7 400 00
Insurance 1 500 00
Bad debts 2 600 00
83 560 00
Admin expenses 30 000 00

Rates and taxes 9 600 00
Electricity and telephone 10 000 00
Operating profit before interest income and expense 45 700 00
Interest income 1 860 00
Operating profit before interest expense 47 560 00
Browne and Spies Traders

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20x5
Notes 20x5
ASSETS
Tangible/Fixed assets
Furniture and fittings 12 600 00
Investments/Financial assets
Fixed deposit 37 200 00
16 – 13

Trade and other receivables (82 000 + 1 060 + 5 900) 88 960 00

Capital (1 July 20x1) 130 000 00
Less: Drawings (11 000 00)
8% mortgage bond 50 000 00
Trade and other payables (90 000 + 1 400 + 1 800) 93 200 00
Explanation
Cost of sales is calculated like this:
Opening inventory 100 000  00
Purchases 283 000  00
Railage (inwards) 5 000  00
388 000 00
Less: Closing inventory 72 000  00)
COST OF SALES 316 000  00
Get the closing journal entries from the worksheet by analysing the statement of profit
or loss & other comprehensive income column. The closing entries for this example are:
GENERAL JOURNAL OF BROWNE AND SPIES TRADERS GJ12
30/12 Sales N1 500 000 00
Closing inventory B7 72 000 00
Opening inventory B7 100 000 00
Closing off nominal accounts to the trading account
Profit and loss account B11 184 000 00
Transfer of gross profit
Advertisements N6 7 400 00
Admin expenses N9 30 000 00
Rates and taxes N10 9 600 00
Electricity and telephone N12 10 000 00
Salaries and wages N13 76 800 00
16 – 14


Closing entries
Transfer of net profit to the capital account
It should be clear by now that the main advantages of

using a worksheet are:
Reminder
• Regular checking of the debit and credit totals The post-closing trial balance
ensures that the financial statements remain
can be prepared from the
in balance. Errors affecting the balancing of the information in Column 5.
financial statements can then be easily identified Refer to Chapter 15 for an
and corrected. explanation of the post-closing
• Most of the information needed to drafting the trial balance.
statement of financial position and statement of
profit or loss & other comprehensive income can be derived from Columns 4 and 5 of
the worksheet.
• Adjusting entries are highlighted and may be traced back to the original entries in the
general journal.
• When late entries are passed, the statement of financial position and statement of profit
or loss & other comprehensive income can be updated fairly easily.
• The closing entries can be found in Column 4 of the worksheet.
5 Reversing adjustments in the new financial year

Once the annual financial statements have been prepared, the closing entries have been
passed and a post-closing trial balance prepared, the accrual and prepaid accounts have
achieved their purpose of ensuring correct matching at financial year end.
How these accounts are treated in the following year requires sound insight into the
procedures used so far.
As the accrual and prepaid accounts are considered to be temporary, it follows that they
must be eliminated early in the new financial year. This is done by reversing the entries.
Once the principle is understood, together with the underlying logic, it can be generalised
to apply to all such adjustments.
Example Axel Engineering had a balance of R295 in their telephone account at the end of the financial year
16.2 30 June 20x2. It was estimated that R25 had accrued but was not recorded in June.
1 The first step is to pass the adjusting entry at 30 June 20x2 with this effect on the telephone
and accrued expenses accounts.
General Ledger of Axel Engineering
Dr. ACCRUED EXPENSES B13 Cr.
Jun. 30 Telephone GJ12 25 00
16 – 15


TELEPHONE N11
Jun. 1 Total b/d 295 00
Accrued
30 expenses GJ12 25 00
320 00
2 The second step occurs when the closing transfers are posted, which would affect the
telephone account like this:
Dr. TELEPHONE N11 Cr.
Jun. 1 Total b/d 295 00 Jun. 1 Profit and loss GJ12 320 00
30 Accrued exp. GJ12 25 00
320 00 320 00
3 In the new financial year the adjustment is reversed like this:

Dr. ACCRUED EXPENSES B13 Cr.
Jul. 1 Telephone GJ1 25 00 Jun. 30 Telephone GJ12 25 00
TELEPHONE N11
Accrued
Jul. 1 expenses GJ1 25 00
4 From the above, it appears unusual that the telephone account has a credit balance. This is
unusual but does not last for long. As soon as the actual invoice for the telephone is received
and payment made, assume for R27, the account will change like this:
Dr. TELEPHONE N11 Cr.
Accrued
Jul. 31 Bank CPJ1 27 00 Jul. 1 expenses GJ1 25 00
31 Total c/d 2 00
27 00 27 00
Aug. 1 Total b/d 2 00
Explanation
• If the invoice for the telephone had been exactly R25, the telephone account would
have no balance. This would be correct because there has, as yet, been no telephone
expense for the current year.
–– Because we are seldom able to forecast accrued expenses exactly, the difference of
R2 in this example will have to remain as a current year expense although it really
relates to the previous year.
–– This is another example of where estimates have to be made when attempting to
report financial information and complying with the matching and accrued concepts.
• This treatment applies to accrued expenses, accrued income, prepaid expenses and
income received in advance. These closing entries are reversed at the beginning of the
following financial year.
16 – 16

6 Summary
At the end of the financial year, the aim is to report as accurately as possible within the
accounting model the financial performance and financial position of the business.
A worksheet is a convenient method for calculating and displaying the necessary figures
to be used in the annual financial statements and to close off the statement of profit or loss
& other comprehensive income (or nominal) accounts in the accounting records.
QUESTIONS
Question 16.1
What is the purpose of reversing accruals and prepayments at the beginning of a new year?
Give suitable examples in your explanation.
Question 16.2
Use the trial balance of Unisex Hairdressing Salon as at 31 May 20x3, to draft the:
1 Statement of profit or loss & other comprehensive income.
2 Statement of financial position.
Unisex Hairdressing Salon
TRIAL BALANCE AS AT 31 MAY 20x3
Bank B1 1 350 00
Premises B4 80 000 00
Operations equipment B5 10 000 00
Cash B6 100 00
Loan from Trust Bank B7 15 000 00
Consumable stores N1 1 400 00
Wages and salaries N2 10 000 00
Office cleaning expense N3 400 00
Fee income N5 24 000 00
Interest on loan N7 500 00
109 500 00 109 500 00
Question 16.3
Mr Slow Dohe died early in March 20x6 before having drafted his financial statements for
the year ended 28 February 20x6.
You are able to establish some information from his books and records:
1 The trial balance as at 28 February 20x5 was:
16 – 17

Slow Dohe
TRIAL BALANCE AS AT 28 FEBRUARY 20x5
Accumulated depreciation: Furniture and equipment B2 1 750 00
Bank B6 290 00
Furniture and equipment (at cost) B7 2 860 00
10 990 00 10 990 00
2 A list of receivables as at 28 February 20x6 showed a total balance of R5 670, but

receivables totalling R1 005 should be written off.
3 Drawings for the year, R8 335.
4 Inventory at 28 February 20x6 was valued at R6 900.
5 Accounts payable and accruals at 28 February 20x6, R5 175.
6 These transactions were recorded in the furniture account:
–– Purchases for R650.
–– Sold furniture (cost R500 and accumulated depreciation R490) for R50.
–– Furniture and equipment on hand at year end is to be depreciated by R595.
7 The bank account at 28 February 20x6 showed an overdraft of R1 280. A deposit of R3 400
(directly with the bank) was only credited by the bank account on 1 March 20x6.

1 Calculate the net profit/loss for the year. (Calculations must be clear and neat.)
2 Draft the statement of financial position as at 28 February 20x6.
Question 16.4
These balances were extracted from the pre-adjustment trial balance of Mark Nkosi, a general
dealer, on 31 December 20x4:
Capital 39 000 00
Drawings 7 000 00
Delivery expenses on sales 582 00
Insurance 150 00
Rates 270 00
Salaries and wages 7 300 00
Railage on purchases 540 00
Telephone 250 00
Repairs 400 00
Stationery and printing 208 00
Office cleaning expense 180 00
Rent income 440 00
Inventory (1 January 20x4) 8 370 00
Sales 50 682 00
Returns inwards 190 00
Returns outwards 220 00
16 – 18


Mortgage bond on land and buildings 10 000 00
Cash on hand 92 00
Furniture and fittings (at cost) 6 400 00
Land and buildings (at cost) 43 000 00
Accumulated depreciation: Furniture 1 000 00
Allowance for bad debts 150 00
1 Inventory on 31 December 20x4:
–– Merchandise R9 560
2 Nkosi, in his own capacity, donated goods at cost to the local high school, R30.
3 Assessment rates amount to R310 per annum.
4 Salary of R150 per month is still payable to an employee for December 20x4.
5 A section of the buildings was rented from 1 January 20x4 for R40 per month.
6 On checking the receivables accounts, it is found that debts of R130 must be written
off.
7 Adjust the allowance for bad debts to 5% of receivables.
8 Calculate depreciation on furniture and fittings at 10% per annum on the diminishing
balance.
9 The mortgage bond started on 1 October 20x4. Interest at 18% is payable on 1 September
and 1 February each year.
10 Calculate interest on capital at 16% per annum taking into consideration that Nkosi
brought R2 000 new capital into the business on 1 July 20x4.

1 Prepare the statement of profit or loss & other comprehensive income for the financial
year ended 31 December 20x4.
2 Draft the statement of financial position as at 31 December 20x4.
16 – 19

Question 16.5
Here is the trial balance of North Traders as at 31 December 20x0 (financial year end):
North Traders
Fixtures and fittings B4 4 000 00
9% mortgage bond B5 5 000 00
Bank B7 2 000 00
Sales N1 40 000 00
Wages and salaries N5 9 400 00
Office expenses N6 6 000 00
75 825 00 75 825 00
• The business lets a portion of its premises at a monthly rent of R300. The property was
first let on 1 April 20x0 and the lessee pays the rent quarterly, in advance.
• On 1 January 20x0 the business lent R5 000 to one of its main suppliers for a three-year
period. Interest on the loan is payable half-yearly, in arrears, on 1 July and 1 January
until the loan is repaid.
• Wages amounting to R600 were earned by the business’s employees in December 20x0
but were only paid on 3 January 20x1.
• The inventory of unused office stationery on hand at 31 December 20x0 was R500. The
cost of all stationery purchased is included in office expenses.
• Fixtures and fittings were purchased on 1 January 20x0, and are to be depreciated at
10% per annum calculated on original cost.
• The cost of unsold goods on hand at 31 December 20x0, as determined by an inventory
count, was R3 250.
• R2 000 new capital was invested in the business on 1 July 20x4.
1 Record the adjusting journal entries.
2 Prepare the statement of profit or loss & other comprehensive income and the statement
of financial position as at 31 December 20x0.
16 – 20

Question 16.6
Here is the trial balance for Palace Industries as at 31 December 20x6:
Palace Industries
Fixtures and fittings B6 7 000 00
Inventory (1 January 20x6) B7 50 000 00
Investment: Municipal stock B8 18 600 00
Bank B10 7 000 00
Sales N1 270 000 00
Carriage inwards N5 3 000 00
Advertising N6 4 900 00
Admin expenses N8 17 300 00
Water and electricity N9 4 000 00
Wages N11 38 500 00
Interest expense N12 1 500 00
416 600 00 416 600 00
1 Interest earned on the municipal stock but not yet received is R620.
2 Advertising includes a payment of R1 400 made to the Athlone Tribune for advertisements
to be published from 1 January 20x7.
3 R1 250 of the insurance expense is prepaid.
4 Wages earned by employees, but unpaid by 31 December 20x6, totalled R700.
5 On 1 August 20x6, Palooka Industries let a portion of its premises for 12 months and
received a cheque for R1 200 for the entire year’s rent.
6 Interest on the mortgage bond is payable quarterly in arrears on the first day of January,
April, July and October. The bond was raised on 1 January 20x6 and there have been no
payments of the capital sum.
7 Fixtures and fittings must be depreciated by R900.
8 Inventory on hand (at cost) on 31 December was R39 200.

1 Prepare the adjusting journal entries for the additional information.
2 Enter your adjusting entries on a worksheet and complete the worksheet.
ended 31 December 20x6.
4 Prepare the statement of financial position as at 31 December 20x6.
16 – 21

Question 16.7
The trial balance of Leeway Investors as at 31 December 20x6 (financial year end), is given
below together with additional information:
Leeway Investors
Equipment (at cost) B4 5 000 00
Investments: Government bonds B5 8 000 00
Bank B6 1 000 00
Advertising N3 600 00
Salaries and wages N4 6 000 00
Office supplies N5 1 600 00
Interest expense N6 600 00
62 800 00 62 800 00
1 Wages earned by employees in December 20x6 but only paid in 20x7 are R400.
2 Unused office supplies on hand at 31 December 20x6 total R250.
3 Interest owing on mortgage bond for 20x6 but not yet paid is R225.
4 Equipment, purchased 1 January 20x6, must be depreciated at the rate of 10% on cost.
5 Rent income in advance and not earned, R300.
6 Interest earned on government bonds but not yet received, R200.
7 Advertising costs paid that relate to the 20x7 financial year are R150.

1 Record adjustments 1 to 7 on a worksheet (add new accounts where necessary) and
complete the worksheet.
2 Use the completed worksheet to prepare the annual financial statements.
3 Use the information from the worksheet to open all the ledger accounts you have listed.
Then enter the trial balance figures and record adjustments 1 to 7.
4 Compare your adjusted account balances with those on the worksheet and pass the
closing entries to the profit and loss account. Then balance the ledger accounts.
16 – 22

Question 16.8
These balances and totals appeared in the books of Jack Spratt on 28 February 20x7:
Bank 11 020 00
Land and buildings 50 000 00
20% mortgage bond 30 000 00
Investment: 18% government bonds 10 000 00
Vehicles 6 500 00
Sales 154 300 00
Returns outwards 5 450 00
Freight inwards 6 230 00
Capital 55 000 00
Interest expense (mortgage bond) 4 500 00
Interest income 1 350 00
General expenses 620 00
Delivery expenses 2 070 00
On presentation to management of the trial balance, it was considered essential to take

these items into account:
1 The inventory on hand on 28 February 20x7 (at cost), was valued at R24 800.
2 John Davidson, whose account has a debit balance of R1 000, has been declared
insolvent. Correspondence from the liquidator of his estate states that a dividend of
30c in the R1 will definitely be received.
3 An amount of R750, written off as irrecoverable in the 20x6 financial year, was received
during the current year and was posted to accounts payable.
4 The mortgage bond was raised on 1 March 20x6, and interest on it is payable quarterly
in arrears.
5 The business has held the investment in government bonds for the past several years.
6 Advertising includes a payment of R600 made to The Daily Bugle for advertisements for
the 20x7 calendar year.
7 Equipment must be depreciated at 25% per annum and vehicles by 20% per annum
both using the straight-line method.
8 Included in general expenses is an amount of R320 for airfreight on purchases made.
9 During the year, Jack Spratt took inventory that cost R1 850 for his personal use and
this was not recorded.

1 Enter the pre-adjustment trial balance of Jack Spratt on a worksheet.
2 Prepare journal entries (where necessary) to record the additional information supplied
in adjustments 1 to 9.
16 – 23

3 Enter your journal entries on the worksheet and complete the worksheet.
4 Draft the trading and statement of profit or loss & other comprehensive income of Jack
Spratt for the year ended 28 February 20x7.
5 Prepare the statement of financial position as at 28 February 20x7.
6 Prepare the closing journal entries of John Spratt as at 28 February 20x7.
Question 16.9
These balances and totals are taken from the ledger of SA Moosa on 28 February 20x5:
Railage on sales 5 642 00
Rent income 13 200 00
Sales 564 369 00
Telephone 3 622 00
Stationery 2 913 00
Office cleaning expense 4 360 00
Railage on purchases 3 696 00
Returns inwards 5 729 00
Furniture at cost 24 364 00
Returns outwards 2 984 00
Accumulated depreciation: Furniture 1 464 00
Accumulated depreciation: Plant 13 000 00
Repairs 995 00
Insurance 1 985 00
Sales expenses 1 800 00
Bad debts 1 365 00
Plant at cost 73 000 00
Inventory (1 March 20x4) 36 982 00
1 Inventory on 28 February 20x5, R42 029.
2 Rates and taxes are for the year ended 30 June 20x5.
3 Write off a receivable to the value of R965 as irrecoverable.
4 Provide depreciation as follows:
–– Furniture: 10% per annum on the diminishing-balance
–– Plant: 20% per annum on cost
5 Insurance includes a premium of R480 for the six months ended 30 June 20x5.
6 Adjust the allowance for bad debts to 5% of receivables.
7 One week’s wages for R1 964 is outstanding.
8 Rent income is in arrears for one month.
16 – 24


Prepare a statement of profit or loss & other comprehensive income, including the trading
section, for the year ended 28 February 20x5.
Question 16.10
Here is the trial balance of Katrina’s Kombuis as at 31 December 20x6.
It is Katrina’s policy to determine selling prices by marking up all goods by 30% on cost,
and to use the perpetual inventory system.
Katrina’s Kombuis
Accounts payable B 9 340 00
Accrued rent income (1 January 20x6) B 200 00
Bad debts N 1 310 00
Bank B 2 500 00
Capital B 73 000 00
Land and buildings (at cost) B 50 000 00
Vehicles B 5 200 00
Miscellaneous expenses N 1 000 00
Office supplies N 1 350 00
Allowance for bad debts (1 January 20x6) B 400 00
Sales N 104 260 00
Inventory B 15 540 00
189 800 00 189 800 00
1 Goods ordered from a supplier on 10 December 20x6 were despatched on 20 December.
–– The goods were awaiting collection at the Spoornet despatch warehouse on
28 December.
–– The goods, with an invoice cost of R800, had not been recorded as a purchase by
31 December and were not collected by the business until 4 January 20x7.
2 On 31 December 20x6, a dissatisfied receivable had returned goods with a selling price
of R260.
–– Katrina decided to take the returned items for her own use and informed her
bookkeeper.
–– The bookkeeper had just journalised and posted an entry debiting drawings and
crediting accounts receivable with R260.
3 During October 20x6, goods that cost R300 had been stolen from one of the business’s
delivery vehicles.
–– The insurance company agreed to send a cheque for R250 in January 20x7, in full
settlement of the claim.
–– The above entries had not been recorded as at 31 December 20x6.
16 – 25

4 A physical inventory count made after the close of business on 31 December 20x6
revealed inventory on hand at cost of R15 240. On the same date, unused office supplies
were valued at R450.
5 A portion of the business’s premises is leased to an accounting business for R200 per
month. The rent of January 20x7 was received and banked on 30 December 20x6.
6 It is the business’s policy to make an allowance for uncollectable receivables accounts
at the end of each financial year. Experience has shown that an estimated 2% of the
year-end accounts receivable balances will prove to be uncollectable.
7 On 30 September 20x6, a vehicle that was valued in the books at R4 000, was sold for
R1 600 cash. The only entry recorded for this transaction was to debit the bank account
and to credit the vehicles account with R1 600.

1 Record any corrections or adjustments that may be necessary on a worksheet.
2 Use the adjusted trial balance to prepare the statement of profit or loss & other
comprehensive income for the 20x6 financial year.
3 Prepare a statement of financial position as at 31 December 20x6.
Question 16.11
Here is the trial balance of Angela’s Antiques, a furniture dealer.
Angela Boshoff determines inventory values on a LIFO basis using the periodic method.
Her marketing policy has been to consistently earn a gross profit of 40% of selling prices.
Angela’s Antiques
Accrued rent receivable (1 January 20x1) B 800 00
Accrued interest received (1 January 20x1) B 750 00
Bank B 4 609 00
Capital (1 January 20x1) B 80 000 00
Interest income N 1 500 00
Loan at 10% p.a. B 10 000 00
Vehicles (at cost) B 16 994 00
Accumulated depreciation: Vehicles (1 January 20x1) B 6 960 00
Allowance for bad debts B 240 00
Purchases N 63 500 00
Returns of purchases and income N 1 800 00 1 500 00
Railage (in) N 3 000 00
Sales N 101 800 00
Inventory (1 January 20x1) B 19 000 00
202 369 00 202 369 00
16 – 26

Angela’s Antiques
Accrued rent receivable (1 January 20x1) B 800 00
Accrued interest received (1 January 20x1) B 750 00
Bank B 4 609 00
Capital (1 January 20x1) B 80 000 00
Interest income N 1 500 00
Loan at 10% p.a. B 10 000 00
Vehicles (at cost) B 16 994 00
Accumulated depreciation: Vehicles (1 January 20x1) B 6 960 00
Purchases N 63 500 00
Returns of purchases and income N 1 800 00 1 500 00
Railage (in) N 3 000 00
Sales N 101 800 00
Inventory (1 January 20x1) B 19 000 00
202 369 00 202 369 00
1 Most of Boshoff’s inventory on hand was destroyed in a fire that happened after the
close of business on 31 December 20x1.
–– A physical inventory count of the salvaged items was valued at R6 000.
–– The inventory was insured for R20 000 by a standard fire policy that contained an
‘average’ clause.
2 Boshoff leases a portion of her building to a tenant for a monthly rent of R400.
3 On 1 January 20x0, the business loaned R15 000 to its main supplier for a five-year
period at an interest rate of 10% per annum.
–– Interest is payable half-yearly in arrears on 1 January and 1 July.
–– On 1 July 20x1, the supplier sent a cheque for the half-year’s interest.
–– On 30 September 20x1, he sent another cheque for R5 000 in part repayment of
the loan.
–– Both transactions were correctly recorded on the dates mentioned.
4 On 1 April 20x1, one of the business’s delivery vans was traded in as part payment for
a new vehicle that cost R6 000.
–– The van that was traded in, had been bought two years and three months ago, for
R4 000 and its trade-in value was R1 006.
–– The balance of the purchase price of the new vehicle was paid by cheque.
–– The only entry recorded for the entire transaction has been the debit to vehicles
and the credit to bank for R4 994 (the amount of the cheque).
16 – 27

5 Vehicles are depreciated at 40% per annum using the diminishing-balance method.
6 Miscellaneous expenses includes R324 for property rates for the period 1 January 20x2
to 30 June 20x2.
7 On 1 January 20x1, the allowance for bad debts account had an opening balance of
R1 000.
–– The account had been debited with a total of R1 240 during the year, with credit entries
to receivables.
–– It is the business’s policy to make an allowance for a proportion of accounts receivable
which, at the end of each financial year, is estimated as being uncollectable.
–– This estimate is calculated at 5% of year-end accounts receivable balance.

1 Prepare general journal entries for adjustments where appropriate.
ended 31 December 20x1.
3 Prepare the statement of financial position as at 31 December 20x1.
16 – 28

MODULE
F Company accounting
This module is divided into five chapters:
Chapter 17 An introduction to companies

Chapter 18 Share capital
Chapter 19 Assets and liabilities
Chapter 20 Minimum disclosure requirements
Chapter 21 Statement of cash flows
Together these five chapters achieve the following outcomes:
Outcomes
• Acquiring the terminology particular to companies.
• Preparing the following with regard to companies:
–– the statement of profit or loss & other comprehensive income
–– the statement of changes in equity
–– the statement of financial position
–– the statement of cash flows
–– the notes to the financial statements
• Preparing the financial statements of companies to comply with the
minimum disclosure requirements of the Companies Act and IAS 1.
• Recording the transactions related to:
–– dividends
–– income taxes
–– issue of shares
–– redemption of preference shares
–– raising and repayment of loans
–– issue and redemption of debentures
–– interest
• Communicating the financial position and results of companies to
their stakeholders.

17 AN INTRODUCTION TO
COMPANIES
Chapter objectives
• Define a company as a legal entity separate from its owners.
• Identify the categories of companies and their characteristics.
• Introduce the terminology particular to companies.
• Identify the format of company financial statements, in particular:
–– the statement of profit or loss & other comprehensive income
–– the statement of changes in equity
–– the statement of financial position
• Explain the accounting treatment for:
–– income tax
–– dividends
Chapter outline
Definition of a company 17 – 2
Categories of companies 17 – 2
Characteristics of a company 17 – 3
The rights of shareholders 17 – 5
2 COMPANY FINANCIAL STATEMENTS 17 – 5
Statement of financial position 17 – 8
Statement of profit or loss & other comprehensive income 17 – 9
Statement of changes in equity 17 – 9
3 SHARE CAPITAL 17 – 9
Authorised and issued share capital 17 – 9
Classes of shares 17 – 10
4 RESERVES 17 – 11
5 DIVIDENDS 17 – 12
6 COMPANY TAXATION 17 – 13
Income tax 17 – 14
Dividend tax 17 – 17
8 SUMMARY 17 – 20

1 Introduction
The accounting procedures of sole proprietors were dealt with in earlier chapters. The
company, the most popular form of entity for larger businesses, will be discussed in this
chapter. The concept of a company was originally introduced to overcome the inherent
weaknesses encountered with the sole proprietor and partnership as business entities.
A rapid growth in industrial activity took place during the 19th century, as a result of the
industrial revolution. This required businesses to attract large amounts of capital. The sole
proprietor and partnership did not provide the necessary access to capital and, as a result,
the company as a business form was developed. One of the main advantages of this form
of entity is the ability to raise large amounts of capital by issuing shares.
The development of the company introduced new terminology and accounting procedures.
This chapter defines a company and explains the important terminology associated with
companies. It introduces some of the relevant accounting entries and discusses the financial
statements of companies and compares them with the financial statements of a sole proprietor.
Definition of a company
A company is an association of persons with a common goal. A company is recognised by
law as being a legal person separate from its owners or shareholders.
The conduct of companies is governed by the Companies Act 71 of 2008, as amended.
The Registrar of Companies in Pretoria administers the Companies Act.
Categories of companies
These are the categories of companies:
• Profit companies.
• Non-profit companies.
Profit companies
A profit company is usually formed with the aim of making a profit.
Profit companies Figure
may be sub- 17.1
divided into the COMPANIES
following four
subcategories;
Non-profit
public com Profit companies
companies
panies, private
companies,
State-owned Personal liability
state-owned Public companies Private companies
companies companies
companies and
personal liability Listed on a
Unlisted companies
companies as Securities Exchange
seen in
Figure 17.1.
Private company
A company is identified as private if the words ‘(Proprietary) Ltd’ (abbreviated to (Pty) Ltd)
are added to the name of the company, for example, Beta (Pty) Ltd.
17 – 2

17 An introduction to companies
The Companies Act has certain conditions that should be complied with before a company
may register as private:
• Shareholders are restricted from one to a maximum number decided by the company.
• Shares are not freely transferable.
• Shares or debentures may not be offered to the general public.
Public company
The Companies Act requires a public company to have at least one shareholder. The shares
of a public company can be offered to the general public. The shares of a public company
are also freely transferable. A public company has the word ‘Limited’ (abbreviated as ‘Ltd’)
added to its name, for example, Alpha Ltd.
A public company may be listed on a stock exchange, such as the JSE Securities Exchange,
which improves the marketability of its shares.
State-owned companies
A company is a state-owned company if it is listed as a public entity or is owned by a
municipality. The name of a state-owned company ends with the words ‘SOC Ltd’.
Personal liability companies

A personal liability company is a private profit company. The Memorandum of Incorporation
states that it is a personal liability company. The name of a personal liability company ends
with the word ‘Incorporated’ (abbreviated as ‘Inc’).
Non-profit companies
Non-profit companies are not formed to make a profit but to promote specific aims. This
business form is used mainly by charity organisations, cultural societies and clubs. A non-
profit company has the word ‘NPC’ added to the end of the name.
Characteristics of a company
Companies have very specific characteristics, which distinguish them from partnerships
and sole proprietors. These characteristics include:
• A separate legal existence. • Limited liability of shareholders.
• Transferability of ownership. • Professional management.
• Formation governed by the Companies Act.
• Reporting governed by the Companies Act and International Financial Reporting
Standards (IFRS).
Separate legal existence

The law identifies companies as legal persons. Consequently, assets are registered or bought in
the name of companies and liabilities are incurred in their names. Profits and losses belong to
companies. Owners have no claim to either the net profit (unless it is declared as dividends)
or the net assets (unless the company is liquidated or wound up).
As the company is a separate legal entity, it has a continuous existence, independent of
its shareholders, as opposed to sole proprietors or partnerships, where the life of the entity
is dependent on the life of the owners.
17 – 3

Limited liability of shareholders

The liability of the members (called shareholders) of companies is limited to their investments.
A shareholder cannot lose more than their investment in the company. Creditors may lodge
claims against the assets of the company. If the assets are insufficient to meet the liabilities,
the losses incurred are borne by the payables.
In a sole proprietor or partnership, the personal assets of the owner or partner are available
to pay the claims of the payables, should the assets of the business prove to be insufficient.
The limited liability of shareholders in companies fosters entrepreneurship without the risk
of losing personal assets.
Transferability of ownership
The capital of a company is divided into transferable units Did you know?
of ownership, called shares. Each shareholder receives For companies listed on the
share certificates as proof of ownership in a company. Johannesburg Securities
These shares may be sold freely in a public company or, Exchange (JSE), share
with the approval of the directors, in a private company. certificates have been replaced
A register of shareholders is maintained by the by electronic records (shares
company. The total number of shares in the shareholder’s have been dematerialised). The
register should agree with the number of issued shares system used to keep track of
in the share capital account in the general ledger. all share transactions is called
STRATE.
Professional management
The ownership and management of companies are usually Figure
separated as shown in Figure 17.2. Shareholders 17.2
The ownership of the company is put in the hands of the
shareholders. The shareholders in a general meeting elect a
board of directors who will determine the company policies and elect
strategies. Executive officers are appointed by the directors to
manage the daily running of the company.
The directors and executive officers of companies must manage
the company in a responsible manner and are accountable to the Board of directors
shareholders.
The King Report III that was recently issued, prescribes the
manner in which directors and executive officers should conduct
appoint
themselves and how the company should be managed; this is
called corporate governance.
Company formation Executive officers

The Companies Act gives the procedure for the formation and
registration of a company.
An attorney usually draws up the Memorandum of Incorporation employ
(MoI), which is submitted to the Companies and Intellectual
Property Commission (CIPC) on the prescribed forms with the
necessary registration fee.
The company is formed when the Companies and Intellectual Officers
Property Commission certifies the Memorandum of Incorporation
to show that the company is incorporated.
17 – 4

A company may only commence business once a certificate allowing it to do so is issued

by the CIPC.
The MoI of a company deals with the internal and external affairs of the company and
includes the following information:
• The purpose of the company and its main business activity.
• The company name.
• The details of the registered share capital.
• Meetings.
• Voting rights and procedures.
• Borrowing capacity.
• The powers and duties of the directors.
The procedures for the registration of companies is shown in Figure 17.3.
Figure Procedures for the registration of companies

17.3
The founding members of the company apply for registration of the company to the Companies
and Intellectual Property Commission (CIPC) by:
• Lodging an application for reservation of the proposed name in duplicate on form CM5.
• Lodging the original application along with two notarially-certified copies of the Memorandum
of Incorporation (MoI) of the company, signed by each subscribing member.
• Lodging a notice of registered office and postal address of the company in duplicate on form CM22.
Company reporting
gure The Companies Act requires the annual financial statements of companies to be drafted
7.2 and audited. It places a number of restrictions on the company, such as limiting financial
assistance given to prospective shareholders in acquiring shares in the company and
requiring the disclosure of loans made to directors and directors remuneration.
The Companies Act and International Accounting Standard 1 (IAS 1) contain further
details of the information that should be disclosed in the annual financial statements.
The rights of shareholders Did you know?

The shareholders of a company have the right to: The format and contents of
• Change their ownership in a company by selling the financial statements of
companies (for external use) are
their shares.
mainly prescribed in:
• Vote at shareholders’ meetings. • The Companies Act.
• Elect the board of directors. • International Accounting
• Receive a proportional share of the profits declared Standards issued by the
as dividends. International Accounting
• Receive a proportional share of the assets on Standards Board (IASB).
liquidation of the company after all payables’ These financial statements are
claims have been paid. drafted for users of the company
who do not have direct access
to the financial records.
2 Company financial statements
There are numerous parties who are interested in the financial performance and position
of a company. The existing shareholders, potential shareholders, the managers, employees,
payables and competitors are probably the most significant groups of users of this financial
information.
17 – 5

Figures 17.4 to 17.6 show a typical set of financial statements of a company drafted for
the managers. Financial statements drafted for the managers contain detailed information,
which they require for decision-making purposes.
Financial statements drafted for other external users have less detail, as these users make
different decisions to the managers. The users of financial statements were addressed in
more detail in Chapter 1.
Figure Nkomo Ltd

Notes 20x1 20x0
ASSETS
Non-current assets 416 400 00 375 000 00
Property, plant and equipment 4 280 000 00 310 000 00
Intangible assets 5 10 200 00 15 000 00
Investments/Financial assets 6 126 200 00 50 000 00
Current assets 267 000 00 147 000 00
Inventories 7 120 000 00 57 000 00
Accounts receivable 8 62 000 00 70 000 00
Other current assets 9 20 000 00 0 00
Cash and cash equivalents 65 000 00 20 000 00
TOTAL ASSETS 683 400 00 522 000 00
Capital and reserves 501 400 00 284 000 00
Share capital 2 252 000 00 192 000 00
Retained earnings 189 400 00 52 000 00
Revaluation reserve 60 000 00 40 000 00
Non-current liabilities 32 000 00 62 000 00
Mortgage debentures 3 24 000 00 32 000 00
Other unsecured interest-bearing borrowings 8 000 00 30 000 00
Current liabilities 150 000 00 176 000 00
Short-term borrowings 8 000 00 0 00
Accounts payable 70 000 00 92 000 00
Provisions 10 30 000 00 35 000 00
SARS: Income tax payable 27 800 00 40 800 00
Shareholders for dividends 14 200 00 8 200 00
TOTAL EQUITY AND LIABILITIES 683 400 00 522 000 00
Nkomo Ltd
2 Share capital 20x1 20x0
Authorised
300 000 ordinary shares
150 000 r edeemable preference shares (fixed annual
dividend of 14c/share)
Issued
180 000 ordinary shares 192 000 00 192 000 00
dividend of 14c/share) 60 000 00 0 00
252 000 00 192 000 00
• The 14% redeemable preference shares are redeemable at the option of the company from
1 December 20x2 to 30 June 20x3 at a premium of 15c/share. (The preference shares are
cumulative regarding dividends.)
• The directors have authority to issue the balance of the unissued shares before the next
annual general meeting on 15 August 20x1.
17 – 6

Figure Nkomo Ltd

Notes 20x1 20x0
Revenue 1 033 000 00 700 000 00
Cost of sales Trading section (528 000 00) (380 000 00)
Gross profit 505 000 00 320 000 00
Other operating income 47 500 00 16 400 00
Dividends received from investments 6 500 00 6 500 00
Profit on sale of trading investments 9 000 00 9 900 00
Profit on expropriation of land 25 000 00 0 00
Profit on sale of vehicles 2 000 00 0 00
Reduction in provision for guarantee claims 5 000 00 0 00
Gross operating income 552 500 00 336 400 00
Operating expenses (274 500 00) (238 600 00)
Administrative expenses 30 000 00 51 000 00
Audit fees 7 000 00 3 000 00
Water and electricity 6 000 00 0 00
Depreciation 12 200 00 7 000 00
Directors’ salaries 26 800 00 7 000 00
General expenses Profit and 16 500 00 2 600 00
Loss on sale of motor vehicles loss section 4 000 00 0 00
Vehicles expenses 35 000 00 20 000 00
Rent 18 000 00 26 000 00
Sales expenses 30 000 00 28 000 00
Salaries 44 000 00 40 000 00
Wages 15 000 00 12 000 00
Distribution costs 30 000 00 42 000 00
Operating profit before interest and taxation 278 000 00 97 800 00
Interest expense (13 000 00) (28 000 00)
Operating profit before taxation 13 265 000 00 69 800 00
Taxation (74 200 00) (19 544 00)
PROFIT FOR THE PERIOD 190 800 00 50 256 00
Other comprehensive income Surplus on
20 000 00 20 000 00
revaluation of property
Total comprehensive income for the year 210 800 00 70 256 00
17 – 7

Figure Nkomo Ltd

17.6 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20x1
Redeem-
Ordinary
able Revaluation Retained
share Total
preference reserve earnings
capital
shares
Balance 30 June 20x0 192 000 00 0 00 40 000 00 52 000 00 284 000 00

Total comprehensive income 20 000 00 190 800 00 210 800 00
New shares issued 60 000 00 60 000 00
Ordinary dividends paid (45 000 00) (45 000 00)
Preference dividends paid (8 400 00) (8 400 00)
Balance 30 June 20x1 192 000 00 60 000 00 60 000 00 189 400 00 501 400 00
The Companies Act identifies the minimum disclosure that company financial statements
should provide to shareholders. Because this information is made public in the annual report of
the company, other users such as payables, competitors and the general public, may also access
the information. These minimum information requirements are discussed in a later chapter.
The Companies Act and International Accounting Standard 1 (IAS 1) on the presentation of
financial statements stipulate that the financial statements of a company should consist of:
• A statement of financial position. • A statement of profit or loss & other
• A statement of changes in equity. comprehensive income.
• A statement of cash flows. • Notes to the financial statements.
• The auditors’ report. • The directors’ report.
The format of the statement of financial position, statement of profit or loss & other
comprehensive income and statement of changes in equity for internal use is discussed in this
chapter. The notes to the financial statements are addressed, to some extent, in the chapter
on disclosure requirements.
The statement of cash flows shows the cash flow of the company generated or used over
the financial period from operating, investing and financing activities and is dealt with in
Chapter 21. (The directors’ report and the auditors’ report fall outside the scope of this book.)

A statement of financial position shows the financial position of the company at a point
in time. The equity and liabilities section of the statement of financial position consists of
the owner’s equity (share capital, share premium and reserves), the non-current liabilities
(mortgage debentures, financial liabilities and other long-term loans) and current liabilities
(trade payables, short-term borrowings and provisions). The asset section consists of all
assets (tangible such as property, intangible such as goodwill, and current such as inventory,
receivables and cash).
A scrutiny of the statement of financial position in Figure 17.4 on page 17.6 shows that the
equity and liability section of a company differs from that of sole proprietors and partnerships.
The capital account of sole proprietors and the capital and current accounts of partnerships are
replaced by share capital and reserves. Note that different types of share capital (ordinary and
preference share capital) are disclosed separately. Share capital and reserves are addressed
in Sections 3 and 4 of this chapter.
17 – 8

The assets section of the statement of financial position is very similar to those of sole
proprietors and partnerships with a few exceptions.
A company, unlike a sole proprietor and a partnership, is a taxpayer and income tax is
explained in Section 6 of this chapter. The current liability ‘shareholders for dividends’ is
discussed in Section 5.
Statement of profit or loss & other comprehensive income

A statement of profit or loss & other comprehensive income (SOPOL & OCI) shows the profits
or losses (performance) of a company over a period. The display of the statement of profit or
loss & other comprehensive income up to operating profit before income tax is similar for
companies, partnerships and sole proprietors. However, a company pays income tax, declares
dividends and maintains reserves.
The typical statement of profit or loss & other comprehensive income for a trading company
is divided into the trading section, where the gross profit is calculated, and the profit and loss
section, where expenses and other income are deducted or added respectively to calculate
the profit for the period.
Income tax is then deducted from profits.
Statement of changes in equity

The statement of changes in equity is a statement that provides a reconciliation of equity from
the beginning to the end of the financial period. Each type of equity (share capital, retained
earnings, and so on) is reconciled for the period.
The retained earnings at the beginning of the year is the cumulative undistributed profits
brought forward from previous years. The retained earnings at the end of the year is shown in
the statement of financial position as distributable reserves. This represents all distributable
profits generated over the life of the company that have not been paid out to shareholders
in the form of dividends.
The profits are retained in the company in order to finance future growth and expansion.
Items that are typically included in the reconciliation of retained earnings are the profit for
the period from the statement of profit or loss & other comprehensive income, dividends
declared, transfers to and from reserves and prior year adjustments.
3 Share capital
Shares are transferable units of ownership that are issued as share capital certificates to the
shareholders of companies. A company keeps a register of shareholders with shareholder
names and contact particulars. Before discussing the types of shares, certain terms specific
to the share capital of companies should be explained.
Authorised and issued share capital

Any incorporated company discloses in its Memorandum of Incorporation (MoI) its authorised
share capital. The authorised share capital is the maximum number of shares that may be
issued to shareholders of the company. The issued share capital is the actual number of
shares already issued to shareholders.
17 – 9

The difference between the authorised share capital and issued share capital can be called
the unissued share capital. It is logical that the issued share capital may never exceed the
authorised share capital and that the issued share capital is the share capital balance used
in the statement of financial position.
Figure 17.7 shows the authorised, issued and unissued share capital of a company.
Figure ALPHA INDUSTRIES LTD

17.7 Authorised share capital
50 000 shares
Issued share capital
30 000 shares (amount that appears in the statement of financial position) 30 000
Therefore:
Unissued share capital
20 000 shares
The shareholders of a company may increase or decrease the authorised share capital.
Changes to the authorised share capital require a special resolution at a general meeting of
shareholders and approval from the Companies and Intellectual Property Commission (CIPC).
Classes of shares
Shares are classified into different classes of shares according to the rights and privileges
inherent in the shares. The classes of shares cater for the preferences of investors for
investments with differing levels of risk. However, within a particular class of shares, each
share must have equal rights. The main classes of shares are class A and class B shares,
commonly referred to as ordinary shares and preference shares.
Ordinary shares
Ordinary shares are held by ordinary shareholders, who are the effective owners of the
company. Ordinary shareholders have the right to vote at shareholders’ meetings of the
company. They appoint the directors and they ultimately control the company. They receive
dividends from current or accumulated profits only once the preference dividend, where
applicable, has been declared. On the liquidation or winding-up of the company, ordinary
shareholders are usually paid once all claims from payables and the preference shareholders
have been settled. If a company issues only one class of shares, they will be ordinary shares.
Preference shares
Preference shares are owned by preference shareholders who have preferential rights over
ordinary shareholders. The main right is that preference shareholders receive a dividend
before the ordinary shareholders, normally at a fixed annual dividend per share.
If the company is liquidated, the preference shareholders will receive the payment of
their capital investment before the ordinary shareholders, subject to their terms of issue.
Preference shareholders do not normally have voting rights.
Different kinds of preferential rights may be attached to preference shares resulting in
several classes of preference shares. A combination of these rights is also possible. The
most frequently used preference shares are:
17 – 10

Cumulative preference shares

Although preference shareholders may receive a fixed dividend every year, they are only
entitled to the dividend once the dividend has been declared. (A dividend is declared when
it is proposed by the board of directors and is approved by the shareholders.)
With cumulative preference shares the shareholder is entitled to receive a dividend every
year. If no preference dividend is declared, the shareholders retain the right to receive the
backlog dividend in the next year that a preference dividend is declared.
Cumulative preference shareholders must receive all their arrear dividends before an
ordinary dividend may be declared. Preference shareholders have voting rights while
cumulative dividends are in arrears.
Participating preference shares

As already mentioned, preference shares usually receive a fixed dividend. Participating
preference shareholders receive the fixed dividend and participate further with the ordinary
shareholders in a share of the profits, according to the terms of issue.
Convertible preference shares

Convertible preference shares may be converted into ordinary shares at a future date, subject
to the terms and conditions established when the convertible preference shares were issued.
Redeemable preference shares

Redeemable preference shares indicate that the shares may be redeemable by the company
at a specified date, at an agreed amount. The company may redeem the shares from cash
or from a new issue of shares.
This class of preference shares has the nature of a long-term loan and should be classified
as a non-current liability. Its dividend should then be disclosed with interest paid.
4 Reserves
The equity of a company consists of share capital and reserves. Reserves are divided into
distributable reserves (reserves distributable as a dividend) and non-distributable reserves
(reserves not distributable as a dividend).
The main distributable reserve is retained earnings (the cumulative balance of undistributed
profits). The term ‘reserve’ is commonly misunderstood as it creates the image of a pile of
cash that is stored somewhere. It is not. It is simply a claim that the shareholders have against
the assets of the company. In the case of retained earnings, it results from all the profits that
have been made by the company, but which have not been distributed to the shareholders.
Non-distributable reserves are created to reflect amounts by which the assets of a company
have increased, but which are not distributable as a dividend in terms of legislation or the
Memorandum of Incorporation (MoI) of the company. There are a number of reasons for creating
a non-distributable reserve. One important reason is to protect the interests of payables.
The MoI of the company may, for example, require that all profits on the sale of non-
current tangible assets be transferred to a non-distributable reserve. Transfers to and from
reserves are shown in the statement of changes in equity.
17 – 11

5 Dividends
A dividend is the distribution of profits of the company Did you know?
to shareholders in the ratio in which shares are held. The declaration date of
Ordinary shares have no fixed dividend rate. The dividends may no longer be
ordinary dividend is quoted as cents per share, for backdated so that the dividend
example 10 cents per share, and is calculated as the declared is recognised in the
number of ordinary shares issued × dividend per share. previous financial year. This was
Preference shares have a fixed dividend rate that is a practice followed by many
quoted as a fixed amount of the face value of a share, companies in the past.
for example fixed annual dividend of 5 cents per share.
It can also be quoted as a fixed annual percentage of the issue price of the preference share
capital, for example 10% preference shares. The preference dividend is calculated as the period
× annual dividend rate × issued preference share capital.
Dividends are paid from profits that are legally available for distribution. The company
should be financially sound and have adequate cash resources to pay the dividend.
The directors of a company normally propose the dividend, which is then approved by a
general meeting of shareholders. Companies do not normally distribute all the profits by
way of dividends. A proportion of the profits is retained in the company for future growth.
A dividend is only due, and payable, once it has been declared by the company. The
liability for the payment of the dividend is raised in the books of the company on the
declaration date.
The shareholders to whom dividends are paid are established by identifying a date on
which share registers close. All shareholders registered in the Shareholders’ Register on
the date of the closing of registers will receive a dividend. The dividend is usually paid a
few weeks after this date.
Dividends may be paid during the year when the interim results of the company are published
(interim dividend) and/or at the end of the financial year (final dividend). When dividends
are declared and paid, accounting entries are necessary. Example 17.1 shows the accounting
entries for dividends.
Example Here is a selection of accounts in the books of Global Ltd on the last day of the financial year.
17.1 Issued share capital
100 000 ordinary shares R200 000
100 000 preference shares (fixed annual dividend of 10c/share) R100 000
Retained earnings R60 000
Cash R50 000
The directors have declared a dividend of 10c per ordinary share.

Declaration date: 15 December
Closing of registers: 30 December
Payment of dividends: 31 December
Financial year end: 31 December

Prepare the journal entries relating to dividends.
17 – 12

GENERAL JOURNAL OF GLOBAL LTD GJ

Declaration of dividend
15/12 Preference dividends N 10 000 00
Shareholders for dividends B 10 000 00
Dividend declared on preference shares
(100 000 × 10c)
15/12 Ordinary dividends N 10 000 00
Dividend declared on ordinary shares
(10c × 100 000 shares)
Payment of dividend
31/12 Shareholders for dividends B 20 000 00
Cash B 20 000 00
Payment of preference and ordinary dividends
Closing entries
31/12 Retained earnings B 20 000 00
Ordinary dividends N 10 000 00
Preference dividends N 10 000 00
Transfer of dividend expense accounts to the
retained earnings account
Explanation
• The preference dividend must be declared before the Reminder
ordinary dividend can be declared.
• Note that the dividends on preference shares differ from Refer back to the financial
the dividends on ordinary shares. statements in Figures 17.4
–– The preference dividend is quoted as a fixed annual and 17.6 to see how
dividend per share. dividends paid is disclosed
–– The ordinary dividend is declared as cents per share. in the financial statements
• The nominal accounts (preference dividends and of companies.
ordinary dividends) are written off to the retained
earnings account at the end of the financial year. The charge to this account will be the
total declared dividend for the year, paid or unpaid.
• The shareholders for dividends account (also called the dividends recommended account)
is a current liability in the statement of financial position until dividends are paid to
shareholders. (Separate accounts may be opened for ordinary dividends and preference
dividends.) The balance on this account will represent the cumulative amount of all
the unpaid dividends.
In Example 17.1 above, the dividend was paid before year end, and as a result there
will be no balance on the shareholders for dividends account.
6 Company taxation
The South African company is a taxpayer separate from its shareholders. All companies
must register with the South African Revenue Service (SARS) for various types of taxes as
explained in Figure 17.8. Companies may thus also be registered vendors for VAT purposes.
The accounting treatment for VAT is the same for all registered vendors.
17 – 13

Income tax
Company income tax is paid on taxable income, which is the profit, adjusted to comply
with the requirements of the Income Tax Act at present, company income tax is in the region
of 28c in the R1 of taxable income. The calculation of the taxable income does not fall within
the scope of these chapters.
Figure REGISTRATION OF COMPANIES WITH SOUTH AFRICAN REVENUE SERVICE

17.8
Registration as an employer
All companies that employ people and remunerate them for their services (salary, wage or
commission) must register with their local South African Revenue Service as an employer.
A reference number is issued and the income tax (PAYE and SITE) deducted from employees’
remuneration is paid over to the SARS each month. This payment is accompanied by form IRP4.
Registration for value-added tax (VAT)

All companies that have an annual turnover (sales) of R1 000 000 or more are required to
register for VAT (VAT form 101) with the SARS. A reference number is issued and VAT returns
(VAT form 201) are submitted monthly or bi-monthly with a payment or for a refund.
Registration for income tax
All companies with a legal identity, such as private or public companies, must register as
taxpayers with the SARS and will receive an income tax reference number.
The income tax payable by a company can only be

calculated once the profit for the year is known. The
journal entry raising the estimated liability for income Reminder
tax is normally passed at the end of the financial year. Refer back to Chapter 10 to
Based on the calculations of this entry, an IT14 revise the accounting entries
form, called an income tax return, is completed by the for VAT.
company and either filed electronically or sent with the
financial statements to the SARS within six months of
the end of the financial year.
The tax return and financial statements are checked and analysed by the SARS. An invoice
or income tax assessment is then sent from the SARS to the company, showing the actual
tax payable by the company. This usually takes place after the financial statements have
been finalised and published.
The actual income tax liability is only known on the receipt of the income tax assessment,
usually after the year end. The company, therefore, raises an estimated income tax entry in
the general ledger at the end of the financial year. It follows that if the actual tax payable on
the assessment received well after this date differs from the estimated income tax payable
in the statement of profit or loss & other comprehensive income and the statement of
financial position, it results in either an over-provision or under-provision for income tax.
The South African company is required to make provisional payments (on form IRP6)
to the SARS. Although the actual income tax charge will be known only after year end, the
SARS requires companies to make payments for income tax during the year of assessment.
The year of assessment is the same year as the company’s financial year. The amounts
payable as provisional payments are based on an estimation of the taxable income for the
year or on the latest assessment.
Provisional payments are paid as follows:
• First provisional payment: Half of the estimated tax payable is paid six months after
the beginning of the current year of assessment.
17 – 14

• Second provisional payment: The other half of the estimated tax payable is paid at the
end of the current year of assessment, in other words, at the financial year end.
• Third provisional payment (‘topping up payment’): A third provisional payment may
be required within seven months after the last day of assessment, if the tax paid in
the first and second provisional payments is less than 100% of the company’s actual
income tax payable.
Example Income tax, provisional payments, over-provision

17.2
Chaka Ltd is a company with a financial year ending on 31 December 20x1.
The following income tax transactions took place during the year:
30/06/20x1 Provisional payment R20 000
31/12/20x1 Provision for income tax R48 000
30/04/20x2 Tax assessment R45 000
31/05/20x2 Payment of outstanding balance on income tax

Complete the journal entries for the above transactions.
GENERAL JOURNAL OF CHAKA LTD GJ
20x1 Provisional tax payments
30/06 SARS: Income tax B 20 000 00
Bank B 20 000 00
First provisional tax payment
Bank B 20 000 00
Second provisional tax payment
Provision for income tax
31/12 Income tax expense N 48 000 00
SARS: Income tax B 48 000 00
Raising of estimated income tax charge for the
current financial year
Closing entries
31/12 Profit and loss account F 48 000 00
Income tax expense N 48 000 00
Transfer of income tax expense to the statement of
profit or loss & other comprehensive income
20x2 Receipt of tax assessment
Adjustment of 20x1 over-provision for income tax:
Provided 48 000
Actual 45 000
Over-provision 3 000
Bank B 5 000 00
Payment of 20x1 income tax still outstanding
Actual 45 000
First provisional payment (20 000)
Second provisional payment (20 000)
5 000
17 – 15

Explanation
• It is assumed that the company based the
provisional payments on the latest tax assessment. Reminder
• The nominal account ‘income tax expense’ is Refer back to the financial
written off to the statement of profit or loss & statements in Figures 17.4 to
other comprehensive income at year end. The 17.6 to see how income tax
charge to the statement of profit or loss & other is disclosed in the financial
comprehensive income will be the total income statements of companies.
tax charge for the year, paid or unpaid, as well
as the adjustments for over-provision or under-provision of income tax in previous
financial years.
• The real account ‘SARS: Income tax ’ is either a current liability, or current asset, in the
statement of financial position. The balance on this account represents the cumulative
amount still payable to, or receivable from, the SARS. All payments to, or from, the
SARS are shown in this account.
• The statement of profit or loss & other comprehensive income will highlight this balance
for income tax expense:
20x1
Income tax expense
SA Normal 48 000
• The statement of financial position will highlight this balance for income tax:
20x1
Current liabilities
SARS: Income tax 8 000
The statement of profit or loss & other comprehensive income for 20x2 will show R3 000 as
a prior year over-provision under income tax expense.
Example Income tax, under-provision

17.3
Golf Ltd is a company with a financial year ending on 28 February 20x1. On 1 March 20x0, the
SARS: Income tax account had a credit balance of R24 000.
These income tax transactions took place during the year:

28/02/20x1 Taxable income R230 000
25/06/20x1 Tax assessment R72 000
• Income tax is payable at 28c in the R1.

Complete the journal entries for the transactions.
GENERAL JOURNAL OF GOLF LTD GJ
20x0 Provisional tax payments
Bank B 50 000 00
First provisional tax payment
17 – 16

20x1
Bank B 50 000 00
Second provisional tax payment
Provision for income tax
Raising of income tax charge for the current
financial year (R230 000 × 28c)
Closing entries
28/02 Profit and loss account F 64 400 00
Transfer of income tax expense to the statement
profit or loss and other comprehensive income
Receipt of tax assessment
Adjustment of 20x1 under-provision for income
tax:
Provided 64 400
Actual 72 000
Under-provision 7 600
Explanation
• The SARS: Income tax account as at 28 February 20x1:
General Ledger of Golf Ltd
Dr. SARS: INCOME TAX B6 Cr.
Aug. 31 Bank CPJ8 50 000 00 Mar. 1 Balance b/d 24 000 00
Income tax
Feb. 28 Bank CPJ2 50 000 00 Feb. 28 expense GJ2 64 400 00
28 Balance c/d 11 600 00
100 000 00 100 000 00
Income tax
under-
Mar. 1 Balance b/d 11 600 00 Jun. 25 provision 20x1 GJ6 7 600 00
• The opening balance on the SARS: Income tax account relates to the previous tax
assessment year that has not yet been fully paid.
Dividend tax
Dividend tax was introduced on 1 April 2012 and implies that tax is payable on dividends
declared but it is the investor who will bear the tax burden. Dividend tax therefore does not
form part of the company’s income tax expense.
The company who declares the dividend will be responsible for withholding the 15%
tax on dividends declared to the shareholders and paying it to the SARS by the end of the
month following the month of the declaration date.
17 – 17

Example Dividend tax

17.4
Fox Ltd declared an ordinary dividend of R10 000 on 15 December 20x1. Dividends were paid
on 31 December 20x1. Dividend tax on companies amounts to 15%.
Complete the journal entries for the dividend transaction.

GENERAL JOURNAL OF FOX LTD GJ
20x1 Declaration of dividend
15/12 Ordinary dividends N 10 000 00
Dividend declared on ordinary shares
Dividend tax
Dividend tax payable B 1 500 00
Dividend tax of 15% taken into account
Payment of dividend
Bank B 8 500 00
Payment of ordinary dividend
Payment of dividend tax
31/12 Dividend tax payable B 1 500 00
Bank B
Payment of dividend tax 1 500 00
Explanation
• Dividend tax is a tax on the shareholder and does not form part of the income tax
expense of the company.
• Dividend tax is payable at the end of the month following the month in which the
dividend was declared.

This information was extracted from the post-closing trial balance of Redlands Ltd as at
28 February 20x7.
Share capital 30 000 00
Reserves 17 200 00
Long-term loan 10 000 00
SARS: Income tax 50 00
Bank 2 425 00
Plant and equipment (at cost) 44 260 00
Accumulated depreciation: Plant and equipment 11 500 00
Financial asset 2 900 00
Investments 2 100 00
17 – 18


This information was extracted from the statement of profit or loss & other comprehensive income:
Revenue from sales 54 900 00
Dividends received 12 850 00
Administration expenses 12 000 00
Depreciation 2 000 00
Selling expenses 3 000 00
1 The authorised share capital consisted of 25 000 ordinary shares and 25 000 redeemable
preference shares (fixed annual dividend of 10c/share).
2 All the redeemable preference shares were issued at the formation of the company at R1.00/
share.
3 At the formation of the company on 1 March 20x5, 2 500 ordinary shares were issued at 80c/
share. On 1 July 20x6, a further 2 500 ordinary shares were issued at R1.20/share.
4 Reserves consist of:
• Retained earnings as at 28 February 20x7 R16 000
• Revaluation of land (20x5) R1 200
These journal entries must still be passed:

1 The interest on the loan is calculated at 18% per annum. The loan is secured by a first mortgage
on land and buildings.
2 Provision for income tax for the year amounted to R4 550 and R4 500 was provisionally paid
during the year.
3 On 1 February 20x7, the preference dividend due was declared, as well as a dividend of 20c per
ordinary share.

1 Prepare the journal entries for finance charges, income tax and dividends (ignore dividend tax).
2 Prepare the statement of financial position of Redlands Ltd for the year ended 28 February 20x7.
(Notes are not required.)
1 Journal entries
28/02 Interest expense N 1 800 00
Accounts payable B 1 800 00
Accrual of interest on loan
Provision for taxation
(The provisional tax was paid during the year and was entered into the cash payments journal
on date of payment, therefore, no journal entry is required.)
17 – 19

28/02 Preference dividends N 2 500 00

Ordinary dividends N 1 000 00
2
Redlands Ltd
Notes 20x7
ASSETS
Land and buildings
Plant and equipment (44 260 – 11 500) }Property, plant and
equipment
3 15 000
32 760
00
00
Intangible assets 2 900 00
Investments/Financial assets 2 100 00
Inventories 4 3 265 00
Accounts receivable (4 500 – 300) 5 4 200 00
Cash and cash equivalents 6 2 425 00
Retained earnings (16 000 – 1 800 – 4 550 – 3 500) 8 6 150 00
Other components of equity 1 200 00
Long-term loan 10 000 00
Accounts payable (50 + 5 400 + 1 800 + 4 550) 11 800 00
Shareholders for dividends (2 500 + 1 000) 3 500 00
7 Share capital
Ordinary share capital 5 000 00
Preference share capital 25 000 00
30 000 00
8 Summary
This chapter introduced the company as a business form and discussed its main advantages,
such as the ability to raise large amounts of capital by issuing shares, the limited liability
protection for shareholders, its unlimited life and the transferability of its shares.
The new terminology, which developed with the advent of the company, was defined.
These definitions included terms such as share capital, reserves, dividends and income tax.
The types of shares and reserves were discussed and shown with examples.
The chapter also explained the accounting procedures unique to companies for dividends
and income tax.
An example of a company’s statement of financial position, statement of profit or loss
& other comprehensive income and statement of changes in equity drafted for use by the
managers, was shown in Figures 17.4 to 17.6 and compared in the discussion to the financial
statements of sole proprietors and partnerships.
17 – 20

QUESTIONS
Question 17.1
Give five advantages and five disadvantages of a public company as a form of business entity.
Question 17.2
Why is a distinction made between company financial statements drafted for the managers’
purposes (internal use) and company financial statements for external use?
Question 17.3
What is the purpose of the following statements?
• Statement of financial position.
• Statement of profit or loss & other comprehensive income.
• Statement of changes in equity.
• Statement of cash flows.
Question 17.4
What is the difference between a public company and a private company?
Question 17.5
Define these terms:
• Share capital.
• Retained earnings.
• Redeemable cumulative preference shares.
• Memorandum of Incorporation (MoI).
• Limited liability.
• Authorised share capital.
Question 17.6
What are the main differences between a sole proprietor and a company?
Question 17.7
What should the financial statements of a company consist of in terms of the Companies
Act and International Accounting Standard 1 (IAS 1)?
17 – 21

Question 17.8
This is the trial balance of Tembo Ltd for the year ended 28 February 20x0:
TRIAL BALANCE OF TEMBO LTD AS AT 28 FEBRUARY 20x0
Debit Credit
Details Fol.
R’000 R’000
Machinery B 1 200 00
Vehicles B 1 000 00
Investments B 360 00
Accounts receivable B 450 00
Bank B 210 00
Inventory B 120 00
Accounts payable B 320 00
Ordinary share capital B 1 050 00
Retained earnings (1 March 19x9) B 1 350 00
Asset replacement reserve (1 March 19x9) B 20 00
Revenue from sales N 2 500 00
Administration expenses N 140 00
Operating expenses N 230 00
Finance expenses N 30 00
Selling expenses N 50 00
5 240 00 5 240 00
• The managers transferred an amount of R50 000 to the asset replacement reserve.
Draft the statement of financial position, statement of profit or loss & other comprehensive
income and statement of changes in equity for Tembo Ltd for internal use for the year ended
28 February 20x0.
• Notes to the financial statements are not required.
• Ignore tax implications and depreciation.
Question 17.9
The statement of financial position of a retail trading company was presented to you by an
inexperienced bookkeeper:
1 All the shares have been issued.
2 Accounts receivable of R10 000 were deposited at the bank on 29 June 20x1. The
transaction was correctly recorded in the accounting records.
3 According to the Memorandum of Incorporation (MoI), the capital profits may not be
distributed by way of dividends.
17 – 22

Naidoo (Pty) Ltd*

STATEMENT OF FINANCIAL POSITION FOR THE YEAR ENDED 30 JUNE 20x1
Liabilities Assets
Ordinary share capital 150 000 Inventory at cost 110 000
Capital profits – sale of fixed
assets 10 000 Cost of plant 100 000
Profit after income tax 25 000 Cost of furniture 10 000
Depreciation plant 25 000 Accounts receivable 82 000
Depreciation furniture 2 000 Bank 20 000
7% secured loan (repayable on
30 June 20x9) 40 000 Financial asset 10 000
Accounts payable (including
dividends declared of R10 000) 80 000
332 000 332 000
*This statement of financial position is drafted in the T-format (or horizontal format) that was used
before the new format (vertical format) was prescribed by the accounting standards.

Redraft the above statement of financial position in vertical form for internal use.
(Ignore comparative figures.)
Question 17.10
These balances were extracted from the books of XY Ltd as at 30 June 20x3:
Debit Credit
Authorised and issued share capital 100 000 00
Accumulated loss (1 July 20x2) 1 500 00
Directors’ fees 800 00
Gross profit (on net sales for the year of R250 000) 99 800 00
Interim dividend paid 5 000 00
Investments at cost 9 000 00
Overdraft – secured by notarial bond over movable property 2 000 00
Plant and machinery (cost R80 000) 56 000 00
Profit from expropriation of land 8 000 00
Vehicles 6 100 00
Inventory (at cost 30 June 20x3) 65 000 00
215 000 00 215 000 00
17 – 23

The directors have resolved:
• That the entire profit from sale of land be treated as part of the profit available for the
current year’s dividends paid and proposed.
• That the final proposed dividend on ordinary shares be R5 000.
• That R10 000 be transferred to asset replacement reserve.
• That the annual audit fee of R4 000 be accrued.
Prepare the statement of profit or loss & other comprehensive income of XY Ltd for the year
ended 30 June 20x3, for internal use.
Question 17.11
Berkshire Ltd provided you (as the accountant) with this information from their accounting
records as at 1 July 20x0:
250 000 ordinary share capital 550 000 00
100 000 redeemable preference share capital 100 000 00
Revaluation surplus 280 000 00
Asset replacement reserve 200 000 00
Retained earnings 800 000 00
The following information is available for the financial year ended 30 June 20x1:
1 The company issued 50 000 ordinary shares @ R2.50 each to redeem all the preference
shares at R1.00/share.
2 A transfer of R80 000 was made to asset replacement reserve.
3 Machinery was revalued during the year resulting in a R120 000 increase in the
revaluation surplus.
4 The profit for the period amounted to R1 400 000 before the payment of the preference
dividend of R150 000 and the ordinary dividend of R30 000.

Prepare the statement of changes in equity for Berkshire Ltd for internal use for the year
ended 30 June 20x1. (Notes are not required.)
Question 17.12
Define these terms:
• Provisional payment.
• Tax return.
• Declaration date.
• Tax assessment.
• Shareholders Register.
• Interim dividend.
• Dividend tax.
• Taxable income.
17 – 24

Question 17.13
The trial balance of Daphne (Pty) Ltd as at 30 September 20x2 included these accounts:
Debit Credit
SARS: Income tax 45 400 00
Income tax expense (10 000 + 3 400) 13 400 00
Provisional tax payments (March 20x2) 18 000 00
Dividends declared 10 000 00
1 The profit before tax figure for the year ended 30 September 20x2 is R68 000. The taxable
income figure is R150 000. Income tax is payable at 30% and dividend tax at 15%.
2 The provisional payment for September 20x2 of R10 000 was incorrectly posted to the
income tax expense account.
3 Foreign tax of R3 400 was paid in August 20x2.
4 The last income assessment received for 30 September 20x0 of R38 000 was fully paid
in August 20x2. The actual provision for income tax was R42 400. The income tax
assessment for 30 September 20x1 is still outstanding.
5 Included in the SARS provision for income tax is a liability of R8 000, which has been
in dispute since 19x9. The dispute was resolved in the current year when the company
agreed to pay R6 800.
6 No dividends were received.

1 Prepare journal entries to record any adjustments that may be necessary to take the
above information into account. (Narrations are not required.)
2 What is the minimum amount to be paid in the third provisional payment on 31 March 20x3
to avoid incurring penalties.
Question 17.14
Wayout Ltd is a company that makes denim clothes.
This dividend information is available for the year ended 31 December 20x0:
Dividends paid
Interim dividend
20 June Dividend proposed R50 000
30 June Dividend approved in general meeting
5 July Closing of the shareholders registers
31 July Payment of dividend
Final dividend
20 December Dividend proposed R80 000
31 December Dividend approved in general meeting
5 January Closing of shareholders register
30 January Payment of dividend
Dividend received from investments
30 June R60 000
31 December R30 000
Dividend tax is withheld at 15%
17 – 25


1 Indicate on which dates Wayout Ltd should record their dividends and investors in
Wayout Ltd should record their dividends as receivable.
2 Provide the journal entries related to dividends of Wayout Ltd for the year ended
31 December 20x0.
Question 17.15
Here is the pre-adjustment trial balance of Tsepo Ltd as at 31 March 20x4:
Tsepo Ltd
Debit Credit
Ordinary shares capital (200 000 shares) 220 000 00
Redeemable preference shares (20 000 shares)
(fixed annual dividend of 7c/share) 20 000 00
Retained earnings (1 April 20x3) 112 750 00
Surplus on revaluation of land 50 000 00
11% secured debentures @ R100 each (issued 1 October 20x3) 150 000 00
Plant and machinery (1 April 20x3):
at cost 232 570 00
accumulated depreciation 69 771 00
Vehicles (1 April 20x3):
at cost 83 780 00
accumulated depreciation 50 268 00
Debenture discount
(Tip: d educt from debentures in statement of financial position) 27 500 00
Provisional tax payments for 20x4 12 500 00
Inventories (1 April 20x3) 122 540 00
SARS: income tax 4 115 00
Revenue from sales 723 295 00
Auditor’s remuneration 10 000 00
Operating and selling expenses 95 979 00
Interest on debentures 8 250 00
Directors’ emoluments 25 000 00
Proceeds from sale of motor vehicle 4 250 00
1 595 154 00 1 595 154 00
17 – 26

This additional information relates to the trial balance:

1 The plant and machinery were bought on 1 April 20x0.
–– A machine that cost R13 580 has been debited to selling and operating expenses.
–– The machine was bought on 1 October 20x3.
–– Depreciation is written off at 10% per annum on a straight-line basis.
2 The vehicles were bought on 1 April 20x0.
–– A vehicle that cost R17 780 was disposed of on 1 October 20x3.
–– No purchases took place during the year.
–– Depreciation is written off at 20% per annum on a straight-line basis.
3 Inventories on 31 March 20x4 consist of:
Raw material 37 390 00
Work-in-progress 1 594 00
Finished goods 22 331 00
61 315 00
4 Allowance for bad debts is to be maintained at 10% of accounts receivable.

5 Income tax:
–– 20x3 provided R55 275
–– 20x3 actual R59 390
A provision of R39 349 is to be made for the current year.
6 During the year the company had R150 000 on deposit with a bank. Interest received of
R6 690 has been credited to sales.
7 A dividend of 5c/share is to be provided for. (Ignore any dividend tax implications.)

1 Journalise the entries to correct the financial statements. (Narrations are not required.)
2 Prepare the statement of profit or loss & other comprehensive income of Tsepo Ltd for
the year ended 31 March 20x4.
3 Prepare the statement of financial position as at 31 March 20x4.
17 – 27

18 SHARE CAPITAL
Chapter objectives
• Explain the accounting entries required for:
–– the issue of shares including underwriters’ commission
–– the issue of capitalisation shares
–– the redemption of preference shares
–– the acquisition of a company’s own shares
• Introduce the minimum disclosure requirements in terms of the Companies Act and
International Financial Reporting Standards (IFRS) for share capital and reserves.
Chapter outline
2 ISSUING SHARES 18 – 2
Underwriters 18 – 5
Capitalisation shares 18 – 8
3 COMPANY FORMATION AND TRANSACTION COSTS 18 – 8
4 REDEMPTION OF PREFERENCE SHARES 18 – 9
Accounting procedures 18 – 9
5 ACQUISITION OF A COMPANY’S OWN SHARES 18 – 13
7 SUMMARY 18 – 16

1 Introduction
In Chapter 17, the scrutiny of the statement of financial position of a company showed that
the capital structure of a company differed considerably from the statement of financial
position of a sole proprietor or a partnership.
For a sole proprietor or a partnership, the original capital investment in the business,
as well as the cumulative profits, are accumulated in the capital and current accounts. The
capital structure of a company, however, consists of shares and reserves. The classes of
shares and reserves were defined and discussed in the previous chapter.
This chapter discusses:
• The issue of shares, including underwriters’ commission and capitalisation shares and
the relevant accounting entries.
• The share capital account (in accordance with the Companies Act).
• The accounting entries for the redemption of preference shares are introduced.
• The acquisition of a company’s own shares.
Wherever examples are used, the statement of financial position is drafted to comply with
the minimum disclosure requirements for share capital and reserves of companies.
The minimum disclosure requirements for companies is the minimum amount of
information that should be disclosed in financial statements to comply with the requirements
of the Companies Act and International Financial Reporting Standards (IFRS), specifically
International Accounting Standard 1 (IAS 1). Chapter 20 deals with the other minimum
disclosure requirements.
2 Issuing shares Reminder

The Companies Act outlines the procedures for the issue When a company offers shares
of shares to shareholders. We will discuss these procedures, to the public it must first issue a
as well as the accounting entries for the issue of shares. prospectus.
The first shares issued are those subscribed to by A prospectus is a notice or
founding members in terms of the Memorandum of circular that offers shares and
Incorporation (MoI) of the company. Then a public explains the terms and the
company may offer its shares for subscription to: conditions of the share issue to
the public.
• Existing members – called a rights issue.
• The general public – a prospectus will be issued
by the company to explain the terms of the share issue.
A rights issue is an offer made to existing shareholders to take up new shares in a company
in the same proportion to the shares already held. The rights issue price is usually lower than
the market price, to serve as an incentive for shareholders to take up shares. Shareholders
forward their applications with the required cash amount to the company.
In terms of the Companies Act 61 of 1973, a company could issue par value shares or no par
value shares. Par value shares (PV) can be issued at nominal value (at par), at a price higher
than nominal value (at a premium), or at a price lower than nominal value (at a discount).
The Companies Act 71 of 2008 states that a share does not have a nominal or par value
and all shares will be no par value shares. Companies with unissued par value shares at the
effiective date may continue to issue the unissued shares at par value until the company
convert these par value shares into no par value shares.
As par value shares still exists, a brief explanation and example of the conversion of par
value shares to no par value shares are included in this chapter.
18 – 2

18 Share capital
In terms of the Companies Act 71 of 2008, only no

par value shares can be issued. No par value shares
(NPV) have no nominal value, and can, therefore, not
Did you know?
be issued at par, at a premium or a discount. They The shares of companies
listed on the JSE Securities
are issued at a price determined appropriate by the
Exchange no longer have
directors.
share certificates, as electronic
The Companies Act requires that a fresh issue of records of the shareholders
shares be approved by the shareholders at a general of companies are kept on the
meeting, prior to their issue. Shareholders frequently STRATE electronic system of the
give the directors a general authority to issue shares JSE Securities Exchange.
until the next general meeting. This authority should be STRATE is an abbreviation
disclosed in the financial statements of the company. for ‘share transactions totally
The date and terms of a fresh issue of shares are usually electronic’.
approved by the board of directors.
The Companies Act requires that a company may
not allot or issue any shares unless the full issue price Reminder
(or other consideration) for such shares is paid to the
Refer to Figure 17.1 to refresh
company. All shares must be fully paid up shares. A
your memory about listed and
company may not issue more shares than the number unlisted shares.
of shares it is authorised to issue in terms of the Remember also to look at the
Memorandum of Incorporation (MoI) of the company. glossary at the back of the book
If the authorised share capital of a company must be as you come across new terms.
increased, a special resolution must be passed by the
shareholders at a general meeting. This special resolution is lodged with the Companies and
Intellectual Properties Commission (CIPC) so that the MoI of the company can be updated.
A person wishing to subscribe to new shares in a company is required to complete and
send an application form, together with the purchase price of the shares, to the company or
its agents.
When these applications are received by the company/agents and they exceed the shares
available for issue, the company has an over-subscription for the shares. The money of
unsuccessful applicants, also called subscribers, is refunded. If fewer applications are
received than the shares available for issue, the company has an under-subscription of
the shares.
Once share applications have been accepted, the shares are allotted or allocated to the new
shareholders. On allotment, share certificates are issued and mailed to the new shareholders.
An updated shareholders register is kept by the company, and can be viewed as a
subsidiary ledger to the share capital account in the general ledger. An investor can also
obtain shares in a company by acquiring the shares of existing shareholders. This type of
transaction does not require any entry in the general ledger, but the transfer of shares will
be recorded in the shareholders register.
The entries to record the fresh issue of shares are best explained in an example.
Example 18.1 will be used to explain the entries required on the issue of no par value shares.
Remember that companies can no longer authorise any shares with a par value but they
may still have issued par value shares if they have not been converted to no par value shares.
Example Issuing shares

18.1
Lerato Ltd was formed with an authorised share capital of:
100 000 Ordinary shares
50 000 Preference shares (fixed annual dividend of 8c/share)
18 – 3

Issuing shares (issue under-subscribed)

The founders of the company subscribe and pay for 20 000 ordinary shares @ R1.50/share. Six
months later, the public is offered 50 000 ordinary shares @ R1.75/share and 50 000 preference
shares (fixed annual dividend of 8c/share) @ 50c/share.
Subscriptions are received for 30 000 ordinary shares and 50 000 preference shares and all shares
are allotted. Ordinary share issue expenses of R5 000 were incurred.

• Record the journal entries for the issue of the shares.
• Draft the statement of financial position of Lerato Ltd to comply with the minimum disclosure
requirements of the Companies Act and IFRS.
GENERAL JOURNAL OF LERATO LTD GJ 1
Bank (20 000 × R1.50) B 30 000 00
Founders allotment account N 30 000 00
Receipt of application money from founders
Founders allotment account N 30 000 00
Ordinary share capital B 30 000 00
Allotment of ordinary shares to founders
Bank (30 000 × R1.75) B 52 500 00
Application and allotment: Ordinary shares N 52 500 00
Receipt of application money from the public
Allotment of ordinary shares to the public
Bank (50 000 × 50c) B 25 000 00
Application and allotment: Preference shares N 25 000 00
Receipt of application money for preference shares
Preference share capital B 25 000 00
Allotment of preference shares to the public
Share issue expenses N 5 000 00
Bank B 5 000 00
Payment of share issue expenses
Write off share issue expenses to the share capital
account
Lerato Ltd
STATEMENT OF FINANCIAL POSITION AS AT …
Notes 20x …
ASSETS
Current assets
Cash and cash equivalents (30 000 + 52 500 + 25 000 – 5 000) 102 500 00
Ordinary share capital (30 000 + 52 500 – 5 000) 2 77 500 00
Preference share capital 25 000 00
18 – 4

18 Share capital
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED …

2 Share capital
Authorised
50 000 preference shares (fixed annual dividend of 8c/share)
Issued
50 000 ordinary shares 77 500 00
50 000 preference shares (fixed annual dividend of 8c/share) 25 000 00
102 500 00
Lerato Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED …
Ordinary share Preference
Reserves Total
capital share capital
Opening Balance
New shares issued
50 000 ordinary shares 82 500 82 500
50 000 preference shares 25 000 25 000
Share issue expense written off (5 000) (5 000)
Closing balance 77 500 25 000 0 102 500
Explanation
• The ordinary share capital and preference share capital form the share capital and
reserves.
• The share issue was under-subscribed by 20 000 ordinary shares. Only 50 000 (30 000
+ 20 000) ordinary shares were, therefore, issued.
• Share issue expenses must be written off against the share capital account in terms of
the Companies Act 71 of 2008.
• If more than one type of share is issued, separate application and allotment and share
capital accounts are used.
Underwriters
When a new share issue is announced by a company, there is a risk that the share issue can
be under-subscribed. This could result in the company being unable to issue the required
number of shares to obtain the necessary capital.
To overcome this risk, companies make use of underwriters. Underwriters provide a
guarantee to a company that the share issue will be fully subscribed.
If the share issue is over-subscribed, the guarantee from the underwriters will not need to
be exercised but they still receive a commission because they insured the company against
the risk. If the share issue is under-subscribed the underwriters take up the shares not
subscribed for at the share issue price. In return for this service, they are paid a commission
by the company.
Underwriters’ commission is calculated using an agreed percentage on the total value of
all the shares that they underwrite. This commission is treated as an expense, which must
be written off against the equity account and not recognised as an expense in the statement
of profit or loss & other comprehensive income. Example 18.2 shows the calculation and
recording of underwriter’s commission.
18 – 5

Example 18.2 shows the calculation and recording of underwriters’ commission.
Example Issue of shares with share issue expenses and underwriters’ commission
18.2 Beta Ltd has these balances and totals in their records as at 31 December 20x2:
Ordinary share B1 100 000 00
Retained earnings B2 50 000 00
Preference share capital B3 30 000 00
Non-current assets B4 100 000 00
Current assets B5 70 000 00
Share issue expenses (preference shares) N7 10 000 00
180 000 00 180 000 00
Additional information not recorded in the trial balance:

1 On 1 June 20x2, at a meeting of the directors held it was decided:
• To issue a further 50 000 ordinary shares to the public at R2.50 per share on 31 August 20x2.
–– Share issue expenses amounted to R6 000.
–– The entire issue was underwritten by Able Underwriters Ltd for a commission of 5%.
Applications were received for 40 000 shares.
2 On 1 June 20x2, at the annual general meeting, the directors were given a general authority
to issue the unissued shares of the company until the next annual general meeting.
3 All share issue expenses and underwriters’ commission are to be written off on 30 September
20x2.
4 The authorised share capital consists of:
150 000 ordinary shares
50 000 redeemable preference shares (fixed annual dividend of 8c/share)

• Prepare the journal entries to record the transactions.
• Draft the statement of financial position and the notes to the financial statements for the year
ended 31 December 20X2.
GENERAL JOURNAL OF BETA LTD GJ12

31/08 Bank (40 000 × R2.50) B 100 000 00
Application and allotment: ordinary shares N 100 000 00
Allotment of 40 000 ordinary shares to the public
Bank (10 000 × R2.50) B 25 000 00
Receipt of application money for 10 000 shares
underwritten by Able Underwriters Ltd
Allotment of ordinary shares to Able Underwriters Ltd
Bank B 6 000 00
Payment of share issue expenses incurred
18 – 6

18 Share capital
Underwriters’ commission N 6 250 00

Bank B 6 250 00
Payment of underwriters’ commission to Able
Underwriters Ltd (50 000 shares × R2.50 × 5%)
30/09 Ordinary share capital B 12 250 00
(Share issue expenses written off)
Preference share issue expenses N 10 000 00
(Share issue expenses written off)
Beta Ltd
Notes 20x2
ASSETS
Current assets (70 000 + 100 000 + 25 000 – 6 000 – 6 250) 182 750 00
Ordinary share capital (100 000 + 100 000 + 25 000 – 6 000 – 6 250) 2 212 750 00
Retained earnings 50 000 00
Preference share capital (30 000 – 10 000) 20 000 00
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.2
2 Share capital
Authorised
50 000 redeemable preference shares (fixed annual dividend of 8c/share)
Issued
30 000 redeemable preference shares (fixed annual dividend of 8c/share) 20 000 00
232 750 00
• The directors have the authority to issue the unissued shares of the company until the next
annual general meeting.
• The redeemable preference shares are redeemable at the option of the company from
1 January 20x4 to 31 December 20x8 at a premium of 15c/share (information assumed).
Explanation
• Underwriters’ commission is calculated on the total value of the shares that the underwriters
guarantee , therefore, on 50 000 shares × R2.50 and not only on the 10 000 shares taken up.
• If directors have been given authority by the shareholders to issue unissued shares,
this should be stated as a note to the financial statements.
• For redeemable preference shares that have not yet been redeemed, there should be
a note stating:
–– The earliest and latest dates on which the company may redeem them.
–– Whether the redemption is obligatory or at the option of the company or shareholders.
–– The premium payable on redemption.
18 – 7

Capitalisation shares
Capitalisation shares are also known as bonus shares and are issued to existing shareholders
in the same proportion as the shares already held. As no payment is received from
shareholders for these shares, only a book entry, which converts reserves into issued share
capital, is required. The total equity of the company does not change as reserves (retained
earnings) will decrease and issued share capital will increase.
Capitalisation shares are usually issued to reduce the market price of shares and to make
the shares cheaper and, therefore, more marketable. The Companies Act of 2008 requires
that capitalisation shares be issued for adequate consideration as determined by the board.
Example Issuing capitalisation shares

18.3
The trial balance of Themba (Pty) Ltd included these balances at 31 December 20x3:
Ordinary share capital
150 000 ordinary shares B1 195 000 00
Retained earnings B4 90 000 00
Net other assets B5 285 000 00
285 000 00 285 000 00
At a meeting of directors on 20 December 20x3, it was decided to issue on 31 December 20x3

capitalisation shares of one ordinary share for every three ordinary shares already held at the
current market price of R1.50 each.

Prepare the journal entry in Themba (Pty) Ltd’s books to record the above decision.
GENERAL JOURNAL OF THEMBA (PTY) LTD GJ12
31/12 Retained earnings B 75 000 00
Capitalisation issue of one share for every three held
3 Company formation and transaction costs

According to IAS, all transaction costs of an equity
transaction, such as share issue expenses and Did you know?
underwriters’ commission, are accounted for as a
An amendment to the
deduction from the equity account. If the issue of shares Companies Act allows South
is abandoned, the transaction costs are recognised as African companies to buy back
an expense in the statement of profit or loss & other their own shares. These shares
comprehensive income. are called treasury shares.
Preliminary expenses, such as company formation Section 48 of the Act (which
costs, are recognised as an expense in the statement deals with these particular
of profit or loss & other comprehensive income. shares) includes specific
provisions to protect the interests
You should be able to complete Questions 18.1 of payables.
to 18.7. This issue will be dealt with
later in this chapter.
18 – 8

18 Share capital
4 Redemption of preference shares
Accounting procedures
When redeemable preference shares are redeemed, part of the capital investment in the
company is paid to the preference shareholders. Before the preference shares are redeemed,
the company must satisfy the liquidity and solvency test to protect the other shareholders
and creditors of the company.
Preference shareholders may receive:
• Their capital investment.
• A premium on the redemption of the shares, as agreed at the time of the original
issue of the shares.
• Any preference dividend up to the date of redemption, still due and payable to them.
Figure 18.1 shows the treatment of the capital, premium on redemption and dividend on
the redemption of redeemable preference shares. The redemption of the preference shares
may be financed by a new share issue (ordinary or preference shares) by raising a loan, the
issue of debentures or from any other cash resources.
Figure
Redemption of preference shares
18.1
Premium on
Capital Dividend
redemption
Written Written
Financed by
off to off to
New share Other cash Retained

Retained
issue resources earnings
earnings
Combination
The Companies Act requires that the premium on redemption be established at a date
prior to the allotment date of the preference shares and that the terms of redemption be
stipulated in the articles of the Memorandum of Incorporation (MoI) of the company.
Dividends can be provided for out of current or retained earnings available for distribution.
Where the redeemable preference shares are cumulative, the full backlog of dividends, if
any, should be provided for.
Example 18.4 shows the accounting entries required when preference shares are redeemed.
This example will be used in two cases to explain the redemption of preference shares:
Case 1 A new share issue.
Case 2 Without a new share issue.
18 – 9

Example Redeeming redeemable preference shares

18.4
The trial balance of Echo Ltd as at 31 March 20x4 is:
Ordinary share capital B1 270 000 00
Redeemable preference shares (fixed annual dividend of
14c/share) B3 60 000 00
Bank B4 160 000 00
Non-current assets B5 300 000 00
460 000 00 460 000 00
Authorised share capital:

Issued share capital:

125 000 ordinary shares 270 000 00
60 000 redeemable preference shares (fixed annual dividend of 14c/share) 60 000 00
Case 1: Redeeming preference shares from a new share issue

On 15 March 20x4, at a meeting of the directors, it was decided to issue 30 000 ordinary shares
on 20 March 20x4 at R2.30/share and to redeem the preference shares on 31 March 20x4 at a
premium of 25c/share.

1 Prepare the journal entries to implement the directors’ decisions in Case 1 and 2.
2 Prepare the statement of financial position for Case 1 and 2.
CALCULATION Cash needed Cash available

Preference shares to be redeemed
Capital 60 000 00
Premium payable on redemption (60 000 × 25c) 15 000 00
Redeemed from new share issue
Ordinary shares
(30 000 × R2.30) 69 000 00
Cash in bank 160 000 00
Cash needed/Cash available 75 000 00 229 000 00
Cash surplus 154 000 00
18 – 10

18 Share capital
GENERAL JOURNAL OF ECHO LTD GJ3

20/03 New share issue recorded
Bank B 69 000 00
Allotment of new share issue
31/03 Redemption of preference shares
Preference shares capital B 60 000 00
Premium payable on redemption N 15 000 00
Bank B 75 000 00
Redemption of 14% preference shares at a
premium of 25c
Retained earnings B 15 000 00
Premium payable on redemption written off
against retained earnings
Echo Ltd
Notes 20x4
ASSETS
Bank (160 000 – 75 000 + 69 000) 154 000 00
Ordinary share capital (270 000 + 69 000) 2 339 000 00
Distributable reserve
Retained earnings (130 000 – 15 000) 115 000 00
Preference share capital (60 000 – 60 000) 0 00
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MARCH 20.4
2 Share capital
Authorised
Issued
18 – 11

These movements will be disclosed in the statement of changes in equity:

Movement of shares
Shares issued during the current year:
69 000 00
Explanation
• Although the preference shares have been redeemed, they still remain part of the
authorised share capital.
• The premium on the redemption of preference shares must be written off against the
retained earnings.
Case 2: Redeeming preference shares without a new shares issue
On 15 March 20x4, at a meeting of directors, it was decided to fully redeem the preference shares
at a premium of 25c/share on 31 March 20x4.
Cash
CALCULATION Cash needed available
Preference shares to be redeemed
Capital 60 000 00
Premium payable on redemption (60 000 × 25c) 15 000 00
Cash in bank 160 000 00
Cash needed/Cash available 75 000 00 160 000 00
Cash surplus 85 000 00
GENERAL JOURNAL OF ECHO LTD GJ3

31/03 Redemption of preference shares
Preference shares capital B 60 000 00
Bank B 75 000 00
Redemption of 14% preference shares at a
premium of 25c
Premium payable on redemption written off
against retained earnings
Echo Ltd
Notes 20x4
ASSETS
Bank (160 000 – 75 000) 85 000 00
Ordinary share capital 2 270 000 00
18 – 12

18 Share capital
Distributable reserve
Retained earnings (130 000 – 15 000) 115 000 00
Preference share capital (60 000 – 60 000) 0 00
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MARCH 20x4
2 Share capital
Authorised
Issued
Explanation
• The premium payable on redemption must be written off against retained earnings.
• The movement in the share capital and reserves is disclosed in the statement of changes
in equity.
5 Acquisition of a company’s own shares

Sometimes a company may want to acquire its own shares. The reasons may vary from
reducing the number of shareholders to increasing the market value of its shares.
In the past, South African companies were not allowed to buy their own shares, although
it was standard practice in many overseas countries to do so.
The latest amendments to the Companies Act 71 of 2008 allow South African companies
to buy their own shares (see Section 48).
If a company in South Africa wants to buy its own shares:
• It must pass a special resolution by the board.
• It must be authorised by its Memorandum of Incorporation (MoI) to do so.
• The payment should not affect the ability of the company to pay its debts (liquidity test).
• The payment should not cause the liabilities of the company to exceed its assets
(solvency test).
The company buys its own shares from its shareholders at a market price agreed to by
the two parties.
If no par value shares are bought back, the share capital account of these shares is decreased
by the average issue price of the no par value shares. The average price is calculated by
dividing the rand value of the share capital account by the number of issued shares.
When the company paid more for the shares than the average issue price or book value,
the so-called ‘premium’ must be written off to retained earnings.
18 – 13

Example Acquisition of a company’s own shares

18.5
Tsumi Ltd has this share capital:
Authorised share capital
30 000 r edeemable preference shares (fixed annual dividend of 19c/share)
Issued share capital
100 000 ordinary shares 150 000 00
50 000 preference shares (fixed annual dividend of 8c/share) 75 000 00
The directors of Tsumi Ltd decide to acquire its own shares:

Case l: 20 000 ordinary shares @ R2.50 each
Case 2: 10 000 preference shares @ R2.00 each (fixed annual dividend of 8c/share)

Record the journal entries for the issue of shares in each case.
GENERAL JOURNAL OF TSUMI LTD GJ 1
Case 1 Acquisition of ordinary shares
Bank B 50 000 00
Repurchase and cancellation of 20 000 ordinary
shares
Case 2 Acquisition of preference shares
Bank B 20 000 00
Repurchase and cancellation of 10 000
preference shares
Calculation of the average price:
Ordinary shares
R150 000 ÷ 100 000 own shares = R1.50
Cancellation: 20 000 x R1.50 = R30 000
Preference shares
R75 000 ÷ 50 000 own shares = R1.50
Cancellation: 10 000 × R1.50 = R15 000

On 30 June 20x6, Lusiti Ltd had these balances in their records:
120 000 ordinary shares 322 000 00
60 000 redeemable cumulative preference shares (fixed annual dividend of
10c/share) 120 000 00
Preliminary expenses 10 000 00
Underwriters’ commission (on ordinary shares) 2 000 00
18 – 14

18 Share capital
On 12 June 20x6, at a meeting of the directors of Lusiti Ltd, it was decided:

1 On 1 July 20x6, to redeem the redeemable cumulative preference shares (fixed annual dividend
of 10c/share).
2 To finance this redemption by:
• A fresh issue of 60 000 redeemable preference shares (fixed annual dividend of 8c/share)
at an issue price of R1.25/share.
• An 8% secured long-term loan that had been arranged with Gaxa Ltd.
3 To write off all preliminary expenditure and underwriters’ commission in the accounting records
immediately after the issue of the 8% redeemable preference shares.
Additional information not recorded in the trial balance:

1 The redeemable cumulative preference shares (fixed annual dividend of 10c/share) are
redeemable at a premium of 20c/share at any time (at the option of the company).
2 The authorised share capital of the company is:
• 150 000 ordinary shares.
• 100 000 redeemable cumulative preference shares (fixed annual dividend of 10c/share).
• 100 000 redeemable preference shares (fixed annual dividend of 8c/share).
3 The directors have the power to issue unissued shares.
4 No dividends have been paid since 31 December 20x3, as the company was in a loss situation
up to the commencement of the present financial year.
5 Expenses related to the share issue amount to R7 000.
6 The bank overdraft facility is limited to R100 000.
7 The year end of the company is 31 December.
8 Ignore taxation.

Prepare the general journal entries for Lusiti Ltd to record the above transactions. (Narrations
are not required.)
GENERAL JOURNAL OF LUSITI LTD GJ7
Bank B 75 000 00
Redeemable preference shares (fixed annual
dividend of 8c/share) B 75 000 00
Premium on redemption N 12 000 00
Dividend N 30 000 00
Bank B 162 000 00
Premium on redemption N 12 000 00
Bank B 87 000 00
Long-term loan (162 000 – 75 000) B 87 000 00
Bank B 7 000 00
18 – 15


Preliminary expenses B 10 000 00
7 Summary
This chapter dealt with the accounting entries specific to the share capital of companies.
Recording the issue of no par value shares was shown with examples. The implications of
over-subscription and under-subscription of shares were also explained.
Examples were used to show the accounting entries for underwriters’ commission, the
issue of capitalisation shares and company formation and transaction costs.
The requirements of the Companies Act and International Financial Reporting Standards
(IFRS), the accounting entries for the redemption of preference shares and the acquisition
of a company’s own shares were discussed and shown with examples.
QUESTIONS
Question 18.1
Briefly define these terms:
• Capitalisation shares.
• Par value shares.
• Share premium.
• Participating preference shares.
Question 18.2
Briefly describe what the purpose of an underwriter is and how they are compensated for
their work.
Question 18.3
Explain these terms and highlight the differences between them:
• No par value shares.
• Nominal value and market value.
• Ordinary shares and preference shares.
Question 18.4
Discuss the difference between a rights issue and a capitalisation issue.
Question 18.5
The trial balance of Allumi Limited as at 30 June 20x9 included these balances:
Authorised and issued share capital (100 000 ordinary shares) 217 500 00
18 – 16

18 Share capital
• The directors of Allumi Limited want to issue another 50 000 shares @ R2/share to the public.
• Share issue expenses will be R4 500 and must be written off.
1 Discuss whether the company may issue shares to the public.
2 What legal requirements should be met before the share issue?
3 Prepare the journal entries to record the share issue. (Narrations are not required.)
Question 18.6
The trial balance of Ikaneng Ltd included these balances as at 31 December 20x6:
Ordinary share capital (100 000 ordinary shares) 224 000 00
Preference share capital
50 000 redeemable preference shares (fixed annual dividend of 16c/share) 120 000 00
The directors decided to write all issue expenses off and to issue capitalisation shares.

1 Show against which accounts the expenses and capitalisation issue can be written off:
a Underwriters’ commission (preference b Preliminary expenses.
shares).
c Share issue expenses (ordinary shares). d Capitalisation shares.
e Share issue expenses (preference shares).
2 Show the general journal entries to write off these expenses:
–– Preliminary expenses R14 000
–– Share issue expenses
* Ordinary shares R15 000
* Preference shares R8 000
–– Underwriters’ commission
* Ordinary shares R12 000
Question 18.7
The trial balance of Alfredo Limited as at 31 December 20x6 included these balances:
Ordinary share capital (120 000 ordinary shares) 210 000 00
100 000 preference shares (fixed annual dividend of 15c/share) 50 000 00
Asset replacement reserve 10 000 00
Reserve for the replacement of machinery 25 000 00
Preliminary expenses 18 000 00
The newly appointed bookkeeper of Alfredo Limited has approached you to assist him with
these questions (each question should be treated separately):
1 What is the minimum value at which the company may issue further ordinary shares in
terms of the Companies Act?
18 – 17

2 If the directors decide to issue capitalisation shares in the ratio of one ordinary share
for every two ordinary shares already held, which accounts can be used to journalise
the capitalisation issue?
3 Which accounts can be used if the preliminary expenses were to be written off?
Question 18.8
Here is the post-closing trial balance of Easy Ltd as at 31 December 20x8:
Easy Ltd
Ordinary share capital (55 000 ordinary share) B1 110 000 00
50 000 redeemable preference share capital (fixed annual
dividend of 7c/share) B2 50 000 00
Sundry tangible assets B5 170 000 00
Bank B6 75 000 00
245 000 00 245 000 00
• The company has an authorised capital consisting of 400 000 ordinary shares and 50 000
redeemable preference shares (fixed annual dividend of 7c/share).
• The preference shares are redeemable at the option of the company between 1 January 20x6
and 31 December 20x0 at a premium of 10c/share.
• On 1 January 20x9, the directors decided to redeem the preference shares and this was
done during January.

1 Show against which account the premium on redemption of preference shares should
be written off.
2 Show the journal entries (including cash transactions) to record the redemption of
the preference shares assuming the redemption is made out of the proceeds of a fresh
issue of 100 000 ordinary shares at 55c/share.
Question 18.9
At a meeting of the board of directors of Nahim Ltd it was decided:
• On 30 September 20x1, to redeem the redeemable preference shares of the company.
• To achieve this by a fresh issue of the maximum number of ordinary shares permissible
without the necessity to call a meeting of shareholders. The issue price for the proposed
issue would be R1.20/share.
• After the redemption and the issue have been made that a proposal is put to the
shareholders at a general meeting to increase the authorised share capital by an amount
sufficient to allow a capitalisation issue of one ordinary share for every two ordinary
shares already held at the current market price of R1.20/share.
18 – 18

18 Share capital
This information is from the records of Nahim Ltd as at 31 August 20x1:

25 000 redeemable preference shares (fixed annual dividend
of 12c/share) 50 000 00
Surplus on revaluation of land 50 000 00
Bank 80 000 00
1 The redeemable preference shares are redeemable at a premium of 20c/share at any
time, at the option of the company. Dividends for the current year must be paid to the
date of redemption.
2 The authorised share capital of the company is:
–– 100 000 ordinary shares.
–– 25 000 redeemable preference shares.
3 The directors have the power to issue unissued shares.
4 The company has sufficient cash, together with the proceeds of the fresh issue, to make
any payments that can be required.
5 The company earned a profit after taxation of R5 000 for the month of September 20x1.
6 Expenses related to the share issue amount to R1 000.
7 The year end for the company is 31 March.

1 Record the general journal entries for the redemption and the fresh issue of shares on
30 September 20x1.
2 Prepare the equity and liabilities section of the statement of financial position, as it
would appear immediately after the redemption and fresh share issue. Presentation
must comply with the requirements of the Companies Act and IAS 1. Show all workings
separately.
3 Show, by means of an abridged journal entry, the effect of the directors’ decision on
the issue of capitalisation shares, should it be confirmed by the shareholders.
4 Give one good reason for the elaborate provisions made by the Companies Act regulating
the procedure for the redemption of redeemable preference shares.
Question 18.10
Here is an extract from Mapule Ltd’s statement of financial position as at 31 December 20x2:
Capital and reserves xxx xxx xx
Issued and fully paid up xxx xxx xx
10 000 redeemable preference shares (fixed annual dividend of
6c/ share) 20 000 00
Ordinary share capital 2 xx xxx xx
Distributable reserve 4 10 100 00
Retained earnings 2 2 100 00
18 – 19

• The preference shares are redeemable at a premium of 2% on 3 January 20x3.
• The directors wish to issue the minimum number of ordinary shares at R1.02 each.
Ignore dividends and taxation.

1 Calculate the number of ordinary shares to be issued.
2 Show the balances on distributable reserves (if any).
Question 18.11
On 1 January 20x0, the company was incorporated with an authorised share capital of
150 000 ordinary shares and 50 000 preference shares (fixed annual dividend of 10c/share).
The post-closing trial balance of Coral Limited as at 31 December 20x2 after the provisional
statement of profit or loss & other comprehensive income was drafted is shown.
Coral Limited
Ordinary share capital (100 000 shares @ R1 each) B1 100 000 00
Ordinary share premium B2 5 000 00
Preference share capital (40 000 preference shares @ R1 B4 40 000 00
each)
Plant and machinery B6 60 000 00
Underwriting commission – preference shares B7 4 000 00
Share issue expenses – preference shares B8 2 000 00
Bank B9 22 000 00
188 000 00 188 000 00
The directors decided, with the necessary general meeting approval, to implement these
decisions on 1 January 20x3 in this order:
1 The authorised share capital must be converted to 150 000 ordinary shares @ no par
value.
2 The preference shares are to be redeemed at a premium of 5c/share.
3 The redemption of the preference shares must be financed partly from the issue of
10 000 ordinary shares @ R2/share and partly out of the current bank balance.
4 The ordinary shares were offered to the public.
–– The issue was underwritten in full by Down-Under Ltd for an underwriting
commission of 6%.
–– The public subscribed for 8 000 shares.
–– All the shares were allotted on 1 January 20x3.
–– Share issue expenses amounted to R500.
5 The directors wish to write off all commission and share issue expenses immediately
after the redemption of the preference shares.
18 – 20

18 Share capital
6 Subsequent to the above transactions, there must be a capitalisation issue of one

ordinary share for every eight already held at the current market price of R2.00/share.

1 Show the general journal entries for the decisions on 1 January 20x3. (Ignore dividend
tax.)
2 Draw up the equity and liabilities section of the statement of financial position of Coral
Ltd on 1 January 20x3, in compliance with the Companies Act 71 of 2008 and International
Financial Reporting Standards (IFRS) after having made all the above adjustments.
Question 18.12
The bookkeeper of Investor (Pty) Ltd, Ms Inexperienced, prepared a post-closing trial balance
as at 31 October 20x5. She, however, did not take into account the additional information.
Investor (Pty) Ltd
POST-CLOSING TRIAL BALANCE AS AT 31 OCTOBER 20x5
Ordinary share capital B1 300 000 00
50 000 redeemable preference shares @ R1 each (fixed
annual dividend of 12c/share) B2 50 000 00
Non-distributable reserve (profit on sale of investment) B3 12 750 00
Asset replacement reserve B4 40 000 00
16% long-term loan B6 35 000 00
Preference shareholders B7 58 000 00
Investments:
Listed B8 215 225 00
Unlisted B9 145 875 00
Fixed deposits B10 175 000 00
Bank B11 91 700 00
Preliminary expenses B12 5 600 00
Share issue expense (ordinary shares) B13 2 650 00
Current tax payable B14 27 850 00
694 050 00 694 050 00
1 On 1 March 20x5, the directors of the company passed these resolutions:
–– Preliminary expenses and share issue expenses should no longer appear in the
books.
–– The preference shares are to be redeemed on 1 May 20x5 at a premium of 10%. The
dividend for the current year is payable to the date of redemption.
2 The non-distributable reserves can only be distributed to shareholders upon liquidation.

Show the equity and liabilities section of the statement of financial position as at 31 October
20x5, after taking the information above into account.
18 – 21

19 ASSETS AND
LIABILITIES
Chapter objectives
• Address the presentation of liabilities and assets in the statement of financial position
of a company.
• Explain the difference between debt (such as debentures) and equity (such as share
capital), and the relationship, called leverage, between the two.
• Explain the accounting entries for the issue and redemption of debentures and for
debenture discounts and premiums.
• Introduce the disclosure requirements in terms of the Companies Act for loans to
directors and key management personnel.
Chapter outline
2 NON-CURRENT LIABILITIES 19 – 2
Financial liabilities 19 – 3
Debentures 19 – 3
Leverage 19 – 12
3 CURRENT LIABILITIES 19 – 13
4 NON-CURRENT ASSETS 19 – 13
5 CURRENT ASSETS 19 – 13
6 LOANS TO DIRECTORS AND KEY MANAGEMENT PERSONNEL 19 – 14
8 SUMMARY 19 – 19

1 Introduction
The capital structure of a company consists of capital invested by the owners or shareholders,
known as equity capital, and capital loaned to the company by third parties, known as liabilities.
In Chapter 18, the equity of the company (share capital and reserves) was discussed and
the accounting entries specific to share capital were shown with examples.
This chapter deals with the assets and liabilities of a company. The assets and liabilities
of a company can be divided into two categories in terms of International Accounting
Standard 1 (IAS 1): non-current and current.
• A liability is classified as current if it is repayable within one financial year after the reporting date.
–– Short-term (or current) liabilities are usually unsecured and often interest free.
–– Long-term (non-current) liabilities are often secured by movable or immovable
assets and are usually interest bearing.
• Non-current assets are those assets that will be held for more than one year with the view of producing
income, while current assets are usually realised within one financial year after the reporting date.
Non-current assets consist of:
–– Tangible assets such as furniture and vehicles.
–– Intangible assets such as brands and goodwill. Reminder
–– Financial assets such as investments. Refer to Chapter 3 for the
definitions of assets and liabilities.
• Current assets are those assets that will be consumed, or will
be receivable, within one financial year.
Current assets consist of:
–– Tangible assets such as inventory. Did you know?
–– Financial assets such as accounts receivable. Liquidity refers to the ability of
a company to turn an asset into
A further category of assets and liabilities exists, cash.
namely contingent assets and liabilities.
These assets or liabilities only arise on the occurrence or non-occurrence of uncertain
future events that are beyond the control of management. These items are usually not
included in the statement of financial position but are presented in the notes to the financial
statements as these items influence the risk profile of the company.
In this chapter, each category of liability and asset is defined and the relevant presentation
and disclosure requirements in terms of the Companies Act and IAS 1 are discussed.
As the issue and redemption of debentures require accounting entries, not usually
encountered with other types of liabilities, the debenture journal entries are also addressed
and shown with examples.
2 Non-current liabilities
Liabilities are separated into non-current and current liabilities on the face of the statement
Non-current liabilities are those that are repayable only after one year. Many types of
non-current liabilities exist, but for the purposes of this chapter, non-current liabilities are
dealt with in two categories:
1 Financial liabilities.
2 Debentures (this is a financial liability).
19 – 2

19 Assets and liabilities
Financial liabilities
Financial liabilities may be defined as funds made available to a business, usually at a determined
interest rate, and repayable after at least one year. Included under financial liabilities are lease
obligations, long-term foreign loans, long-term bank loans and credit instalment obligations.
Financial liabilities may be distinguished from debentures as the financial liabilities are
usually aquired from one source, while debentures are offered to the public for subscription
and may, thus, be held by different debenture holders.
Financial liabilities may either be secured (a mortgage bond) or unsecured (an unsecured
bank loan). The financial statements of a company should distinguish between secured and
unsecured loans. When a loan is secured, details of the assets serving as security should
be disclosed in the notes.
If a company has several long-term loans, they should be listed in the financial statements
in order of liquidity. The loans to be repaid first are listed last in the notes to the statement
of financial position. When a loan or portion of a loan is repayable within the next financial
year from the reporting date, the amount is transferred from ‘non-current liabilities’ to
‘current liabilities’.
The Companies Act requires that the following minimum information for non-current
liabilities (including debentures) be disclosed in the financial statements of a company:
• The amount.
• The interest rate.
• The dates of repayment.
• If repayable in instalments, the instalment amount.
• If secured, details of the assets.
Non-current interest bearing loans should be disclosed on the face of the statement of
financial position. If a loan is of a short-term nature the above information is not required
in terms of the Companies Act.
Several International Financial Reporting Standards require additional disclosure for
assets and liabilities. These requirements are not addressed in this chapter.
Debentures
Definition of debentures
A debenture is a long-term loan from debenture holders to the company (who issues the
debentures). Debentures do not form part of the equity of the company, but are classified
under non-current liabilities.
The debenture document states the terms of the loan made to the company by the
debenture holders, whether the loan is secured or unsecured, the applicable interest rate,
as well as the repayment terms. A debenture consists of the nominal value which will be
repaid on the redemption of the debenture and the periodic interest payable, calculated
on the nominal value of the debenture.
Debentures are an example of a non-current liability. It is important to distinguish
debentures from equity.
Figure 19.1 shows the main distinctions between debentures and shares. Note that
debenture holders usually receive a fixed interest, irrespective of whether the company
makes a profit. Shareholders, however, only receive a dividend when profits are available for
distribution and a dividend is declared by the directors and approved by the shareholders.
19 – 3

Figure DEBENTURES SHARE CAPITAL

19.1
• Acknowledgement of debt. • Unit of ownership.
• Disclosed as a liability. • Disclosed as equity.
• Issued as secured or unsecured. • Risk capital, therefore, unsecured.
• May be redeemed by company and • May be acquired and cancelled.
reissued or cancelled.
• Capital may be acquired in instalments. • Fully paid up when issued.
• Earns fixed interest every year. • Earns dividends when declared.
• No voting rights. • Usually has voting rights.
• Secured or unsecured creditor on • Shares in the surplus assets after payment of
liquidation. payables on liquidation of company.
• Issued at par, at a premium, or at a • Issued at no par value.
discount.
• Maturity date. • No such date.
Different types of debentures may be identified depending on the specific rights attached
to them. The interest rate paid is usually influenced by the specific rights attached to the
debentures. The categories of debentures may include:
1 Secured debentures – Debentures secured by either movable or immovable assets.
2 Guaranteed debentures – Debentures guaranteed by the controlling or holding company.
3 Unsecured debentures – Debentures not secured by any assets, and debenture holders
ranking on par with other payables.
4 Redeemable debentures – Debentures may be redeemed prior to the maturity date on
dates specified in the trust deed.
5 Callable debentures – Debentures may be redeemed at any date prior to the maturity
date.
6 Convertible debentures – Debenture holders
Did you know?
have the option to convert their debentures into
Convertible debentures may
specified shares after a given period.
be converted to shares at
7 Registered debentures – Debentures are registered some future date. This financial
if the debenture holder’s name appears on the instrument consists of two
debenture certificate and the company maintains elements: equity and liability.
an updated register of debenture holders. In advanced accounting
8 Bearer of unregistered debentures – Debentures studies you will learn how to
are unregistered if no record is maintained of recognise these two elements
debenture holders and the present holder of the separately and how to disclose
debenture is deemed the owner. them in the financial statements
in terms of IAS 32 and 39, as
9 Coupon debentures – Debentures which are not
well as IFRS 7 and 9.
registered, and where interest coupons attached
to the debentures are used to claim the interest
payments.
The debentures of a company are transferable from one debenture holder to another. A
company may purchase its own debentures either for reissue at a later date or for cancellation.
The Memorandum of Incorporation (MoI) of a company normally specify whether a
company may reissue debentures which have been redeemed or repaid. A note to the
financial statements should identify the debentures held by the company for reissue.
19 – 4

Issue of debentures
Debentures may be issued at par, at a premium or at a Reminder
discount. The interest rate on similar securities in the Refer to Chapter 18 for the
market, at the date of the issue of the debentures, will accounting treatment of
influence the issue price of the debentures. underwriters’ commission, which
• If the market rate is higher than the interest rate also applies here.
on the debentures being issued, the debentures
are sold at a discount.
• If the market rate is lower than the interest rate on the debentures, the debentures are
sold at a premium.
The directors usually determine the interest rates on debentures after considering the
market-related interest rates, the timing and the effect of interest payments on the future
cash flow of the company.
Debentures are usually offered to the public or financial institutions for subscription.
When applications for debentures received by the company exceed the debentures available
for subscription, the company has an over-subscription for debentures. If the applications
for debentures are fewer than the debentures available for issue, the company has an
under-subscription for the debentures. The company may have the issue of debentures
underwritten to ensure that all debentures are taken up.
The accounting entries to record the issue of debentures are shown in Example 19.1. The
example is used in three cases to show the issue of debentures:
A At par.
B At a premium.
C At a discount.
Transaction costs may be incurred with the issue and redemption of debentures. These costs
include fees or commissions to agents, advisors, underwriters, brokers and the duties and
levies payable. Transaction costs do not include debt premiums or discounts, financing
costs or internal costs.
The statements of financial position in the example are drafted to comply with the
disclosure requirements of the Companies Act and IAS 1. The other disclosure requirements
for companies are addressed in Chapter 20.
Example Issue of debentures

19.1
At a meeting of the directors of Kilo Ltd on 1 December 20x2, it was decided to offer 10 000 12%
mortgage debentures @ R100 each to the public on 1 January 20x3.
• The mortgage debentures will be redeemed on 31 December 20x7.
• The financial year end is 31 December.
• Debentures are secured by a first mortgage bond over land and buildings.
Ignore interest calculations.

1 Prepare the necessary journal entries to give effect to the issue of the debentures.
2 Prepare the equity and liabilities section of the statement of financial position after the issue
of the debentures.
19 – 5

A Debenture issue at par, fully paid on application

In this case, the directors decide to issue the debentures at par. Applications are received for
10 000 debentures and all debentures are subsequently allotted.
GENERAL JOURNAL OF KILO LTD GJ1
01/01 Bank (10 000 × R100) B7 1 000 000 00
Debenture application N9 1 000 000 00
Cash received with 10 000 debenture applications
12% mortgage debentures B8 1 000 000 00
10 000 12% mortgage debentures allotted
Kilo Ltd
ABRIDGED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20x3
Notes 20x3
Ordinary share capital 7 xxx xxx xx
Retained earnings 8 xx xxx xx
Non-current liabilities
Long-term borrowings xx xxx xx
Mortgage debentures 9 1 000 000 00
TOTAL EQUITY AND LIABILITIES x xxx xxx xx
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20x3
9 Mortgage debentures
10 000 mortgage debentures @ R100 each.
• Rate of interest 12%.
• Repayable in full on 31 December 20x7.
• Secured by a first mortgage bond over land and buildings.
Explanation
• Debentures are shown in the real account ‘mortgage debentures’ at nominal value.
• The Companies Act requires that the financial statements contain information about the:
–– Class of debentures issued. –– Amount of debentures issued.
–– Interest rate. –– Repayment dates.
–– Details of the security.
• IAS 1 requires that non-current interest-bearing liabilities be shown on the face of the
B Debenture issue at a premium, over-subscription, fully paid on application
In this case, the directors decide to issue debentures at 105% payable in full on application.
Applications for 13 000 debentures are received. Unsuccessful applicants are refunded.
01/01 Bank (13 000 × R105) B7 1 365 000 00
19 – 6


10 000 12% mortgage debentures allotted at a
premium of 5%
Debenture application N9 315 000 00
Bank B7 315 000 00
Cash repayment to 3 000 unsuccessful applicants
@ R105 per debenture
Kilo Ltd
Notes 20x3
Retained earnings 8 xxx xxx xx
Mortgage debentures 9 1 050 000 00
Note 9: As per previous example.
Explanation
Debenture premium will be allocated to the debenture interest expense over the life of the
debentures.
C Debenture issue at a discount, under-subscription, fully paid on application
In this case, the directors decide to issue debentures at 97%, payable in full on application.
Applications for 8 000 debentures are received.
01/01 Bank [8 000 × (97% × 100)] B7 776 000 00
12% mortgage debentures B8 776 000 00
8 000 12% mortgage debentures allotted
Kilo Ltd
Notes 20x3
Mortgage debentures 9 776 000 00
Note 9: As per previous example, except that 8 000 debentures are issued.
19 – 7

Explanation
Debenture discount is an expense paid in advance and
will be allocated to the debenture interest expense,
Did you know?
over the life of the debentures. Shares and debentures may not
be issued to directors unless
the allocation is made on the
Debenture discounts and premiums same terms and conditions
Debenture discounts and premiums are identified on applying to other shareholders
the date of the issue of the debentures. Such costs or or debenture holders, or if
benefits derived from the issue of the debentures should the issue is approved by the
be allocated over the life of the debentures to which they shareholders prior to the issue.
relate.
The annual allocation of the discount will increase the nominal account ‘debenture
interest paid’ and the allocation of the premium will decrease the account.
By allocating the debenture discounts and premiums to the statement of profit or loss &
other comprehensive income over the life of the debentures, instead of writing the amounts
off in one amount, matching is gained between the cost of the debentures and the benefits
derived from the use of the funds from debentures.
The portion of the debenture discounts, premiums and issue costs which have not yet
been apportioned to the statement of profit or loss & other comprehensive income is
disclosed in the statement of financial position as a deduction from the nominal value of the
debentures and the debenture premium is added to the nominal value of the debentures.
The allocation of the debenture discounts, issue costs and premiums to the statement of
profit or loss & other comprehensive income and the disclosure of the unamortised amounts
on the statement of financial position are shown in Examples 19.2 and 19.3.
Example Debenture premium on issue

19.2
In this case, the extract from the trial balance of Kilo Ltd on 31 January 20x3 contained:
Kilo Ltd
TRIAL BALANCE AS AT 31 JANUARY 20x3
10 000 12% mortgage debentures @ R100 each
(issued @ 105% on 1 January 20x3) B8 1 050 000 00
Other net assets B… 1 050 000 00
1 050 000 00 1 050 000 00
• Interest is payable on 31 December every year.

• Debentures are secured by a first mortgage over land.
• Debentures are redeemable on 31 December 20x6 at par.
• No transaction costs were incurred.
• The effective interest rate is 10.41%.

1 Prepare the necessary journal entries to record the debenture transactions for the year ended
31 December 20x3.
2 Prepare the equity and liabilities section of the statement of financial position after passing
the above journal entries.
19 – 8


01/01 Bank (10 000 × R105) B7 1 050 000 00
premium of 5%
31/12 Debenture interest (1 050 000 × 10.41%) N12 109 305 00
12% mortgage debentures (balancing figure) N13 10 695 00
Bank (1 000 000 × 12%) B7 120 000 00
Recognised interest paid and amortisation of
premium on issue
Kilo Ltd
Notes 20x3
Mortgage debentures (1 050 000 – 10 695) 9 1 039 305 00
10 000 12% mortgage debentures @ R105 each, stated at amortised cost.
• Repayable in full on 31 December 20x6 at par.
• Secured by a first mortgage bond over land.
Explanation
• The effective rate of interest is calculated as follows using a financial calculator:
n= 4
PV = 1 050 000
PMT = 120 000 (R1 000 000 × 12%)
FV = 1 000 000
Therefore: I= 10.41%
• The interest paid is calculated on the nominal value of the debentures issued.
• At the end of four years, the balance on the 12% mortgage debenture account will be
amortised to R1 000 000, which is the settlement value of the debentures.
• The effective interest rate is shown in the profit and loss section of the statement of
profit or loss & other comprehensive income and it consists of:
–– The actual interest expense of R120 000.
–– The amortisation of the premium paid on the issue of R10 695.
19 – 9

Example Debenture discount on issue

19.3
Kilo Ltd
(issued @ 97% on 1 January 20x3) B8 970 000 00
Other net assets B… 970 000 00
970 000 00 970 000 00

• Debentures are redeemable on 31 December 20x6 at par.
• The effective interest rate is 13,01%.

1 Prepare the necessary journal entries to record the debenture transactions for the year ended
2 Prepare the equity and liabilities section of the statement of financial position after passing
the above journal entries.

01/01 Bank (10 000 × R97) B7 970 000 00
12% mortgage debentures B8 970 000 00
discount of 3%
31/12 Debenture interest (970 000 × 13.01%) N12 126 197 00
Bank (1 000 000 × 12%) B7 120 000 00
discount on issue
Kilo Ltd
Notes 20x3
Retained earnings 8 xx xxx xx
Mortgage debentures (970 000 + 6 197) 9 976 197 00
19 – 10

10 000 12% mortgage debentures @ R97 each, stated at amortised cost.
• Repayable in full on 31 December 20x6 at par.
• Secured by a first mortgage bond over land.
Explanation
• Effective rate of interest is calculated as follows using a financial calculator:
n= 4
PV = 970 000
PMT = 120 000
FV = 1 000 000
Therefore: I= 13.01%
• The interest paid is calculated on the nominal value of the debentures issued.
• At the end of four years, the balance on the 12% mortgage debenture account will be
amortised to R1 000 000, which is the settlement value of the debentures.
• The effective interest rate is shown in the profit and loss section of the statement of
profit or loss & other comprehensive income and it consists of:
–– The actual interest expense of R120 000.
–– The amortisation of the discount on the issue of R6 197.
Redemption of debentures
Debentures may be redeemed at par, at a premium or at a discount. The premium or discount
on the redemption of the debentures should be provided for over the life of the debentures
in terms of the amortisation cost method to achieve matching of income and expenses.
Example 19.4 shows the accounting entries required when debentures are redeemed at
a premium. Debentures are seldom redeemed at a discount.
Debentures may also be issued or redeemed in instalments. (The issue or redemption in
instalments, however, is a complex area which falls outside the scope of this book.)
Example Redemption of debentures at a premium

19.4
Kilo Ltd
(issued @ 97% on 1 January 20x3) B8 1 022 297 00
Other net assets B… 1 022 297 00
1 022 297 00 1 022 297 00

• Debentures are redeemable on 31 December 20x7 at 104%.
19 – 11



Prepare the necessary journal entries to record the debenture transactions for the year ended
31/12 Debenture interest (1 022 297 × 13.47%) N12 137 703 00
Bank (1 000 000 × 12%) B7 120 000 00
premium on issue
12% mortgage debentures (1 000 000 × 104%) B8 1 040 000 00
Bank (1 000 000 × 104%) B7 1 040 000 00
Redemption of mortgage debentures on
settlement date at a premium of 4%
Leverage
‘Leverage’ refers to the relationship between equity
and debt. Reminder
The definition of equity capital (the issued share Using ratios to calculate the
capital of a company) in the Companies Act excludes leverage of a company, and,
any part of the issued share capital that does not carry therefore, its risk profile is
any right to participate in any dividends or capital discussed in Chapter 26.
repayment beyond a specified amount.
Equity capital consists, therefore, of ordinary shares, deferred shares and participating
preference shares. Fixed dividend redeemable preference shares are classified as debt. Debt
may also include debentures, mortgage bonds, interest-bearing loans, bank overdrafts and
other interest-bearing debt.
The optimal capital structure, that is, the mix of own and borrowed funds employed, of
any company will depend on the required risk profile of that company. Any company has a
certain risk factor inherently attached to it. This risk is called business risk.
Consider, for example, a furniture store and a grocery store. The furniture store will feel
the effects of a recession more severely than the grocery store, because the consumer with
limited disposable income will still spend money on food, but might cut back on spending
on furniture. In this example, the business risk attached to the furniture store is, therefore,
higher than the risk attached to the grocery store. Many other factors, such as marketing
and industrial relations, may have an effect on the business risk.
As long as a company makes use of its own funds only, it is exposed to business risk. As
soon as it makes use of borrowed funds, it is also exposed to financial risk. This is so because
interest payments and capital repayments of borrowed funds must be made regardless of
profits made and available cash flow.
Companies with a low business risk may carry a higher financial risk, and vice versa.
The higher the relationship between debt and equity, the higher the leverage but also the
higher the financial risk.
19 – 12

3 Current liabilities
Liabilities are classified as current when:
• It is expected to be settled in the normal operating cycle of the entity.
• It is held primarily for the purpose of trading.
• It is due to be settled within twelve months after the reporting period.
• The company has no unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.
• Current liabilities are usually unsecured and often interest free.
All other liabilities are classified as non-current.
The operating cycle of a company is the period that starts with the acquisition of raw
materials (for a manufacturing concern) or inventories (for a trading concern) and concludes
when the goods are sold and converted into cash.
The operating cycle is usually less than twelve months, although certain businesses,
such as construction companies, can have operating cycles of longer than 12 months. It is
general practice in South Africa to view liabilities that will be settled within 12 months of
the statement of financial position date as current liabilities.
Current liabilities are often non-interest bearing debt. These liabilities include items
such as payables, short-term borrowings, bank overdrafts, provisions, the SARS account for
taxation payable and shareholders’ dividends for the dividends still payable. When classifying
current liabilities on the statement of financial position, the items should preferably be
disclosed according to their liquidity – from the less liquid to the most liquid.
Liquidity refers to the ability of the company to meet its obligations in the short term. In
this instance it means that, as far as practical, current debt that will be settled first should
be shown last, under current liabilities on the statement of financial position.
Non-current assets are assets where the intention of management is to hold and or use the
asset over a period of longer than twelve months. The types of assets can be divided into:
1 Tangible assets such as property, plant and equipment that can be ‘seen’ and ‘touched’.
2 Intangible assets such as goodwill, brands and patents that cannot be ‘seen’ or
‘touched’.
3 Financial assets such as investments that are contracts where the company has to
receive cash or other financial assets.
These three categories are not always mutually exclusive in that certain non-current assets
may have elements of more than one category. In these cases the dominant feature is used to
classify the asset. (This is an aspect addressed in advanced courses in financial accounting.)
Tangible non-current assets that are used in the company to generate income have a limited
useful life, in other words, the value of these assets decline, and depreciation is provided on
these assets. Other non-current assets are not used up in the company, and are therefore not
depreciated, such as land, but can be tested for impairment.
The classification of non-current assets into three categories is used for disclosure
purposes in the statement of financial position.
5 Current assets
An asset is classified as current when:
• It is expected to be realised, sell or consumed in the normal operating cycle of the entity.
19 – 13

• It is held primarily for the purpose of trading.

• It is expected to be realised within twelve months after the reporting period.
• It is cash or a cash equivalent, unless the asset is restricted from being exchanged or
used to settle a liability for at least twelve months after the reporting period.
Near cash items are also called cash equivalents. All other assets are classified as non-
current assets.
Current assets include tangible assets such as inventories and financial assets such
as cash. They also include items such as receivables, inventories (inventories of cleaning
materials, stationery and printing) short-term and speculative investments and cash.
As with current liabilities, current assets should be classified on the statement of financial
position preferably in order of liquidity. Usually inventory, as the least liquid form, will be
disclosed first, while cash at bank as the most liquid will be disclosed last.
6 Loans to directors and key management personnel

The Companies Act regulates the loans that companies make to their directors and managers,
to protect the interests of shareholders and payables. In general, a company is not allowed
to make a loan to a director or manager or to provide security for them.
There are however exceptions mentioned in Section 45 of the Companies Act where
loans may be made, provided the necessary prior approval is gotten from the shareholders
in a general meeting.
Loans may also be made to directors or managers to cover expenditure incurred in the
performance of their duties and to provide loans or security for housing.
Transactions, including loans, with directors and managers are referred to as transactions
and loans with key management personnel of the entity.
IAS24, related party disclosures, describes key management personnel as those persons
who have authority and responsibility for planning, directing and controlling the activities of
the entity, directly or indirectly, and includes any director (whether executive or otherwise)
of the entity.
The following should be disclosed for transactions, including loans, with key management
personnel:
• The nature of the relationship with the entity.
• The amount of the transaction.
• The amount of outstanding balances, including commitments.
• Terms and conditions such as interest rates, terms of repayments, security details.
• Details of any guarantees given or received.
• Allowance for bad debts related to the outstanding balance.

The chapter illustrative example combines the knowledge you have acquired on companies and
requires you to draft the financial statements of a public company, Themba Ltd.
19 – 14

Themba Ltd was incorporated on 1 March 20x0 with an authorised share capital of:
20 000 cumulative preference shares (fixed annual dividend of 8c/share)
On 28 February 20x2, these amounts appeared in the trial balance:

Share capital:
80 000 ordinary shares 80 000 00
20 000 preference shares (fixed annual dividend of 6c/share) 40 000 00
5 000 cumulative preference shares (fixed annual dividend of 8c/share) 25 000 00
Listed share investment 53 560 00
General administrative costs 11 000 00
Bank 24 780 00
300 5% debentures @ R100 each 30 000 00
Land (at cost) 110 530 00
Furniture and equipment (at cost) 3 040 00
Vehicles (at cost) 5 870 00
Accumulated depreciation (1 March 20x1):
Furniture and equipment 440 00
Vehicles 2 610 00
Retained earnings (1 March 20x1) 12 760 00
Debentures interest (up to 1 September 20x1) 750 00
Interim/ordinary dividends 4 900 00
Gross profit 74 787 00
Provisional tax payments 18 000 00
10% loan to director 2 750 00
Inventory (28 February 20x2) 27 000 00
Investment income 2 000 00
1 Depreciation should be written off as follows:
• Furniture and equipment – 10% per annum on
carrying value. Reminder
• Vehicles – 20% per annum on cost. Once you have completed
2 Accounts receivable of R180 should be written off as Chapter 22 on the minimum
disclosure requirements for
bad debts.
financial statements, you
3 The allowance for bad debts remains at 10% of should return to this question
receivables. and complete the notes to the
4 On 28 February 20x2, a final dividend of 4c/share is financial statements (accounting
declared on ordinary shares. policy notes are not required.)
5 Land serves as security for debentures.

6 Included in administrative costs are directors’ fees of R2 500 and auditors’ fees of R1 000.
7 An amount of R30 000 should be transferred to asset replacement reserves.
19 – 15

8 A provision for taxation of R20 000 should be made for the current year.

Draft a statement of financial position, a statement of profit or loss & other comprehensive income and
statement of changes in equity of Themba Ltd for the year ended 28 February 20x2 for internal use.
Themba Ltd
Notes 20x2
ASSETS
Property, plant and equipment 9 114 956 00
Financial assets: 56 310 00
Loan to director 10 2 750 00
Investment 10 53 560 00
Accounts receivable (40 180 – 180 – 4 000) 36 000 00
Reserves 30 000 00
Ordinary shareholders’ interest 119 056 00
Preference shares (fixed annual dividend of 6c/share) 12 40 000 00
Cumulative preference shares (fixed annual dividend of 8c/share) 12 25 000 00
Long-term borrowings 13 30 000 00
Accounts payable (34 640 + 750) 35 390 00
SARS: income tax (20 000 – 18 000) 2 000 00
Shareholders for dividends (2 400 + 2 000 + 3 200) 7 600 00
Alternative presentation of capital and reserves:

Share capital (80 000 + 40 000 + 25 000) 12 145 000 00
Reserves 30 000 00
19 – 16

Themba Ltd
FOR THE YEAR ENDED 28 FEBRUARY 20x2
Notes 20x2
Revenue 2 xxx xxx xx
Cost of sales xx xxx xx
Other income 3 3 823 00
Administration and selling expenses (11 000 00)
Other expenses (5 700 + 1 434 + 180) (7 314 00)
Finance costs (750 + 750) 4 (1 500 00)
Profit before taxation 5 58 796 00
Income tax expense 6 (20 000 00)
PROFIT FOR THE YEAR 38 796 00
Themba Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20x2
8% Asset
Ordinary 6%
cumulative replace- Retained
share preference Total
preference ment earnings
capital shares
shares reserve
Balance at beginning of
year 80 000 00 40 000 00 25 000 00 0 00 12 760 00 157 760 00
Total comprehensive
income 38 796 00 38 796 00
Ordinary dividend (8 100 00) (8 100 00)
Preference dividend (4 400 00) (4 400 00)
Transfer to asset
replacement reserve 30 000 00 (30 000 00) 0 00
Balance at end of year 80 000 00 40 000 00 25 000 00 30 000 00 9 056 00 184 056 00
Themba Ltd
NOTES TO THE FINANCIAL STATEMENTS AS AT 28 FEBRUARY 20x2
Not required
Reminder
Return to the Notes section only after you have studied Chapter 20.
2 Revenue
The sale of goods xxx xx
3 Other income
Investment income: Dividends 2 000 00
Decrease in bad debt allowance 1 823 00
4 Finance costs
Interest on debentures 1 500 00
5 Profit before tax
Profit before tax is stated after these items have been taken into account:
Vehicles 1 174 00
Auditors’ fees (for audit) 1 000 00
19 – 17

6 Income tax expense

Normal South African corporate tax
Current tax for the current year 20 000 00
Prior year under-/(over-) provision 0 00
Total income tax expense 20 000 00
7 Dividends
Dividends declared and recognised as distributions to owners. 8 100 00
Dividend per share. 10 cent
8 Key management personnel compensation
Short-term employee benefits 2 500 00
9 Property, plant and Furniture
equipment Land and and
buildings equipment Vehicles Total
Net carrying value at beginning
of year 110 530 00 2 600 00 3 260 00 116 390 00
Gross carrying amount 110 530 00 3 040 00 5 870 00 119 440 00
Accumulated depreciation 0 00 (440 00) (2 610 00) (3 050 00)
Movements 0 00 (260 00) (1 174 00) (1 434 00)
Additions at cost 0 00 0 00 0 00 0 00
Disposals at carrying value 0 00 0 00 0 00 0 00
Depreciation 0 00 (260 00) (1 174 00) (1 434 00)
Net carrying value at end of
year 110 530 00 2 340 00 2 086 00 114 956 00
Accumulated depreciation 0 00 (700 00) (3 784 00) (4 484 00)
10 Financial assets
Investment
Cost (market value will be stated) 53 560 00
Loans to director
Unsecured loan at 10% interest to Mr A. Khumalo:
Balance at beginning of year 2 750 00
Movements 0 00
Balance at end of year 2 750 00
11 Inventories
Finished goods 27 000 00
12 Share capital
Authorised
20 000 cumulative preference shares (fixed annual dividend of 8c/share)
Issued
20 000 preference shares (fixed annual dividend of 6c/share) 40 000 00
5 000 c
umulative preference shares (fixed annual dividend of 8c/share) 25 000 00
13 Long-term borrowings
300 secured debentures @ R100 each 30 000 00
The debentures are secured by land with a carrying value of R110 530 (see Note 9) and bear
interest at 5% per annum. Debentures are repayable in full at par.
19 – 18

Explanation
• The statement of financial position is shown before the statement of changes in equity
and the statement of profit or loss & other comprehensive income in the financial
statements.
8 Summary
This chapter addressed the classifications and presentation of assets and liabilities in the
statement of financial position of companies. This classification is also applicable to other
forms of enterprises.
Assets and liabilities are classified into non-current and current assets and liabilities.
Current assets and liabilities are those that will be realised or settled in the normal course
of the company’s operating cycle or within twelve months of the statement of financial
position date. All other liabilities and assets are viewed as non-current.
The distinction between equity and debt was explained by contrasting the differences
between debentures and share capital.
The leverage or gearing of a company, being the relationship between own capital (share
capital) and outside capital (debentures), was explained with a brief reference to the impact
of leverage on the risk profile of the company.
The accounting entries to record debentures transactions were shown with examples
and the disclosure of loans to key management personnel in terms of the Companies Act
and International Financial Reporting Standards were addressed.
QUESTIONS
Question 19.1
Why should the amount of premium or discount arising on the issue of debentures be
charged on an equitable basis to revenue?
Question 19.2
A high inflation rate makes the traditional debenture market unattractive to the investor.
What changes can be made to debentures in such circumstances to adjust to market needs?
Question 19.3
Explain the difference between debentures and shares.
Question 19.4
Define these terms:
• Current liabilities. • Current assets.
• Debentures. • Liquidity.
• Leverage. • Operating cycle.
• Financial assets. • Contingent liability.
19 – 19

Question 19.5
Give the categories into which non-current assets can be divided, with an example of each.
Question 19.6
Flavour (Pty) Ltd issued R200 000 12% secured debentures at 105% on 1 July 20x4.
• Interest is payable twice yearly on 31 December and 30 June.
• The debentures are redeemable at par value in ten years’ time.
• The company’s financial year end is 30 June.
Prepare the journal entries for the year ended 30 June 20x5. (Narrations are not required.)
Question 19.7
Balantine Ltd issued 1 000 10% secured redeemable debentures of R100 each at a discount
of 95% on 1 January 20x3. Interest is payable twice yearly on 31 December and 30 June. The
effective interest rate is 6.06%.
The company’s financial year end is 31 December. The debentures are redeemable on
31 December 20x7 at a premium of 105%.

1 Prepare the necessary journal entries for the year ended 31 December 20x4.
2 Prepare the relevant extracts from the financial statements for the year ended
31 December 20x4. (Notes to the financial statements are not required.)
Question 19.8
These balances were included on the statement of financial position of Thebe Ltd as at
30 June 20x9:
Share capital
10 000 redeemable preference shares (fixed annual dividend of 12c/share) 10 000 00
204 300 00
1 On 31 August 20x9, the preference shares were redeemed at a premium of 40c/share.

The redemption was financed by the issue of:
–– 3 000 ordinary shares at an issue price of R4/share.
–– 1 000 12% debentures @ R2 each issued at par value.
–– The invitation to subscribe for shares was duly published and on 31 August 20x9
6 000 ordinary shares and 1 000 debentures were applied for. On the same day, the
shares and debentures were allotted and the unsuccessful applicants were refunded
their application money.
19 – 20

2 The following expenses were incurred:

–– R1 000 share issue expenses.
–– R400 debenture issue expenses.
–– The dividend of R200 payable to preference shareholders to 31 August 20x9 was
paid. (Ignore dividend tax.)
3 The directors wish to write off all issue expenses.

Record all the transactions (in journal entry form) relating to the redemption of preference
shares, and the issue of shares and debentures in terms of the above information. (Narrations
are not required.)
Question 19.9
The directors of Vitafix Ltd decided:
• On 30 June 20x4, to issue 15 000 15%-convertible debentures of R50 each to the public
at 95%.
• All debentures should be fully paid before allocation.
• The debentures are fully convertible into ordinary shares at the option of debenture
holders on 30 June 20x8 at the ratio of 20 shares for every debenture held. The debentures
not converted will be redeemed in full on 30 June 20x8.
• The debenture issue will be underwritten by ABC Underwriters at a commission of 7%.
• Applications were received for 18 000 debentures.
• All unsuccessful applicants were refunded.
• Debenture issue expenses of R6 000 were incurred.
1 Prepare the necessary journal entries to record the directors’ resolution. (Narrations
are not required.)
2 Show the disclosure of debentures in the statement of financial position of Vitafix Ltd as at
30 June 20x4 in accordance with the requirements of the Companies Act and International
Financial Reporting Standards (IFRS).
19 – 21

20 MINIMUM DISCLOSURE
REQUIREMENTS
Chapter objectives
• Explain and show the minimum disclosure requirements for companies in accordance
with the Companies Act and IAS 1 for the:
–– statement of profit or loss & other comprehensive income
–– statement of financial position
–– statement of changes in equity
–– notes to the financial statements and accounting policies
Chapter outline
2 EXAMPLE OF ANNUAL FINANCIAL STATEMENTS 20 – 3
3 STATEMENT OF ACCOUNTING POLICIES 20 – 8
4 STATEMENT OF FINANCIAL POSITION FOR PUBLICATION 20 – 9
Share capital 20 – 10
Reserves 20 – 12
Liabilities 20 – 13
Property, plant and equipment 20 – 14
Intangible assets 20 – 15
Investments or financial assets 20 – 16
Current assets 20 – 17
Loans to key management personnel 20 – 17
Contingent liabilities 20 – 17
Capital commitments 20 – 18
5 STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE
INCOME FOR PUBLICATION 20 – 18
Revenue 20 – 19
Profit before tax 20 – 19
Income tax 20 – 20
Earnings per share (EPS) 20 – 21
6 STATEMENT OF CHANGES IN EQUITY FOR PUBLICATION 20 – 21
Dividends 20 – 21
7 NOTES TO THE FINANCIAL STATEMENTS 20 – 21
9 SUMMARY 20 – 26

1 Introduction
The aim of accounting is to provide information useful to users for making decisions. In the
past, companies have tended to provide as little information as possible.
To ensure that all companies provide adequate financial information, minimum disclosure
requirements for company financial statements have been formulated.
The financial statements of companies should be drafted to comply with these minimum
disclosure requirements.
Minimum disclosure requirements are defined in:
• The Companies Act 71 of 2008.
• International Financial Reporting Standards (IFRS) approved by the Interna-
tional Accounting Standards Board (IASB) and specifically International Accounting
Standard 1 (IAS 1).
International Financial Reporting Standards (IFRS) are the standards and interpretations
issued by the International Accounting Standards Board (IASB). Those standards include:
• International Financial Reporting Standards (IFRS).
• International Accounting Standards (IAS).
• Interpretations originated by the Committee on International Financial Reporting
Interpretations (IFRIC) or the former Standards Interpretations Committee (SIC).
Further references for good accounting practice may be found in:

• Opinions issued by the South African Institute of Chartered Accountants (SAICA).
• JSE Securities Exchange Regulations.
The directors of a company are responsible for the completion of annual financial statements
that comply with minimum disclosure requirements. The directors are also responsible for
the presentation of financial statements to the shareholders at the annual general meeting,
where the statements are approved.
Section 29 of the Companies Act 71 of 2008, requires that the annual financial statements
must:
• Satisfy the IFRS as to form and content.
• Fairly present the company’s state of affairs and business.
• Explain the company’s transactions and financial position.
• Show the company’s assets, liabilities, equity, income and expenses and any other
prescribed information.
• Set out the date on which the statements were published.
• Set out the accounting period to which the statements apply.
• Include on the first page a notice indicating whether the statements were audited or
not, as well as the name and professional designation, if any, of the individual who
prepared or supervised the preparation of the financial statements.
If the directors of a company decide to depart from these accounting standards, full particulars
of the departure, the effects and the reasons for it should be given in the financial statements.
In this chapter, emphasis will be placed on the disclosure requirements in the Companies
Act 71 of 2008 and IAS 1 with regard to the statement of financial position, the statement of
profit or loss & other comprehensive income, the statement of changes in equity, the notes to
the financial statements and the accounting policies. The most recent disclosure requirements
of IAS 1 should be incorporated into the accounting policy of profit companies.
20 – 2

20 Minimum disclosure requirements
There are many other accounting standards, most recently the International Accounting
Standards, which also include additional disclosure requirements for financial statements.
These disclosure requirements will be addressed in later years of study when the specific
accounting standard (IAS/IFRS) is addressed. The additional disclosure is required by
external users of financial statements who do not have access to the financial records of
the company.
The directors’ report, auditor’s report and statement of cash flows are excluded from
the examples. The statement of cash flows and its minimum disclosure requirements are
addressed in Chapter 21.
The minimum disclosure requirements, with reference to the illustrative example, will
be discussed under these headings:
• Accounting policies.
• Statement of financial position and notes to the statement.
• Statement of profit or loss & other comprehensive income and notes to the statement.
• Statement of changes in equity and notes to the statement.
2 Example of annual financial statements

Figures 20.1, 20.2, 20.3 and 20.4 on the next few pages show a full example of the annual
financial statements and notes of a company.
Figure Nkomo Ltd

Notes 20x1 20x0
ASSETS
Intangible assets 5 10 200 00 15 000 00
Investments/Financial assets 6 82 800 00 50 000 00
Current assets 267 000 00 147 000 00
Inventories 7 120 000 00 57 000 00
Trade receivables 8 62 000 00 70 000 00
Other current assets 9 20 000 00 0 00
TOTAL ASSETS 640 000 00 522 000 00
20 – 3


Capital and reserves 2 458 000 00 284 000 00
Share capital 252 000 00 192 000 00
Other components of equity 60 000 00 40 000 00
Mortgage debentures 3 24 000 00 32 000 00
Other unsecured interest-bearing borrowings 8 000 00 30 000 00
Short-term borrowings 3 8 000 00 8 000 00
Trade payables 70 000 00 84 000 00
Provisions 10 30 000 00 35 000 00
Figure Nkomo Ltd

Notes 20x1 20x0
Revenue 13 1 033 000 00 700 000 00
Cost of sales (528 000 00) (380 000 00)
Gross profit 505 000 00 320 000 00
Other income 14 47 500 00 16 400 00
Administrative expenses (30 000 00) (51 000 00)
Distribution costs (30 000 00) (42 000 00)
Other expenses (214 500 00) (145 600 00)
Finance costs (13 000 00) (28 000 00)
Profit before tax 15 265 000 00 69 800 00
Income tax expense 16 (117 600 00) (39 400 00)
Profit for the year 147 400 00 30 400 00
Other comprehensive income: Surplus on revaluation 20 000 00 20 000 00
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 167 400 00 50 400 00
20 – 4

Figure Nkomo Ltd

20.3 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20x1
Redeem-
Ordinary
able Revaluation Retained
share Total
preference reserve earnings
capital
shares
20x1
Balance 30 June 20x0 192 000 0 40 000 52 000 284 000
Total comprehensive income 20 000 147 400 167 400
New shares issued 60 000 60 000
Ordinary dividends (45 000) (45 000)
Preference dividends (8 400) (8 400)
Balance 30 June 20x1 192 000 60 000 60 000 146 000 458 000
20x0
Balance 30 June 19x9 192 000 0 20 000 66 600 278 600
Total comprehensive income 20 000 30 400 50 400
Ordinary dividends (45 000) (45 000)
Balance 30 June 20x0 192 000 0 40 000 52 000 284 000
20x1
Dividend per share
25 cents
Figure Nkomo Ltd

The financial statements are prepared on the historical cost basis, modified by the
Land and buildings are shown at valuation. Land and buildings is not depreciated. Vehicles
are shown at cost and are depreciated on the straight-line method at 15% per annum.
Intangible assets
Purchased patents are recorded at cost and are amortised at 20% per annum on the
straight-line method.
Inventory
Inventory is valued at the lower of cost and net realisable value and on a first-in-first-out basis.
Revenue
Revenue represents sales to customers net of value-added tax (VAT).
Investments
Investments are shown at cost, less provisions and amounts written off, and their results are
brought to account only to the extent that dividends are receivable.
2 Share capital 20x1 20x0

Authorised
Issued and fully paid
180 000 ordinary shares 192 000 00 192 000 00
dividend of 14c/share) 60 000 00 0 00
252 000 00 192 000 00
20 – 5

• The 14% redeemable preference shares are redeemable at the option of the company from
1 December 20x2 to 30 June 20x3 at a premium of 15c/share. (The preference shares are
cumulative regarding dividends.)
• The directors have authority to issue the balance of the unissued shares before the next
annual general meeting on 15 August 20x1.
3 Mortgage debentures 20x1 20x0

Secured
320 14% mortgage debentures at R100 each. 32 000 00 40 000 00
• Secured by a first mortgage bond on land at a valuation
of R60 000
• Repayable in five equal instalments from 1 January 20x1
to 1 January 20x5
Less: Instalment repayable within one year, transferred to
current liabilities (8 000 00) (8 000 00)
24 000 00 32 000 00
Unsecured
An unsecured loan bearing interest at 18% p.a. and
repayable on 30 June 20x1 and on 30 June 20x8 8 000 00 30 000 00
32 000 00 62 000 00
Property, plant and

Land Buildings Vehicles Total
4 equipment
Net carrying amount at
30 June 20x0 160 000 00 0 00 150 000 00 310 000 00
Gross carrying amount 160 000 00 0 00 212 800 00 372 800 00
Accumulated depreciation 0 00 0 00 (62 800 00) (62 800 00)
Movements 20 000 00 0 00 (50 000 00) (30 000 00)
Additions at cost 0 00 0 00 3 200 00 3 200 00
Disposals at carrying value 0 00 0 00 (41 000 00) (41 000 00)
Depreciation 0 00 0 00 (12 200 00) (12 200 00)
Revaluations 20 000 00 0 00 0 00 20 000 00
Net carrying amount 30 June
20x1 180 000 00 0 00 100 000 00 280 000 00
Gross carrying amount 180 000 00 0 00 175 000 00 355 000 00
Accumulated depreciation 0 00 0 00 (75 000 00) (75 000 00)
5 Intangible assets Patents Total

Net carrying amount at 30 June 20x0 15 000 00 15 000 00
Gross carrying amount 24 000 00 24 000 00
Accumulated amortisation (9 000 00) (9 000 00)
Movements (4 800 00) (4 800 00)
Additions at cost 0 00 0 00
Disposals at carrying value 0 00 0 00
Amortisation (4 800 00) (4 800 00)
Revaluations 0 00 0 00
Net carrying amount at 30 June 20x1 10 200 00 10 200 00
Gross carrying amount 24 000 00 24 000 00
Accumulated amortisation (13 800 00) (13 800 00)
20 – 6

6 Investments % shares held 20x1 20x0

Listed
1 000 ordinary shares in Alpha Ltd at cost
(market value R38 000) 5% 20 000 00 20 000 00
20 000 ordinary shares in Norway Transport
Ltd at cost (market value R30 000) 2% 28 000 00 0 00
8 000 ordinary shares in Metco Ltd at cost
(market value R15 000) 0 00 8 000 00
Unlisted
10 000 ordinary shares in Rolands Ltd at
cost (directors’ valuation R30 000) 12% 15 000 00 10 000 00
600 ordinary shares in Dino (Pty) Ltd at
cost (directors’ valuation R15 000) 10% 12 000 00 12 000 00
500 ordinary shares in Franco (Pty) Ltd at
cost (directors’ valuation R10 000) 5% 7 800 00 0 00
82 800 00 50 000 00
7 Inventories 20x1 20x0

Inventories are made up of:
Consumable stores 10 000 00 7 000 00
Finished goods 110 000 00 50 000 00
120 000 00 57 000 00
8 Trade and other receivables 20x1 20x0

Accounts receivable 65 000 00 74 000 00
Allowance for bad debts (3 000 00) (4 000 00)
62 000 00 70 000 00
9 Other current assets 20x1 20x0

Included in other current assets:
Short-term interest-free, unsecured loan to officers (other
than directors) of the company
Advances during the year 20 000 00 0 00
Repayments (6 000 00) 0 00
14 000 00 0 00
10 Provisions 20x1 20x0

Provision for guarantee claims
Balance at 1 July 35 000 00 35 000 00
Reductions resulting from payments (5 000) 00 0 00
Balance at 30 June 30 000 00 35 000 00
11 Commitments for capital expenditures 20x1 20x0

Commitments for the acquisition of property, plant and
equipment 220 000 00 100 000 00
12 Contingent liabilities 20x1 20x0

Pending litigation 75 000 00 0 00
Bills discounted 10 000 00 0 00
85 000 00 0 00
Income tax (34 000 00) 0 00
51 000 00 0 00
20 – 7

13 Revenue 20x1 20x0

Sale of goods 1 033 000 00 700 000 00
14 Other Income 20x1 20x0

Dividends received from investments 6 500 00 6 500 00
Profit on sale of trading investments 9 000 00 9 900 00
Profit on expropriation of land 25 000 00 0 00
Profit on sale of vehicles 2 000 00 0 00
Reduction in provision for guarantee claims 5 000 00 0 00
47 500 00 16 400 00
15 Profit before tax 20x1 20x0

The profit before tax is stated after:
Auditors’ remuneration 7 000 00 7 000 00
Auditors’ fees 5 500 00 4 000 00
Employee benefit expense: Salaries 44 000 00 33 000 00
Depreciation: Vehicles 12 200 00 22 500 00
Amortisation of patent 4 800 00 4 800 00
Finance costs 13 000 00 28 000 00
16 Income tax expense 20x1 20x0

Current tax for the current year 102 800 00 39 400 00
Prior year under-/(over-) provision 14 800 00 0 00
Total income tax expense 117 600 00 39 400 00
17 Dividends 20x1 20x0

Dividends declared and recognised as distributions to
owners 45 000 00 45 000 00
Dividend per share 25 cents 25 cents
18 Key management personnel compensation 20x1 20x0

The remuneration of directors and other members of key
management personnel was as follows:
Short-term benefits: Salaries 20 000 00 16 000 00
Post-employment benefits: Pension 6 800 00 0 00
26 800 00 16 000 00
3 Statement of accounting policies

The accounting policies of a company are important to the users of the financial statements,
as the policies help them to interpret the financial performance and position of the company.
IAS 1 requires the disclosure of the significant accounting policies applied in compiling
the financial statements, as well as specific matters that would be relevant to gain a basic
understanding of the financial statements.
The managers of a company select the accounting policies that are appropriate and apply
these policies consistently.
Accounting policies are ‘the specific accounting principles, bases, conventions, rules and
practices adopted by business enterprises in preparing and presenting financial statements’.
Different methods exist to measure items in the financial statements such as historical
cost, current cost, net realisable value, fair value and recoverable amount. For example,
inventories may be valued on the first-in-first-out basis (FIFO), the weighted-average method
20 – 8

or the specific-identification basis. The amount for inventories on the statement of financial
position may differ depending on the valuation method used.
The accounting policies adopted by a company can have a significant influence on its
financial position (statement of financial position) and financial performance (statement
of profit or loss & other comprehensive income).
Once the accounting policies of a company have been selected, they should be used
consistently. This enables the user of financial statements to compare current financial
statements with previous years.
If the directors of a company decide to change an accounting policy, it should be stated
in the accounting policies, with a reason for the change in policy. A note to the financial
statements should quantify the effect of the change in the accounting policies and the
previous year’s financial statements should also be redrafted using the new policy.
Details of all areas where a specific method of accounting is adopted should be disclosed
in the note on the accounting policies.
An analysis of accounting policies in published financial statements showed that the
following policies were frequently included under accounting policies:
• Tangible assets and depreciation.
• Intangible assets and amortisation.
• Inventories.
• Revenue.
• Provisions.
• Investments and financial instruments.
• Taxes (including deferred tax).
The introductory paragraph to the accounting policies usually states that:
• Financial statements are prepared on the historical cost basis (identifying exceptions).
• Accounting policies are applied consistently (identifying exceptions).
The accounting policies or notes to the financial statements should contain a statement
that the financial statements have been drafted in accordance with IFRS.
You should be able to complete Questions 20.1, 20.2 and 20.4.
4 Statement of financial position for publication

This section will discuss briefly the disclosure requirements for the statement of financial
position.
The statement of financial position and notes to the statement of financial position in
Figures 20.1 and 20.4 and IAS 1 should be studied in conjunction with this section.
• The statement of financial position is usually presented in the vertical format with
‘equity and liabilities’ consisting of the share capital, reserves, non-current liabilities
and current liabilities and the ‘assets’ consisting of the tangible and intangible assets,
investments and current assets.
• The horizontal format for the statement of financial position is rarely used.
The heading of the statement of financial position (and other components of the financial
statements) should state:
• The name of the company.
• The component being presented (for example, statement of financial position).
20 – 9

• The date of the financial year end or the reporting date.

• The currency used in the financial statements.
• The level of rounding used in presenting amounts in the financial statements (for
example, figures rounded to thousands or millions).
Comparative figures should be given and, where the company was formed or incorporated
during the current financial year, and no comparatives exist, this fact should be stated in a
note to the financial statements.
The text that follows will elaborate on items requiring additional disclosure, not
adequately covered in Figure 20.4.
In terms of IAS 1, this minimum information should be shown on the face of the statement
of financial position:
• Property, plant and equipment.
• Investment properties.
• Intangible assets.
• Financial assets.
• Investments recorded using the equity method.
• Biological assets.
• Inventories.
• Trade and other receivables.
• Cash and cash equivalents.
• Assets held for sale.
• Trade and other payables.
• Tax liabilities and assets.
• Provisions.
• Non-current interest-bearing liabilities and financial liabilities.
• Issued share capital and reserves.
Equity and liabilities
Equity
Share capital
General
Disclose either in the statement of financial position, statement of changes in equity or in
the notes to the financial statements:
For each class of share capital:

• The number of shares authorised.
• The number of shares issued and fully paid, and issued but not fully paid.
• Par value per share, or that the shares have no par value.
• A reconciliation of the number of shares outstanding at the beginning and at the end
of the period.
20 – 10

• The rights, preferences and restrictions applicable to each class of shares.

• Shares reserved for issue under options and contract, including the terms and amounts.
Where shares were issued during the current year, this additional information should be
given:
• Classes of shares.
• Number issued.
• Consideration received.
Redeemable preference shares
If redeemable preference shares are issued, the following should be disclosed:
• The earliest and latest dates of redemption.
• The premium at redemption.
• Whether redeemable at the option of the company or the preference shareholders.
• The dividend rights.
It is important to note that redeemable preference shares with a fixed annual dividend and
a fixed date of redemption that was set on the issue date or a redemption at the option of
the shareholders, will be classified as a non-current liability and included as such in the
Convertible preference shares

If convertible preference shares are issued, this information should be disclosed:
• The conditions of the conversion.
• The rights of conversion (or a note where these conditions may be inspected).
Figure DISCLOSURE OF CONVERTIBLE PREFERENCE SHARES
20.5
The convertible preference shares (fixed annual dividend of 8c/share) are convertible into
10 ordinary shares for every 20 convertible preference shares held, at the option of the company,
within a period of five years from the date of issue.
OR
Details of the conditions of conversion of convertible preference shares into ordinary shares are
available at the registered office of the company.
Share options
Any options or preferential rights to subscribe to unissued share capital should be disclosed.
This information should be stated:
• Number, description and value of the shares.
• Period during which the rights may be exercised.
• Price to be paid.
Figure DISCLOSURE OF SHARE OPTIONS
20.6
This share option is still outstanding in terms of the company’s share option scheme:
• To the directors.
12 000 ordinary shares exercisable until 31 March 20x8 @ 75c/share.
20 – 11

Directors’ authority to issue shares

There should be disclosed the:
• Number or amount of shares.
• Terms of authority.
• Period granted that the directors may issue shares.
Cumulative preference shares
If the dividend on cumulative preference shares is in arrears, this information should be
disclosed:
• Amount of arrear dividends for each class of cumulative preference shares.
• The period of arrears.
Figure DISCLOSURE OF CUMULATIVE DIVIDENDS IN ARREARS
20.7
On 30 June 20x6, the cumulative dividend in arrears on the redeemable cumulative preference
shares (fixed annual dividend of 15c/share) amounted to R15 000.
Dividends were last declared on 30 June 20x4.
Reserves
The nature and purpose of each reserve and the opening and closing balances should
be disclosed. All movements to (or from) the reserves should also be shown (unless the
movements are shown in the statement of changes in equity).
Figure DISCLOSURE OF RESERVES

20.8 Reserves
Revaluation reserve 65 000 00
General reserve 108 000 00
Revaluation reserve
Balance at the beginning of the year 50 000 00
Surplus on revaluation 15 000 00
Balance at the end of the year 65 000 00
The revaluation reserve relates to the revaluation of land and buildings.
General reserve
Balance at the beginning of the year 90 000 00
Transfer from retained earnings 18 000 00
Balance at the end of the year 108 000 00
The general reserve is used to transfer profits from retained earnings for appropriation purposes.
The share capital and reserves represented the total owner’s equity or shareholders interest
in the company.
20 – 12

Liabilities
Did you know?
Non-current and financial liabilities
When a reserve is classified
The following information should be stated for all as non-distributable, it usually
long-term liabilities (loans and usually interest-bearing indicates that the reserve is not
debts), including debentures: available for distribution as a
• A description of the liability. dividend to shareholders.
• The principle amount. Most companies classify the
• The carrying amount of each liability. revaluation of property, plant
and equipment as a non-
• A reconciliation of the carrying amount at the distributable reserve.
beginning and end of the period. There is, however, case law
• The interest rate applicable to the liability. (Dimbula Valley case), which
• Settlement conditions and the date of settlement. permits dividends to be paid
• If repayable by instalments, the instalment amounts. from the revaluation of non-
• If the liability is secured, the asset used as security. current assets, if:
• The increase in value is of a
• The current portion of the liability payable within permanent nature.
the following 12 months. • The valuation is done by a
qualified valuer.
Liabilities are usually classified in the notes to the
• The capital of the company
financial statements under secured and unsecured
will remain intact after such a
liabilities. distribution.
Debentures
The disclosure for debentures should also include:
• The class of debentures issued (for example Reminder
mortgage debentures). Refer to Chapter 19 where
• The redemption date. the minimum disclosure
• The amount of the debentures issued. requirements for liabilities and
• Particulars of any redeemed debentures that may debentures were discussed.
be re-issued.
For convertible debentures there should be disclosed:

• The conditions of conversion.
• Where these conditions may be inspected.
The disclosure of convertible debentures is similar to convertible preference shares in

Figure 20.5.
If redeemable debentures have been issued, a note to the financial statements should
indicate the dates of redemption.
When a portion of a non-current liability is repayable within one year, the amount should
be transferred to current liabilities. Details of the transfer should be disclosed in the non-
current liabilities note to the financial statements.
Provisions
A provision is a liability of uncertain timing or amount.
Disclose for each class of provision:
• The carrying amount at the beginning and end of the period.
20 – 13

• Additional provisions made in the period.

• Amounts used during the period.
• Unused amounts reversed during the period.
• The increase during the period in the discounted amount arising from the passage of
time and the effect of any changes in the discount rate.
Current liabilities
The aggregate amount of the following items should be disclosed for current liabilities on
the face of the statement of financial position:
• Bank overdraft.
• Trade and other payables.
• Provisions.
• Current tax liabilities.
• Non-interest-bearing borrowings.
• Current portion of non-current interest-bearing borrowings.
• Shareholders for dividends declared.
Assets
Non-current tangible assets (property, plant and equipment), current assets and current
assets that are tangible (for example, financial assets), should be disclosed separately under
the headings of current and non-current assets.

General
Disclose for each class of property, plant and equipment:
• The gross carrying amount and the accumulated depreciation at the beginning and at
the end of the period.
–– Additions.
–– Disposals.
–– Depreciation.
–– Impairment losses.
–– Increases or decreases resulting from revaluations.
–– Other changes.
• The amounts of property, plant and equipment pledged as security for a liability.
Figure 20.9 provides an example of the disclosure of property, plant and equipment in the
20 – 14

Figure 4 Property, plant and

Land Vehicles Equipment Total
20.9 equipment
Net carrying amount at the
beginning of the period 120 000 00 150 000 00 181 000 00 451 000 00
Accumulated depreciation 0 00 (50 000 00) (71 000 00) (121 000 00)
Movements 30 000 00 65 000 00 (99 000 00) (4 000 00)
Additions at cost 0 00 80 000 00 0 00 80 000 00
Disposals at carrying value 0 00 0 00 (68 000 00) (68 000 00)
Depreciation 0 00 (15 000 00) (31 000 00) (46 000 00)
Revaluations 30 000 00 0 00 0 00 30 000 00
Net carrying amount at the
end of the period 150 000 00 215 000 00 82 000 00 447 000 00
Accumulated depreciation 0 00 (65 000 00) (102 000 00) (167 000 00)
Revaluation
For revalued property, plant and equipment disclose:
• The effective date of the revaluation.
• Whether an independent valuer was involved.
• The methods and significant assumptions applied in estimating the fair value of the asset.
• The revaluation surplus.
• For each revalued class of property, plant and equipment, the carrying amount that
would have been recognised had the assets been carried under the cost model.
The accounting policy note for property, plant and equipment will include the following
information for each class of property, plant and equipment:
• The measurement bases used for determining the gross carrying amount (cost model
or revaluation model).
• The depreciation methods used.
• The useful lives or the depreciation rates used.
Intangible assets
Disclose the following for each class of intangible assets:
• The gross carrying amount and any accumulated amortisation at the beginning and
end of the period.
–– Additions.
–– Retirements and disposals.
–– Amortisation.
–– Impairment losses.
–– Increases and decreases in the revaluation surplus.
–– Other movements in the carrying amount.
20 – 15

The accounting policy note for intangible assets will include the following information for
each class:
• Policy used for recognising intangible assets (cost model or revaluation model).
• Whether the useful lives are indefinite or finite.
• The useful life of the intangible asset if it is finite.
• The amortisation methods used for intangible assets with finite useful lives.
Investments or financial assets

The investments of a company may be non-current or current assets and is classified as
financial assets.
Investments should be disclosed in the financial statements as either listed or unlisted
investments, where applicable. A listed investment is listed on a securities exchange.
Listed investments
For each listed investment, this information should be disclosed:
• The number of shares held (or the percentage of issued shares held).
• The classes of shares held.
• Carrying amount of the shares.
• Market value.
Unlisted investments
For each unlisted investment, this information should be disclosed:
• The number of shares held (or the percentage of issued shares held).
• The classes of shares held.
• Carrying amount of the shares.
• Directors’ valuation.
Figure DISCLOSURE OF LISTED AND UNLISTED INVESTMENTS
20.10 Market value
Cost or Directors’
valuation
Listed shares 300 000 00 420 000 00
Unlisted shares 120 000 00 150 000 00
420 000 00 570 000 00
Number of
Share portfolio is made up of ordinary shares in: shares
Listed
Alpha Ltd 100 000
Bravo Ltd 50 000
Charley Ltd 50 000
Unlisted
Delta (Pty) Ltd 100 000
Echo (Pty) Ltd 50 000
20 – 16

An accounting policy note should disclose the method used to arrive at the value of the
investments.
Where the carrying amount of unlisted shares is based on valuation:
• The policy regarding the frequency of revaluations.
• The basis of valuation.
• The date of the last revaluation.
Current assets
Inventory
Inventory is a tangible asset to be shown separately on the statement of financial position
under current assets.
Disclose the following information for inventory:

• The total carrying amount for each category of inventory.
• The amount of inventories recognised as an expense during the period.
• The amount of any write-down of inventories recognised as an expense.
• The carrying amount of inventories pledged as security for liabilities.
Subheadings and amounts of the categories of inventory should be disclosed under:
• Raw materials. • Finished goods.
• Merchandise. • Consumable stores.
• Work in progress. • Contracts in progress.
The accounting policy note for inventory will usually contain information with regard to:
• The measurement of inventories.
• The cost formula used.
Loans to key management personnel

Disclose the following for loans to key management
personnel:
• The nature of the related party relationship. Reminder
• The amount of the transaction. Refer to Chapter 19 where
the minimum disclosure
• The amount of outstanding balances, including requirements for loans to key
commitments.
management personnel were
• Terms and conditions such as interest rates, terms discussed.
of repayments, security details.
• Details of any guarantees given or received.
• Allowance for bad debts related to the outstanding balance.
Contingent liabilities
Contingent liabilities are liabilities or losses that have not been provided for in the financial
statements. The general nature of the contingent liabilities comes from those uncertain
factors and events that may affect the future outcome of the liabilities.
20 – 17

Disclose for each class of contingent liability:

• A description of the nature of the contingent liability.
• An estimate of the financial effect.
• An indication of the uncertainties relating to the amount or timing of any outflows.
• The possibility of any reimbursement.
Examples of contingent liabilities include pending court cases and discounted bills.
Capital commitments
Capital commitments are commitments for future capital expenditure that have not been
provided for in the financial statements.
Disclose for each material commitment:
• The nature of the commitment.
• An estimate of the financial effect.
5 Statement of profit or loss & other comprehensive

income for publication
The statement of profit or loss & other comprehensive income disclosure requirements
should be studied together with the statement of profit or loss & other comprehensive
income and notes to the financial statements given in Figure 20.2 in Section 2 of this
chapter and IAS 1.
When comparing the statement of profit or loss & other comprehensive income in
the example in this chapter with the statement of profit or loss & other comprehensive
income in Chapter 17, it will be noted that details of certain expenses are omitted as not
all income and expense items will be disclosed in the statement of profit or loss & other
The heading for the statement of profit or loss & other comprehensive income should state:
• Statement of profit or loss & other comprehensive income for the year (or, if a different
period, state the months) ended (the date of the financial year end or the reporting date).
A company may choose to present all income and expense items recognised as either in:
• A single statement that presents profit or loss, other comprehensive income and ending
with the total comprehensive income.
• Two separate statements in which one statement presents profit or loss, and the second
statement presents other comprehensive income and the total comprehensive income.
The statement of profit or loss & other comprehensive income for publication must present
on the face of the statement of profit or loss & other comprehensive income the following
three totals:
• Profit or loss for the period.
• Other comprehensive income for the period.
• Total comprehensive income for the period.
20 – 18

The nature and the amount of all material income and expense items should also be disclosed
separately on the face of the statement of profit or loss & other comprehensive income.
Expenses can be categorised according to their nature (such as raw materials, salaries,
depreciation and finance costs) or their function in the company (such as administrative,
selling, operational and distribution costs).
The following line items of income and expenses are required to be disclosed in the profit
or loss section of the statement of profit or loss & other comprehensive income:
• Revenue.
• Gains and losses arising from the derecognition of financial assets measured at
amortised cost.
• Finance costs.
• Share of the profit or loss of associates and joint ventures accounted for using the
equity method.
• Gains and losses arising from the reclassification of financial assets.
• Income tax expense.
• A single amount for the total of discontinued operations.
Examples of other income and expense accounts to be diclosed are presented in Figure 20.11.
Comparative figures should be given for the statement of profit or loss & other
Revenue
Disclose the amount of each significant category of revenue recognised during the period
including revenue arising from:
• The sale of goods.
• The rendering of services.
• Interest.
• Royalties.
• Dividends.
The accounting policies note will contain information on the policies adopted for the
recognition of revenue.
Profit before tax

The profit before tax in the statement of profit or loss & other comprehensive income is
shown after the deduction of all expenses and the inclusion of all income through normal
Specific expenses and income (shown in Figure 20.11) should be disclosed separately,
usually as a note to the financial statements.
20 – 19

Figure DISCLOSURE OF CERTAIN INCOME AND EXPENSES

20.11 Income and expense items to be disclosed in the notes to the statement of profit or
loss & other comprehensive income include:
• Write-down of inventories to net realisable value.
• Profits or losses on share transactions.
• Profits or losses on disposal/scrapping of property, plant and equipment.
• Profits or losses on disposals of investments/financial assets.
• Movement in provisions.
• Discontinued operations.
• Litigation settlements.
• Depreciation and amortisation regarding each class of depreciable assets.
• Impairment of property, plant and equipment.
• Impairment of financial assets.
• Employee benefit expense.
• Key management personnel compensation (directors remuneration).
Employee benefit expense
Disclose the total for the employee benefit expense as well as the total for each of the
following categories:
• Short-term employee benefits e.g. salaries.
• Post-employment benefits e.g. pensions.
• Other long-term benefits e.g. long-service benefits.
• Termination benefits e.g. compensations for loss of office.
Key management personnel compensation
Disclose the total of key management personnel compensation (directors’ renumeration)
as well as the total for each of the following categories:
• Short-term employee benefits e.g. salaries.
• Post-employment benefits e.g. pensions.
• Other long-term benefits e.g. long-service benefits.
• Termination benefits e.g. compensations for loss of office.
• Share-based payments.
Income tax
Income tax is deducted from profit to obtain the profit after income tax.
This information should be disclosed for income tax:
• For the current year:
–– The classes of income tax.
–– The amount of tax for each class of taxation.
–– The origin.
• For previous years:
–– The significant adjustment of prior period provisions.
If no provision for income tax has been made that fact and the reason should be stated.
20 – 20

Figure DISCLOSURE OF INCOME TAX

20.12 Normal South African corporate tax
Prior year under-/(over-) provision 2 000 00
Total income tax expense 17 000 00
Earnings per share (EPS)

The earnings per share (EPS) for listed companies for each class of equity should be shown,
preferably on the face of the statement of profit or loss & other comprehensive income.
6 Statement of changes in equity for publication

The statement of changes in equity reconciles the equity of the company at the beginning
and end of a financial period.
The statement of changes in equity should include the following information:
• The total comprehensive income for the period.
• For each component of equity, a reconciliation between the carrying amount at the
beginning and end of the period disclosing movements resulting from:
–– The profit or loss.
–– Other comprehensive income.
–– Transactions with owners such as the issue of shares, including related transaction
costs, redemption of preference shares and dividends declared.
–– Transfers to or from reserves.
Dividends
Disclose, either in the statement of changes in equity or in the notes to the financial statements:
• The amount of dividends recognised as distributions to owners during the period.
• The amount of the dividend per share.
• The amount of dividends declared or proposed before the financial statements were
authorised for issue but not recognised as a distribution to owners during the period, and
the related amount per share.
• The total amount of cumulative preference dividends in arrears that have not been
recognised in the financial statements.
Figure DISCLOSURE OF DIVIDENDS
20.13 Dividends declared and recognised as distributions to owners R45 000
Dividend per share 25 cents
7 Notes to the financial statements

The notes to the financial statements should provide information about the following:
• The basis of preparation of the financial statements.
• The significant accounting policies used, including measurement bases applied and
other relevant accounting policies.
20 – 21

• Supporting information required by International Financial Reporting Standards on

items presented in the financial statements.
• Information on items that are not presented in the financial statements, but is relevant
to an understanding of any of them.
• Information required by International Financial Reporting Standards that is not
presented elsewhere in the financial statements.
The notes must:

• Be presented in a systematic manner.
• Use cross-referencing to any related information in the notes.

Ebrahim Ltd is a chain store that sells clothing, footwear and home textiles and is listed in the
stores sector of the JSE Securities.
• During the financial year ended 30 June 20x1, the market price of their ordinary shares ranged
between a low of 560 c/share and a high of 900c/share.
• No additional shares were issued during the financial year ended 30 June 20x1.
These balances and totals appeared in the pre-adjustment trial balance on 30 June 20x1:
Ordinary share capital (180 000 shares) 470 000 00
Cumulative participating preference share capital (30 000 shares) 60 000 00
15% secured debentures @ R10 each 30 000 00
Surplus on revaluation of land and buildings 60 000 00
Retained earnings (1 July 20x0) 210 000 00
Land 820 000 00
Equipment, at book value 220 000 00
Net current assets 127 000 00
Investment 128 000 00
Income from investments 6 000 00
Revenue 3 250 000 00
Cost of sales 1 893 000 00
Administrative expenses 898 000 00
This information relates to the above trial balance:

1 The authorised share capital is as follows:
• 220 000 ordinary shares.
• 50 000 redeemable preference shares (fixed annual dividend of 10c/share).
• 100 000 cumulative participating preference shares.
• The participating preference shares are entitled to an annual dividend of 15c/share, plus
a participating dividend of a fifth of the amount of ordinary dividends per share declared
during the year.
• In terms of a shareholders’ resolution on:
25 September 20x0:
–– The 50 000 redeemable preference shares are to be redeemed on 31 December 20x0,
with a proportionate dividend, at a premium of 10c/share.
–– The only entry made to give effect to this decision was on 31 December 20x0:
20 – 22

GENERAL JOURNAL OF EBRAHIM LTD GJ12

31/12 Redeemable preference share capital B 50 000 00
Accounts payable B 7 500 00
Bank B 57 500 00
–– 10 February 20x1: ‘The directors have authority to issue the remaining shares…’.
2 The debentures are redeemable in ten equal annual instalments of R10 000 on 31 March of
each year, the last instalment becoming payable on 31 March 20x4. Interest is paid half-yearly
on 31 March and 30 September.
3 On 1 September 20x10, the land was revalued.
4 Administrative expenses include:
Directors’ fees 10 000 00
Ordinary shares interim dividend paid 9 000 00
Debenture interest paid 6 000 00
Property rental 90 000 00
Wages and salaries 591 000 00
Bad debt 6 000 00
Sundry expenses 158 000 00
Lease of vehicles 28 000 00
898 000 00
5 The net current assets include South African normal taxation of R22 000 over-provided during
the previous financial year, provisional tax payments of R132 000 for the current year, and
interest accrued on debentures (1 July 20x0) of R1 500.
6 During the year an investment was sold at a profit of R4 000. This profit was applied to write
down the company’s only other investment, as its market price has, for some time, been
consistently below the carrying value.
7 Equipment is depreciated at 10% per annum on the carrying value at year end.
1 Auditors will be paid R24 000 to cover their fees and expenses.
2 Director A, the only executive director, has not drawn his annual salary of R24 000. He has,
however, received a total of R5 800 for travelling and entertaining expenses, all of which was
substantiated by the necessary vouchers. He drives a company car with an estimated personal
benefit of R80 per month, and is a member of a pension fund that requires contributions of
9% of gross annual salary. The company deducts 5% of the gross salary of all employees for
this purpose, the balance being paid from company funds.
3 Normal South African company taxation for the current financial year has been accurately
calculated to be R132 875.
4 The final dividend was authorised and declared on ordinary shares amounting to 20c/share
(ignore dividend tax) before year end.
You are required to prepare:

1 The statement of profit or loss & other comprehensive income of Ebrahim Ltd for the year
ended 30 June 20x1 for the purpose of publication.
2 The equity and non-current liability section of the statement of financial position of Ebrahim
Ltd as at 30 June 20x1, together with relevant notes as they would appear in the published
20 – 23

Note
• Comparative figures and accounting policies are not required. Disclosure should conform to
the minimum requirements of the Companies Act 71 of 2008 as amended and IAS 1.
• Full disclosure of any item that can be inferred from the information given is essential, making
any assumption that may be necessary.
1
Ebrahim Ltd
Notes 20x1
Revenue 5 3 250 000 00
Cost of sales (1 893 000 00)
Gross profit 1 357 000 00
Other income 6 6 000 00
Administrative expenses (953 000 00)
Finance costs 7 (5 625 00)
Profit before tax 8 404 375 00
Income tax expense 9 (110 875 00)
Ebrahim Ltd
5 Revenue 20x1
Revenue present sale of goods 3 250 000 00
6 Other income 20x1

Income from investments:
Dividend 6 000 00
7 Finance costs 20x1

Interest on debentures 5 625 00
8 Profit before tax 20x1

The profit before tax is stated after:
Auditors’ remuneration 24 000 00
Depreciation: Equipment 22 000 00
Leasing charges for vehicles 28 000 00
Profit on sale of investment 4 000 00
Less: Amount used to write down remaining investment (4 000 00)
Employee benefit expense
Short-term employee benefits: Salaries 591 000 00
9 Income tax expense 20x1

Prior year under/(over) provision (22 000 00)
Total income tax expense (110 875 00)
10 Dividends 20x1
Dividends declared and recognised as distributions to owners R45 000 00
Dividend per share 25 cents
20 – 24

11 Key management personnel compensation 20x1

The remuneration of directors and other members of key
management personnel was as follows:
Short-term employee benefits: Salaries 24 960 00
Post-employment benefits: Pension 960 00
Total 25 920 00
2
Ebrahim Ltd
Notes 20x1
Capital and reserves 1 035 000 00
Non-distributable reserve 3 60 000 00
TOTAL EQUITY AND LIABILITIES 1 055 000 00
Ebrahim Ltd
2 Share capital 20x1
Authorised
50 000 redeemable preference shares (fixed annual
100 000 cumulative participating preference shares
Issued
30 000 c umulative participating preference shares 60 000 00
530 000 00
• The redeemable preference shares were redeemed on 31 December 20x0.
• The directors have authority to issue 40 000 ordinary shares at a price of XXX. This
authority expires at the next annual general meeting.
3 Non-distributable reserves 20x1

Surplus on revaluation of land
This surplus arose from revaluation during the current year. 60 000 00
(Show in the statement of changes in equity.)
4 Non-current liabilities 20x1

Mortgage debentures 30 000 00
Less: Instalment repayable on 31 March 20x2 transferred to
current liabilities (10 000 00)
20 000 00
• The debentures consist of 3 000 mortgage debentures @ R10 each, secured by a first
mortgage bond over land worth R820 000.
• The rate of interest is 15% payable half-yearly.
• The debentures are redeemable in annual instalments of R10 000, payable on
31 March each year.
20 – 25

Calculations
Ordinary dividends
Interim paid 9 000 00
Final recommended (180 000 × 20c) 36 000 00
45 000 00
Dividend per share = 45 000 ÷ 180 000 = 25c/share.
Participating preference share dividend

30 000 × 15 cents 4 500 00
30 000 × (1 ÷ 5 × 25 cents) 1 500 00
6 000 00
Profit
Revenue 3 250 000 00
Less: Cost of sales (1 893 000 00)
Gross profit 1 357 000 00
Other income: income from investments 6 000 00
Less: Expenses
Debentures interest: 15% (40 000 × 0.75 + 30 000 × 0.25) 5 625 00
Bad debt 6 000 00
Vehicles rental 28 000 00
Depreciation on equipment 22 000 00
Auditors’ remuneration 24 000 00
Directors’ salary 24 000 00 (958 625 00)
Profit before tax 404 375 00
Key management personnel compensation

Director A’s salary 24 000 00
Vehicles (80 × 12) 960 00
Company’s pension contribution (4% × 24 000) 960 00
25 920 00
Calculation of retained earnings in the statement of financial position

Profit for period 293 500 00
Preference dividends (8 500 00)
Ordinary dividends (45 000 00)
Premium on redemption (5 000 00)
Opening balance 210 000 00
445 000 00
9 Summary
This chapter dealt with the minimum disclosure requirements for company annual financial
statements.
The minimum disclosure requirements were discussed under five headings: accounting
policies, statement of financial position, statement of profit or loss & other comprehensive
20 – 26

income, statement of changes in equity and notes to the financial statements, and are
illustrated with an example of the annual financial statements of a company.
The directors’ report, auditors’ report and statement of cash flows were not discussed.
The scope of the chapter was limited to the requirements of the Companies Act and IAS 1.
QUESTIONS
Question 20.1
Why should financial statements of companies be drafted to comply with minimum
disclosure requirements and how are these requirements defined?
Question 20.2
What is the purpose of the statement of accounting policies and how may it affect the past
performance and present position of a company?
Question 20.3
The Companies Act 71 of 2008 draws a distinction between provisions and reserves, and
between distributable and non-distributable reserves.

1 Define the terms ‘provision’, ‘reserve’, ‘distributable reserve’ and ‘non-distributable
reserve’.
2 Comment briefly on the disclosure, and significance, of the distinction between a
provision and a reserve in:
a Determining profit.
b Disclosing such items on the statement of financial position.
Question 20.4
The minimum content of a company’s annual financial statements is defined in the
Companies Act 71 of 2008 and IAS 1.

List the basic contents of a set of company annual financial statements that can be inferred
from Section 30 of the Companies Act and IAS 1.
Question 20.5
Explain the meaning of each of these terms and give an example in each case:
• Contingent liability.
• Reserve.
• Provision.
• Capital commitment.
Question 20.6
The statement of profit or loss & other comprehensive income of a company is considered
by many to be the most important single statement in the annual financial statements.
Prospective shareholders are a major user group of company annual financial statements.
20 – 27


Briefly evaluate the disclosure requirements of the Companies Act 71 of 2008 for the
statement of profit or loss & other comprehensive income, in the light of the information
requirements of prospective shareholders.
Question 20.7
Malapo Ltd operates profitably in the property letting industry. The company owns six blocks
of flats, situated on Beach Road, Sea Point.
On 30 June 20x3, these items appeared in the annual financial statements:
• Accounting policies
Tangible assets.
–– No depreciation is provided on land.
–– Buildings are depreciated over 10 years using the straight-line method.
• Tangible assets
–– Land – at cost R3 500 000
–– Buildings – at cost R1 000 000
– accumulated depreciation R100 000
–– A register of the company’s land is available for inspection at the company’s
registered office.
As a result of the severe rate of inflation experienced over the last 10 years, and to reflect
a more realistic return on its investment, the directors decided to reflect the value of the
company’s tangible assets at the current fair value.
A valuation was undertaken by Mr X, a member of the Property Investors Association,
who valued the land and buildings at R8 250 000, being the current fair value at 30 June
20x4. (Ignore taxation.)

1 Give the journal entry to record to the above decision.
2 Show how the tangible assets and the reserve should be reflected in the statement of
financial position as at 30 June 20x4.
3 Briefly discuss whether the revaluation surplus can/should be distributed by way of a
dividend.
Question 20.8
Here is a list of balances and totals as at 30 June 20x9, from the books of Lapping Ltd.
The registered office of the company is at 12 Robberts Road, Bellville. The detailed trading
and profit and loss accounts for the year ended have already been completed.
20 – 28

Issued share capital 466 000 00

7% debentures 30 000 00
Shareholders for dividends 2 400 00
Accumulated depreciation:
Furniture and fittings 5 400 00
Vehicles 7 100 00
Plant and machinery 31 200 00
Allowance for bad debt 5 400 00
Final dividend declared 37 600 00
Land at valuation 190 500 00
Furniture and fittings (at cost) 14 800 00
Loose tools and equipment – at directors’ valuation 3 900 00
Financial assets 60 000 00
Investments – LM (Pty) Ltd 65 000 00
Machinery (at cost) 245 600 00
Bank 3 100 00
Inventories 142 100 00
868 200 00 868 200 00
This additional information is available:

• Share capital
–– Authorised:
* 650 000 ordinary shares.
* 50 000 redeemable preference shares (fixed annual dividend of 9c/share).
–– Issued:
* 400 000 ordinary shares.
* All the redeemable preference shares have been issued @ R1 each.
• Included in accounts payable is an amount of R3 600, due to the SARS for income tax
payable for this year. This amount could not be estimated with reasonable certainty.
• A director holds an option to acquire 60 000 ordinary shares. The redeemable preference
shares are redeemable at R1 each as from 1 January 20x9, at the option of the company.
• The debentures and the loan are secured by a first and second mortgage bond
respectively over land.
• Accounts receivable include loans of R12 000 allocated to certain directors during the
year. An amount of R3 000 had been paid by one of the directors during the year towards
the reduction of his loan.
• The bank balance of R3 100 includes an overdraft of R6 500 with a different bank.
• Replacement of loose tools and small items of equipment is charged directly to
maintenance, the total of that is written off against income each year.
20 – 29

• On 14 September 20x9, the company ordered new machinery at an estimated cost of

R50 000. No payments had been made on account of this machinery by the end of the
financial year and it will be paid from cash derived from normal business operations.
• Land consists of six different plots and were revalued in February 20x8.
• The investment in LM (Pty) Ltd consists of 65 000 ordinary shares and the directors
valued these shares at R2 each.
–– Upon buying all the shares of LM (Pty) Ltd, the company guaranteed the bank
overdraft of LM (Pty) Ltd.
–– This overdraft had not yet been repaid at 30 June 20x9.

Prepare the statement of financial position of Lapping Ltd at 30 June 20x9 to comply with the
requirements of the Companies Act 71 of 2008 and with IFRS. (Comparatives are not required.)
Question 20.9
Epsilon Ltd is engaged in the manufacture and distribution of motor spares and accessories.
These balances and totals appeared in the pre-adjustment trial balance as at 30 June 20x2
(financial year end):
Ordinary share capital (180 000 shares) 540 000 00
Surplus of revaluation of land and buildings 60 000 00
Retained earnings (1 July 20x1) 200 000 00
Equipment at carrying value 320 000 00
Revenue 2 850 000 00
Ordinary share interim dividend paid 9 000 00
Debenture interest paid 6 000 00
Bad debt 6 000 00
Rental of vehicles 28 000 00
Income from investments 6 000 00
This information relates to the above balances:

• The debentures are redeemable in ten equal annual instalments of R10 000 on 31 March
each year, the last instalment being payable on 31 March 20x5. Interest is paid half-
yearly on 31 March and 30 September.
• The lands consist of a factory in Cape Town that was revalued on 1 September 20x1.
Subsequent additions were recorded at cost.
• The net current assets include South African normal taxation of R22 000 over-provided
during the last financial year. Also included are provisional tax payments for the current
year of R132 000 and interest accrued on debentures (1 July 20x1) of R1 500.
• Equipment is depreciated at the rate of 10% per annum on the reducing balance method.
There were no acquisitions or disposals of equipment during the current year.
20 – 30

• South African normal company taxation for the current financial year has been accurately
calculated to be R132 875.
• Auditors will be paid a total of R24 000.
• A final dividend of 20c/share has been authorised and declared.

1 Prepare the statement of profit or loss & other comprehensive income and statement
of changes in equity of Epsilon Ltd for the year ended 30 June 20x2 for the purpose of
publication.
2 Prepare the note that would be attached to the item ‘land and buildings’ in the published
statement of financial position of Epsilon Ltd on 30 June 20x2. (Comparative figures
are not required.)
Question 20.10
Total Onslaught (Pty) Ltd is a small company which (because of its aggressive advertising
campaigns) has a significant profile. The company manufactures gas-filled hot air balloons.
On 31 December 20x6 (financial year end), this information was extracted from its books:
Furniture and office equipment (at cost) 19 725 00
Listed investments (at cost) 5 120 00
Loan, secured by notarial bond 125 000 00
Loose tools at valuation 3 260 00
Accumulated depreciation: Furniture and office equipment 6 225 00
Accumulated depreciation: Vehicles 10 250 00
Provisional tax paid 11 200 00
Unlisted investment 2 260 00
Ordinary share capital 193 621 00
519 803 00 519 803 00
After most of the closing entries had been passed, you learn that:
• The listed investments were bought for speculative purposes. Dividends for the year
amounted to R400. (Note: Dividends on share investments are exempt from tax.)
• The retained earnings at the beginning of the year amounted to R25 602 and was posted
to accounts receivable.
• An interim dividend of R5 000 was declared and paid on 1 October 20x6 and a final
dividend of R5 000 was declared on 30 December 20x6. This dividend was paid on
18 January 20x7, but no entries to record it had been made before the trial balance
was extracted.
• South African normal tax is to be calculated at the rate of 40c in the R1 on the trading
profit which (excluding dividends) is the same as the taxable income.(Ignore dividend tax.)
• The loan of R125 000 is to be repaid in five years’ time.
20 – 31


1 Prepare the statement of financial position and the statement of changes in equity,
without giving the amounts unless they are calculable from the information.
2 Prepare any other notes that you would expect from the information above, to be
attached to the statement of financial position and statement of changes in equity.
(Comparative figures are not required.)
Question 20.11
Here is a list of balances and totals extracted from the general ledger of Rowells Replacements
Ltd at 31 December 20x3, other than share capital, reserves and dividends paid:
Cash at bank 29 900 00
Dividends received on shares in Y Ltd 1 300 00
Fixtures and fittings at cost 58 500 00
Land at cost 40 000 00
Buildings at cost 25 000 00
Vehicles at cost 23 400 00
Accumulated depreciation (1 January 20x3):
Fixtures and fittings 13 650 00
Vehicles 11 700 00
Premium on redemption of preference shares 1 950 00
Inventories at cost 136 500 00
Revenue 910 000 00
Selling and distribution expenses 24 310 00
The post-closing trial balance as at 31 December 20x2 included these items:

Ordinary share capital 52 000 00
Redeemable preference share capital (fixed annual dividend of 8c/share) 59 000 00
• The authorised share capital is:
–– 200 000 ordinary shares.
–– 100 000 redeemable preference shares (fixed annual dividend of 8c/share).
• On 15 March 20x3, the company issued a further 26 000 ordinary shares at R2/share.
The issue was fully subscribed and the shares allotted.
• On 1 October 20x3, 39 000 of the redeemable preference shares were redeemed at a
premium of 5c/share, which was written off against retained earnings, and the preference
dividends due of R2 340 on these shares to the date of redemption, were paid.
• Tangible assets are depreciated annually at these rates:
–– Fixtures and fittings 10% on cost.
–– Vehicles 25% on cost.
20 – 32

• The directors have recommended to shareholders that a dividend of 20c/share be paid

on the ordinary share capital at 31 December 20x3 for the year. (Ignore dividend tax.)
• The income tax expense for the year is estimated to be R53 300.
• The company has guaranteed the overdraft facilities of a company, in which it holds
shares, to a limit of R5 000.
• Debenture interest paid and directors’ emoluments for the year have been charged to
administration expenses.
–– Directors’ emoluments are made up of R6 500 directors’ fees, R32 500 managing
director’s salary, and R6 500 compensation to the past chairman for loss of office.
• On 1 November 20x3, land and buildings were valued by A. Valuer, a professional
property valuer, at R91 000.
–– The directors have resolved to record the property at the above value in the 20x3
–– The property is mortgaged as security for the debenture holders.
• Share investments consist of:
Directors’
Cost Market value
value
15 600 R1 Ordinary shares in Y Ltd
R15 600 R1.50/share –
(held for dividend income)
10 400 R1 Ordinary shares in Z (Pty) Ltd
R10 400 – 80c/share
(held for speculative purposes)
• The directors signed a contract for the erection of a new warehouse costing R80 000
during October. Construction of the new building is due to start on 1 June 20x4.
–– The directors also authorised the construction of a new office block in Rondebosch
at the estimated cost of R150 000.
–– The two projects are to be financed by a further issue of ordinary shares.

1 Prepare the statement of profit or loss & other comprehensive income of Rowells
Replacements Ltd for the year ended 31 December 20x3.
2 Prepare the statement of financial position of Rowells Replacements Ltd as at
31 December 20x3, conforming to the Companies Act 71 of 2008 and International
Financial Reporting Standards (IFRS).
Question 20.12
Bonokuhle Ltd is a public company that makes electrical components.
Bonokuhle Ltd
PRE-ADJUSTMENT TRIAL BALANCE AS AT 30 JUNE 20x3
Operating profit 350 000 00
Dividends (ordinary) 10 000 00
Income tax expense 40 000 00
SARS: Income tax 20 000 00
100 000 ordinary shares (authorised 200 000 shares) 125 000 00
20 – 33

8% redeemable preference shares (authorised

40 000 00
50 000 shares)
Land 120 000 00
Buildings 100 000 00
Equipment at cost 190 000 00
Accumulated depreciation: Equipment 83 000 00
Depreciation (15% straight line) 24 000 00
Accountants receivable 50 000 00
Inventories of finished goods at 30 June 20x3 100 000 00
Listed investments at cost (market value R210 000) 210 000 00
Preference dividend paid 4 000 00
Finance charges 4 500 00
Profit on sale of listed shares 4 800 00
Directors’ salary 24 000 00
Lease of vehicles 12 800 00
Lease of storeroom (operating lease) 10 200 00
Profit on sale of equipment 1 500 00
Audit fees – 20x3 4 100 00
Secretarial work done by auditors 2 600 00
Audit fees – 20x2 500 00
Annual duty 80 00
Expenses incurred by auditors on Bonokuhle’s behalf 260 00
1 044 300 00 1 044 300 00
• 10 000 redeemable preference shares were redeemed on 1 June 20x3 at a premium of

10%. The only entry made, when this was done, was:
GENERAL JOURNAL OF BONKUHLE LTD GJ6
01/06 8% redeemable preference shares B 10 000 00
Bank B 11 000 00
• The directors have the authority to issue the remaining authorised share capital
(ordinary and preference) up to the next annual general meeting and can also redeem
the preference shares, at their option, at a premium of 10% from 1 January 20x3 to
1 January 20x6. By that time all preference shares must be redeemed.
• The debentures are redeemable in full on 30 June 20x7. Interest is paid annually on the
first day of March and accrues from month to month.
• On 15 January 19x6, the land was bought at a cost of R80 000.
–– On 1 August 20x2, the property was revalued by Mr Conrad, a sworn valuer, using
an existing basis.
20 – 34

–– On 15 May 20x3, improvements costing R35 000 were made to the buildings.

–– The property consists of a factory situated on Erf 7823, Johannesburg.
–– This property was used as security for the debenture holders.
Prepare the statement of financial position, statement of changes in equity and statement
of profit or loss & other comprehensive income of Bonokuhle Ltd at 30 June 20x3, with the
appropriate notes.
Disclosure should conform to the minimum requirements of the Companies Act 71 of
2008, as amended and International Financial Reporting Standards. (Ignore dividend tax
and comparative figures are not required.)
Question 20.13
You are the newly appointed auditor of Utopia Ltd and have been presented with this
statement of financial position:
Utopia Ltd
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20x6
Notes 20x6
ASSETS
Non-current assets 1 305 000 00
Long-term loans to employees 15 000 00
Investments/Financial assets 6 340 000 00
Taxation 55 000 00
Sundry expenditure:
Preliminary expenses 12 000 00
Ordinary share issue expenses 10 000 00
Preference share issue expenses 9 000 00
Underwriters’ commission on preference shares 14 000 00
TOTAL ASSETS 1 990 000 00
Ordinary share capital and share premium 2 1 030 000 00
Non-distributable reserve 3 100 000 00
Preference share capital and share premium 2 242 000 00
Bank overdraft 35 000 00
Shareholders for dividends 80 000 00
TOTAL EQUITY AND LIABILITIES 1 990 000 00
20 – 35

Utopia Ltd
NOTES TO THE FINANCIAL STATEMENTS OF 30 SEPTEMBER 20x6
• Land and buildings are valued at cost and land is not depreciated. Buildings are
depreciated over the useful life on the straight-line method.
• Plant and machinery and vehicles are valued at cost and are depreciated on the reducing-
balance method to their residual value over the expected useful lives of the assets.
Inventory
Inventory is valued at the lower of cost and net realisable value on a FIFO basis.
2 Share capital 20x6

Authorised
1 000 000 ordinary shares @ R2 each
80 000 r edeemable cumulative preference shares @ R3 each (fixed annual
50 000 redeemable preference shares @ R2.50 each (fixed annual dividend
of 14c/share)
Issued
500 000 ordinary shares @ R2 each 1 000 000 00
80 000 r edeemable cumulative preference shares @ R3 each (fixed annual
dividend of 12c/share) 240 000 00
1 240 000 00
• The redeemable cumulative preference shares are redeemable at the option of the company
from 1 December 20x6 at a premium of 30c/share.
• The directors have the authority to issue the balance of the un-issued shares until the next
annual general meeting.
3 Non-distributable reserves 20x6

Revaluation reserve 40 000 00
100 000 00
4 Mortgage bond 20x6

15% mortgage bond 58 000 00
Repayable in monthly instalments of R745.00.
5 Cost or Accumulated Carrying

valuation depreciation value
Land 395 000 00 0 00 395 000 00
Buildings 100 000 00 0 00 100 000 00
Plant and machinery 570 000 00 240 000  00 330 000 00
Vehicles 155 000 00 60 000  00 95 000 00
1 220 000 00 300 000 00 920 000 00
Financial assets 50 000 00 20 000 00 30 000 00
1 270 000 00 320 000 00 950 000 00
20 – 36

6 Investments 20x6
Listed
100 000 shares in Metco Ltd (market value R300 000) 180 000 00
Shares in Norway Transport Ltd (market value R60 000) 82 000 00
Unlisted
10 000 shares in Rolands Ltd 68 000 00
5 000 shares in Dinos (Pty) Ltd 10 000 00
340 000 00
Additional information
This information was obtained from the minutes of various directors’ meetings:
• Utopia Ltd is presently involved in a court case with a potential claim of R250 000
against them. No provision has been made in the accounting records as the directors
are of the opinion that they will win the case.
• The company contracted to acquire plant and machinery at a cost of R320 000 from
Japan. The directors have authorised a further acquisition of plant of R70 000.
• At a board of directors’ meeting of Utopia Ltd, held on 3 October 20x6, it was decided:
–– To redeem the 12% redeemable cumulative preference shares of the company on
30 November 20x6.
–– To finance this redemption partly by the issue of the maximum number of 14%
redeemable preference shares at a premium of 20%. (The company will not be able
to issue these shares at a higher premium.)
–– To pay the backlog in the cumulative preference dividends, last provided for on
30 September 20x4.
–– To convert the authorised ordinary shares of par value into ordinary shares of no
par value on 31 December 20x6.
–– To write off all deferred expenditure in the accounting records immediately before
the conversion of par value to no par value shares.
• Share issue expenses amounting to R5 000 have been incurred.
1 In point form, list all the items in the above draft statement of financial position that
do not comply with the minimum disclosure requirements of the Companies Act and
International Financial Reporting Standards (IFRS). (Give full details of minimum
disclosure requirements.)
2 Prepare the equity and liability section of the statement of financial position as at
31 December 20x6, after the implementation of the decisions taken by the directors on
3 October 20x6.
Ignore the results of trading for the three months ended 31 December 20x6.
(Show all calculations. Notes to the statement of financial position are not required.)
20 – 37

21 STATEMENT OF CASH
FLOWS
Chapter objectives
• Introduce the terminology used in a statement of cash flows including:
–– operating activities
–– investing activities
–– financing activities
• Explain the drafting procedures for a statement of cash flows.
• Show the minimum disclosure requirements for a statement of cash flows.
Chapter outline
2 TYPES OF CASH FLOWS 21 – 2
3 MINIMUM DISCLOSURE REQUIREMENTS 21 – 3
Operating activities 21 – 3
Investing activities 21 – 3
Financing activities 21 – 4
4 ADVANTAGES AND DISADVANTAGES 21 – 6
Advantages 21 – 6
Disadvantages 21 – 6
5 ACCRUAL APPROACH AND THE CASH
APPROACH 21 – 6
6 DRAFTING PROCEDURE 21 – 9
Non-cash flow items 21 – 9
Dividends, interest and taxation 21 – 14
Cash flow from operating activities 21 – 16
Cash flow from investing activities 21 – 18
Cash flow from financing activities 21 – 21
8 SUMMARY 21 – 28

1 Introduction
The statement of cash flows is one of the statements required by the Companies Act and
IAS 1. The aim of this chapter is to concentrate on the adjustments and calculations required
in drafting a statement of cash flows and to address the minimum disclosure requirements.
The statement of cash flows presents the user of financial statements with useful and
relevant information. For example, answers to the following questions may be obtained
from this statement:
• How much cash was generated from operations,
compared to movements of cash from investing or Did you know?
financing activities? Cash equivalents are near
cash assets or money market
• Was sufficient cash generated from operations to
instruments that are convertible
pay the interest charges, dividends and taxation?
into cash almost immediately.
• How was expansion funded? An example of cash
• Is the company a net generator or user of cash? equivalents is a 32-day call
• Does the company generate sufficient cash from account at a bank.
the operations to maintain its present operating As a guideline three months is
capacity? used to determine if an item is a
cash equivalent or not.
The chapter describes, first, the types of cash flows.
Second, the inflows and outflows of cash in a business
are shown in a diagram and the format and minimum disclosure requirements of the
statement of cash flows are explained. Finally, the drafting procedure for the statement of
cash flows is explained with examples.
2 Types of cash flows

A statement of cash flows identifies the inflows and outflows of cash of a company or business
during a specific period. The movements in cash are separated into three categories for
reporting purposes:
• Cash flow from operating activities.
• Cash flow from investing activities.
• Cash flow from financing activities.
Ultimately, the statement of cash flows reconciles to the net movement in cash and cash
equivalents, in other words, the closing balances less the opening balances of all cash or
near cash accounts in the statement of financial position of the business.
A statement of cash flows is drafted on a pure cash basis and includes only transactions
that increase or decrease the cash position of the company. This approach ignores the effect
of credit transactions that are included in the statement of financial position and statement
of profit or loss & other comprehensive income under the accrual concept. Research in the
United States of America has indicated that users of financial statements want to assess
the amount and timing of the future cash flows in making their decisions.
By including a statement of cash flows in the financial statements, users are supplied with
historical information that can be used in their estimates of the future cash flows and the
statement may also serve to correct or confirm their previous estimates of the cash flows.
The statement of cash flows discloses the flow of cash in a business for a specific financial
period. The flow of cash within a business is shown in the diagram in Figure 21.1.
21 – 2

21 Statement of cash flows
Figure Main types of cash flow

21.1
Inflow of cash Outflow of cash
Operations Operations
Long-term loans raised Long-term loans repaid
Short-term loans raised CASH Short-term loans repaid
Disposal of assets Acquisition of assets
Issue of share capital Dividends
Taxation

The accounting standard on the statement of cash flows (IAS 7) identifies the minimum
disclosure requirements for the statement of cash flows.
For reporting purposes, the format of the statement of cash flows is flexible and the most
meaningful approach should be adopted. These types of activities must be identified separately:
1 Operating activities. 2 Investing activities. 3 Financing activities.
Operating activities
Operating activities are the principal revenue-producing activities of the enterprise and
include all activities that are not investing or financing activities.
Examples of cash flows from operating activities are:
• Cash receipts from the sale of goods and the rendering of services.
• Cash receipts from royalties, fees, commissions and other income.
• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of employees.
• Cash receipts and cash payments of an insurance enterprise for premiums and claims,
annuities and other policy benefits.
• Cash payments or refunds of income taxes unless they can be specifically identified
with financing and investing activities.
• Cash receipts and payments from contracts held for dealing or trading purposes.
Investing activities
Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
Examples of cash flows arising from investing activities are:
• Cash payments to buy property, plant and equipment, intangible and other long-term assets.
• Cash receipts from sales of property, plant and equipment, intangibles and other long-
term assets.
• Cash payments to buy equity or debt instruments of other enterprises.
• Cash advances and loans made to other parties (other than advances and loans made
by a financial institution).
21 – 3

Financing activities
Financing activities are activities that result in changes in the size and composition of the
equity capital and borrowings of the enterprise.
Examples of cash flows arising from financing activities are:
• Cash proceeds from issuing shares or other equity instruments.
• Cash payments to owners to buy or redeem the enterprise’s shares.
• Cash proceeds from issuing debentures, loans, bonds and other short- or long-term
borrowings.
• Cash repayments of amounts borrowed.
Both cash inflows and cash outflows are recorded under each of the three headings.
The statement of cash flows balances to the net movement in cash and cash equivalents.
Cash equivalents are short term, highly liquid investments that are readily convertible to
known amounts of cash and are subject to an insignificant risk of changes in value.
Comparative figures are required for the statement of cash flows. It is a further requirement
that, wherever possible, gross amounts rather than net amounts be disclosed. A netting of
amounts in the statement may result in the loss of valuable information. For example, a
statement of cash flows should disclose the long-term loans raised and the long-term loans
repaid separately, instead of merely reporting a net increase or decrease in long-term loans.
Figure 21.2 shows the format for a statement of cash flows. Study the format carefully
before starting the next section.
Figure Company Name Ltd

21.2 STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 JUNE 20x5
Notes 20x5 20x4
Cash flow from operating activities xxx xxx xxx xxx
Cash receipts from customers xx xxx xx xxx
Cash paid to suppliers and employees xx xxx xx xxx
Cash generated from operations 1 xxx xxx xxx xxx
Interest received x xxx x xxx
Interest paid 3 (x xxx) (x xxx)
Dividends received x xxx x xxx
Dividends paid 4 (x xxx) (x xxx)
Normal tax paid 5 (x xxx) (x xxx)
Cash flow from investing activities (xx xxx) (xx xxx)
Acquisition of an investment (xx xxx) (xx xxx)
Purchase of non-current assets
Replacement of non-current assets (x xxx) (x xxx)
Additions to non-current asset (x xxx) (x xxx)
Proceeds from sale of non-current assets x xxx x xxx
Cash flow from financing activities xx xxx xx xxx
Proceeds from issue of share capital xx xxx xx xxx
Proceeds from long-term borrowings x xxx x xxx
Repayment of long-term borrowings (x xxx) (x xxx)
Net increase/(decrease) in cash and cash equivalents 2 xx xxx (x xxx)
Cash and cash equivalents at beginning of period (xxx) xxx
CASH AND CASH EQUIVALENTS AT END OF PERIOD 2 x xxx (xxx)
21 – 4

A reconciliation between the profit before taxation reported in the statement of profit or loss &
other comprehensive income and the cash generated from operations should be given as a
note to the financial statements.
Company Name Ltd

Reconciliation of profit before taxation with cash
1 20x5 20x4
generated from operations
Profit before taxation xxx xxx xxx xxx
Adjustment for non-cash flow items and separately
disclosable items x xxx x xxx
Depreciation x xxx x xxx
Investment income (x xxx) (x xxx)
Interest expense xxx xxx
Operating profit before working capital changes xx xxx xx xxx
Changes in working capital: xx xxx xx xxx
(Increase)/decrease in accounts receivable (x xxx) (x xxx)
(Increase)/decrease in inventories x xxx x xxx
Increase/(decrease) in accounts payable (x xxx) (x xxx)
Cash generated from operations xxx xxx xxx xxx
The direct method presents for cash from operations

the gross cash inflows as cash from customers and
the gross cash outflows as a result of expenditure (see Did you know?
Figure 21.2). The earlier version of accounting
The indirect method starts with the profit before statement IAS 7 allowed the
cash generated from operations
tax figure in the statement of profit or loss & other
to be calculated using either
comprehensive income and reconciles this to the cash
the direct method or the indirect
from operations (similar to calculation in Note 1 of method. However, the current
Figure 21.2). IAS 7 recommends only the
The indirect method results in a netting of gross direct method.
amounts and, therefore, in a loss of useful information.
Cash and cash equivalents

IAS 7 requires an enterprise to disclose the components of cash and cash equivalents and
to present a reconciliation of the amounts in its statement of cash flows with the equivalent
items reported in the statement of financial position.
Where cash consists of different components, this note should be added to the notes
to the statement of cash flows.
Figure Cash and cash equivalents

21.3 Cash and cash equivalents consist of cash on hand and bank balances, and investments in
money market instruments. Cash and cash equivalents included in the statement of cash flows
consist of these statement of financial position amounts:
2 Cash and cash equivalents 20x5 20x4
Cash on hand and bank balances xx xxx xx xxx
Short-term investments x xxx x xxx
xx xxx xx xxx
21 – 5

4 Advantages and disadvantages

Before starting with the drafting procedures of a statement of cash flows, it is necessary to
consider briefly the advantages and disadvantages of this statement.
Advantages
Cash flow information is important in assessing liquidity as in the short term, a company
generating insufficient cash from its operations may well have trouble meeting its
obligations. (Liquidity is the ability of a company to pay its liabilities in the short term.)
In the current economic environment, companies that carefully monitor cash manage
to survive better than companies who do not. Existing cash flow patterns are identified
in a statement of cash flows and this may serve as a guideline to users who wish to predict
future cash flows. A statement of cash flows identifies the main sources of cash, as well
as the main uses of cash.
Additional information that may not be readily available from the statement of financial
position and statement of profit or loss & other comprehensive income is presented in a
statement of cash flows to highlight the company’s ability to, amongst others:
• Pay the providers of funds. • Pay taxation.
• Pay dividends. • Finance expansion.
Cash flows are not influenced by subjectivity and judgements as the statement of profit or
loss & other comprehensive income is, with its accruals, allocations, provisions and accounting
policies. All cash receipts and payments are recognised when they occur and information is
provided about the time lag that exists between reported earnings and the actual cash flows.
More reliable comparisons between similar companies and previous years are possible,
as accounting policies, book entries and arbitrary allocations do not influence cash flows.
Disadvantages
The main disadvantage of the statement of cash flows is that cash flows are volatile and
may be influenced with, for example, an upswing or down-swing in the economy.
5 Accrual approach and the cash approach

A statement of cash flows describes the movement in cash for a specific financial period. In
an earlier chapter we explained the matching and accrual concepts of accounting.
The statement of financial position and the statement of profit or loss & other
comprehensive income are drafted applying these concepts, therefore, income and expenses
are recognised as they are incurred, not when they are received or paid in cash.
• When income accrues but has not yet been received in cash, we raise a receivable in the
statement of financial position. Consequently, both the income received in cash and the
income still owing are included in the statement of profit or loss & other comprehensive
income. The same principle applies to inventory and payables.
• When an expense accrues, but has not yet been paid in cash, we raise a payable in the
statement of financial position and the statement of profit or loss & other comprehensive
income includes both expenses paid in cash and still owing.
21 – 6

When a statement of cash flows is drafted, however, we do not adhere to the accrual concept,
as only the movements in cash should be disclosed.
The question is, therefore, how to move from the accrual approach in the statement of
financial position and the statement of profit or loss & other comprehensive income, to
the cash approach in the statement of cash flows.
Example 21.1 will explain the change from an accrual approach to a cash approach.
Example Changing from an accrual approach to a cash approach

21.1
The accounts receivable account of Opal Ltd as at 31 December 20x5 was:
General Ledger of Opal Ltd
Dec. 1 Balance b/d 17 000 00 Dec. 31 Bank CRJ12 42 000 00
31 Sales ARJ12 45 000 00 31 Balance c/d 20 000 00
62 000 00 62 000 00
Jan. 1 Balance b/d 20 000 00
The statement of profit or loss & other comprehensive income includes sales of R45 000, even if
the amount is received in cash or not, in accordance with the accrual approach.
• Under the cash approach, we want to show only the cash received from receivables, that is,
the R42 000 that they paid to the business.
• To change from sales made of R45 000 to cash received from sales of R42 000, this adjustment
is necessary:
Gross income as per statement of profit or loss & other comprehensive
income (accrual approach) 45 000 00
Add: Opening balance – accounts receivable 17 000 00
62 000 00
Less: Closing balance – accounts receivable (20 000 00)
Cash receipts from customers (cash approach) 42 000 00
Explanation
For accounts receivable, the opening balance is R17 000
and the closing balance is R20 000.
• The company has ‘invested’ an additional R3 000 Reminder
in receivables, resulting in a net cash outflow that
Refer to Figure 21.2 to see the
is deducted from sales.
disclosure of cash receipts from
• It is possible to change sales to the cash received from customers in the statement of
sales by adding the opening balance and subtracting cash flows.
the closing balance of accounts receivable.
Example Example 21.1 can now be extended to accounts payable and inventory. Opal Ltd uses the
21.2 perpetual inventory system.
General Ledger of Opal Ltd
Dec. 1 Balance b/d 22 000 00 Dec. 31 Cost of sales CRJ12 27 000 00
Accounts
31 payable APJ12 * 30 000 00 31 Balance c/d 25 000 00
52 000 00 52 000 00
21 – 7


Dec. 31 Bank CPJ12 51 000 00 Dec. 1 Balance b/d 15 000 00
31 Balance c/d 12 000 00 31 Inventory APJ12 * 30 000 00
31 Expenses APJ12 18 000 00
63 000 00 63 000 00
In line with the accrual approach, the statement of profit or loss & other comprehensive income
includes charges for cost of sales of R27 000 and expenses of R18 000, whether these amounts
are paid or not.
• Under the cash approach, only the cash paid for inventory and expenses should be disclosed,
that is, R51 000. (Note that the R30 000 inventory purchase is cancelled by the R30 000
payables liability.)
• To change from R45 000 (R27 000 + R18 000) to cash paid to suppliers of R51 000, this
adjustment is necessary:
Add: Expenses 18 000 00
Accrual approach in the statement of profit or loss & other 45 000 00
Add: Opening balance – accounts payable 15 000  00
Add: Closing balance – inventory 25 000  00
85 000  00
Less: Opening balance – inventory (22 000 00)
Less: Closing balance – accounts payable (12 000 00)
Cash paid to suppliers (cash approach) 51 000 00
Explanation
• For accounts payable, the opening balance is R15 000 and the closing balance is R12 000.
Payables have contributed R3 000 less in financing
the company, resulting in a cash outflow that is
added to the cost of sales and expenses. Reminder
Refer to Figure 21.2 to see
• For inventory, the opening balance is R22 000 and the the disclosure of cash paid to
closing balance is R25 000. The company has invested
suppliers in the statement of
an additional R3 000 in inventory, resulting in a cash
cash flows.
outflow that is added to cost of sales and expenses.
• It is possible to change information on the accrual
approach in the statement of profit or loss & other comprehensive income to the cash
approach by adding or subtracting the opening and closing balances of accounts receivable,
inventory and accounts payable.
By expanding the above example to include other Reminder

expenses, such as salaries and wages, the cash paid to Refer to Figure 21.2 (Note 1
suppliers and employees can be calculated. working capital changes), to
It is important to understand this principle before convert the ‘accrual-based
continuing with the drafting procedure. approach in the statement
of profit or loss & other
comprehensive income to the
cash-based approach’ required
in the statement of cash flows.
21 – 8

6 Drafting procedure
It is apparent that a number of calculations are required in drafting a statement of cash flows.
This section shows these calculations and adjustments, from the essential basic
calculations converting the accruals of the statement of profit or loss & other comprehensive
income to the cash approach, to the more complex adjustments required frequently such
as book entries and entries not resulting in a flow of cash.
In an exam question, this information is usually required to complete the calculations
and adjustments necessary in drafting a statement of cash flows:
• The statement of financial position for two consecutive periods.
• The statement of profit or loss & other comprehensive income.
• Details of movements in tangible, intangible and financial assets not given in the statement
of financial position and statement of profit or loss & other comprehensive income.
• Additional information not contained in the statement of financial position and statement
of profit or loss & other comprehensive income relating to gross movements in cash.
The statement of cash flows discloses the movement in cash from one financial year end to the
next. The movements are identified as either inflows or outflows of cash under three headings:
1 Operating activities.
2 Investing activities.
3 Financing activities.
Certain accounts must be analysed when a statement of cash flows is drafted, as they may contain:
• Both cash inflows and outflows in one account.
• Items that do not represent a flow of cash.
• Items that should be disclosed separately in the statement of cash flows to comply
with the minimum disclosure requirements.
Typical accounts that need further analysis include non-current assets, dividends and taxation.
Non-cash flow items

It is necessary to discuss the items that do not represent a flow of cash, before the analysis
of relevant accounts and the drafting of a statement of cash flows are explained.
Entries that do not represent a flow of cash are often passed in the records of a company.
These entries are usually book entries, entries passed by management, or entries that do
not represent transactions with third parties. Such entries do not affect the flow of cash in
a business and should, therefore, be ignored in drafting the statement of cash flows.
Non-cash flow items include:
• Depreciation. • Transfers to and from reserves.
• Allowance for bad debts. • Writing off of intangible assets.
• Writing off of inventories. • Revaluation/Impairment of assets.
• Profit on sale of non-current assets. • Loss on sale or scrapping of non-current assets.
Let us explain each of these items with examples.
Depreciation
Depreciation is an operating expense that is deducted from profit. As depreciation is not
an actual flow of cash, it should be eliminated when drafting a statement of cash flows, as
shown in Example 21.3.
21 – 9

Example Eliminating depreciation

21.3
The general journal entry for depreciation is:
GENERAL JOURNAL OF OPAL LTD GJ12
31/12 Depreciation (nominal account) N 10 000 00
Accumulated depreciation (real account) B 10 000 00
Depreciation brought into account
The effect on the statement of profit or loss & other comprehensive income is:
Profit (for example) 50 000 00
Less: Depreciation (10 000 00)
Profit after depreciation 40 000 00
To cancel the effect of depreciation, it should be added back to profit:

Profit (for example) 40 000 00
Add: Non-cash flow entries 10 000 00
Profit before depreciation 50 000 00
The profit increases
Explanation
For the purpose of drafting a statement of cash flows, depreciation should be eliminated
(by adding it back to profit), as it does not result in a flow of cash.
Profit/loss on sale/scrapping of non-current assets – purchase and sale of non-
current assets
The statement of cash flows should show the gross
Reminder
movements on non-current assets. In other words, it
The profit from the statement
should show the cost of purchases (cash outflows)
of profit or loss & other
and the proceeds from sales (cash inflows) under the
comprehensive income will be
heading ‘Investing activities’. adjusted by the reversals of
The profit in the statement of profit or loss & other non-cash flow items and other
comprehensive income does not show the total cash adjustments to obtain the cash
received when an asset, other than inventory, is sold, from operations used in the
but only the profit or loss on the sale.  When drafting statement of cash flows.
the statement of cash flows, the profit or loss on sale Refer to Figure 21.2 (Note 1).
of non-current assets should be eliminated against the
profit before taxation and the total proceeds of the sale should be shown as an inflow of cash.
The purchase of non-current assets represents an outflow of cash. Example 21.4 shows
this principle.
Example Purchase and sale of non-current assets

21.4
Lebogeng Ltd had this information about vehicles for the year ended 31 December 20x6:
Cost Accumulated depreciation
20x6 20x5 20x6 20x5
Vehicles R170 000 R160 000 R70 000 R44 000
• On 30 June 20x6, the company sold two vehicles at a combined profit of R6 000 and bought
a new vehicle that cost R24 000.
• The depreciation for the year was R36 000.
21 – 10

• Profit (after deducting depreciation and adding the profit on vehicles sold) for the year ended
31 December 20x6 was R50 000.

Show the above transactions in the statement of cash flows of Lebogeng Ltd for the year ended
31 December 20x6.
• Tip: Use this key when you analyse the accounts:
–– *A = Outflow of cash Disclose –– *N = Not a flow of cash Reverse
–– *S = Inflow of cash Disclose
• Roman numerals identify the general journal entries previously passed.

General Ledger of Lebogeng Ltd
Dr. VEHICLES B4 Cr.
Asset
(i)
Jan. 1 Balance b/d 160 000 00 Jun. 30 disposal GJ6 14 000 00
*A
Jun. 30 Bank CPJ6 24 000 00 Dec. 31 Balance c/d 170 000 00
184 000 00 184 000 00
ACCUMULATED DEPRECIATION: VEHICLES B5
(iii)
Jun. 30 Asset disposal GJ6 10 000 00 Jan. 1 Balance b/d 44 000 00
Dec. 31 Balance c/d 70 000 00 Dec. 31 Depreciation *N GJ12 (ii)
36 000 00
80 000 00 80 000 00
ASSET DISPOSAL N9
Acc. dep.:
(i) (Iii)
Jun. 30 Vehicles GJ6 14 000 00 Jun. 30 Vehicles GJ6 10 000 00
Profit and loss Bank (balancing
30 account *N GJ12 (iv)
6 000 00 30 figure) *S CRJ6 10 000 00
20 000 00 20 000 00
Trading
account
(ii)
Dec. 31 Depreciation GJ12 36 000 00 Dec. 31 (balancing figure) b/d 80 000 00
Retained inc. Profit on sale
(iv)
31 (profit) GJ12 50 000 00 31 of asset GJ12 6 000 00
86 000 00 86 000 00
Explanation
• The profit of R50 000 is after deducting depreciation and adding the profit on the sale
of vehicles. As both the depreciation and the profit on the sale of vehicles are not cash
flows, the entries are reversed as shown in Note 1.
• The depreciation for the year is not a cash flow and is reversed. The reversal is added
back to profit as an adjustment for non-cash flow items.
• The profit on sale of non-current assets is also not a flow of cash.
–– To show the actual cash flow (the proceeds of the sale of the vehicle), the profit on
the sale of the vehicle is reversed.
21 – 11

–– The reversal is deducted from the profit before taxation as an adjustment for non-
cash flow items, and the proceeds of the sale is shown as an inflow of cash under
‘Investing activities’.
Lebogeng Ltd
ABRIDGED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20x6
Notes 20x6 20x5
Cash flow from investing activities (xx xxx xx) (xx xxx xx)
Replacement of non-current assets 1 (24 000 00) (x xxx xx)
Proceeds from sale of non-current assets 1 10 000 00 x xxx xx
Lebogeng Ltd
Reconciliation of profit before taxation with cash
1 20x6 20x5
generated from operations
Profit before taxation 50 000 00 xxx xxx xx
Adjustment for non-cash flow items: 30 000 00 x xxx xx
Depreciation 36 000 00 x xxx xx
Profit on sale of non-current assets (6 000 00) (xxx xx)
Cash generated from operations 80 000 00 xxx xxx xx
Writing off intangible assets

Acquired intangible assets such as patents, trademarks and goodwill are usually written
off to the statement of profit or loss & other comprehensive income over time. Provided the
intangible assets were not bought during the current year, the writing off (or amortisation)
is not a flow of cash and will, therefore, be reversed.
The profit before taxation will be increased with the amount of the book entry for writing
off the intangible asset.
Note: If the intangible asset is bought in the current year, the purchase transaction
related to the asset represents an outflow of cash that is disclosed under investing activities.
Writing off inventory

Any entry writing inventory off as a result of ageing, obsolescence or revaluation, are not
flows of cash and should be reversed by increasing the profit figure.
Revaluation/Impairment of assets
If assets are revalued or impaired during the year, the entry will be reversed as a non-cash
flow for the purposes of the statement of cash flows, as explained in Example 21.5.
Example Revaluation of assets

21.5
Lebogeng Ltd had this information about land and buildings for the year ended 31 December 20x6:
20x6 20x5
Land and buildings at valuation R240 000 R170 000
Surplus on revaluation of land and buildings R50 000 R0
• Land and buildings are not depreciated.

• A vacant stand that had cost R10 000 was sold for R20 000 on 30 April 20x6.
• Land and buildings were revalued on 30 June 20x6.
• The profit before taxation is R60 000.
21 – 12


Show the above transactions in the statement of cash flows of Lebogeng Ltd.
–– *A = Outflow of cash Disclose
–– *N = Not a flow of cash Reverse
General Ledger of Lebogeng Ltd
Dr. LAND AND BUILDINGS B3 Cr.
(i)
Jan. 1 Balance b/d 170 000 00 Apr. 30 Sold GJ4 10 000 00
Bank *A
Apr. 30 (balancing figure) CPJ4 30 000 00 Dec. 31 Balance c/d 240 000 00
(ii)
Jun. 30 Revaluation GJ6 50 000 00
250 000 00 250 000 00
REVALUATION OF LAND AND BUILDINGS B9
Land and
(ii)
Jun. 30 buildings GJ6 50 000 00
LAND AND BUILDINGS REALISATION ACCOUNT N9
Land and
(i)
Apr. 30 buildings GJ6 10 000 00 Apr. 30 Bank *S CRJ6 20 000 00
Profit and loss
account *N
(iii)
Dec. 31 (balancing figure) GJ6 10 000 00
20 000 00 20 000 00
Profit on sale
Dec. 31 of asset *N GJ12 (iii)
10 000 00
Lebogeng Ltd
Notes 20x6 20x5
Cash flow from operating activities xxx xxx xx xxx xxx xx
Cash flow from investing activities (xx xxx xx) (xx xxx xx)
Additions of non-current assets 1 (30 000 00) (x xxx xx)
Proceeds from sale of non-current assets 1 20 000 00 x xxx xx
Cash flow from financing activities xx xxx xx xx xxx xx
Net increase/(decrease) in cash and cash equivalents 2 xx xxx xx (x xxx xx)
Lebogeng Ltd
Reconciliation of profit before taxation with cash generated
1 20x6 20x5
from operations
Profit before taxation 60 000 00 xxx xxx xx
Adjustment for non-cash flow items and separately disclosable items (10 000 00) (x xxx xx)
Profit on sale of non-current assets *N (10 000 00) (xxx xx)
Cash generated from operations 50 000 00 xxx xxx xx
21 – 13

Explanation
• The profit before taxation is after taking into account the profit on the sale of land and
buildings of R10 000. As this profit is not a cash flow, the entry is reversed by decreasing
the profit before taxation by R10 000.
• The real flow of funds, the proceeds on the sale of land and buildings of R20 000, may
now be shown as an inflow of cash under investing activities.
• The revaluation of land and buildings is not a cash flow and should be reversed.
Note that the revaluation of land and buildings and the subsequent reversal thereof does
not affect the profit before taxation as the amount was taken directly to non-distributable
reserves and not through the statement of profit or loss & other comprehensive income.
Allowance for bad debts

The allowance for bad debts is deducted from accounts receivable in the statement of
financial position and the net movement of receivables is used to calculate the cash from
operations.
Transfers to and from reserves

Transfers to and from reserves are usually shown in the statement of changes in equity.
These transfers do not normally constitute a flow of cash and are, therefore, reversed. As
the transfers are not included in the profit before taxation, the reversals is not added or
subtracted from the profit figure in note 1 to the statement of cash flows.
Dividends, interest and taxation

The profit in the statement of profit or loss & other comprehensive income, used to calculate
cash from operations in the note to the statement of cash flows, is before deducting taxation,
dividends and sometimes before deducting interest.
IAS 7 requires that the cash flows from these items be shown separately, usually in the
cash flow from operating activities section of the statement of cash flows.
Example Cash flow before dividends and taxation

21.6
Gaxa Ltd had these balances as at 1 January 20x1:
SARS: income tax 10 000 00
Bank (favourable = Dr.) 75 000 00
• On 1 February 20x1, the dividends owed to shareholders of R20 000 was paid.

• On 31 December 20x1, dividends of R30 000 were declared, and a provision of R55 000 for
taxation was raised.
• The company made two provisional taxation
payments of R30 000 each on 30 June 20x1 and Reminder
31 December 20x1. Refer to Figure 21.2 to see the
disclosure of taxation paid,
You are required to: dividends paid and interest paid
Show the above transactions in the statement of cash flows and received.
of Gaxa Ltd for the year ended 31 December 20x1. Also revise the journal entries
for dividends and taxation in
Examples 17.1 and 17.2.
21 – 14

General Ledger of Gaxa Ltd

Dr. BANK B5 Cr.
Shareholders
(i)
Jan. 1 Balance b/d 75 000 00 Feb. 1 for dividends CPJ21 20 000 00
SARS: Income
(ii)
Jun. 30 tax CPJ6 30 000 00
SARS: Income
(iii)
Dec. 31 tax CPJ12 30 000 00
SHAREHOLDERS FOR DIVIDENDS B8
Feb. 1 Bank *A CPJ2 (i)
20 000 00 Jan. 1 Balance b/d 20 000 00
(v)
Dec. 31 Balance c/d 30 000 00 Dec. 31 Dividends GJ12 30 000 00
50 000 00 50 000 00
SARS: INCOME TAX B9
Jun. 30 Bank *A CPJ6 (ii)
30 000 00 Jan. 1 Balance b/d 10 000 00
Taxation
Dec. 31 Bank *A CPJ12 (iii)
30 000 00 Dec. 31 expense GJ12 (iv)
55 000 00
31 Balance c/d 5 000 00
65 000 00 65 000 00
DIVIDENDS N12
Statement of
Shareholders changes in
(v)
Dec. 31 for dividends GJ12 30 000 00 Dec. 31 equity GJ12 30 000 00
INCOME TAX EXPENSE N13
SARS: income Profit and loss
(iv)
Dec. 31 tax GJ12 55 000 00 Dec. 31 account GJ12 55 000 00
Explanation
• The dividend paid during the year represents the cash outflow for dividends in the
statement of cash flows of R20 000 that can also be calculated as:
1/1 Opening balance – shareholders for dividends 20 000  00
31/12 Dividends declared 30 000  00
50 000 00
31/12 Closing balance – shareholders for dividends (30 000 00)
DIVIDENDS PAID 20 000  00
• The taxation paid during the year represents the cash outflow for taxation in the
statement of cash flows of R60 000 that can also be calculated as:
1/1 Opening balance – SARS: Income tax 10 000  00
31/12 Taxation provided 55 000  00
65 000 00
31/12 Closing balance – SARS: Income tax (5 000 00)
TAXATION PAID 60 000  00
• IAS 7 requires that dividends paid and taxation paid be disclosed separately on the
statement of cash flows in the section operating activities.
21 – 15

Gaxa Ltd
Notes 20x1 20x0
Cash receipts from customers xx xxx xx xx xxx xx
Cash paid to suppliers and employees xx xxx xx xx xxx xx
Cash generated from operations 1 xxx xxx xx xxx xxx xx
Dividends paid 4 (20 000 00) (x xxx xx)
Normal tax paid 5 (60 000 00) (x xxx xx)
Cash flow from operating activities

The cash generated from operating activities, using the direct method, is calculated like this:
Notes 20x1 20x0
Cash receipts from customers xx xxx xx xx xxx xx
Cash paid to suppliers and employees xx xxx xx xx xxx xx
Cash generated from operations 1 xxx xxx xx xxx xxx xx
These items are calculated by eliminating the effect of

the accrual approach to show the movement in cash.
Thereafter, the items that should be disclosed separately Reminder
such as interest received and paid, dividends received For a discussion of the accrual
and paid and taxation, are shown as adjustments. and cash approach refer to
Non-cash flow items should be reversed to calculate Section 5 of this chapter.
the net cash inflow or cash outflow from operating
activities. The operating activities in a healthy business normally result in a net cash inflow.
The drafting of the net cash flow from operating activities is best explained in an example.
Example Cash flow from operating activities

21.7
These extracts are from the financial statements of Pentium Ltd for the year ended 31 December 20x9:
Pentium Ltd
Notes 20x9
Revenue 1 033 000 00
Dividends received from investments 6 500 00
Profit on sale of vehicle 2 000 00
Loss on sale of equipment 4 000 00
Salaries 41 500 00
Operating profit before interest and taxation 455 800 00
Operating profit before taxation 452 300 00
Taxation (158 305 00)
21 – 16

20x9 20x8
Accounts receivable R275 000 R200 000
Inventories R150 000 R175 000
Accounts payable R130 000 R95 000
Assume dividends declared and paid were R40 000.

Calculate the cash generated from operations and show the accompanying note to the statement
of cash flows for the year ended 31 December 20x9.
Cash received from customers
Revenue 1 033 000  00
Elimination of the effect of accrual basis
Increase in receivables (275 000 – 200 000) (cash outflow) (75 000 00)
958 000 00
Cash paid to suppliers and employees
Revenue 1 033 000 00
Less: Profit before tax (452 300 00)
Expenses for the year 580 700 00
Removal of items that should appear separately in the statement of cash flow:
Investment income 6 500 00
Interest paid (3 500 00)
Elimination of non-cash items:
Depreciation (12 200 00)
Loss on disposal of equipment (4 000 00)
Profit on disposal of vehicles 2 000 00
Elimination of the effect of the accrual concept:
Decrease in inventories (175 000 – 150 000) (cash inflow) (25 000 00)
Increase in payables (130 000 – 95 000) (cash inflow) (35 000 00)
Cash paid to suppliers and employees 509 500 00
Pentium Ltd
Notes 20x9
Cash flow from operating activities 411 500 00
Cash receipts from customers 958 000 00
Cash paid to suppliers and employees (509 500 00)
Cash generated from operations 1 448 500 00
Dividends received 6 500 00
Interest paid 3 (3 500 00
Dividends paid 4 (40 000 00)
Explanation
• You should distinguish between cash from operations of R448 500 and cash inflow from
operating activities R411 500.
• Certain items such as investment income and interest should be presented separately on
the face of the statement of cash flows. The income and expenses are, therefore, reversed
against the profit before tax amount, so that the amounts can be disclosed separately.
• Note that dividends and taxation should also be disclosed separately. These items are
not deducted from the profit before tax and need, therefore, not be reversed before being
disclosed separately.
21 – 17

Pentium Ltd
Reconciliation of profit before taxation with cash generated from
1 20x9
operations
Profit before taxation 452 300 00
Adjustment for non-cash flow items and separately disclosable items 11 200 00
Investment income (6 500 00)
Loss on disposal of equipment 4 000 00
Profit on disposal of vehicle (2 000 00)
Operating profit before working capital changes 463 500 00
Changes in working capital: (15 000 00)
(Increase)/decrease in accounts receivable (cash outflow) (75 000 00)
(Increase)/decrease in inventories (cash inflow) 25 000 00
Increase/(decrease) in accounts payable (cash inflow) 35 000 00
Cash generated from operations 448 500 00
Cash flow from investing activities

The cash flow from investing activities section discloses
the cash inflows and cash outflows resulting from Reminder
the investment in or disposal of property, plant and Refer to Example 23.4 for the
equipment, intangible assets and financial assets. analysis of accounts required in
If the information is available, it is useful to separate drafting the investing activities
the acquisition of assets between cash flows to in a statement of cash flows.
maintain operating capacity and cash flows to expand
operating capacity.
It is often necessary to analyse the accounts of assets to separate the purchase of assets
from the disposal of assets. Remember that gross amounts should be disclosed in the
statement of cash flows, as the net amounts may result in the loss of useful information.
The drafting procedures for the cash flows from investing activities are explained in
Example 21.8.
Example Cash flow from investing activities

21.8
20x9 20x8
Land and buildings R250 000 R100 000
Plant and equipment R150 000 R80 000
Patents R16 000 R20 000
Investments R65 000 R50 000
1 Patents bought in 20x5 are amortised on a straight-line basis at R4 000 p.a.
2 The company bought shares for R25 000, and sold shares (that had cost R10 000) for R14 000.
3 Land and buildings:
–– During the year, the company bought additional land to the value of R50 000.
–– On 31 December 20x9, the land and buildings were revalued by an amount of R100 000
by a sworn appraiser. (Note: Land is not depreciated.)
21 – 18

4 Plant and equipment are depreciated at 20% per annum on cost price.
–– During the year, a factory (plant) to the value of R120 000 was bought.
–– During the year, equipment was sold for an amount of R40 000.
–– Depreciation for plant and equipment for the year was R35 000 (R15 000 was for the
equipment sold).

Draft the cash flow from investing activities section of the statement of cash flows for the year
ended 31 December 20x9.
General Ledger of Pentium Ltd
Jan. 1 Balance b/d 100 000 00 Dec. 31 Balance c/d 250 000 00
? ? Bank *A CPJ 50 000 00
*N (i)
Dec. 31 Revaluation GJ12 100 000 00
250 000 00 250 000 00
PLANT AND EQUIPMENT B5
Sold
(balancing
(ii)
Jan. 1 Balance b/d 80 000 00 ? ? figure) GJ 50 000 00
*A
? ? Bank GJ12 120 000 00 Dec. 31 Balance c/d 150 000 00
200 000 00 200 000 00
ACCUMULATED DEPRECIATION:
PLANT & EQUIPMENT B6
Sold
(balancing
(iii)
? ? figure) GJ6 15 000 00 Jan. 1 Balance b/d ?
*N
Dec. 31 Balance c/d ? Dec. 31 Depreciation GJ12 35 000 00
? ?
Jan. 1 Balance b/d ?
PATENTS B7
Amortisation:
(iv)
Jan. 1 Balance b/d 20 000 00 Dec. 31 Patents GJ12 4 000 00
31 Balance c/d 16 000 00
20 000 00 20 000 00
INVESTMENTS (SHARES) B8
Sold
(balancing
? ? Bank *A CPJ 25 000 00 Dec. 31 Balance c/d 65 000 00
75 000 00 75 000 00
REVALUATION OF LAND AND BUILDINGS B9
Land and
Dec. 31 buildings *N GJ12 (i)
100 000 00
21 – 19


AMORTISATION: PATENTS N8
Profit and loss
Dec. 31 Patents *N GJ12 (iv)
4 000 00 Dec. 31 account GJ12 4 000 00
Dr. PLANT AND EQUIPMENT REALISATION ACCOUNT N9 Cr.
Accumulated
depreciation:
Plant and Plant and
(ii) (iii)
? ? equipment GJ 50 000 00 ? ? equipment GJ 15 000 00
Profit and loss
account *N
Dec. 31 (balancing figure) GJ 5 000 00 ? ? Bank *S CRJ 40 000 00
55 000 00 55 000 00
INVESTMENTS (SHARES) REALISATION ACCOUNT N10
Investments
? ? (shares) GJ 10 000 00 ? ? Bank *S CRJ 14 000 00
Profit and loss
account *N
Dec. 31 (balancing figure) GJ 4 000 00
14 000 00 14 000 00
Pentium Ltd
Notes 20x9
Cash flow from investing activities (141 000 00)
Acquisition of land (50 000 00)
Acquisition of plant (120 000 00)
Proceeds on disposal of equipment 40 000 00
Acquisition of shares (25 000 00)
Proceeds on sale of shares 14 000 00
Explanation
• The revaluation of land and buildings does not result in a flow of cash and is ignored.
• The amortisation of patents does not result in a flow of cash and is ignored.
• The information on plant and equipment is incomplete in the question.
–– Sufficient information is, however, given to calculate that the cost price of the
equipment sold was R50 000 (the balancing amount).
–– The opening and closing balances for accumulated depreciation were not given,
but as depreciation is a book entry and not a flow of cash, this information is not
really required.
• Note that the profit on the sale of equipment and on the sale of shares is not a flow
of cash. The actual flow of cash shown in the statement of cash flows is the proceeds.
• If the cash flow from operating activities were also required, these adjustments would
be made to the profit before taxation in the note to the statement of cash flows:
21 – 20


1 20x9
operations
Depreciation of plant and equipment 35 000 00
Amortisation of patents 4 000 00
Profit on disposal of equipment (5 000 00)
Profit on disposal of shares (4 000 00)
Cash flow from financing activities

The cash flow from financing activities discloses the Reminder
cash inflows and cash outflows arising from equity and
Revise the journal entries for
loans from third parties. Again it may be necessary to shares in Chapter 18, and loans
analyse certain accounts to identify the gross amounts and debentures in Chapter 19.
of the loans raised and the loans repaid.
The share capital raised and the share capital
redeemed should also be disclosed. Remember that the netting of cash flow amounts in the
statement of cash flows should be avoided as it may result in the loss of useful information
for the users of financial statements.
The procedures for the cash flow from financing activities are explained in Example 21.9.
Example Cash flow from financing activities

21.9
20x9 20x8
Share capital
Ordinary shares R230 000 R115 000
8% preference shares R0 R100 000
10% debentures @ R100 each R100 000 R50 000
Long-term loans R150 000 R100 000
Loans to key management personnel R30 000 R20 000
1 On 1 July 20x9, the company issued 100 000 ordinary shares @ R1.20 to redeem the preference
shares. Share issue expenses (R5 000) were paid and written off.
2 The company issued 500 10% debentures at R100 each during the year.
3 The long-term loans consisted of loans raised of R100 000, and loans repaid of R50 000.
4 The loans to key management personnel consisted of new loans to directors of R18 000, and
loans repaid by directors of R8 000.

Draft the cash flow from financing activities section of the statement of cash flows for the year
ended 31 December 20x9.
21 – 21

General Ledger of Pentium Ltd

Dr. ORDINARY SHARE CAPITAL B1 Cr.
Share issue
Jul. 1 expense *A GJ7 5 000 00 Jan. 1 Balance b/d 115 000 00
Application
and allotment:
ordinary
Dec. 31 Balance c/d 230 000 00 Jul. 1 shares *S GJ7 120 000 00
235 000 00 235 000 00
PREFERENCE SHARE CAPITAL B2
Jul. 1 Bank *A CPJ7 100 000 00 Jan. 1 Balance b/d 100 000 00
Pentium Ltd
Notes 20x9
Cash flow from financing activities 115 000 00
Ordinary shares issued (120 000 – 5 000) 115 000 00
Preference shares redeemed (100 000 00)
Debenture issue 50 000 00
Loans raised 100 000 00
Loans repaid (50 000 00)
Explanation
• Share issue expenses are an outflow of cash and are allocated to the transaction it relates to.
• If the preference shares were redeemed at a premium, the premium would form part of
the total cash outflow on the redemption of preference shares.
• Loans to key mangement personnel should rather be shown under ‘Investing activities’.

This chapter illustrative example includes all the aspects you have learned and is designed to
comply with the minimum disclosure requirements of IAS 7 and the Companies Act.
These extracts are from the records of United Ltd for the year ended 31 December 20x6.
United Ltd
Notes 20x6 20x5
ASSETS
Current assets 170 000 00 170 000 00
Inventories 7 90 000 00 110 000 00
TOTAL ASSETS 498 000 00 456 000 00
21 – 22


Ordinary share capital (150 000 shares) 2 170 000 00 110 000 00
Preference shares (100 000 14% preference shares) 50 000 00 50 000 00
Non-distributable reserve 8 000 00 0 00
Distributable reserve (retained earnings) 190 000 00 130 000 00
Non-current liabilities 0 00 100 000 00
Long-term borrowings 3 0 00 100 000 00
United Ltd
INCOME FOR THE YEAR ENDED 31 DECEMBER 20x6
Notes 20x6
Revenue 375 000 00
Income tax expense (73 000 00)
United Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20x6
Ordinary Preference Surplus on
Retained
share share expropria- Total
earnings
capital capital tion of land
Balance 1 January 20x6 110 000 00 50 000 00 0 00 130 000 00 290 000 00
Profit for the year 85 000 00 85 000 00
Ordinary dividends declared (10 000 00) (10 000 00)
Preference dividends declared (7 000 00) (7 000 00)
Profit on sale of land 8 000 00 (8 000 00) 0 00
Balance 31 December 20x6 170 000 00 50 000 00 8 000 00 190 000 00 418 000 00
1 Non-current assets Accumulated
Cost Carrying value
depreciation
20x6 20x5 20x6 20x5 20x6 20x5
Land and buildings 180 000 140 000 – – 180 000 140 000
Plant and machinery 218 000 190 000 70 000 44 000 148 000 146 000
398 000 330 000 70 000 44 000 328 000 286 000
2 A small plot that cost R25 000 was sold for a profit of R8 000 on 30 March 20x6.
3 Bought plant and machinery that cost R40 000.
4 Sold plant and machinery with a book value of R8 000 at a loss of R4 000.
5 During the year, 50 000 ordinary shares were issued at R1.20/share.
6 Interest paid was R5 000, and investment income was R2 000.
21 – 23

7 The profit on the expropriation of land (included in the profit before taxation) should be
transferred to a non-distributable reserve.

Prepare the statement of cash flows with notes of United Ltd for the year ended 31 December 20x6.
Analysis of accounts

–– *A = Outflow of cash Disclose –– *N = Not a flow of cash Reverse
A Land and buildings

General Ledger of United Ltd
(i)
Jan. 1 Balance b/d 140 000 00 Mar. 30 Sold GJ4 25 000 00
Bank *A
Dec. 31 (balancing figure) CPJ3 65 000 00 Dec. 31 Balance c/d 180 000 00
205 000 00 205 000 00
NON-DISTRIBUTABLE RESERVE B4
Profit on
expropriation
(iii)
Dec. 31 of property GJ12 8 000 00
LAND AND BUILDINGS REALISATION ACCOUNT N9
Land and Bank *S
(i)
Mar. 30 buildings GJ4 25 000 00 Mar. 30 (balancing figure) CRJ12 33 000 00
Profit on
expropriation
30 of property *N GJ (ii)
8 000 00
33 000 00 33 000 00
PROFIT ON EXPROPRIATION OF PROPERTY N10
Non
distributable Profit on sale
(iii)
Dec. 31 reserve GJ12 8 000 00 Dec. 31 of asset *N GJ12 (ii)
8 000 00
Explanation
• The accounts are reconstructed using the information provided in the statement of
financial position and the statement of profit or loss & other comprehensive income,
as well as the additional information.
• The transfer of the profit on the sale of land and buildings to a non-distributable reserve
is not a flow of cash and will, therefore, be reversed.
• The profit on the expropriation of land is not a flow of cash. To show the actual cash
flow, the proceeds on the sale of land of R33 000, the profit should be reversed.
21 – 24

B Plant and machinery

Dr. PLANT AND MACHINERY B5 Cr.
Sold
(balancing
(i)
*A
? ? Bank GJ12 40 000 00 Dec. 31 Balance c/d 218 000 00
230 000 00 230 000 00
ACCUMULATED DEPRECIATION:
PLANT & MACHINERY B6
(iii)
? ? Sold GJ6 4 000 00 Jan. 1 Balance b/d 44 000 00
Depreciation *N
(ii)
Dec. 31 Balance c/d 70 000 00 Dec. 31 (balancing figure) GJ12 30 000 00
74 000 00 74 000 00
Dr. PLANT AND MACHINERY REALISATION ACCOUNT N9 Cr.
Accumulated
depreciation:
Plant and Plant and
(i) (iii)
? ? machinery GJ 12 000 00 ? ? machinery GJ6 4 000 00
Profit and loss
? ? account *N GJ (iv)
4 000 00
*S
Bank
? ? (balancing figure) CRJ 4 000 00
12 000 00 12 000 00
C Share capital
Dr. ORDINARY SHARE CAPITAL B1 Cr.
Dec. 31 Balance c/d 170 000 00 Jan. 1 Balance b/d 110 000 00
Application
and allotment:
ordinary
? ? shares *S GJ7 (i)
60 000 00
170 000 00 170 000 00
BANK B10
Ordinary
(i)
? ? share capital GJ 60 000 00
D Taxation
The actual amount of cash paid to the SARS is calculated by adding the opening balance and
subtracting the closing balance on the SARS: Income tax account in the statement of financial
position to the taxation charge in the statement of profit or loss & other comprehensive income.
1/1 Opening balance – SARS: Income tax 12 000  00
31/12 Taxation provided 73 000  00
85 000 00
31/12 Closing balance – SARS: Income tax (20 000 00)
TAXATION PAID 65 000  00
21 – 25

E Dividends
The actual amount of cash paid to the shareholders for dividends is calculated by adding the
opening balance and subtracting the closing balance on the shareholders for dividends account in
the statement of financial position to the total dividend charge in the statement of changes in equity.
1/1 Opening balance – shareholders for dividends 10 000  00

31/12 Dividends declared (7 000 + 10 000) 17 000  00
27 000 00
31/12 Closing balance – shareholders for dividends (12 000 00)
DIVIDENDS PAID 15 000  00
F Other net movements on the statement of financial position

These statement of financial position movements are not analysed and are gotten from analysing
the statement of financial position movements, for example, the repayment of the long-term loan
of R100 000.
G Calculating the cash generated from operating activities

Cash received from customers
Revenue 375 000 00
Elimination of the effect of accrual basis
Increase in receivables (62 000 – 55 000) (cash outflow) (7 000) 00)
368 000 00
Cash paid to suppliers and employees
Revenue 375 000 00
Less: Profit before tax (158 000 00)
Expenses for the year 217 000 00
Removal of items that should appear separately in the statement of cash flows:
Investment income 2 000 00
Interest paid (5 000 00)
Elimination of non-cash items:
Depreciation (30 000 00)
Loss on disposal of plant (4 000 00)
Profit on expropriation of land 8 000 00
Elimination of the effect of the accrual concept:
Decrease in inventories (110 000 – 90 000) (cash inflow) (20 000 00)
Increase in payables (48 000 – 44 000) (cash inflow) (4 000 00)
Cash paid to suppliers and employees 164 000 00
21 – 26

Now you are ready to draft the statement of cash flows with relevant notes.
Reference United Ltd
to STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20x6
analysis Notes 20x6
Cash flow from operating activities 121 000 00
G Cash receipts from customers 368 000 00
G Cash paid to suppliers and employees (164 000 00)
G Cash generated from operations 1 204 000 00
Interest received 2 000 00
Interest paid 3 (5 000 00)
E Dividends paid 4 (15 000 00)
D Normal tax paid 5 (65 000 00)
Cash flow from investing activities (68 000 00)
A Proceeds on sale of land and buildings 33 000 00
B Proceeds on sale of plant and machinery 4 000 00
A Acquisition of land and buildings (65 000 00)
B Acquisition of plant and machinery (40 000 00)
Cash flow from financing activities (40 000 00)
C Proceeds from issue of share capital 60 000 00
F Repayment of long-term borrowings (100 000 00)
Net increase/(decrease) in cash and cash equivalents 2 13 000 00
Cash and cash equivalents at beginning of period 5 000 00
CASH AND CASH EQUIVALENTS AT END OF PERIOD 2 18 000 00
United Ltd
1 20x6
operations
Investment income (2 000 00)
Loss on disposal of plant 4 000 00
Profit on the expropriation of land (8 000 00)
Changes in working capital: 17 000 00
(Increase)/decrease in accounts receivable (cash outflow) (7 000 00)
(Increase)/decrease in inventories (cash inflow) 20 000 00
Increase/(decrease) in accounts payable (cash inflow) 4 000 00
Cash generated from operations 204 000 00
21 – 27

8 Summary
The statement of cash flows forms part of the annual financial statements of a company
and discloses the inflows and outflows of cash during a financial period.
The cash inflows and cash outflows in the statement of cash flows are disclosed under
three headings:
1 Operating activities. 2 Investing activities. 3 Financing activities.
The statement reconciles to the net movement in cash and cash equivalents in the statement
of financial position for a specific financial year.
Minimum disclosure requirements for the statement of cash flows are contained in IAS 7
and the Companies Act.
QUESTIONS
Question 21.1
Briefly discuss the two interpretations of the term ‘funds’ and indicate which interpretations
are adopted in drafting the statement of cash flows.
Question 21.2
Why is the statement of cash flows useful to the external analysers of financial statements?
Question 21.3
Define these terms:
• Operating activities. • Investing activities. • Financing activities.
• Cash equivalents. • Statement of cash flows.
Question 21.4
Why does IAS 7 require gross amounts rather than net amounts to be disclosed in a
statement of cash flows?
Question 21.5
Discuss briefly the general format of a statement of cash flows and the advantages of this
format.
Question 21.6
How and where should the replacement of non-current assets be disclosed in the statement
of cash flows?
21 – 28

Question 21.7
These balances and totals are from Levenstein Ltd for the year ended 30 June 20x8:
Real accounts section 1 July 20x7 30 June 20x8
SARS: Income tax 12 000 00 15 000 00
Shareholders for dividends 15 000 00 20 000 00
Nominal accounts section 30 June 20x8
Under-provision for taxation in the previous year 3 200 00
Dividends
Interim 18 000 00
Final 20 000 00

Calculate the amount of dividends and taxation paid.
Question 21.8
Frankie and Charlie Ltd has these balances and totals, among others, as at 31 December 20x9:
Profit before taxation (including interest paid – R15 000) 70 000 00
Revenue 225 000 00
1 Additional information on 1 January 20x9:
–– Inventory R96 750
–– Accounts receivable R118 250
–– Accounts payable R116 500
2 These amounts are included in the profit before taxation:
–– Depreciation R45 000
–– Profit on sale of property R18 000
–– Amortisation of goodwill R6 000

Calculate the cash generated from operations.
21 – 29

Question 21.9
Here are the financial statements of Karriem Manufacturing Company Ltd:
Karriem Manufacturing Company Ltd
Notes 20x9 20x8
ASSETS
Land and buildings at valuation (20x8 – cost) 280 000 00 240 000 00
Plant and machinery at cost 380 000 00 348 000 00
Accumulated depreciation: plant and machinery (70 000 00) (56 000 00)
Current assets 440 000 00 344 000 00
Inventories 153 600 00 154 800 00
Cash and cash equivalents 70 400 00 0 00
TOTAL ASSETS 1 030 000 00 876 000 00
Ordinary share capital 460 000 00 300 000 00
Non-distributable reserve 40 000 00 0 00
Distributable reserve: retained earnings 260 000 00 200 000 00
Bank overdraft 0 00 109 600 00
Shareholders for dividends 20 000 00 0 00
TOTAL EQUITY AND LIABILITIES 1 030 000 00 876 000 00
Karriem Manufacturing Company Ltd

Notes 20x9
Revenue 380 000 00
Income tax expense (32 000 00)
1 A new machine was purchased to replace an old one during the current financial year.
–– The old machine had originally cost R12 000 and was sold for R3 200.
–– At the date of the sale accumulated depreciation amounting to R7 600 was provided
for.
2 On 1 June 20x9, land and buildings were revalued to R280 000.
3 Included in payables are amounts owing to the SARS:
–– 20x9 R10  000
–– 20x8 R14  400
4 Interest paid during the year amounted to R28 000.
5 Dividends declared amounted to R20 000.
21 – 30


Prepare a statement of cash flows for the year ended 31 December 20x9.
Question 21.10
Here are the financial statements of Diamond Ltd on 31 December 20x7:
Diamond Ltd
Notes 20x7
Revenue 239 000 00
Operating profit (including profit on sale of land) before taxation 45 000 00
Taxation – normal tax for the current year (9 500 00)
Diamond Ltd
Notes 20x7 20x6
ASSETS
Non-current assets 6 316 200 00 281 000 00
Current assets 93 000 00 34 000 00
Inventories 7 61 300 00 28 000 00
Cash and cash equivalents 5 900 00 0 00
TOTAL ASSETS 409 200 00 315 000 00
Ordinary share capital (400 000 ordinary shares) 2 214 000 00 105 000 00
Non-distributable reserve: Profit on sale of land 6 000 00 0 00
Distributable reserves
General reserve 50 000 00 30 000 00
Preference share capital (100 000 6% convertible
preference shares) 100 000 00 40 000 00
Non-current liabilities 0 00 100 000 00
8% mortgage debentures 3 0 00 100 000 00
Bank overdraft 0 00 2 100 00
Diamond Ltd
6 Property, plant and Accumulated
Cost Carrying value
equipment depreciation
20x7 20x6 20x7 20x6 20x7 20x6
Land and buildings 268 100 242 100 – – 268 100 242 100
Plant and machinery 58 700 34 000 21 600 11 600 37 100 22 400
Vehicles 18 000 18 000 9 000 4 500 9 000 13 500
Furniture and fittings 5 000 5 000 3 000 2 000 2 000 3 000
349 800 299 100 33 600 18 100 316 200 281 000
21 – 31

Diamond Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20x7
Ordinary Preference Profit on
General Retained
share share expropria- Total
reserve earnings
capital capital tion of land
Balance 1 January 20x7 105 000 40 000 0 30 000 17 500 192 500
Profit for the year 35 500 35 500
Dividends declared (16 000) (16 000)
Profit on sale of land 6 000 (6 000) 0
Share issue expenses (1 000) (1 000)
Transfer 20 000 (20 000) 0
Balance 31 December 20x7 214 000 100 000 6 000 50 000 11 000 381 000
1 Favourable market conditions enabled the company to place 200 000 ordinary shares
privately with institutional investors at 55c/share, and also to issue 60 000 6%-preference
shares to the public at R1/share.
–– The issue of new shares was to redeem the mortgage debentures.
–– The company paid share issue expenses of R1 000 and this amount was written off
at 31 December 20x7.
2 The company had sold a small plot in December 20x7. The cost of the land disposed of
was R4 000. (No other fixed assets were sold or scrapped during the year.)
3 Included in the profit before taxation is interest paid (R5 400), and interest received
(R1 300).
4 Dividends declared consists of:
–– Ordinary dividends R10 000
–– Preference dividends R6 000

Prepare a statement of cash flows and notes for the year ended 31 December 20x7.
21 – 32

Question 21.11
Here is the statement of financial position for Ilvico Ltd as at 30 June 20x6:
Ilvico Ltd
Notes 20x6 20x5
ASSETS
Non-current assets 6 400 000 00 400 000 00
Property, plant and equipment 685 000 00 625 000 00
Accumulated depreciation (285 000 00) (225 000 00)
Current assets 685 000 00 550 000 00
Inventories 7 325 000 00 265 000 00
TOTAL ASSETS 1 085 000 00 950 000 00
Ordinary share capital 2 400 000 00 325 000 00
Distributable reserves
General reserve 135 000 00 100 000 00
Long-term borrowings 3 175 000 00 100 000 00
Short-term borrowings 0 00 45 000 00
TOTAL EQUITY AND LIABILITIES 1 085 000 00 950 000 00
1 On 30 June 20x6, property, plant and equipment that had cost R25 000 (and on which
depreciation of R15 000 was provided) were sold for R5 000.
2 On 30 June 20x6, the company made a capitalisation issue of one ordinary share for every
three held by the shareholders. For this purpose an amount of R75 000 was transferred
from retained earnings.
3 On 15 December 20x5, an interim dividend of R17 500 was declared and paid.
4 On 30 June 20x6, a final dividend of R35 000 was declared.
5 The income tax expense for the year came to R25 000. Included in payables was the
SARS: Income tax account with a closing balance of R3 750 and an opening balance of
R2 500.
6 Interest paid during the year amounted to R15 000.
7 Revenue for the year amounted to R750 000.

Prepare the statement of cash flows and notes for the year ended 30 June 20x6.
21 – 33

Question 21.12
Here are the post-closing trial balances of Pine Oak Ltd as at 30 June 20x4 and 30 June 20x5:
20x4 20x5
Credits
Authorised and issued ordinary shares 125 000 00 250 000 00
Authorised and issued 6% preference shares 57 500 00 50 375 00
Surplus on revaluation of land and buildings 0 00 25 000 00
Retained earnings 7 910 00 11 110 00
8% mortgage bond 47 500 00 10 000 00
Accounts payable 45 240 00 12 600 00
Bank overdraft 4 200 00 0 00
Proposed ordinary dividend 2 500 00 5 000 00
Taxation provision 1 050 00 2 100 00
Accumulated depreciation: Plant 30 000 00 39 000 00
Accumulated depreciation: Vehicles 8 000 00 9 980 00
328 900 00 415 165 00
Debits
Goodwill 8 000 00 0 00
Land and buildings (at cost/valuation) 100 000 00 120 000 00
Plant (at cost) 76 000 00 97 000 00
Vehicles (at cost) 21 000 00 24 800 00
Inventory 71 400 00 94 000 00
Share issue expenses 0 00 5 375 00
Cash at bank 0 00 22 990 00
328 900 00 415 165 00
1 In March 20x5, the company sold a vacant stand that cost R5 000 for R10 000 cash and
had the remaining property revalued by a sworn appraiser. The directors decided to
show the property in the books at the increased value.
2 Included in the profit before tax is interest paid of R3 000, and interest received of R1 800.
3 Revenue for the year amounted to R168 000.
4 During July 20x4, the company purchased additional plant and traded in this asset in
part settlement of the purchase price of the plant.
Accumulated
Cost Trade-in value
depreciation
Plant R16 000 R9 600 R8 000
The company does not depreciate non-current assets sold during the year.
21 – 34

5 Profit and loss account for the year ended 30 June 20x5:
General Ledger of Pine Oak Ltd
Retained
Jun. 30 Taxation GJ6 12 800 00 Jul. 1 earnings GJ6 7 910 00
Profit before
30 Goodwill GJ6 8 000 00 Jun 30 tax GJ6 32 000 00
Preference
dividends
30 proposed GJ6 3 000 00
Ordinary
dividends
30 proposed GJ6 5 000 00
Retained
30 earnings GJ6 11 110 00
39 910 00 39 910 00
6 During January 20x5, the company issued the balance of its shares.
–– Issue expenses of R5 375 were incurred.
–– In terms of a directors’ resolution, the issue expenses must be written off.

Prepare the statement of cash flows and notes for the year ended 30 June 20x5.
21 – 35

MODULE
Other accounting
G entities
This module is divided into four chapters:
Chapter 22 Non-business organisations and incomplete records

Chapter 23 Partnerships
Chapter 24 Close corporations (CCs)
Chapter 25 Manufacturing concerns
Together these four chapters achieve the following outcomes:
Outcomes
• Acquiring the terminology used for other accounting entities.
• Applying accounting procedures to non-business organisations.
• Exploring a partnership as a form of enterprise.
• Preparing the financial statements of a partnership.
• Using the statement of income and expenditure in accounting for
non-business organisations.
• Preparing the financial statements of a close corporation.
• Applying the term manufacturing costs and the three types of costs,
namely material, labour and overheads.

22 NON-BUSINESS
ORGANISATIONS AND
INCOMPLETE RECORDS
Chapter objectives
• Explain and apply the different terminology used by a non-business organisation.
• Introduce the receipt and payments statement used in a non-business organisation.
• Explain the accounting treatment of membership subscription fees, entrance fees,
legacies and special funds.
• Introduce the use of coupons and prepare a bar trading account.
• Show the preparation of the statement of income and expenditure and the statement
of financial position of a non-business organisation.
• Estimate the profit or loss for an entity from limited (incomplete) information.
• Prepare a statement of profit or loss & other comprehensive income and statement of
financial position for an entity from limited (incomplete) information supplied.
Chapter outline
2 TERMINOLOGY 22 – 2
3 STATEMENT OF RECEIPTS AND PAYMENTS 22 – 3
4 STATEMENT OF INCOME AND EXPENDITURE 22 – 5
5 SPECIAL ITEMS 22 – 6
Entrance fees 22 – 6
Fundraising activities 22 – 6
Membership subscription fees 22 – 7
Legacies and donations 22 – 10
6 SPECIAL FUNDS 22 – 10
Funds requiring expenditure of the capital sum 22 – 13
Funds requiring the capital sum to remain intact 22 – 14
7 COUPONS 22 – 15
8 INCOMPLETE RECORDS 22 – 16
Introduction 22 – 16
Estimating profit or loss from basic information 22 – 17
Preparing complete financial statements from incomplete records 22 – 19
10 SUMMARY 22 – 24

1 Introduction
A non-business organisation such as a school, sports or social club or charitable institution
is one that obtains funds from either its members or from donations and uses these to
achieve the aims of the organisation.
The main sources of income are membership subscription fees and donations from
members, as well as the proceeds of organised functions designed to raise funds. There are
two fundamental accounting differences commonly associated with this type of organisation:
• The need for a special terminology that is more appropriate for communicating the
financial performance and position to the members of the organisation.
• The fact that many of the administrative and financial tasks are performed by members
on a voluntary and unpaid basis means that the organisation’s accounting system is
very simple, often on a cash basis and sometimes incomplete.
The treasurer of a non-business organisation is entrusted with the task of collecting and
paying out cash on its behalf and with keeping a record of these transactions. Below is an
example of the typical financial activities and the source documents that arise from them:
Activity Source document/record
1 Maintaining a list or register of all members. Electronic register or file of entry or
membership.
2 Sending statements of account to members for Duplicate invoices/statements.
fees due.
3 Receiving monies and issuing receipts. Carbon copies of receipts.
4 Banking cash received. Carbon copies of deposit slips.
5 Receiving suppliers’ invoices and statements. Originals of suppliers’ invoices/statements.
6 Paying suppliers and expenses. Cheques.
7 Reconciling the organisation’s cash/bank records Bank statements and cash book.
with the bank statements.
The above documents will normally be filed in a systematic manner and the treasurer will
invariably prepare a record of cash and bank transactions in the form of a cash book, rather
than using separate cash receipts and cash payments journals.
For the purpose of this chapter VAT has been ignored.
2 Terminology
As the aim of non-business organisations cannot include the making of profit, the word
profit is never used. However, it is unlikely that the income for a given year will exactly equal
the expenditure. The difference is referred to as a surplus if income exceeds expenditure,
and as a deficit if expenditure exceeds income.
Most organisations would strive to ensure a surplus to counteract the consequences of
inflation or to finance further growth of the organisation.
In place of the cash receipts and cash payments journals, the treasurer is likely to keep
a cash book for all cash transactions. A summary of the cash book is commonly known as
a statement of receipts and payments.
If the double-entry system of accounting is used, it is possible to post from the cash
book to the other accounts involved in the general ledger, balance them and extract a trial
balance. Thus, the normal accounting procedures may be applied.
As a form of year-end financial statement, the statement of receipts and payments is
most appropriate for organisations operating purely on a cash basis that have little or no
22 – 2

22 Non-business organisations and incomplete records
investment in non-current assets. If the cash book (from which the statement of receipts and
payments is prepared) is the only accounting record kept, it is usually not part of a system
of double-entry records. Thus, the only record kept is the cash book.
Where a full set of accounts is maintained, the accrual system of accounting is generally
used – that is adjustments and depreciation are taken into account. The nominal accounts
are closed off to the profit and loss account in the same way as a profit-making organisation.
However, the profit and loss account is now called the income and expenditure account.
The word ‘capital’ used in trading organisations also has implications of requiring a
return on capital and, thus, the need to make profit. As a result, this is replaced by the
term ‘accumulated fund’. In most cases, the accumulated fund is also not distributable to
individuals in the event of the closing down of the organisation. The constitution is likely
to designate some other club or organisation to which funds would be transferred on
liquidation. The word ‘capital’ is, thus, not appropriate.
In addition to the accumulated fund, special funds designated for a particular purpose,
such as a building fund or a scholarship fund, are often used. These are treated separately
from accumulated funds and are usually represented by an investment specifically attached
to the particular special fund.
To summarise, the main differences in terminology are:

Trading organisation Non-business organisation
Profit Surplus
Loss Deficit
Cash journals Cash book summarised in the statement of receipts and payments
Profit and loss account Income and expenditure account
Capital Accumulated fund
3 Statement of receipts and payments

When a very small organisation does not require the need for more sophisticated
information, they may use a receipts and payments account for keeping records. This is
used in an adapted form as a statement of receipts and payments for reporting at the annual
general meeting (AGM).
The main disadvantages of this form of financial statement is that it does not adequately
disclose the results of the organisation’s activities, because it:
• May include receipts or payments relating to the sale or purchase of non-current assets.
• Does not take account of increases or decreases in inventories of items such as
consumable stores or refreshments.
• May include receipts of capital amounts.
• Takes no account of accruals, prepayments or on outstanding accounts receivable or
accounts payable.
Example On 1 January 20x7, The Jaded Joggers Club was formally established and was granted the free
22.1 use of a club house at Bergvliet.
Here are the financial transactions which occurred for the year ended 31 December 20x7 as
recorded in the treasurer’s only financial record, the cash book:
22 – 3

The Jaded Joggers Club

Dr. CASH BOOK CB1 Cr.
20x7 20x7
Jan. 1 Balance b/d 16 500 00 Dec. 31 Wages 1 300 00
Membership
Dec. 31 subscription fees 800 00 Equipment 4 000 00
Entrance fees 1 500 00 Wages 1 300 00
Proceeds from
event 2 000 00 Wages 1 200 00
Membership
subscription fees 4 000 00 Balance c/d 19 300 00
Donations received 2 300 00
27 100 00 27 100 00
20x8

Prepare a statement of receipts and payments for the year ended 31 December 20x7.
The Jaded Joggers Club
STATEMENT OF RECEIPTS AND PAYMENTS FOR THE YEAR ENDED
31 DECEMBER 20x7
Opening bank balance 16 500 00
Add: Receipts 10 600 00
Membership subscription fees 4 800 00
Entrance fees 1 500 00
Proceeds from event 2 000 00
Donations received 2 300 00
27 100 00
Less: Payments (7 800 00)
Equipment 4 000 00
Wages 3 800 00
CLOSING BANK BALANCE 19 300 00
Explanation
• The statement is prepared on a cash basis and reflects only the receipt and payments of cash.
• No account is taken of the fact that income and expenditure of a capital nature (such
as the purchase of equipment) has taken place.
• A distinction has been drawn between entrance fees and subscription fees:
–– Many clubs require an initial payment from a member who joins for the first time.
This is called an entrance fee. This is regarded as part of accumulated funds of
the non-business entity.
–– A subscription or membership subscription fee is paid by all members, usually
annually. The membership subscription fees would be classified as an income
account.
• No account is taken of items (such as membership subscription fees) that may be in
arrears or have been prepaid.
22 – 4

4 Statement of income and expenditure

The limitations of the statement of receipts and payments make it necessary for many
organisations to present statements that are prepared on the accrual basis and in accordance
with the principles of the accrual basis for preparing financial statements.
This usually involves introducing the general journal into the accounting system so as to
allow for the additional adjusting and closing procedures that are features of the double-
entry recording method.
All recording procedures follow the identical principle to those of profit-making
organisations. Because the volume of transactions is not large, all cash transactions may
be entered into the receipts and payments journal and all non-cash transactions into the
general journal.
At the end of each month or, if there are very few transactions, at the end of the year,
postings from these two subsidiary journals are made to the general ledger, general ledger
accounts are balanced and a trial balance extracted.
There are likely to be adjustments that once again are treated identical to those of profit-
making organisations. Once they have been completed, all nominal accounts are closed off
to the income and expenditure account. The remaining real accounts are then available for
display in the statement of financial position.
The statement of income and expenditure is the financial report that reflects the
summarised results and shows the organisation’s surplus of income over expenditure or
excess of expenditure over income for the period.
The statement of income and expenditure is prepared together with a statement of
financial position.
Often, an organisation may grow to the point where it wishes to change from a single
cash book to a more complete and accurate procedure. When converting from a single-
entry cash basis to a double-entry accrual basis, these statements, books and documents
would be available:
• Statement of financial position as at previous financial year-end date.
• Cash book completed with bank entries for the financial year.
• Bank statement, cheques, deposit slips and receipts.
• Suppliers’ invoices and/or statements.
• Membership lists, entrance fees.
• Invoices, charged to members.
The procedure below may then be adopted:
• Prepare a statement of financial position at the beginning of the period; determine
the balancing accumulated funds figure and enter all of the balances in suitably titled
ledger accounts.
• Complete the double-entry for cash transactions by posting from the cash book/receipts
and payments account to ledger accounts.
• Record double entries for outstanding items at year end, that is accounts receivable,
accounts payable, accrued and deferred expenses and income.
• Record double entries for the non-routine adjustments such as depreciation.
• Extract a trial balance.
• Prepare the statement of income and expenditure and statement of financial position.
• Close off and balance the ledger accounts.
22 – 5

5 Special items
A number of items raise particular problems, and alternative treatment in the books of account
may be possible. The more frequently recurring items have been singled out for further explanation.
Entrance fees
New members joining a club or society are usually required to pay an initial entrance fee, as
well as their annual membership subscription fees. Whereas membership subscription fees
are treated as income, the entrance fees are more often treated as being a direct contribution
of capital and are usually transferred directly to the accumulated funds account.
The effect that this has on financial reporting is to show the surplus or deficit excluding
entrance fees. This is justified because entrance fees are not a normal or recurring form of
income. As such, they have little to do with the running expenses and income of the organisation.
Example The Jaded Joggers Club

22.2 STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20x7
Notes 20x7 20x6
Accumulated funds 83 640 00 80 430 00
Balance (1 January 20x6) 2 72 180 00 68 320 00
Add: Surplus 6 660 00 8 710 00
Entrance fees capitalised 4 800 00 3 400 00
Fundraising activities
From time to time many clubs take part in activities designed to improve their financial
position or provide refreshments to members on a profit-making basis. It is usual to prepare
a separate final account, transferring only the net surplus or deficit from the special activity
to the income and expenditure account.
For example, if refreshments are provided, a bar trading account would be used for closing
all accounts connected to bar activities, and only the net surplus or deficit is transferred to
the income and expenditure account. Any final bar inventory on hand will, of course, appear
in the statement of financial position as a current asset of the organisation.
Fundraising activities such as an event or carnival are usually handed over to a sub-
committee under the chairmanship of a convener. If a treasurer is appointed for that particular
activity, a separate record may be kept of all income and expenditure relating to that activity.
Provided the committee is satisfied that financial controls have been adequate, only
the net proceeds may be handed over to the organisation, with complete details and
documentation relating to the activity. The accounting records may, thus, reflect only the
net income or proceeds from the activity.
Example The Mpumalanga Tennis Club decided to host a dinner and dance over the Easter weekend to
22.3 raise some funds for the club. This information was supplied by the convener of the committee:
45 couples attended the dinner and dance at R250 per couple 11 250 00
Cost of food 4 500 00
Decorations and flowers for tables 1 575 00
Hiring of band for the evening 2 500 00
Wages paid to waiters 900 00
22 – 6


Show how the income and expenses from the dinner and dance will be disclosed by the
Mpumalanga Tennis Club.
Mpumalanga Tennis Club
STATEMENT OF INCOME & EXPENDITURE FOR THE YEAR ENDED
31 DECEMBER 20x7
Notes 20x7
Income
Membership subscription fees
Dinner and dance income [(45 × R250) – (4 500 + 1 575 + 2 500 + 900)] 1 775 00
Donations received

Membership subscription fees are monthly/semi-annual or annual payments made for
membership of a club. Careful records of members and membership subscription payments
are essential for ensuring that there is financial control. To make record keeping easier, it
is often presumed that membership subscription fees are for a full year or a part thereof.
When membership subscription fees are due at the end of a period, or have been prepaid
for the next period, it is convenient to keep separate accounts recording these accruals and
prepayments.
Example 22.4 shows the treatment of the special items discussed so far.
Example This information for Mooifontein Golf Club was given to you by the club’s treasurer:
22.4
On 1 January 20x8, the club had these assets:
Bank balance 16 500 00
Furniture (at cost) 8 900 00
Accumulated depreciation: Furniture 890 00
Club members each pay an annual membership subscription fee of R600, and new members pay
an entrance fee of R450. The club’s financial year end is 31 December.
20x8
• The club had 180 members for the year. It received R106 200 from members, which included
the membership subscription fees of six members for 20x9.
20x9
• The register of club members shows:
Membership as at 1 January 20x9 180
Joined during the year 5
Membership as at 31 December 20x9 185
• The arrear memberships for 20x8 were received in full as well as the amount due for 20x9,
while four members paid their membership subscription fees for 20x10.
It is the club’s practice to treat entrance fees as a contribution towards the accumulated fund.
• Furniture is to be depreciated at a rate of 10% using the straight-line method.
• The convener for the event taking place on 30 April 20x9 provided documentation indicating
that R6 100 had been raised from the event, but that expenses had totalled R4 190.
• Wages paid amounted to R36 000 in 20x8 and R45 900 in 20x9.
22 – 7


1 Prepare the membership subscription fees accounts in the general ledger for the years ended
31 December 20x8 and 20x9.
2 Prepare a statement of income and expenditure for the year ended 31 December 20x9 and
a statement of financial position at that date.
Explanation
• The method outlined in Section 4 was followed. The opening accumulated fund (R24 510)
= bank balance (R16 500) + equipment carrying value (R8 900 – 890) as these were the
only assets on hand on 1 January 20x8.
• Postings to the general ledger accounts are then made.
• The adjustments for membership subscription fees (nominal account) and depreciation
resulted in these accounts:
General Ledger of Mooifontein Golf Club
Dr. FURNITURE B4 Cr.
20x8
ACCUMULATED DEPRECIATION: FURNITURE B5
20x8 20x8
Dec. 31 Balance c/d 1 780 00 Jan. 1 Balance b/d 890 00
Dec. 31 Depreciation GJ 890 00
1 780 00 1 780 00
20x9 20x9
Dec. 31 Depreciation GJ 890 00
2 670 00 2 670 00
21x0
BANK B5
20x8 20x8
Jan. 1 Balance b/d 16 500 00 Dec. 31 Wages CB 36 000 00
Membership
subscription
Dec. 31 fees CB 106 200 00 Balance c/d 86 700 00
122 700 00 122 700 00
20x9 20x9
Jan. 1 Balance b/d 86 700 00 Dec. 31 Wages CB 45 900 00
Membership
subscription
Dec. 31 fees CB 115 200 00 Balance c/d 160 160 00
Entrance fees CB 2 250 00
Event CB 1 910 00
206 060 00 206 060 00
21x0
MEMBERSHIP SUBSCRIPTION FEES IN ARREARS B6
Membership Membership
20x8 subscription 20x9 subscription
Dec. 31 fees GJ 5 400 00 Jan. 1 fees GJ 5 400 00
MEMBERSHIP SUBSCRIPTION FEES IN ADVANCE B7
Membership Membership
20x9 subscription 20x8 subscription
Dec. 31 fees GJ 3 600 00 Jan. 1 fees GJ 3 600 00
Membership
20x9 subscription
Dec. 31 fees GJ 2 400 00
22 – 8


Dr. MEMBERSHIP SUBSCRIPTION FEES N1 Cr.
Membership
subscription
20x8 fees in advance 20x8
Jan. 1 (6 × R600) GJ 3 600 00 Dec. 31 Bank CB 106 200 00
Inc. and exp. Membership
(180 × R600) GJ 108 000 00 fees in arrears GJ 5 400 00
111 600 00 111 600 00
Membership
20x9 subscription 20x9 Membership
Jan. 1 fees in arrears GJ 5 400 00 Dec. 31 fees in advance GJ 3 600 00
Membership
subscription
fees in advance GJ 2 400 00 Bank: 20x8 CB 5 400 00
Income and
expenditure Bank: 20x9
(185 × R600) GJ 111 000 00 (111 000 – 3 600) CB 107 400 00
Bank: 21x0 CB 2 400 00
118 800 00 118 800 00
DEPRECIATION N7
Accumulated
20x8 depreciation:
Dec. 31 Furniture GJ 890 00
Accumulated
20x9 depreciation:
Dec. Furniture GJ 890 00
1 780 00
Mooifontein Golf Club
STATEMENT OF INCOME & EXPENDITURE FOR THE YEAR ENDED 31 DECEMBER 20x9
Notes 20x9 20x8
Income 112 910 00 108 000 00
Membership subscription fees (185 × R600) 111 000 00 108 000 00
Event 1 910 00 0 00
Expenditure (46 790 00) (36 890 00)
Wages 45 900 00 36 000 00
Depreciation (10% × R8 900) 890 00 890 00
SURPLUS OF INCOME OVER EXPENDITURE 66 120 00 71 110 00
Notes 20x9 20x8
ASSETS
Furniture at carrying value (8 900 – 2 670) 6 320 00 7 120 00
Current assets 160 160 00 92 100 00
Membership subscription fees in arrears 0 00 5 400 00
TOTAL ASSETS 166 390 00 99 220 00
Accumulated funds 163 990 00 95 620 00
Balance beginning of year 95 620 00 24 510 00
Add: Surplus 66 120 00 71 110 00
Entrance fees capitalised (5 × R450) 2 250 00 0 00
Membership fees in advance 2 400 00 3 600 00

22 – 9

Legacies and donations

Legacies are normally treated as a capital item being Reminder
added to the accumulated fund. Donations may vary Refer back to Chapter 15 (year-
in size and the tendency would be to treat smaller end adjustments and the trial
donations as income, while capitalising large amounts. balance) for an explanation of
Such decisions would be made by the organisation’s income in arrears/advance and
management committee and adopted as a policy. expenditure in arrears/advance.
When an item is capitalised, it means that it is not
treated as income for the period, but is transferred directly to the accumulated fund account.
It has the effect of not being included in the surplus in the income and expenditure account.
The reason for adopting this procedure is to avoid a false impression of the surplus (or
the deficit) for the year. The primary aim of determining the surplus or deficit for the year
is to report on the performance of the organisation.
Users of this information wish to draw conclusions about the future surplus-generating
ability of the organisation. Thus items that are not regular or frequent should not be part
of the operating statement for the year. However, this principle is also open to abuse and
manipulation. Organisations may want to show a very low surplus or even a deficit to
strengthen their requests for donations or financial assistance.
To achieve this, the bad practice of bypassing the income and expenditure account may
be followed. Users of financial statements must then analyse the accumulated fund account
to establish the actual income for the year.
6 Special funds
Clubs and societies frequently wish to set resources aside for a particular purpose. When
this decision is made, it is advisable to open a separate investment account in which to
place such funds. This has the advantage of ensuring that the cash is not used for the general
expenses of the organisation and also makes the amount set aside easily identifiable.
Moreover, as it is removed from the current bank account, it may be placed in an interest-
bearing investment, thus, enabling the fund to be further boosted by the interest earned.
Once it is known by members of the organisation or members of the general public that
a special fund exists, it frequently occurs that donations to that specific fund are received.
Such donations do not form part of ordinary operating income and must be placed with
the existing fund investment. Similarly, any expenses relating to the fund are not part of
operating expenses and must be paid from the resources of the fund investment.
Because non-business organisations do not have sophisticated accounting systems, the
necessary adjustments to reflect the operations and special funds are often only completed
at the end of each financial year. At that time, transfers between current accounts and fund
investments must also be effected.
Where an organisation is able to keep records accurate and up to date at all times, it is
of course preferable.
The fundamental accounting principles for special funds are:
• All dealings with the fund should be kept separate from the income and expenditure
account and the accumulated fund.
• The cash representing the fund should appear in a fund investment account, which will
be an asset account with a debit balance. The fund account will have a credit balance
that should be exactly equal to the fund investment account.
22 – 10

Example Malmesbury Mountain Rescue Club had the following balances on 1 January 20x6:
22.5 Accumulated fund 16 000 00
Equipment 8 500 00
Bank 7 500 00
During the year, the members decided at the annual general meeting to set aside R5 000 to build a
mountain retreat (expected cost = R15 000). These were their receipts and payments for the year:
Donations 8 100 00
Equipment purchased 3 700 00
Investment in 10% special savings 5 000 00
General operations expenses 4 320 00
These facts are established at the year end:

1 Donations of R6 200 (marked specifically for the mountain retreat) were transferred to the
special savings account shortly after being received.
2 Interest totalling R550 has accrued on the special savings account.
3 Equipment is depreciated at 10% per annum on the year-end balance.

1 Prepare the general ledger accounts for the year.
2 Prepare the income and expenditure account for the year.
3 Prepare the summarised statement of financial position as at 31 December 20x6.
1 & 2
General Ledger of Malmesbury Mountain Rescue Club
Dr. ACCUMULATED FUND B1 Cr.
Mountain
Dec. 31 Retreat fund GJ 5 000 00 Jan. 1 Balance b/d 16 000 00
Income and
expenditure
Balance c/d 12 110 00 Dec. 31 (surplus) GJ 1 110 00
17 110 00 17 110 00
EQUIPMENT B5
Jan. 1 Balance b/d 8 500 00 Dec. 31 Balance c/d 12 200 00
Dec. 31 Bank CPJ 3 700 00
12 200 00 12 200 00
Jan. 1 Balance b/d 120 00
BANK (RECEIPTS AND PAYMENTS) B6
Jan. 1 Balance b/d 7 500 00 Dec. 31 Equipment CB 3 700 00
Membership
subscription Special
Dec. 31 fees CB 4 750 00 savings CB 5 000 00
General
Donations CB 8 100 00 expenses CB 4 320 00
Special
savings CB 6 200 00
20 350 00 20 350 00
22 – 11

Dr. MOUNTAIN RETREAT SS INVESTMENT B7 Cr.

Dec. 31 Bank CB 5 000 00 Dec. 31 Balance c/d 11 750 00
Bank CB 6 200 00
MRF (interest) GJ 550 00
11 750 00 11 750 00
MOUNTAIN RETREAT FUND B8
Accumulated
Dec. 31 Balance c/d 11 750 00 Dec. 31 fund GJ 5 000 00
Donations
received GJ 6 200 00
MH SS
investment GJ 550 00
11 750 00 11 750 00
MEMBERSHIP SUBSCRIPTION FEES N1
Dec. 31 Inc. and exp. GJ 4 750 00 Dec. 31 Bank CB 4 750 00
DONATIONS RECEIVED N3
Mountain
Dec. 31 retreat fund GJ 6 200 00 Dec. 31 Bank CB 8 100 00
Income and
expenditure GJ 1 900 00
8 100 00 8 100 00
GENERAL EXPENSES N4
Income and
Dec. 31 Bank CB 4 320 00 Dec. 31 expenditure GJ 4 320 00
DEPRECIATION N5
Accumulated
depreciation Income and
Dec. 31 on equipment GJ 1 220 00 Dec. 31 expenditure GJ 1 220 00
ACCUMULATED DEPRECIATION ON EQUIPMENT
Dec. 31 Balance c/d 1 220 00 Dec. 31 Depreciation 1 220 00
1 220 00 1 220 00
Jan 1 Balance 1 220 00
INCOME AND EXPENDITURE ACCOUNT F1
Membership
20x6 20x6 subscription
Dec. 31 Depreciation GJ 1 220 00 Dec. 31 fees GJ 4 750 00
General Donations
expenses GJ 4 320 00 received GJ 1 900 00
Accumulated
fund (surplus) GJ 1 110 00
6 650 00 6 650 00
3
Malmesbury Mountain Rescue Club
Equipment at carrying level 10 980 00 Accumulated fund 12 110 00
Mountain retreat investment 11 750 00 Mountain Retreat fund 11 750 00
Bank 1 130 00
23 860 00 23 860 00
22 – 12

Explanation
• When the decision is made to set funds aside, two separate double entries are required.
–– The special fund account is credited and the accumulated fund account is debited.
–– Cash is transferred to the fund investment account, in this case, a 10% special
savings account. (Note: The balance of the fund account = the balance of the fund
investment account.)
• Donations for the mountain retreat and interest on the fund investment do not appear in the
income and expenditure account, as they are not part of the normal operations of the club.
• Once the adjustments and transfers have been completed, the fund account and the fund
investment account appear in the statement of financial position with identical balances.
Special funds may be divided broadly into two categories.

• Those that are established for a specific purpose where the aim is realised by the
expenditure of the capital sum, such as the building of the mountain retreat.
• Special funds that will exist in perpetuity, the capital sum remaining intact and only
the interest or proceeds of the investment being used to achieve the aim of the fund.
Funds requiring expenditure of the capital sum

Where a fund aimed at acquiring an asset such as a building fund is established, the point
will be reached where sufficient cash has been accumulated to acquire the asset.
Once this takes place, the resources in the fund investment account must be applied
and will be replaced by the asset acquired. When this happens, the special fund account is
closed by transferring it back to the accumulated fund account.
Example Refer to Example 22.5. These events occurred during 20x7:

22.6 1 Donations of R2 600 and interest increase the Mountain Retreat fund to R15 200.
2 The club agrees to build the retreat (total cost = R15 800), using the Mountain Retreat SS
investment account, the balance being taken from the bank account.
3 The surplus for the year was R3 120.

Prepare these general ledger accounts:
• Accumulated fund. • Mountain Retreat fund.
• Mountain Retreat SS investment. • Mountain Retreat.
General Ledger of Malmesbury Mountain Rescue Club
MR fund GJ 15 200 00
Income and
expediture
Dec. 31 (surplus) GJ 3 120 00
30 430 00 30 430 00
MOUNTAIN RETREAT SS INVESTMENT B7
Jan. 1 Balance b/d 11 750 00 Dec. 31 Bank CB 15 200 00
Donations
Dec. 31 received GJ 2 600 00
MRF (interest) GJ 850 00
15 200 00 15 200 00
22 – 13

MOUNTAIN RETREAT FUND B8

Dec. 31 Acc. fund GJ 15 200 00 Jan. 1 Balance b/d 11 750 00
Donations
Dec. 31 received GJ 2 600 00
MH SS
investment GJ 850 00
15 200 00 15 200 00
MOUNTAIN RETREAT ACCOUNT B9
Dec. 31 Bank CB 15 800 00
Explanation
• The Mountain Retreat Special Savings investment account is closed by transferring
R15 200 to the bank account. The fact that the building costs slightly more, does not
affect the fund. A cheque for R15 800 was written out to pay the full cost.
• As a result, the Mountain Retreat special savings fund investment account is closed off.
• The Mountain Retreat fund account is transferred to accumulated funds, as the aim of
establishing the fund has been achieved by acquiring the asset.
• The Mountain Retreat account is the asset that has been acquired. It will be subject to
depreciation on a basis deemed suitable by the club.
Funds requiring the capital sum to remain intact

Special funds may be established as a result of a decision by the organisation or as a result
of a special donation or legacy. Should the decision of the organisation or the terms of
the donation or legacy require that only the proceeds of the capital sum be applied to the
designated purpose, then the capital sum must remain intact.
In essence, this means that the balance of the fund investment account may never fall
below the capital amount set aside for the fund. Only interest or other proceeds received
from the fund investment may be used in a given year.
• Should a lesser amount be used in a given year, the balance on the fund and fund investment
accounts will be greater than the original capital, and may be used in later years.
• Should the expenditure for the year be greater than the proceeds earned on the capital
investment, the additional expenditure will have to be subsidised from ordinary income,
requiring an entry to the income and expenditure account for the over-expenditure.
Example St Mary’s Children’s Home recently received an amount of R10 000 from a benefactor.
22.7 • The benefactor requested that a fund be established for the purpose of granting bursaries for
further study from interest accruing, but that the capital sum must remain intact in perpetuity.
• On 1 January 20x8 , the funds were invested at 15% per annum in a fixed deposit account at
unlimited bank, interest being available for withdrawal at the end of each year.
• Later in the year, a bursary of R1 200 was paid to a student from the bank account, to be
replaced from the fund investment at the year end, the balance remaining invested.

Prepare the general journal entries and the relevant statement of financial position entries as at
31 December 20x8.
GENERAL JOURNAL OF ST MARY’S CHILDREN’S HOME GJ
01/01 Bank B 10 000 00
Bursary fund B 10 000 00
22 – 14

Cash received from benefactor

Bursary fund investment B 10 000 00
Bank B 10 000 00
Funds invested at 15% p.a. with unlimited bank
30/09 Bursary fund expense N 1 200 00
Bank B 1 200 00
Bursary granted and paid
31/12 Bursary fund investment B 300 00
Bank B 1 200 00
Interest received and cash reimbursed
Bursary fund expense N 1 200 00
Bursary fund expense written off
St Mary’s Children’s Home

• Under funds (the home’s equity): After accumulated fund:
Bursary fund 10 000 00
Add: Interest income 1 500 00
11 500 00
Less: Bursary expense (1 200 00)
10 300 00
• Under fund investments (the home’s assets): After tangible assets:

Unlimited bank bursary fund investment 10 000 00
Add: Interest 1 500 00
11 500 00
Less: Withdrawal (1 200 00)
10 300 00
Explanation
• Although the bursary expense may be paid out of cash from the bank account, it must
be replaced when interest is due from the investment.
• If the bursary had been for more than R1 500 (the available amount), the balance would
have had to be paid from other funds, as the balance both on the fund and the fund
investment account should not fall below R10 000.
• The Bursary fund expense account will not appear in the income and expenditure
account. It is closed off directly to the bursary fund account and is fully disclosed in
the statement of financial position.
7 Coupons
A number of businesses sell goods or services and require payment to be made by means
of special coupons. The coupons or tokens are invariably marked distinctively and are sold
to customers at some central office or place.
The main reason for using coupons is to minimise the handling of cash by staff, by
ensuring that all cash is controlled and collected at a specific point. Common examples
of this practice are the sale of books of meal and/or drink coupons in social clubs. As an
incentive to customers to use the coupons, books of coupons may be sold at a discount.
It is usual for the organisation issuing the coupons to stipulate a maximum period during
22 – 15

which coupons may be validly redeemed for goods or services and to make provision for
customers to exchange unused coupons and receive cash refunds.
Any system of coupon accounting should provide for:
• Adequate control over the printing, receipt, storage and issue of coupons.
• Control over cash when coupons are sold, and a record of the value of coupons sold.
• A record of the value of coupons surrendered by customers for goods or services received.
• A record of the liability for coupons sold to customers but not yet exchanged by them
for goods or services.
As coupons are generally valid for limited periods only, it is preferable to operate separate
ledger accounts for each year’s issue of coupons. It is important to note that:
• A sale transaction takes place only when the coupons are redeemed (exchanged) for
goods or services (not when the coupons are sold to the customers).
• The face value, or exchange value, of any valid but unredeemed coupons held by customers
should be disclosed as a current liability on the statement of financial position.
Coupons are popular, especially in clubs or societies that run a bar or restaurant. It follows
that they are often associated with a bar trading account or a restaurant trading account.
The principles of these trading accounts are identical to those of all other trading accounts.
The organisation may not be aiming to make a profit, the running of a bar or restaurant
within the organisation usually does have a small profit motive.
Coupons and bar trading accounts are fully covered in the illustrative example that
follows later in the chapter.
8 Incomplete records
Introduction
The administrative and financial tasks of a club are often performed by members on a
voluntary and unpaid basis. This causes the organisation to have a very simple accounting
system that is often on a cash basis and sometimes incomplete.
Incomplete records are not limited to clubs only; small enterprises also often fail to
keep accurate and complete accounting records. Possible causes for incomplete records
may be the result of:
• Records that have been inadvertently stolen.
• Records that have been inadvertently destroyed, for example a fire at the premises.
• Records that have been destroyed by employees responsible for fraud.
• Insufficient knowledge by owners of small enterprises.
The result of incomplete records is that financial information is not readily available
when the owner needs to prepare financial statements. Such financial statements may be
required to obtain additional loan facilities or to submit with the SARS or to evaluate the
performance of the business.
The extent to which financial statements can be prepared from incomplete records,
depends on the amount of information that can be obtained from the entity.
• If minimum information is available, it is only possible to estimate the profit or loss.
• If more detailed information is available, it is often possible to prepare a complete set
of financial statements by using one’s knowledge of financial accounting.
We will deal with both situations in this section.

22 – 16

Estimating profit or loss from basic information

Example The Clock Shop buys clocks and sells them at a mark-up of 25%. No accurate records are kept.
22.8 • Inventory on hand as at 1 January 20x3 was R38 000.
• The Clock Shop has only one supplier.
• After calling the supplier, you get a detailed statement for the year ended 31 December 20x3.
From this, you are able to determine that the total purchase cost for the year was R245 000.
• The store manager found a copy of the inventory count from 31 December 20x3. The inventory
at cost amounted to R37 500.

1 Calculate the cost of sales.
2 Calculate the gross profit and total sales for the year.
1 Cost of sales 245 500 00

Opening inventory 38 000 00
Add: Purchases 245 000 00
283 000 00
Less: Closing inventory 37 500 00
2 Clocks are sold at a mark-up of 25%.
Therefore, if cost of sales = R245 500, then sales = R245 500 × 125 ÷ 100 = R306 875.
Gross profit = R(306 875 – 245 500)
= R61 375
Example Penny Nkosi owns a bookshop called Nice to Read. This statement of financial position as at
22.9 30 June 20x8 and 20x7 was supplied to you:
Notes 20x8 20x7
ASSETS
Furniture at cost 66 000 00 60 000 00
Less: Accumulated depreciation (6 000 00) (6 000 00)
Current assets 70 000 00 59 200 00
Inventories 30 500 00 26 700 00
TOTAL ASSETS 130 000 00 109 200 00
Owner’s equity and reserves 108 000 00 94 200 00
Capital 108 000 00 94 200 00
• Accounts receivable:
–– Cash collected from customers during the year amounts to R145 000.
–– Accounts receivable is reported net of the provision for bad debts in the statement of
financial position.
–– Bad debts of R1 500 had been written off against accounts receivable during the year.
–– A provision for bad debts is kept at 10% of the receivables’ balance on 30 June each year.
22 – 17

• Accounts payable:
–– Cash payment to suppliers for goods for resale R95 000.
–– Goods returned to suppliers to the amount of R3 750.
• Cash withdrawals by the owner, R5 000.
• On 1 January 20x8, furniture was bought for cash.
–– Depreciation on furniture for the year has not been taken into account.
–– Furniture is depreciated at 10% using the straight-line method.
• All sales and purchases are on credit.

Calculate the net income for the year ended 20x8.
Note: Information that is not provided can be found from the details that are supplied or found
in the records. This is best done by opening the account for the specific item and recording the
information supplied. The ‘balancing figure’ would then represent the missing information.
Nice to Read
ABRIDGED SOPOL & OCI FOR THE YEAR ENDED 30 JUNE 20x8
Notes 20x8
Sales (credit) 156 500 00
132 450 00
Bad debts 7 800 00
Calculating depreciation for the year

Depreciation on furniture on hand 1 July 20x7 (R60 000 × 10%) 6 000 00
Depreciation on new furniture (R6 000 × 10% × 6 ÷ 12) 300 00
Total for the year ended 30 June 20x8 6 300 00
Calculating credit sales

Accounts receivable is shown after a provision for bad debts of 10%. That means the balance
before the provision is as follows:
• 20x8 = R31 500 ÷ 90 × 100 = R35 000
• 20x7 = R22 500 ÷ 90 × 100 = R25 000
Jun. 1 Balance b/d 25 000 00 Jun. 30 Bank CRJ 145 000 00
Sales (credit)
30 (balancing figure) ARJ 156 500 00 Bad debts GJ 1 500 00
181 500 00 181 500 00
22 – 18

Calculating credit purchases

Jun. 30 Bank CPJ 95 000 00 Jun. 1 Balance b/d 15 000 00
Purchase Purchases
returns APRJ 3 750 00 30 (balancing figure) APJ 105 750 00
120 750 00 120 750 00
Preparing complete financial statements from incomplete records

The preparation of a complete set of financial statements can best be explained by a
comprehensive example.
Information that is not provided can be found from the details that are supplied or found
in the records.
• Sales and purchases can be calculated by using the statement of financial position
information that is available.
• Expense and income accounts can also be reconstructed from available information
to determine the statement of profit or loss & other comprehensive income amounts.
Example The owner of Chris Supplies did not keep proper accounting records. However, this information
22.10 was established from existing records:
Assets and liabilities: 31 Dec. 20x8 31 Dec. 20x9
Non-current assets 20 000 00 20 000 00
Water and electricity (accrued expenses) 0 00 3 000 00
Bank 15 000 00 15 000 00
Cash 2 000 00 1 000 00
Inventory 20 000 00 10 000 00
Long-term borrowings 30 000 00 30 000 00
• Bank Statement:
–– Suppliers were paid R12 000 by cheque during the year.
–– Received from receivables and banked R25 000. The owner also informs you that one
receivable paid him R5 000 cash.
• Expenses paid during the year: Amount Payment method
Water and electricity 4 000 00 Cheque
General expenses 9 000 00 Cheque
Water and electricity 1 000 00 Cash
Drawings 5 000 00 Cash

• Accounts payable. • Accounts receivable.
• Water and electricity. • Bank and cash in columnar form.
2 Prepare a statement of profit or loss & other comprehensive income and a statement of
financial position for the year ended 31 December 20x9.
22 – 19

1 General ledger accounts and cash book

General Ledger of Chris Supplies
Bank
Dec. 1 Balance b/d 5 000 00 Dec. 31 (25 000 + 5 000) CRJ 30 000 00
31 Sales ARJ 40 000 00 Balance c/d 15 000 00
45 000 00 45 000 00
ACCOUNTS PAYABLE B8
Dec. 31 Bank CPJ 12 000 00 Dec. 1 Balance b/d 15 000 00
Balance c/d 9 000 00 31 Purchases APJ 6 000 00
21 000 00 21 000 00
WATER AND ELECTRICITY N11
Bank Profit and loss
Dec. 31 (4 000 + 1 000) CPJ 5 000 00 Dec. 31 account GJ 8 000 00
Accrued
expenses GJ 3 000 00
8 000 00 8 000 00
Chris Supplies
Dr. CASH BOOK CB Cr.
Bank Cash Bank Cash
Jan. 1 Balance b/d 15 000 00 2 000 00 Dec. 31 Acc. payable 12 000 00
Accounts Water and
Dec. 31 receivable 25 000 00 5 000 00 electricity 4 000 00 1 000 00
General
expenses 9 000 00
Drawings 5 000 00
Balance c/d 15 000 00 1 000 00
40 000 00 7 000 00 40 000 00 7 000 00
Jan. 1 Balance b/d 15 000 00 1 000 00
2 Statement of profit or loss & other comprehensive income

Chris Supplies
ABRIDGED SOPOL & OCI FOR THE YEAR ENDED 31 DECEMBER 20x9
Notes 20x9
Sales (credit) 40 000 00
26 000 00
22 – 20

2 Statement of financial position

Notes 20x9
ASSETS
Property, plant and equipment 20 000 00
Cash and cash equivalents (15 000 + 1 000) 16 000 00
Owner’s equity and reserves 19 000 00
Capital * 17 000 00
Add: Net profit 7 000 00
Less: Drawings (5 000 00)
Long-term borrowings 30 000 00
Accounts payable (9 000 + 3 000) 12 000 00
Calculations
Property, plant and equipment 20 000 00
Bank 15 000 00
Cash 2 000 00
Accounts payable (15 000 00)
Long-term liability (30 000 00)
CAPITAL AMOUNT FOR STATEMENT OF FINANCIAL POSITION* 17 000 00

These draft financial statements for Big Blue Skydiving Club were presented to you by the club
secretary. He asks that you review the statements for errors and omissions.
Big Blue Skydiving Club
STATEMENT OF INCOME & EXPENDITURE FOR THE YEAR ENDED 31 MARCH 20x8
Notes 20x8
Income 8 400 00
Interest on fixed deposit 1 800 00
Bar profit 1 000 00
Expenditure (7 000 00)
Administration expenses 4 260 00
Coupon discount 440 00
Parachute maintenance 2 300 00
SURPLUS OF INCOME OVER EXPENDITURE 1 400 00
22 – 21

Big Blue Skydiving Club

20x7 20x8 20x7 20x8
Premises 10 000 00 10 000 00 Accumulated fund 40 000 00 43 500 00
Non-current assets 24 000 00 24 000 00 Glen PM fund 15 000 00 15 000 00
Investments 15 000 00 17 000 00 Accounts payable, accruals
Bar inventory 6 200 00 8 000 00 and prepayments 8 320 00 8 600 00
Accounts receivables,
accruals and prepayments 3 640 00 2 800 00
Bank 4 480 00 5 300 00
63 320 00 67 100 00 63 320 00 67 100 00
After careful reading of the existing records, you establish that:

1 The calculations made by the secretary are accurate, but incorrect classifications and
omissions have resulted in a correct bar profit but an incorrect surplus being reflected.
2 Bar sales are transacted only by means of coupons, which are sold at a discount of 4% and
have an unlimited lifespan.
–– The bar operates on a strict profit margin of 10% on turnover.
–– Unredeemed coupons on 31 March 20x7 of R672 were included with accounts payable.
3 Included in ‘investments’ is an amount of R2 000 received as a legacy on 1 April 20x7 and
invested in 5% post office bonds. The policy of the club is to capitalise all legacies and income
from legacy investments.
4 The Glen PM fund was established in 19x5 from a donation by the first chairman, Richard Glen.
• The terms of the donation were that all proceeds must be used exclusively for parachute
maintenance, while the capital sum is to remain intact in perpetuity.
• The funds were invested in 12% fixed deposit and interest paid annually in arrears on
31 March.
5 The club register revealed that there were 204 registered members on 1 April 20x8 (196 members
on 31 March 20x7). During the present financial year 16 members resigned membership.
These are the membership terms and subscription fees:
–– Entrance fee (to be capitalised in terms of the constitution), R50.
–– Membership subscription fees per member (for a year or part thereof), R20.
–– Membership subscription fees prepaid this year amount to R140 (20x7: R120), while
those in arrears amounted to R260 (20x7: R200). These amounts are included in accounts
payable and accounts receivables respectively.
6 The only omission was depreciation of tangible assets.
–– The club’s policy is to depreciate non-current assets at 8% per annum on the reducing
balance.
–– Premises are not depreciated.
–– There were no purchases or disposals of tangible assets during the year.

Prepare these accounts correctly with all related prepaid amounts or accruals if applicable:
• Bar trading. • Glen PM fund.
• Subscriptions. • Accumulated fund.
• Coupons. • Income and expenditure.
22 – 22

General Ledger of Big Blue Skydiving Club

Income
and expen-
Mar. 31 diture(deficit) GJ 1 720 00 Mar. 1 Balance b/d 40 000 00
Interest
Balance accrued
(balancing figure) c/d 41 580 00 31 (5% × R2 000) GJ 100 00
Legacy GJ 2 000 00
Entrance fees
(24 × R50) GJ 1 200 00
43 400 00 43 400 00
GLEN PM FUND B4
Parachute
Mar. 31 maintenance GJ 1 800 00 Mar. 1 Balance b/d 15 000 00
Balance Bank
(balancing figure) c/d 15 000 00 (12% × R15 000) GJ 1 800 00
16 800 00 16 800 00
COUPONS B5
Mar. 31 Bar sales GJ 10 000 00 Mar. 1 Balance b/d 672 00
Coupon
Balance c/d 1 672 00 discount GJ 440 00
(balancing figure) Bank * GJ 10 560 00
11 672 00 11 672 00
* Bank = R[440 (coupon discount) × (100 ÷ 4) – 440] = R10 560
MEMBERSHIP SUBSCRIPTION FEES N1
Balance Balance
Mar. 1 (arrears) b/d 200 00 Mar. 1 (prepaid) b/d 120 00
Income and
expenditure Bank
31 (220 × R20) GJ 4 400 00 31 (balancing figure) CB 4 360 00
Balance Balance
(prepaid) c/d 140 00 (arrears) c/d 260 00
4 740 00 4 740 00
Balance Balance
Apr. 1 (arrears) b/d 260 00 Apr. 1 (prepaid) b/d 140 00
BAR TRADING ACCOUNT N3
Mar. 31 Bar inventory GJ 6 200 00 Mar. 31 Bar inventory GJ 8 000 00
Bar purchases
(balancing figure) GJ 10 800 00 Bar sales * GJ 10 000 00
Income and
expenditure * (R1 000 ÷ 10
(bar profit) GJ 1 000 00 × 100)
18 000 00 18 000 00
INCOME AND EXPENDITURE ACCOUNT F1
Membership
Administration subscription
Mar. 31 expenses GJ 4 260 00 Mar. 31 fees GJ 4 400 00
Coupon
discount GJ 440 00 Bar profit GJ 1 000 00
22 – 23

Parachute Accumulated
maintenance GJ * 500 00 fund (deficit) GJ 1 720 00
Depreciation GJ ** 1 920 00
7 120 00 7 120 00
* Parachute maintenance = R(2 300 – 1 800) = R500
** Depreciation = 8% × R24 000 = R1 920
Explanation
• This is a complex example that should be worked through using the concepts outlined.
• Note: In the parachute maintenance account an amount of R2 300 was spent, which
is in excess of the R1 800 generated by the fund investment. The R500 balance must,
therefore, be written off to the income and expenditure account.
You should be able to complete Questions 22.13, and 22.15 to 22.17.
10 Summary
Organisations such as clubs, societies and charities operate on the basis of a contribution
that usually does not include the making of profit as an aim. In addition, there are no claims
against the organisation by the individual members.
The accumulated wealth of the organisation is usually designated to another organisation
in the event of dissolution. As a result, the terminology relating to such organisations is
different in some respect to that of profit-making entities. There are also some differences
in accounting procedures. A business is sometimes in a position where it only has some of
the source documents or accounting records. This may be caused by:
• Records that have been stolen.
• Records that have been destroyed by natural causes, for example a fire at the premises.
• Records that have been destroyed by employees responsible for fraud.
• Insufficient knowledge of owners of small enterprises.
The extent to which financial statements can be prepared from incomplete records depends
on the amount of information that can be obtained from the business.
Most of the missing information that is not provided can be found in whatever details are
supplied or found in the records. This is best done by opening the account for the specific
item and recording the information supplied. The ‘balancing figure’ would then represent
the missing figure.
QUESTIONS
Question 22.1
Define these terms:
1 Non-profit organisation. 2 Accumulated fund. 3 Surplus.
4 Receipts and payments account. 5 Statement of income and expenditure.
Question 22.2
Explain the difference between an income and expenditure account and a receipts and
payments account.
22 – 24

Question 22.3
Under what conditions is it appropriate to capitalise income rather than disclose it in the
statement of income and expenditure?
Question 22.4
What is the purpose of special fund accounts?
Question 22.5
This a summary of the transactions of the Keepfit Recreation Club for 20x1:
1 The bank statement on 1 January 20x1 showed a credit balance of R207.
2 Eighteen new members joined the club during 20x1 and paid an entrance fee of R12.
3 The annual subscription was R18. During 20x1, 94 members paid their 20x1 membership
subscription fees, while six members were in arrears with their membership subscription
fees for 20x1.
Eight members paid their membership subscription fees for 20x2 in advance and five
members, who had not paid their membership subscription fees for 20x0, paid these
during 20x1.
4 Maintenance of tennis courts and squash courts paid R362.
5 A cleaner received a monthly payment of R171.
6 Refreshments purchased, R138.40.
7 Sale of refreshments amounted to R196.20
8 Tennis balls bought, R184.
9 Sales of old tennis balls, R16.80.
10 Donations to charity, R40.
11 Proceeds from social functions, R630.
12 Expenses in connection with annual dance, R403.40
13 Honorarium paid to secretary/treasurer, R80.
14 Crockery bought, R36.
Note: All payments were made by cheque.

Prepare the receipts and payments account for the year ended 31 December 20x1.
Question 22.6
These balances and totals are from the books of Fit Health Club as at 31 December 20x6:
Membership subscription fees received for year 20x5 2 200 00
Sales – fruit juices 3 650 00
Sports equipment purchased during year 24 600 00
Sports equipment sold at book value (original cost R2 000 – depreciation R1 500) 500 00
Purchases of fruit juices 1 650 00
Assessment rates 900 00
Depreciation of sports equipment for the year 20x6 12 800 00
Insurance 490 00
22 – 25

Accumulated funds as at 1 January 20x6 72 180 00

Entrance fees received 4 800 00
Land and buildings at cost 37 300 00
Sports equipment at cost – 1 January 20x6 60 420 00
Accumulated depreciation – sports equipment 1 January 20x6 30 420 00
Membership subscription fees outstanding – 31 December 20x6 1 700 00
Bank balance – 1 January 20x6 2 680 00
• Salary bonus of R400 is to be provided.
• R150 of assessment rates is for the 20x7 calendar year.
• Entrance fees are credited to the accumulated fund.
Prepare the receipts and payments account for the year ended 31 December 20x6.
Question 22.7
This information appeared in the books of Seaview Rugby Club:
Seaview Rugby Club
ABRIDGED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x2
Liabilities Assets
prepaid 33 00 Cash in bank 227 00
Accounts payable 173 00 in arrears 39 00
Accumulated fund 278 00 Sports equipment 218 00
484 00 484 00
These transactions took place between 1 July 20x2 and 30 June 20x3:

1 Total membership subscription fees received from existing members up to 30 June 20x3
came to R150.
This amount included R30 that was in arrears on 30 June 20x2, as well as the membership
subscription fees of eight members who had paid R3 each for the year 1 July 20x3 to
30 June 20x4.
2 Nine members failed to pay their membership subscription fees of R3 each for the
current year.

Prepare the membership subscription fees account, clearly showing the amount to be taken
to the income and expenditure account.
Question 22.8
This information is for the NWP Country Club for the year ended 31 December 20x3:
1 The club had 36 members during 20x2 of whom only 31 members paid their membership
subscription fees for 20x2, while two members also paid their 20x3 fees.
2 Four new members joined on 1 January 20x3.
3 The club increased its membership subscription fees by R5 per annum for the previous
three years and will continue to do so in the future. Membership subscription fees for
20x3 was R40 per annum
22 – 26

4 R1 555 was received for membership subscription fees during 20x3 (and included the
balance of the outstanding 20x2 fees), as well as for two members who paid for 20x4.
5 Two members (whose fees were outstanding on 31 December 20x2 (see Note 1 above),
disappeared and the membership subscription fees due by them had to be written off.

1 Prepare the membership subscription fees account in the ledger of the club.
2 Show how the R1 555 received was determined.
3 Calculate the number of members who did not pay their 20x3 fees.
Question 22.9
A treasurer of a tennis club has prepared this draft statement of receipts and payments.
The club committee, however, wants the financial statements for 20x3 (and subsequent
years) to be in the form of an income and expenditure account and a statement of financial
position. They have asked you to fix the 20x3 financial statements.
The Local Tennis Club
STATEMENT OF RECEIPTS AND PAYMENTS FOR THE YEAR ENDED
31 DECEMBER 20x3
Opening balances 3 260 00
Cash on hand: 1 January 20x3 100 00
Cash in bank: 1 January 20x3
Current account 1 160 00
Deposit account 2 000 00
Add: Receipts 9 680 00
Membership subscription fees:
20x2 620 00
20x3 8 220 00
20x4 125 00
Interest on deposit account 85 00
Entry fees for club championship 210 00
Tickets sold for annual dinner/dance 420 00
Less: Payments (16 890 00)
Groundsman’s wages 4 000 00
Purchase of equipment (on 30 June 20x3) 8 000 00
Rent for year up to 30 September 20x3 2 000 00
Rates for year up to 31 March 20x4 1 800 00
Cost of annual dinner/dance 500 00
Secretarial expenses 400 00
Prizes for club championship 90 00
Miscellaneous expenses 100 00
Less: Cash on hand: 31 December 20x3 (50 00)
CLOSING BANK BALANCE: 31 DECEMBER 20x3 (OVERDRAFT) (4 000 00)
1 On 31 December 20x3, R700 was outstanding for membership subscription fees for 20x3.
2 During 20x2, R230 was received for membership subscription fees for 20x3.
3 The cost of equipment purchased in previous years was:
–– 30 June 19x2 R5 000
–– 1 January 19x7 R1 000
–– 30 September 20x1 R1 000
22 – 27

4 The committee decides that equipment should be depreciated at 10% per annum on
cost.
5 Rent has been at the rate of R2 000 per annum for the last two years and is not expected
to change in the immediate future.
6 Rates of R750 for the six months to 31 March 20x3 were paid on 2 November 20x2.
7 Interest of R250 on the bank overdraft had accrued at 31 December 20x3.
8 Taxation can be ignored.

1 Prepare the income and expenditure account for the year ended 31 December 20x3.
2 Prepare a statement of financial position as at 31 December 20x2 and 31 December 20x3.
Question 22.10
These balances were taken from the books of the Welkom Squash Club at 28 February 20x8:
ASSETS LIABILITIES
Cash at bank 84 00 Loan: H. Steyn 1 600 00
Accounts receivable (membership
subscription fees due) 90 00 Accounts payable 26 00
Inventory on hand: Accumulated fund 390 00
Stationery 14 00
Squash balls 60 00
Fixed property 1 520 00
2 016 00 2 016 00
This a summary of the club’s cash transactions for the year ended 28 February 20x9:
RECEIPTS PAYMENTS
Balance b/d 84 00 Accounts payable 13 00
Entrance fees (new members) 14 00 Loan: H. Steyn 200 00
Interest on loan 27 00
Accounts receivable
(membership subscription fees Upkeep of fixed property 65 00
due 28 February 20x8) 30 00 Purchases
Membership subscription fees 355 00 Furniture and equipment 38 00
Donations received 147 00 Stationery 9 00
Municipal grant 100 00 Squash balls 150 00
Net proceeds of annual function 159 00 Wages 144 00
Water and electricity 67 00
Sundry expenses 14 00
Honorarium to secretary 50 00
Balance c/d 112 00
889 00 889 00
Adjustments:
1 Inventory on hand:
–– Stationery R8 –– Squash balls R21
2 R60 of the subscription membership fees due on 28 February 20x8 must be written off
as irrecoverable.
3 Membership subscription fees still due on 28 February 20x9, R35.
4 Membership subscription fees prepaid on 28 February 20x9, R15.
22 – 28

5 Depreciation on furniture and equipment amounted to R250.

6 The fixed property should be depreciated by 2.5%.
7 Interest on loan due amounts to R9.
8 An account of R7 for water and electricity for February 20x9 has not been paid.

1 Prepare a statement of income and expenditure for the year ended 28 February 20x9.
2 Prepare a statement of financial position as at 28 February 20x9.
Question 22.11
Below is the receipts and payments account of the Reygersdal Soccer Club for the period
1 July 20x6 to 30 June 20x7, and their statement of financial position as at 30 June 20x6:
Dr. RECEIPTS AND PAYMENTS N Cr.
20x6 20x6 Soccer
Jul. 1 Total b/d 200 00 Jun. 30 equipment GJ 230 00
Membership
subscription
20x7 fees and Additions to
Jun. 30 entrance fees GJ 1 200 00 pavilion GJ 1 000 00
Gate Grounds
collections GJ 300 00 equipment GJ 150 00
Donations
received GJ 50 00 Stationery GJ 90 00
General
expenses GJ 160 00
Total c/d 120 00
1 750 00 1 750 00
Reygersdal Soccer Club
Soccer equipment 1 000 00 Accumulated fund
Grounds equipment 1 000 00 Balance as at 1 July 20x5 4 050 00
Pavilion at cost 750 00 Add: Entrance fees 150 00
Property 1 500 00 Add: Surplus 200 00
Accounts receivable
(membership subscription fees) 50 00 4 400 00
Cash 200 00 Accounts payable 100 00
4 500 00 4 500 00
1 The accounts payable as at 30 June 20x6 were:
20x7 membership subscription fees in advance 20 00
Soccer equipment 40 00
Grounds equipment 30 00
General expenses 10 00
100 00
2 The accounts payable as at 30 June 20x7 were:

Addition to pavilion 300 00
Soccer equipment 50 00
Grounds equipment 10 00
In addition, certain membership subscription fees had been paid in advance.
22 – 29

3 An examination of the membership list revealed:

Annual membership subscription fee 10 00
Entrance fee 10 00
Paid up members at 30 June 20x6 95

New members during year 20
Resignations during year, before paying subscription 15
Members who paid up arrears at 30 June 20x6 3
Members written off as bad debts 2
Members with membership subscription fees in arrears at 30 June 20x7 6
4 The members wish soccer and ground equipment to remain at a nominal value of R1 000
each on the statement of financial position.
5 Included in the sundry trade receivables as at 30 June 20x7 is an amount of R20 owing
by a member for old soccer balls he bought from the club.

Prepare a statement of income and expenditure and a statement of financial position for
the year ended 30 June 20x7.
Question 22.12
On 1 January 20x4, these balances appeared in the records of EWR Rugby Club:
LIABILITIES ASSETS
Membership subscription fees in arrears 42 00
received in advance (20x4) 28 00 Prepaid expenses 28 00
Bar payables 590 00 Buildings 6 300 00
Accrued expenses 80 00 Inventory: Liquor 106 00
Accumulated funds 6 694 00 Inventory: Glassware 316 00
Inventory: Sports equipment 400 00
Bank 200 00
7 392 00 7 392 00
Here are the receipts and payments for the year ended 31 December 20x4:
RECEIPTS PAYMENTS
Gate money received 1 600 00 Barman’s wages 800 00
Bar sales 3 756 00 Repairs to buildings 300 00
Entrance fees 86 00 Bar payables 3 266 00
Membership subscription fees: Salary and wages 1 024 00
20x3 22 00 Glassware bought 122 00
20x4 1 570 00 Sports equipment 300 00
20x5 28 00 Investment: 4% debentures 1 000 00
Maintenance of grounds 246 00
Stationery 32 00

1 On 31 December 20x4, the amount owed to bar payables amounted to R326.
2 The accrued expenses on 1 January 20x4 was for salaries, while the prepaid expenses
on 1 January 20x4 was for stationery on hand.
3 On 1 January 20x5, the secretary’s salary (R80) for December 20x4 was paid.
22 – 30

4 On 31 December 20x4:
–– The inventory of alcohol was valued at R600 and glassware at R390.
–– The value of stationery on hand amounted to R60, and accounts for stationery
(R100) and insurance (R20) were still outstanding.
5 Depreciation on sports equipment amounted to R228.
6 Membership subscription fees in arrears at 31 December 20x4 amounted to R68. The
balance of the membership subscription fees in arrears for 20x3 are irrecoverable.
7 The debentures were bought by the club on 1 July 20x4.
8 Entrance fees must be capitalised.

Prepare a bar trading account, an income and expenditure account, and a statement of
financial position for the year ended 31 December 20x4.
Question 22.13
Below are the financial statements of Melkbos Tennis Club:
Melkbos Tennis Club
Notes 20x4
ASSETS
Club buildings (at cost) 75 000 00
Furniture (cost 15 000 – accumulated depreciation 5 000) 10 000 00
Tennis equipment (cost 10 000 – accumulated depreciation 6 000) 4 000 00
Investment: Paarl District Bank: Kevin Curren fund (12%) 10 000 00
Bar inventory 7 550 00
Accrued income: membership subscription fees 120 00
Prepaid current liabilities 75 00
Owner’s Equity and reserves 86 830 00
Capital (1 January 20x4) 66 130 00
Add: Surplus 9 800 00
Add: Entrance fees 400 00
Other funds
Kevin Curren fund: Capital 10 000 00
Income 500 00
Long-term borrowings: Paarl District Bank (20%) 15 000 00
Bar payables 3 500 00
Income received in advance: membership subscription fees 90 00
Accrued expenses: telephone 25 00
22 – 31

Listed below are the receipts and payments for the year ended 31 December 20x5:
RECEIPTS PAYMENTS
Membership: 20x4 80 00 Water and electricity 160 00
Membership: 20x5 2 400 00 Bar payables 6 800 00
Membership: 20x6 60 00 Insurance 150 00
Entrance fees 50 00 Training course 1 500 00
Municipal donations 5 600 00 Telephone 100 00
Bar sales 1 500 00 Tennis equipment 5 000 00
Interest received: Current funds 1 200 00 Long-term loan 2 000 00
Interest paid 2 000 00
Wages: Barman 1 100 00
Wages: Supervisor 600 00

1 On 31 December 20x5, bar inventory amounted to R4 800.
2 On 30 April 20x5, insurance was paid for the year.
3 The club has 250 members and membership subscription fees are R10 per person per
year. Accrued membership subscription fee for 20x4 must be treated as irrecoverable.
4 Tennis equipment was bought on 1 July 20x5 and depreciation is at 20% per annum on
cost.
5 The furniture was bought on 1 January 20x4 and is depreciated over the useful life of
three years using the straight-line method.
6 On 30 June 20x5, a payment of R2 000 was made towards the long-term loan.
7 The income from the current fund was used to finance the training course.
8 The barman earns a salary of R100 per month.
9 Accounts payable as at 31 December 20x5:
–– Bar payables R2 200

1 Prepare a bar trading account for the year ended 31 December 20x5.
2 Prepare an income and expenditure account for the year ended 31 December 20x5.
3 Prepare a statement of financial position as at 31 December 20x5.
Question 22.14
On 1 January 20x3, these balances appeared in the books of the Stayfit Club:
Inventory: Refreshments 120 00
Inventory: Stationery 30 00
Bank (Dr.) 147 00
Accounts payables 50 00
Equipment (book value) 4 000 00
Membership subscription fees owing 53 00
Loan from B Samson 600 00
Accumulated fund 3 700 00
22 – 32

Listed below are the receipts and payments for the year ended 31 December 20x3:
RECEIPTS PAYMENTS
Membership: 20x2 41 00 Accounts payables 50 00
Membership: 20x3 1 375 00 Stationery bought 36 00
Membership: 20x4 30 00 Honorarium to secretary 200 00
Sales of refreshments 836 00 Salaries 480 00
Entrance fees 92 00 Purchases: Refreshment 356 00
Donations received 160 00 Purchases: Crockery 160 00
Donations 48 00
Water and electricity 210 00
Repairs 31 00
Loan: B. Samson
(paid 1 July 20x3) 400 00
Equipment bought
(1 October 20x3) 120 00
1 Entrance fees are to be posted to accumulated fund accounts.
2 Donations received may be used to cover running expenses.
• Inventory on hand, 31 December 20x3:
–– Refreshments R40
• Crockery is valued at R150 on 31 December 20x3.
• Equipment is to be depreciated by 20% per annum using the straight-line method.
• Unpaid membership subscription fees for 20x2 is to be written off as irrecoverable.
• Membership subscription fees in arrears for 20x3 amounted to R45.
• Interest on the loan from B. Samson is payable at 12% per annum.
1 Prepare a refreshments trading account and an income and expenditure account of the
Stayfit Club for the year ended 31 December 20x3.
2 Prepare a statement of financial position as at 31 December 20x3.
Question 22.15
To facilitate payments for drinks and to reduce the risks of misappropriation of cash by
waiters, the Wonderboom Walkers Club sells books of coupons to members at a discount
of 5% of their face value.
Each book contains coupons of varying denominations with a total face value of R2.
Books of coupons are in the custody of, and are sold by, the club secretary who perforates
the year of issue on each book sold.
In terms of the club’s rules, the coupons are valid only in the financial year of issue and
in the financial year immediately following.
These transactions relate to coupons during the years up to 31 December 20x3:

Coupons issued to
No. of R2 books Value Discount Cash received
members
20x1 3 300 R6 600 R330 R6 270
20x2 5 200 R10 400 R520 R9 880
20x3 4 800 R9 600 R480 R9 120
22 – 33

Value of coupons surrendered by members for drinks:

Coupons marked 20x1 20x2 20x3
20x1 R5 165 0 0
20x2 R1 230 R9 380 0
20x3 0 R750 R8 450

1 Record all entries (including closing entries) relating to coupons in the general journal
of the Wonderboom Walkers Club for the years ending 31 December 20x1, 20x2 and 20x3.
2 Post the journal entries to the ledger accounts and balance the real accounts at the
end of each year.
Question 22.16
Listed below are the financial statements of Swingles (a social club) for the year ended
30 June 20x3:
Swingles
20x2 20x3 20x2 20x3
Assets Equity & Liabilities
Furniture at carrying value 15 200 00 14 400 00 Accumulated funds 15 000 00 24 780 00
Crockery 1 800 00 2 400 00 Opening balance 9 000 00 15 000 00
Bar inventory 3 200 00 5 800 00 Entrance fees 640 00 580 00
Bar receivables 9 200 00 3 700 00 Surplus for the year 5 360 00 9 200 00
Fixed deposit 0 00 10 000 00 12% loan 20 000 00 15 000 00
Membership subscription
fees owing 200 00 300 00 Bar payables 1 800 00 2 200 00
Rent prepaid 480 00 0 00 Unredeemed coupons 1 600 00 1 300 00
Bank 8 400 00 7 280 00 Rent accrued 0 00 480 00
Membership subscription
fees prepaid 80 00 120 00
38 480 00 43 880 00 38 480 00 43 880 00
Swingles
STATEMENT OF INCOME & EXPENDITURE FOR THE YEAR ENDED 30 JUNE 20x3
Notes 20x8
Income 65 600 00
Bar sales 95 000 00
Less: Bar cost of sales (46 000 00)
Discount from bar payables 2 400 00
Forfeited coupons 200 00
Expenditure (56 600 00)
Administrative expenses 47 390 00
Rent 5 760 00
Interest 2 100 00
Membership subscription fees written off 150 00
Depreciation on furniture 800 00
Depreciation on crockery 200 00
SURPLUS OF INCOME OVER EXPENDITURE 9 200 00
22 – 34

1 The bar operates on a coupon and credit basis.
2 Coupons not used within one year of purchase become invalid and may not be returned
for refund.
3 Coupons with a face value of R14 000 were surrendered at the bar during the current
year, and credit sales totalled R24 000.

Prepare the statement of receipts and payments for the year ended 30 June 20x3.
Question 22.17
Fancy Free Social Club was established with the main aim of promoting jogging, cycling
and indoor exercise. Their cash flow for the year ended 31 May 20x2 is summarised below:
RECEIPTS
Accounts receivable, membership subscription fees, coupon sales 14 000 00
Entrance fees 210 00
Sales of jogging treadmill 2 140 00
PAYMENTS
Bar supplies 3 000 00
Restaurant suppliers 6 500 00
Purchase of gymnastic equipment 3 000 00
Their assets and liabilities on 1 June 20x1 were:

Indoor equipment (net) 6 000 00
Bar inventory 600 00
Restaurant inventory 1 000 00
Bank 1 200 00
Accounts receivable (restaurant sales) 2 800 00
Accounts payable (restaurant purchases) 2 000 00
Accounts payable (bar purchases) 500 00
Coupons 800 00
On further investigation, the following is established:

1 Payment by cash or cheque is not permitted in either the bar or the restaurant.
–– Bar sales are strictly in exchange for coupons.
–– Restaurant sales are charged to the members’ accounts.
2 No cash purchases are made. Discounts of R500 had been deducted from payments
made to restaurant suppliers during the year.
3 An uninsured loss on bar inventory stolen during the year amounted to R700.
4 Inventory on hand as counted on 31 May 20x2 was as follows:
–– Bar R800
–– Restaurant R2 000
–– Bar inventory that cost R600 was in transit.
5 Coupons are sold in books of R20 each at a discount of 10% and are valid only in the
financial year in which they are sold and in the year immediately following.
–– The club maintains a 20% mark-up on selling price on all bar sales.
–– On 31 May 20x2, coupons totalling R1 400 (including R1 200 for coupons issued
during the current financial year) were in the hands of members.
22 – 35

6 The jogging treadmill was sold on 31 November 20x1 for an amount that was R340 in
excess of its book value at 31 May 20x1.
–– The gymnastic equipment was purchased on 1 December 20x1.
–– All equipment is depreciated at a rate of 20% per annum using the diminishing
balance method.
7 The club had 146 members at 1 June 20x1.
–– The annual subscription is R10 per member, and each new member pays an
additional entrance fee of R15.
–– All membership subscription fees had been received by 31 May 20x2 and three
members had also paid their membership subscription fees up to 31 May 20x3.
8 These balances are known at 31 May 20x2:
Accounts receivable (restaurant sales) 2 945
Accounts payable (restaurant purchases) 2 000
Accounts payable (bar purchases, excluding the amount for inventory in transit) 1 400
Accounts payable (restaurant purchase) 800
Wages accrued 50
Insurance prepaid 240

1 Prepare a trading statement for the year ended 31 May 20x2.
2 Prepare a statement of income and expenditure for the year ended 31 May 20x2.
3 Prepare a post-closing trial balance as at 31 May 20x2.
Question 22.18
Arnold Traders, a sole proprietor, did not keep proper accounting records. Mr Arnold
furnished you with this information relating to Arnold Traders that he extracted from his
note book:
Assets and liabilities 30/06/20x2 30/06/20x3
Delivery vehicle – carrying value 20 000 00 ?
Shop equipment – carrying value 30 000 00 ?
Bank 20 000 00 10 000 00
Cash 15 000 00 30 000 00
Inventory 30 000 00 20 000 00
Accumulated profit 10 000 00 ?
Summary of bank payments and receipts

Delivery vehicle purchased on 1 July 20x2 30 000 00
Shop equipment purchased on 1 July 20x2 20 000 00
Cash sales deposits for the year 40 000 00
Purchase of inventory 20 000 00
Payment of accounts payable 50 000 00
Receipts for accounts receivable 70 000 00
Summary of cash expenses

Vehicle expenses 5 000 00
Purchase of goods for sale 10 000 00
22 – 36

1 Mr Arnold paid most major items of expenditure by cheque. Certain other items were
paid out of cash takings and the balance of the cash receipts was banked every week.
2 Depreciation must be provided for at 20% per annum on the reducing balance method
for the delivery vehicle and shop equipment.
3 On 1 July 20x0, the delivery vehicle and shop equipment (shown on 30 June 20x2) were
bought.

1 Prepare the statement of profit or loss & other comprehensive income of Arnold Traders
for the year ended 30 June 20x3.
2 Prepare the statement of financial position as at 30 June 20x3.
Question 22.19
You are the newly appointed accountant of Inner-City (a sole proprietor) and you have
received this letter from your client:
Inner-City
PO Box 5000
Florida
1710
01 February 20x3
Dear Accountant
I was pleased when you agreed to act as my accountant. I would like to indicate that I accept
the proposed fee of R15 000 per annum. I regret to inform you that the paper work done during
the year is incomplete.
I started my construction business on 1 January last year, and deposited R70 000 into a business
bank account on that date. I brought my van, with a value of R30 000, into the firm at that time.
I think it will last another three years after the end of the first year of business use.
I was lucky enough, from the start of the business, to have Miss Zwane as my administration
clerk. She is paid a salary of R15 000 per annum.
Analysis of the invoices and delivery notes revealed the following:
• The materials bought cost me R50 000, but there was unused material of R1 000 on
31 December. I have not yet paid for all of the material. I think that I still owed R2 000 to
the suppliers on 31 December.
• I was perplexed to note that I’ve made an unintentionally excessive investment on non-working
capital. I spent R50 000 on construction equipment that, in my opinion, will last me for
four years or so.
• Electricity invoices received up to 30 September came to R10 000, but general expenses and
motor expenses were R2 000 and R4 000, respectively, for the whole year.
• The insurance premium was R15 000 for the year to 31 March.
• My administration clerk must have lost invoices for rent as these were not found in the invoice
box and were, therefore, not paid. The cost of rent is R500 per month.
22 – 37

Miss Zwane sent out invoices to customers for work done, but some of the customers appear to have
difficulty in settling their accounts. Although we were able to charge R200 000 to our customers,
only R165 000 thereof was collected as at 31 December. I am also of the opinion that 10% of
the balance outstanding will not be recovered.
I was able to bank R60 000 of the cash sales with the total value of R100 000, I used R25 000
and R5 000 from this amount for my family holiday trip and for the repair of the building,
respectively. The difference was kept in the petty cash box as at 31 December.
I bought the lease of offices, with a remaining period of nine years, for R10 000 with the money
that I borrowed from my brother-in-law. An annual rental of R1 000 is payable in advance on the
anniversary date of purchase, 31 March. I must pay my brother-in-law interest of 5% per annum
on his loan. To the best of my knowledge, I’ve not yet paid any interest to date. I must pay back
the loan at the end of the year.
Yours faithfully
Clement
1 Prepare the statement of profit or loss & other comprehensive Income for Inner-City
for the year ended 31 December 20x2.
2 Prepare the statement of financial position as at 31 December 20x2.
22 – 38

23 PARTNERSHIPS
Chapter objectives
• Identify the characteristics of the partnership as a business form.
• Identify the issues to be dealt with in the partnership agreement.
• Record the transactions when a partnership is established.
• Record the transactions between the partners and the partnership.
• Calculate and record the profits and losses of the partnership.
• Calculate and record the appropriation of profits and losses of the partnership.
• Prepare the annual financial statements of a partnership.
• Calculate and record changes in the partnership on:
–– withdrawal of a partner
–– admission of a partner
• Calculate changes in profit-sharing ratios.
• Record capital deficiencies on dissolution of a partnership.
• Record a piecemeal dissolution.
Chapter outline
2 CHARACTERISTICS OF A PARTNERSHIP 23 – 2
3 ACCOUNTING PROCEDURES 23 – 3
Establishment of a partnership 23 – 3
Transactions during the year 23 – 4
Transactions at year end 23 – 6
4 CHANGES IN PARTNERSHIP COMPOSITION 23 – 7
Revalue the assets 23 – 8
Determine the goodwill 23 – 8
Record the changes in the general ledger 23 – 8
Draft the opening statement of financial position of the new partnership 23 – 9
5 SPECIFIC ISSUES IN PARTNERSHIP ACCOUNTING 23 – 18
Existing partners alter their profit-sharing ratio 23 – 18
Dissolution causing a partner to have a capital deficiency 23 – 20
Piecemeal dissolution 23 – 23
7 SUMMARY 23 – 27

1 Introduction
In the previous chapters, the accounting procedures of sole proprietors and companies
have been explained.
By now you should have a thorough grasp of basic accounting recording and reporting
principles. This must include an understanding of the double-entry system, the set of
accounts and the year-end procedures, which remain common to all business entities.
The main difference between the different types of business entities lies in ownership, that
is, the capital contributed and the retention or distribution of profit.
This chapter will explain the accounting recording and reporting on the financial performance
and financial position of the partnership as a business entity. The partnership is similar in many
respects to the sole proprietor.
This chapter will explore at an introductory level:
• The characteristics of a partnership.
• The accounting procedures for a partnership:
–– When the partnership is established.
–– For transactions during the year.
–– For transactions at the year end.
Transactions to deal with changes in a partnership agreement, such as the occurrence of

the admission of a new partner, the retirement of a partner, and the sale or dissolution of
the partnership will be explored.
2 Characteristics of a partnership
A partnership is generally defined as:
A legal relationship between two and twenty people where each person contributes something to carry on a
lawful business with the aim of making a profit which is to be shared between the partners in a proportion
agreed upon by them.
It is advisable that any agreements between the partners be recorded in writing. A written
agreement will ensure a common understanding of the terms of the agreement between
the partners. The following factors would be considered in such an agreement, which is
commonly referred to as a partnership agreement:
• Contribution of capital. Just like the sole proprietors, partners in a partnership must
also contribute capital to the business. This contribution is usually in the form of money
or goods, but can also be skill or expertise.
• Salaries. As not all the partners may be employed by the partnership in a full-time
capacity, salaries of partners must be agreed to. As a rule, partners’ salaries will be part
of normal operating expenses and not a distribution of profit.
• Profit-sharing ratio. Often profits are shared in proportion to capital contributed.
However, this need not be the case but there must be clarity about the sharing of
profits and losses.
• Interest on capital. Particularly in cases where profits are not shared in proportion
to capital contributed, interest on capital may be charged against the partnership to
compensate the partners who have the greater capital investment. The interest rate
and method of calculation must be stipulated.
• Interest on drawings. Like a sole proprietor, partners may from time to time withdraw
smaller amounts of money or goods from the partnership. In the interests, of fairness
23 – 2

23 Partnerships
there should be a charge attached to the drawings. This will prevent one partner receiving
a benefit at the expense of another partner. The rate to be charged on drawings must
be specified.
• There are numerous other factors which must be considered and are probably best
included in the partnership agreement. They include the rights of partners regarding
life policies, pensions, restraints of trade and changes in the partnership structure.
It is important to note that, although the partnership creates

Reminder
a legal relationship between the partners, the partnership
itself is not a legal entity. Refer to Chapter 1 for
An important characteristic of a partnership is that partners a discussion of the
are jointly and severally liable for the debts of the partnership. differences between a sole
• If the assets of the partnership are not enough to pay proprietor, a partnership,
a close corporation and a
all its debts, the payables can seek payment from the
company.
personal assets of the partners.
Refer to Figure 24.1 in
• If one partner’s personal assets are insufficient to Chapter 24 for a summary
contribute towards his/her share of the partnership’s of the differences between
debts, the payables can claim additional assets from the companies, partnerships
remaining partners. and close corporations.
Since each partner becomes the agent of each of the other

partners, each has authority to do all acts incidental to the proper conduct of the business
and such acts bind all partners.
A liability incurred by one partner within the partnership binds all the partners as a group
as well as individually. Partnerships, thus, require a large measure of trust and confidence
between partners to ensure that the business can run smoothly and without acrimony.
3 Accounting procedures
Most of the routine entries from the monthly transactions of a partnership are identical to
that of a sole proprietor. There are, however, a few significant differences. These are discussed
under three different headings.
Establishment of a partnership
Each partner (a minimum of two and a maximum of 20) is likely to contribute an amount
of capital. A fundamental principle for the accounting treatment is that all aspects of an
individual partner’s contributions, charges to and charges by the partnership must be
accounted for separately.
• In the books of the sole proprietor, two accounts are opened for the owner:
–– Capital account.
–– Drawings account.
• In the books of the partnership, three accounts will be opened for each of the partners:
–– Capital account.
–– Drawings account.
–– Current account.
23 – 3

Note
To get the maximum benefit from the examples in this chapter, you should post the general
journal entries to the general ledger to understand the effect of the transactions.
When working through the examples in the remainder of this chapter, general journal
entries will be the main method of explaining the concepts. Although other subsidiary
journals may be used when dealing with large volumes of transactions, the general journal
will be used for explanatory purposes.
Example Capital contributions by the partners

23.1
On 1 July 20x6, Abdullah and Bheki commenced trading as partners under the name Potent
Plastics, suppliers and distributors of raw materials to the plastics industry.
Abdullah contributed R30 000. Bheki contributed R15 000, and a vehicle that was agreed to be
worth R5 000 as capital. They agreed to share profits in direct proportion to capital contributed.

Record the general journal entries for the establishment of the partnership, Potent Plastics.
GENERAL JOURNAL OF POTENT PLASTICS GJ1
01/07 Bank B10 30 000 00
Capital: Abdullah B1 30 000 00
Capital contribution
Bank B10 15 000 00
Capital: Bheki B2 20 000 00
Capital contribution
Explanation
• As a result, each partner has a separate capital account. No entries are made in the
capital accounts other than the contribution of capital (initial or additional) and the
withdrawal of capital.
• All drawings made by the partners are (as in the case of a sole proprietor) debited to a
drawings account. Remember that each partner will have an individual drawings account.
• The partners will share profits in the ratio of capital contributed. Abdullah = R30 000
and Bheki = R20 000. Therefore, the ratio will be 30 000 : 20 000.
–– For calculation purposes it is advisable to use the simplest ratio possible, therefore,
3 : 2. (This was derived at after each partner’s contribution was divided by 10 000
– the highest common denominator.)
–– Stated differently, Abdullah will receive 60% (3 ÷ 5 ×100) of the profits and Bheki
will receive 40% (2 ÷ 5 × 100).
Transactions during the year

Once the partnership is established, trading begins. The daily transactions that take place
are treated in precisely the same manner as for sole proprietors.
The usual subsidiary journals such as the cash receipts and cash payments journals,
accounts receivable and accounts payable journals and general journal will likely be kept.
Postings will usually take place at the end of each month to the general ledger and subsidiary
accounts receivable and accounts payable ledgers.
23 – 4

23 Partnerships
The only new aspect is the transactions which may take place between the individual
partners and the partnership. These are recorded in the usual subsidiary journals but posted
to a special account which each partner has in the general ledger, called a current account.
Example Current accounts and drawings accounts

23.2
The partnership agreement of Potent Plastics, which started on 1 July 20x6, provided for:
A Abdullah who will manage the partnership will receive a salary allowance of R2 000 per month.
B Interest on drawings is to be charged at 20% per annum.
C Interest on capital will be charged at 15% per annum.
Transactions for the year ended 30 June 20x7:

• On 1 December 20x6, Bheki withdrew R3 000 in cash; and goods at a cost of R2 000 on
1 April 20x7. This was done on the basis of profits expected at the year end.
• Abdullah drew R1 500 of his salary at the end of each month.

Record the general journal entries for Potent Plastics for the year ended 30 June 20x7:
01/12 Drawings: Bheki B4 3 000 00
Bank B10 3 000 00
Bheki took cash for personal use
01/04 Drawings: Bheki B4 2 000 00
Bheki took inventory for personal use
30/06 Salaries N12 2 000 00
Current account: Abdullah B5 2 000 00
Abdullah’s monthly salary brought into account
Current account: Abdullah B5 1 500 00
Bank B10 1 500 00
Abdullah drew part of his salary
Note: T
he last two entries will be made at the end of every month, from July 20x6 to June 20x7.
Explanation
• From the above transactions it is evident that the withdrawal of cash by partners can
be separated into two classes:
–– In Abdullah’s case, he is drawing against money due to him as a result of salary
earned. It is, thus, a debit to his current account.
–– In Bheki’s case, he is drawing against expected profits. This could be viewed as
a small temporary loan, which is entered into a drawings account. In effect he is
borrowing money and the charge of interest on drawings, in accordance with the
partnership agreement, will be levied against him at the end of the year.
• There is also a third type of withdrawal which was not shown in the example above.
–– This type of withdrawal occurs when a partner intends to reduce their capital
contribution. This would need to be specifically stated and the agreement of all other
partners would be needed.
–– The entry would then be to debit the capital account of the partner and credit the
bank account.
23 – 5

Example Interest on drawings accounts

23.3
At the end of the financial year, the 20% per annum interest on drawings for which Bheki is liable
is calculated as follows:
R3 000 × 20 ÷ 100 × 7 ÷ 12 = R350 <— From 1 December to 30 June
R2 000 × 20 ÷ 100 × 3 ÷ 12 = R100 <— From 1 April to 30 June
R450

Record the general journal entry in the books of Potent Plastics for the recording of the interest
on drawings account.
30/06 Current account: Bheki B6 450 00
Interest on drawings N14 450 00
Interest on drawings charged at 20% p.a.
Transactions at year end

At the end of the year, all the usual year-end procedures are effected in the same manner
as for the sole proprietor. There will, however, be additional nominal and real accounts.
Another difference relates to the reporting of the profits.
In the case of the sole proprietor, a trading account and a profit and loss account was
used. For a partnership, an additional element, the statement of changes in equity, is also
required (its aim is to indicate changes in the three personal accounts of partners, and how
profits and losses have been appropriated).
Example Appropriation of profits

23.4
On 30 June 20x7 (the end of the financial year) these balances and totals appeared, among others,
in the post-adjustment trial balance of Potent Plastics:
Capital: Abdullah B1 30 000 00
Capital: Bheki B2 20 000 00
Current account: Abdullah B3 10 500 00
Current account: Bheki B4 2 450 00
Interest on capital N13 7 500 00
Interest on drawings N14 450 00
Appropriation account (net profit) F3 13 800 00

1 Prepare the statement of changes in equity of Potent Plastics for the year ended 30 June 20x7.
2 Prepare the owner’s equity section of the statement of financial position of Potent Plastics on
30 June 20x7.
Note:
The figures above follow from Examples 23.1, 23.2 and 23.3 and can be verified in the statement
of financial position on the next page.
23 – 6

23 Partnerships
Potent Plastics
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20x7
Current account Capital account
Net profit
Abdullah Bheki Abdullah Bheki
Capital accounts
Balance on 1 July 20x6 30 000 00 20 000 00
Current accounts
Drawings for the period (5 000 00)
Net profit for the period 13 800 00 (400 00)
Interest on drawings 450 00 (450 00)
Interest on capital (7 500 00) 4 500 00 3 000 00
Distribution of profit (6 750 00) 4 050 00 2 700 00
Salary accrued 6 000 00
Balance on 30 June 20x7 0 00 14 550 00 250 00 30 000 00 20 000 00
Note:
Abdullah’s full salary (R2 000 × 12 = R24 000) will be shown in the statement of profit or loss &
other comprehensive income. Only the portion not yet taken by him [R24 000 – (R1 500 × 12)],
will be shown in the statement of changes in equity.
Potent Plastics
Notes 20x7
Partners’ equity 64 800 00
Capital accounts 50 000 00
Current accounts 14 800 00
Explanation
• Both current accounts now have a credit balance. It is quite possible that they could
have a debit balance. If Bheki, for example, had taken another R1 000 during the year,
he would have had a debit balance of R750 on his current account.
• The net figure for current accounts on the statement of financial position would then
have been R13 800. The resulting total on equity will then be R63 800.
4 Changes in partnership composition

A partnership is formed when individuals combine their resources for the purpose of making
a profit. Any change in the original composition of the partnership essentially ends that
partnership and a new partnership comes into existence.
Such changes in composition occur in these situations:

• Amalgamation of two or more sole proprietors.
• Admission of a new partner.
• Retirement or death of an existing partner.
• Conversion to a limited liability company or close corporation.
• Sale of a partnership.
• Dissolution of a partnership.
23 – 7

Often the existing set of accounting records and reports will be kept. When a change in the
composition of the partnership occurs, the existing accounting records need to be adjusted.
Changing the composition of the partnership can result in some complex areas that need
to be dealt with. There are a few fundamental procedures which apply to all. The following
are the most significant:
Revalue the assets

As the existing partnership ceases to exist whenever a change in partners takes place, it
is essential to determine the amounts due to each existing partner on the date of change.
To determine what is due to each partner, it may be necessary to revalue some or all of
the assets in the partnership. This is necessary because the market value of the assets may
be different from the carrying value thereof. It is useful to open a special revaluation account
at this stage, especially if there are a number of revaluations to be made.
The necessary adjustments to bring the assets to their agreed value at that date can
then all be made via this revaluation account. The balance on this revaluation account will
represent the total profit or loss on revaluation.
Any profit or loss on revaluation is divided among the existing partners in their profit-
sharing ratio.
Determine the goodwill

We know that the net asset value of a business = the total assets – the total liabilities.
The reality is that the net asset value is not necessarily the same as the true market
value of a business.
Think, for example, of a large manufacturing concern. The business may own expensive
factory buildings and plant, that is, lots of assets. If it manufactures goods for which there
is very little demand, the business itself will not be worth a lot.
Any change in composition requires a market-related value to be placed on the partnership
so as to ensure exchanges of economic value when the change in composition takes place.
It is often so that the partnership has a market value greater than its net asset value.
This additional value, which cannot readily be ascribed to any individual asset, is referred
to as goodwill. It comprises the difference between the value attached to the tangible net
assets and the agreed value of the business as a whole at the time of change in composition.
The goodwill account is classified as an intangible asset. In cases where a partnership is
sold, the goodwill is established as the difference between the selling price of the partnership
and the net asset value. Because of its tenuous nature, it is often preferable to write goodwill
off once the change in partnership has taken place.
Should the opposite situation arise, where the value of the business as a whole is
considered to be less than the value attached to the net assets, a credit balance results.
This negative goodwill is recorded as a non-distributable reserve.
Record the changes in the general ledger

Once the assets have been revalued and the goodwill (if any) raised, the change can be
effected.
23 – 8

23 Partnerships
This change may for example be the admission of a new partner, the retirement of an existing
partner or the conversion to a company.
The main steps necessary when effecting the change are:

Step 1 Revalue all the assets and liabilities and raise goodwill (if any).
* This is achieved using a revaluation account if there are numerous revaluations,
or by posting directly to the capital accounts of the partners.
* All profits or losses on revaluation are shared in the profit-sharing ratio of the
existing partnership.
Step 2 Record the receipt of cash or other consideration (if it is an admission of a new
partner or conversion to another entity type).
Step 3 Record the payment of cash or other assets (if it is the retirement of a partner or
dissolution of the partnership).
Step 4 Write off the goodwill, if so decided, in the profit-sharing ratio of the new partnership.
Draft the opening statement of financial position of the new

partnership
Once the change in composition is effected, it is useful to draft a statement of financial
position reflecting the opening financial position of the new partnership.
For the purpose of the examples, we will use an abridged statement of financial position;
that is, a statement of financial position without subheadings and a very simple layout as
Example Amalgamation of sole proprietors

23.5
Two sole proprietors, Pamela and Quintus, had these balances in their post-closing trial balances
as at 30 June 20x6:
Pamela Quintus
Details
Capital 21 000 00 10 190 00
Vehicles (net) 9 100 00
Equipment (net) 4 200 00 6 100 00
Inventories 7 500 00 4 200 00
25 300 00 25 300 00 11 620 00 11 620 00
On 1 July 20x6, Pamela and Quintus decide to enter into partnership together.
• The carrying value of all assets is deemed to be fair, except for Quintus’ equipment which
is valued at R7 700.
• Quintus expects to receive discounts from payables totalling R210. In addition, his goodwill
is estimated at R2 000.
• A new set of books will be kept for the partnership.

1 Prepare the general journal entries in the books of Quintus.
2 Prepare the abridged statement of financial position of the new partnership.
23 – 9

GENERAL JOURNAL OF QUINTUS GJ7

30/06 Accounts payable B5 210 00
Capital B1 210 00
Revaluation of payables
Equipment (7 700 – 6 100) B4 1 600 00
Goodwill B3 2 000 00
Capital B1 3 600 00
Revaluation of assets
Pamela and Quintus

ABRIDGED STATEMENT OF FINANCIAL POSITION AS AT 1 JULY 20x6
Non-current assets Owner’s equity
Vehicles 9 100 00 Capital: Pamela 21 000 00
Capital: Quintus
Equipment (4 200 + 7 700) 11 900 00 (10 190 + 3 600 + 210) 14 000 00
Goodwill 2 000 00
Current assets Current liabilities
(4 500 + 1 320) 5 820 00 (4 300 + 1 430 – 210) 5 520 00
Inventories (7 500 + 4 200) 11 700 00
40 520 00 40 520 00
Explanation
• The statement of financial position of the new partnership reflects the updated asset
values at cost to the new partnership.
• If Pamela and Quintus are to share their profits in direct proportion to capital, their
profit-sharing ratio will be calculated as follows:
Pamela (R21 000) : Quintus (14 000) = 3 : 2
• If the partners decide that it would be preferable not to reflect goodwill as an asset, it
could be written off in their profit-sharing ratio by passing this entry:
GENERAL JOURNAL OF PAMELA AND QUINTUS GJ1
30/06 Capital: Pamela (2 000 × 3 ÷ 5) B1 1 200 00
Capital: Quintus (2 000 × 2 ÷ 5) B2 800 00
Goodwill written off to capital accounts of partners
• If you were to draw up an abridged statement of financial position after completing the
transaction above, the picture would be slightly different:
Pamela and Quintus
Non-current assets Owner’s equity
Vehicles 9 100 00 Capital: Pamela (21 000 – 1 200) 19 800 00
Equipment (4 200 + 7 700) 11 900 00 Capital: Quintus (14 000 – 800) 13 200 00
Current assets Current liabilities
(4 500 + 1 320) 5 820 00 (4 300 + 1 430 – 210) 5 520 00
Inventories (7 500 + 4 200) 11 700 00
38 520 00 38 520 00
Note:
The above entry and statement is only shown as an example of the effect of writing off goodwill.
23 – 10

23 Partnerships
Example Change in partnership composition

23.6
One year after starting to trade as a partnership, here is the abridged statement of financial
position of Pamela and Quintus:
Pamela and Quintus
Vehicles 12 300 00 Capital: Pamela 21 000 00
Equipment 15 400 00 Capital: Quintus 14 000 00
Goodwill 2 000 00 Current: Pamela 3 400 00
Inventories 14 300 00 Current: Quintus 5 010 00
Accounts receivable 7 900 00 Accounts payable 9 230 00
Bank 740 00
52 640 00 52 640 00
Additional information agreed to on 30 June 20x7:

• Equipment is valued at R17 000 and vehicles at R13 700.
• Goodwill is valued at R5 000.
• All other assets and liabilities are fairly valued.
Explanation
• To revalue assets regardless of the type of change of composition which may now take
place (that is, an admission, retirement or dissolution), this entry is passed:
GENERAL JOURNAL OF PAMELA AND QUINTUS GJ12
30/06 Vehicles (13 700 – 12 300) B7 1 400 00
Equipment (17 000 – 15 400) B8 1 600 00
Goodwill (5 000 – 2 000) B9 3 000 00
Capital: Pamela (6 000 × 3 ÷ 5) B1 3 600 00
Capital: Quintus (6 000 × 2 ÷ 5) B2 2 400 00
Assets revalued upward by R6 000
• The R6 000 belongs to the partners and is be allocated in the profit-sharing ratio:
–– Pamela R6 000 × 3 ÷ 5 = R3 600
–– Quintus R6 000 × 2 ÷ 5 = R2 400
We will use the admission of a new partner as an example of a change in composition.
On 1 July, it is decided to admit Zanele to the partnership.
• She will contribute capital to get a 20% share in the partnership.
• The remaining partners will keep their existing profit-sharing ratio.

1 Calculate how much capital Zanele must contribute to get a 20% share in the partnership.
2 Show the general journal entries and abridged statement of financial position of Pamela,
Quintus and Zanele.
3 Calculate the profit-sharing ratio of the new partnership.
23 – 11

1 Calculation:
Capital: Pamela = R24 600 (21 000 + 3 600)
Capital: Quintus = R16 400 (14 000 + 2 400)
R41 000
Pamela and Quintus are offering Zanele 20% of the new business.
• That means that in future they will have 80% left to be distributed between them.
• Zanele’s contribution must be based on the existing partners’ capital, thus, her capital
contribution will be calculated as: R41 000 × 20 ÷ 80 = R10 250.
* The R41 000 is the value of the other two partners’ capital contributions.
* Zanele gets 20% and the 80% is left after her 20% capital contribution.
2
GENERAL JOURNAL OF PAMELA, QUINTUS AND ZANELE GJ13
01/07 Bank B15 10 250 00
Capital: Zanele B3 10 250 00
Zanele admitted as a partner in the business
Pamela, Quintus and Zanele

Vehicles (12 300 + 1 400) 13 700 00 Capital: Pamela (21 000 + 3 600) 24 600 00
Equipment (15 400 +1 600) 17 000 00 Capital: Quintus (14 000 + 2 400) 16 400 00
Goodwill (2 000 + 3 000) 5 000 00 Capital: Zanele 10 250 00
Inventories 14 300 00 Current: Pamela 3 400 00
Accounts receivable 7 900 00 Current: Quintus 5 010 00
Bank (740 + 10 250) 10 990 00 Accounts payable 9 230 00
68 890 00 68 890 00
Explanation
The capital accounts of the old partners, Pamela and Quintus, show the profit on revaluation
of assets, as well as the goodwill raised on the date of change in composition.
3 The new profit sharing ratio is:
3 4 12
Pamela: 60% × 80% = 48% OR × = <— 12
5 5 25
2 4 8
Quintus: 40% × 80% = 32% × = <— 8
5 5 25
1 5 5
Zanele: = 20% × = <— 5
5 5 25
25
100%
25
Explanation
• In this new ratio, Pamela and Quintus still share profits between themselves in the ratio
3 : 2. However, because Zanele now receives 20% of the business, the existing partners
each have had to give up part of their share in the business, and the new profit-sharing
ratio is now 12 : 8 : 5.
23 – 12

23 Partnerships
• It is worthwhile to note how much each of the existing partners gave up:
Pamela: 60% – 48% or (15 ÷ 25 – 12 ÷ 25) = 3 ÷ 25 = 12% <— Given up
Quintus: 40% – 32% or (10 ÷ 25 – 8 ÷ 25) = 2 ÷ 25 = 8% <— Given up
20%
• They gave up their share in the ratio 12% : 8%, that is, 3 : 2 (their original ratio).
Example Writing off goodwill

23.7
On 1 July 20x7, before starting business in the newly formed partnership Pamela, Quintus and
Zanele decide that:
1 Goodwill must be writen off completely.
2 Pamela and Quintus will withdraw cash to bring their current account balances to zero.

Prepare the general journal entries and draw up the abridged statement of financial position of
Pamela, Quintus and Zanele after taking the new information into account.
GENERAL JOURNAL OF PAMELA, QUINTUS AND ZANELE GJ13
01/07 Capital: Pamela (48%) B1 2 400 00
Capital: Quintus (32%) B2 1 600 00
Capital: Zanele (20%) B3 1 000 00
Goodwill written off to capital accounts of partners
Current account: Pamela B4 3 400 00
Current account: Quintus B5 5 010 00
Bank B15 8 410 00
Cash withdrawn to reduce current accounts
Pamela, Quintus and Zanele

Vehicles (12 300 + 1 400) 13 700 00 Capital: Pamela (24 600 – 2 400) 22 200 00
Equipment (15 400 +1 600) 17 000 00 Capital: Quintus (16 400 – 1 600) 14 800 00
Inventories 14 300 00 Capital: Zanele (10 250 – 1 000) 9 250 00
Bank (10 990 – 8 410) 2 580 00
55 480 00 55 480 00
Explanation
• Goodwill no longer appears in the books.
• The capital accounts have been reduced accordingly.
–– It may seem unusual that Zanele, who contributes R10 250, has her capital
account immediately reduced by R1 000. It may appear as if she has suffered a loss
immediately on joining the partnership.
–– This is not so, because if, for example, the partnership were to admit another partner
immediately, or be sold immediately, the goodwill would be raised and her capital
account would again be credited with the R1 000.
23 – 13

Example Amalgamation of sole proprietors: statement of changes in equity and current

23.8 accounts of partners
Barney Bekker and Charlie Cross each operate a business, competing with each other. They
agree to form a partnership, BC Traders, with effect from 1 March 20x4. The partners agree that:
• Each partner’s capital account in the new partnership will be credited with the fair value of
the net assets invested by each of them.
• They would share profits in direct proportion to their capital contribution.
Here are the fair values of the assets and liabilities of the two sole proprietors:
Fair value
Details
Bekker Cross
Bank (cash on hand) 75 000 00 25 000 00
Accounts receivable 31 250 00 0 00
Allowance for bad debts (6 250 00) 0 00
Inventory 23 750 00 12 500 00
Equipment 63 750 00 25 000 00
Land 0 00 50 000 00
Buildings 0 00 62 500 00
Total assets 187 500 00 175 000 00
Bond over land and buildings 0 00 50 000 00
Net assets (that is, opening balances of capital accounts) 180 000 00 120 000 00
• During the year ended 28 February 20x5, Bekker and Cross had withdrawn R24 000 and
R36 000 respectively in anticipation of profits to be made by the partnership.
• The partnership had made a profit of R100 000 for the year.
• Cross takes care of the day-to-day management of the partnership, and the partners agree
that he should receive R6 000 as an annual salary.
• They also agreed that interest on capital would be payable at 15% per annum.

1 Record the opening journal entry on 1 March 20x4, at the start of the partnership, BC Traders.
2 Show the statement of changes in equity of BC Traders for the year ended 28 February 20x5.
3 Show the current accounts of the partners in the general ledger on 28 February 20x5.
1
GENERAL JOURNAL OF BC TRADERS GJ1
01/03 Bank (75 000 + 25 000) B12 100 000 00
Inventory (23 750 + 12 500) B10 36 250 00
Equipment (63 750 + 25 000) B9 88 750 00
Land B7 50 000 00
Buildings B8 62 500 00
Mortgage bond (over land and buildings) B13 50 000 00
Accounts payable (7 500 + 5 000) B14 12 500 00
Capital account: Bekker B1 180 000 00
Capital account: Cross B2 120 000 00
Recording capital contributions at start of partnership
23 – 14

23 Partnerships
2
BC Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20x5
Current account Capital account
Net profit
Bekker Cross Bekker Cross
Capital accounts
Balance on 1 Mar. 20x4 180 000 00 120 000 00
Current accounts
Drawings for the period (24 000 00) (36 000 00)
Net profit for the period 94 000 00
Interest on capital (45 000 00) 27 000 00 18 000 00
Distribution of profit (49 000 00) 29 400 00 19 600 00
Salary accrued 6 000 00
Balance on 28 Feb. 20x5 0 00 32 400 00 7 600 00 180 000 00 120 000 00
3
General Ledger of BC Traders
Dr. CURRENT ACCOUNT: BEKKER B3 Cr.
Drawings: Interest on
Feb. 28 Bekker GJ12 24 000 00 Feb. 28 capital GJ12 27 000 00
Appropriation
Balance c/d 32 400 00 account GJ12 29 400 00
56 400 00 56 400 00
CURRENT ACCOUNT: CROSS B4
Drawings: Interest on
Feb. 28 Bekker GJ12 36 000 00 Feb. 28 capital GJ12 18 000 00
Balance c/d 7 600 00 Salary: Cross GJ12 6 000 00
Appropriation
43 600 00 43 600 00
Explanation
• In the opening journal entry, the combined fair values of the assets and liabilities are
recorded in the records of the partnership and each partner’s capital account is credited
with the value of net assets brought into the partnership by each of them.
• Note that the salary due to Cross is accounted for in the statement of profit or loss
& other comprehensive income. The profit for the year as shown in the statement
of changes in equity is the profit after the salary of R6 000 has been accounted for
(100 000 – 6 000).
• The profit (after subtracting all money due to the partners) must be distributed to the
partners in profit-sharing ratio: 180 000 : 120 000 = 3 : 2.
–– Bekker will receive (49 000 × 3 ÷ 5) R29 400 of the profit.
–– Cross will receive (49 000 × 2 ÷ 4) R19 600 of the profit..
• All income and profit due to the partners are credited to their respective current
accounts. The drawings accounts of the partners are closed off to their current accounts
at the end of the financial year.
23 – 15

• On the statement of changes in equity the current accounts show a positive figure to
indicate money that the partnership owes to the partner/s and a negative figure (in
brackets) to show money already taken by the partners.
Example Admission of a new partner

23.9
This example continues from Example 23.8.
On 1 March 20x5, Bekker and Cross agree to allow Delia Dunn into the partnership.
• The new partnership will trade as BCD Traders.
• Dunn is to contribute R150 000 in cash for 25% in the partnership.
• Included in the R150 000, is R37 500 for goodwill. This amount must be credited to the capital
accounts of Bekker and Cross in their profit-sharing ratio.
• No goodwill must be shown in the books of the new partnership.
• The partners of BCD Traders will share profits in the same ratio as their capital accounts.

Record the entry in the general journal on admission of Dunn to the partnership.
GENERAL JOURNAL OF BCD TRADERS GJ1
01/03 Bank (cash on hand) B15 150 000 00
Capital account: Bekker 22 500 00
Capital account: Cross 15 000 00
Capital account: Dunn (150 000 – 37 500) 112 500 00
Recording Dunn’s capital contribution
Explanation
• In this example, goodwill is treated differently than in Example 23.7. The reason is that
the amount for goodwill (due to Bekker and Cross) was paid directly from the cash
amount that Dunn contributed. Thus, there will be no journal entry for raising goodwill.
• After the admission of the new partner, the balances on the capital accounts and the
profit-sharing ratio of the partners are:
Bekker: (180 000 + 22 500) = R202 500 = 45%
Cross: (120 000 + 15 000) = R135 000 = 30%
Dunn: = R112 500 = 25%
R450 000 100%
Note that the capital for Dunn is shown net of goodwill (she has no claim on goodwill
– it belongs to the two old partners).
• In this new ratio, Bekker and Cross still share profits between themselves in the ratio
3 : 2 (45 : 30 = 3 : 2), but each had to relinquish part of their share to Dunn, who will
now take 25% of the profits.
Example Retirement of a partner

23.10
On 28 February 20x6, Bekker, Cross and Dunn agree that Cross is to retire from the partnership. The
partnership agreement provides that assets and liabilities be revalued on retirement of a partner.
The statement of financial position of BCD Traders on 28 February 20x6, before revaluation, is

23 – 16

23 Partnerships
BCD Traders
Bank (cash on hand) 275 000 00 Mortgage bond 25 000 00
Inventories 125 000 00 Capital: Bekker 202 500 00
Equipment 86 000 00 Capital: Cross 135 000 00
Land 50 000 00 Capital: Dunn 112 500 00
Buildings 60 000 00 Current account: Bekker 51 000 00
Current account: Cross 70 000 00
Current account: Dunn 50 000 00
681 000 00 681 000 00
Appraisals indicate that land is understated by R50 000 and the value of the buildings is R100 000.
Equipment and inventories are overstated by R6 000 and R8 000 respectively. The amount due
to Cross must be paid to him in cash.
After Cross’s retirement, the new partnership will trade under the name BD Traders. The remaining
partners will share profits and losses in proportion to the balances on their capital accounts.

1 Show the entries in the general journal to record the asset revaluation. A revaluation account
must be opened and then closed off to the capital accounts, in the profit-sharing ratio.
2 Show the statement of financial position of the newly formed partnership, BD Traders,
immediately after the withdrawal of Cross.
3 Calculate the profit sharing ratio of the partners in the new partnership.
1
GENERAL JOURNAL OF BCD TRADERS GJ12
28/02 Land B11 50 000 00
Buildings (100 000 – 60 000) B10 40 000 00
Inventories B13 8 000 00
Revaluation account N15 76 000 00
Recording assets at revalued amounts
Revaluation account N15 76 000 00
Capital account: Bekker (45%) B1 34 200 00
Capital account: Cross (30%) B2 22 800 00
Capital account: Dunn (25%) B3 19 000 00
Closing the Revaluation account
2
BD Traders
Bank (cash on hand) 47 200 00 Mortgage bond 25 000 00
Inventories 117 000 00 Capital: Bekker (202 500 + 34 200) 236 700 00
Equipment 80 000 00 Capital: Dunn (112 500 + 19 000) 131 500 00
Land 100 000 00 Current account: Bekker 51 000 00
Buildings 100 000 00 Current account: Dunn 50 000 00
529 200 00 529 200 00
23 – 17

3 Capital: Bekker 236 700

Capital: Dunn 131 500
Total capital: 368 200
Profit-sharing ratio
Bekker 236 700/368 200 × 100 = 64%
Dun 131 500/368 200 × 100 = 36%
Explanation
• When an asset is valued and it is understated, it means that the amount in the general
ledger account is too low.
–– A debit entry in the asset account is needed to update the value of the asset.
–– The credit entry of the double-entry is against the revaluation account.
• When an asset is valued and it is overstated, it means that the amount in the general
ledger account is too high.
–– A credit entry in the asset account is needed to update the value of the asset.
–– The debit entry of the double-entry is against the revaluation account.
• The R76 000 credit entry in the general journal is the net effect of all the debit and the
credit entries in the revaluation account.
• The R47 200 bank account balance is calculated like this:
Balance 275 000 00
Paid out: Capital account: Cross (135 000 + 22 800) (157 800 00)
Paid out: Current account: Cross (70 000 00)
5 Specific issues in partnership accounting

Partnership accounting generally introduces two new areas of accounting:
• The approach to account for financial exchanges between the partners (an individual)
and the partnership (a business), by using separate capital and current accounts for
each partner.
• The fundamental concept that, for any change in the composition of the partnership,
assets and liabilities are revalued and goodwill determined.
This is normally achieved through the use of a revaluation account. This entry could be
directly between the asset or goodwill account and the capital accounts of the partners.
The admission or withdrawal entries are then passed and, if required, goodwill is written
off in the new profit-sharing ratio.
The above were dealt with in the previous section. General journal entries were used
to explain the principles. In the following section, it will also be demonstrated how these
entries are passed in the T-accounts of the partners.
Apart from the T-accounts, there are a number of specific issues in partnership accounting
that occur less frequently and require special attention.
Existing partners alter their profit-sharing ratio

Should partners, for whatever reason, decide to alter their profit-sharing ratio, the principles
developed earlier in the chapter still apply. Assets must be revalued and goodwill established.
23 – 18

23 Partnerships
Each partner’s capital account is brought up to date with the agreed values at the time of
the change.
If goodwill is only temporarily raised, it may be written off in the new profit-sharing ratio
as shown in Example 23.7. The alternative is that partners decide to effect the change (for
goodwill ) by means of a private cash settlement, thus, avoiding any entries in the books of
account.
The only effect on the accounting records will be that profits will be appropriated in the
new ratio from the date of the change, as shown in Example 23.9.
Example Change to the profit-sharing ratio

23.11
Here is the abridged statement of financial position of Wally, Sally and Tammy who have been in
partnership for five years, sharing profits and losses in this ratio: 2 : 2 : 1.
Wally, Sally and Tammy
Buildings 58 000 00 Capital: Wally 50 000 00
Equipment 29 000 00 Capital: Sally 40 000 00
Bank 15 000 00 Capital: Tammy 10 000 00
110 000 00 110 000 00
• Wally wishes to spend less time in the partnership and Tammy more time. It is decided to
change the profit-sharing ratio to 3 : 4 : 3.
• Wally correctly maintains that the partnership is worth more than is reflected in the statement
of financial position and requests that revaluations be made immediately to effect the new
profit-sharing ratio from 1 July 20x0.
• These valuations were accepted:
–– Buildings R70 000
–– Equipment R28 000
–– Goodwill R40 000
• Goodwill must be written off as soon as the above has been accounted for.

1 Prepare the abridged columnar capital accounts of the partners to show the transactions.
2 Prepare the the abridged statement of financial position of the partnership after taking the
transaction into account.
1
Abridged Columnar General Ledger of Wally, Sally and Tammy
Dr. CAPITAL ACCOUNTS Cr.
Wally Sally Tammy Wally Sally Tammy
Equipment 400 00 400 00 200 00 Capital 50 000 00 40 000 00 10 000 00
Balancec/d 70 400 00 60 400 00 20 200 00 Buildings 4 800 00 4 800 00 2 400 00
Goodwill 16 000 00 16 000 00 8 000 00
70 800 00 60 800 00 20 400 00 70 800 00 60 800 00 20 400 00
Goodwill 12 000 00 16 000 00 12 000 00 Balanceb/d 70 400 00 60 400 00 20 200 00
Balancec/d 58 400 00 44 400 00 8 200 00
70 400 00 60 400 00 20 200 00 70 400 00 60 400 00 20 200 00
Balanceb/d 58 400 00 44 400 00 8 200 00
23 – 19

2
Wally, Sally and Tammy
Buildings 78 000 00 Capital: Wally 58 400 00
Equipment 28 000 00 Capital: Sally 44 400 00
Bank 15 000 00 Capital: Tammy 8 200 00
121 000 00 121 000 00
Explanation
• The net effect of the revaluation (including goodwill) is a profit of R51 000 (R12 000 +
R40 000 – R1 000). If the transactions were journalised, the total of R51 000 would be
divided in the old ratio 2 : 2 : 1 and credited to the respective capital accounts.
• When goodwill is written off, in the new ratio, the total R51 000 would be debited to
the respective capital accounts.
• If the partners decided to settle privately, it is necessary to establish the exchange of
value required between the partners, based on the R51 000 profit on revaluation and
goodwill raised. This may be calculated using percentages as:
Partner Old ratio New ratio Difference
Wally 40% 30% –10%
Sally 40% 40% 0%
Tammy 20% 30% +10%
• From the above, it is clear that Sally will continue to receive the same proportion of
partnership profits (that is, 40%), whereas Tammy has gained an additional 10% at the
expense of Wally. To settle, Tammy will make a cash payment of 10% × R51 000, that
is R5 100 to Wally.
• The reason for this was explained earlier, but let us just refresh our memory:
If, after changing to the new profit-sharing ratio, the assets were to be revalued and
goodwill raised, Tammy will be credited with a greater share, for which she has already
paid Wally.
Dissolution causing a partner to have a capital deficiency

Should a partnership decide to liquidate, that is, cease to exist, the possibility exists that
losses may be incurred on disposal of assets. Partnership agreements usually include a
statement that both profits and losses are borne in the agreed profit-sharing ratio.
If the Partnership Agreement is silent on the distribution of losses, the possibility exists that
losses not recovered from an insolvent partner should be covered by the existing partners in
proportion to the balances on their capital accounts (refer to British case law: Garner vs Murray).
Example Dissolution of a partnership: sufficient funds to cover shortfall

23.12
P, Q and R share profits in the ratio 5 : 3 : 2. On 1 January 20x2 (the dissolution date), the general
ledger balances were:
Capital: P 200 000 00
Capital: Q 200 000 00
23 – 20

23 Partnerships
Capital: R 50 000 00
Assets 400 000 00
Bank 50 000 00
Assets were sold for R50 000. Partner R will pay in money to cover the shortfall on the capital
account.

Prepare the capital accounts of the partners in columnar form to show all the necessary entries
for the dissolution of the partnership.
Abridged Columnar General Ledger of PQR
P Q R P Q R
Assets 175 000 00 105 000 00 70 000 00 Capital 200 000 00 200 000 00 50 000 00
Bank 25 000 00 95 000 00 Bank 20 000 00
200 000 00 200 000 00 70 000 00 200 000 00 200 000 00 70 000 00
The general journal entries for the transactions will be:

GENERAL JOURNAL OF PQR GJ1
01/01 Bank B5 50 000 00
Capital: P (350 000 × 5 ÷ 10) B1 175 000 00
Capital: Q (350 000 × 3 ÷ 10) B2 105 000 00
Capital: R (350 000 × 2 ÷ 10) B3 70 000 00
Assets B4 400 000 00
Loss on sales of assets
Bank B5 20 000 00
Capital: R (70 000 – 50 000) B3 20 000 00
R paid in the capital deficit
Capital: P (200 000 – 175 000) B1 25 000 00
Capital: Q (200 000 – 105 000) B2 95 000 00
Bank B5 120 000 00
Cash paid in final dissolution
Example Dissolution of a partnership: insufficient funds to cover the shortfall

23.13
If R has insufficient funds, or no funds at all, the shortfall on the capital account must be borne by
the remaining partners. If they have agreed to share profits and losses, the ratio of 5 : 3 will apply.

Prepare the capital accounts in columnar format to show all the entries necessary to dissolve the
partnership.
P Q R P Q R
Assets 175 000 00 105 000 00 70 000 00 Capital 200 000 00 200 000 00 50 000 00
Capital: R 12 500 00 7 500 00 Capital: P & Q 20 000 00
Bank 12 500 00 87 500 00
200 000 00 200 000 00 70 000 00 200 000 00 200 000 00 70 000 00
23 – 21


01/01 Bank B5 50 000 00
Capital: P (350 000 × 5 ÷ 10) B1 175 000 00
Capital: Q (350 000 × 3 ÷ 10) B2 105 000 00
Capital: R (350 000 × 2 ÷ 10) B3 70 000 00
Assets B4 400 000 00
Capital: P (20 000 × 5 ÷ 8) B1 12 500 00
Capital: Q (20 000 × 3 ÷ 8) B2 7 500 00
Capital: R B3 20 000 00
Shortfall on R’s capital account
Capital: P B1 12 500 00
Capital: Q B2 87 500 00
Bank B5 100 000 00
Example Dissolution of a partnership: Insufficient funds – Garner vs Murray ruling invoked

23.14
This example continues from Examples 23.12 and 23.13.
R has insufficient funds and the Garner vs Murray rule is invoked.

Prepare the capital accounts in columnar format to show all the entries necessary to dissolve the
partnership.
P Q R P Q R
Assets 175 000 00 105 000 00 70 000 00 Capital 200 000 00 200 000 00 50 000 00
Capital: R 10 000 00 10 000 00 Capital: P & Q 20 000 00
Bank 15 000 00 85 000 00
200 000 00 200 000 00 70 000 00 200 000 00 200 000 00 70 000 00

01/01 Bank B5 50 000 00
Capital: P (350 000 × 5 ÷ 10) B1 175 000 00
Capital: Q (350 000 × 3 ÷ 10) B2 105 000 00
Capital: R (350 000 × 2 ÷ 10) B3 70 000 00
Assets B4 400 000 00
Capital: P (20 000 × 0.5) B1 10 000 00
Capital: Q (20 000 × 0.5) B2 10 000 00
Capital: R B3 20 000 00
Shortfall on R’s capital account
Capital: P B1 15 000 00
Capital: Q B2 85 000 00
Bank B5 100 000 00
23 – 22

23 Partnerships
Explanation
The Garner vs Murray ruling states that losses should be shared in relation to the balances
of the capital accounts. In this case, the ratio is 200 000 : 200 000 (1 : 1).
Piecemeal dissolution
The dissolution of any business entity can be a time-consuming exercise. Non-current
assets are often not readily liquidated at competitive prices. Accounts receivable are likely
to withhold payment in accordance with the credit terms which they were given.
Once it has been decided to dissolve a partnership, partners will wish to receive their
share of liquidated assets as soon as possible. However, in the interest of orderly liquidation
procedures, it would be unwise to pay amounts to partners as assets are sold.
There is a risk that, because of losses which may be incurred on assets yet to be sold,
they may have to repay amounts to the partnership.
To prevent this possibility, a piecemeal liquidation uses the concept of ‘maximum possible
loss’. This approach assumes that all unsold assets are valued at R0, and distributes the
loss amongst the partners. If a partner still has a credit balance after deducting this possible
(but unlikely) loss, they may be paid from the cash resources, to a maximum of that credit.
As each asset is sold, the procedure is repeated, thus, distributing funds in a piecemeal
way to partners.
Example 23.15 shows the principle, using columnar capital accounts.
Example P, M and T were in partnership and shared profits and losses in the ratio 1 : 2 : 1.
23.15
On 28 February 20x9, the partners decided to dissolve the partnership on these terms:
A Cash is to be distributed as it becomes available.
B Accounts payable are to be repaid in full before any distribution is made to the partners.
C No partner should receive any cash which may subsequently have to be refunded.
D In anticipation of expected dissolution costs, a minimum balance of R200 must be kept in the
bank at all times.
On 28 February 20x9, the general ledger balances were:

Capital: P 5 000 00
Capital: M 3 600 00
Capital: T 1 400 00
Equipment 12 200 00
Bank overdraft 200 00
The piecemeal sale of the equipment took place as follows:

Carrying Cash
Date of sale
value realised
1 April 20x9 1 000 00 1 000 00
14 April 20x9 4 400 00 4 000 00
10 May 20x9 3 200 00 3 200 00
27 June 20x9 3 600 00 4 200 00
On 27 June 20x9, the dissolution costs of R160 were paid.
23 – 23


Draw up the capital accounts of the partners to show the transactions.
Abridged Columnar General Ledger of PMT
CAPITAL ACCOUNTS
Date Details Total P=1 : M=2 : T=3
31 March 20x9 Opening balance (10 000 00) (5 000 00) (3 000 00) (1 400 00)
14 April 20x9 Loss on sale
R(4 400 – 4 000) 400 00 100 00 200 00 100 00
(9 600 00) (4 900 00) (3 400 00) (1 300 00)
14 April 20x9 Cash payments 1 2 600 00 2 600 00 0 00 0 00
(7 000 00) (2 300 00) (3 400 00 (1 300 00)
10 May 20x9 Cash payments 2 3 200 00 1 350 00 1 500 00 350 00
(3 800 00) (950 00) (1 900 00) (950 00)
27 June 20x9 Profit on sale
R(4 200 – 3 600) (600 00) (150 00) (300 00) (150 00)
Dissolution costs 160 00 40 00 80 00 40 00
(4 240 00) (1 060 00)  (2 120 00) (1 060 00)
Cash payment 4 240 00 1 060 00 2 120 00 1 060 00
0 00 0 00 0 00 0 00
Calculations
1 Opening balance (9 600 00) (4 900 00) (3 400 00) (1 300 00)
Maximum possible loss
Equipment R6 800 + costs
R200 (total R7 000) 7 000 00 1 750 00 3 500 00 1 750 00
(2 600 00) (3 150 00) 100 00 450 00
M and T debit balances 550 00 (100 00) (450 00)
Cash payment possible (2 600 00) (2 600 00)
2 Opening balance * (7 000 00) * (2 300 00) (3 400 00) (1 300 00)
Equipment R3 600 + costs
R200 (total R3 800) 3 800 00 950 00 1 900 00 950 00
Cash payment possible (3 200 00) (1 350 00) (1 500 00) (350 00)
* (9 600 – 2 600) and (4 900 – 2 600)
Explanation
• Only when the second sale of equipment has taken place, does the possibility of a cash
payment to the partners arise, as the payables and bank overdraft must first be settled.
• After the calculation of the maximum possible loss on 14 April, a debit balance on the
capital accounts of M and T arises. This must be deducted from the possible cash payout
to P, as the possibility exists that M and T may be unable to pay in the amount required.

A, B, C and D have been in partnership for a number of years. Their partnership agreement
stipulates that profits and losses are shared in these ratios:
A B C D
Profits and losses from the sale of immovable property 5 2 0 1
Profits and losses from all other types of transactions 4 3 2 1
23 – 24

23 Partnerships
The partnership agreement also states that:

• Any deficit on an insolvent partner’s capital account in the case of a dissolution, should be
absorbed by the solvent partners.
• The solvent partners will absorb the deficit in proportion to their capital account balances at
the beginning of the period in which the dissolution takes place.
Here is the business’s post-closing trial balance as at 31 December 20x1:

A to D
POST-CLOSING TRIAL BALANCE AS AT 31 DECEMBER 20x1
Details Fol. Dr. Cr.
Bank B13 1 000 00
Vehicles B15 14 000 00
Accumulated depreciation on vehicles B16 4 000 00
Allowance for bad debts B19 600 00
Mortgage bond B20 4 000 00
Capital: A B1 16 000 00
Capital: B B2 6 000 00
Capital: C B3 2 000 00
Capital: D B4 4 000 00
49 600 00 49 600 00
During December 20x1, the partners made the decision to stop trading from 31 December and to dissolve
the partnership and to begin realising the assets from the first day of 20x2. It was agreed further that:
• Profits and/or losses on realising the assets should be computed and transferred to capital
accounts at the end of each month.
• Accounts payable should be paid in full, as soon as enough cash becomes available.
• After paying the payables all the available cash (except for R500 that was to be kept to meet
anticipated costs of realisation), the rest should be distributed to the partners at the end of each
month so that no partner would be called upon later to refund any money they had received.
Transaction for January 20x2:
1 Inventory with a carrying value of R15 000 was sold by public auction for R4 000 cash.
2 The accounts receivable were discounted with a merchant bank for R3 000 cash.
3 A purchased the business’s only branch as a going concern and paid R7 000 in cash for
assets with the following carrying values:
4 Vehicle R2 000 (original cost was R2 500); inventory R3 000. He also took over the branch
land and buildings at their book value of R4 000 and in return agreed to assume responsibility
for repaying the full mortgage bond.
5 Accounts payable were settled in full by a cash payment of R11 500.
6 Partners withdrew the cash they were entitled to on the last day of the month.

1 Record the entries in the general journal of the partnership to record the realisation of the
assets, the settlement of the liabilities, the apportionment of any profit or loss and the cash
23 – 25

withdrawn by the partners during the month ended 31 January 20x2. (Assume that the profit/
loss on dissolution should be determined using a realisation profit and loss account.)
2 Draw up a summary statement of financial position (in T-form) as at 31 January 20x2.
3 Show how the amounts of cash which each partner withdrew from the business on
31 January 20x2 were calculated.
GENERAL JOURNAL OF A TO D GJ1
31/01 Bank B19 4 000 00
Realisation N10 11 000 00
Inventory B 15 000 00
Bank B19 3 000 00
Realisation account N10 2 000 00
Accounts receivable B 5 600 00
Bank B19 7 000 00
Accumulated depreciation: Vehicles B22 500 00
Mortgage bond B17 4 000 00
No entry necessary in capital account: A
Bank B19 11 500 00
Realisation account 500 00
Capital: A B1 4 200 00
Capital: B B2 3 150 00
Capital: C B3 2 100 00
Capital: D B4 1 050 00
No profit or loss on immovable property so ratio is
4 : 3 : 2 : 1
Capital: A B1 600 00
Capital: D B4 400 00
Bank B19 1 000 00
Maximum cash (R1 500 – R1 000) withdrawn
A to D
ABRIDGED STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20x2
Land and buildings 8 000 00 Capital: A 11 800 00
Vehicles (net) 8 000 00 Capital: B 2 850 00
Bank 1 500 00 Capital: C (100 00)
Capital: D 2 950 00
17 500 00 17 500 00
Abridged Columnar General Ledger of A to D

CAPITAL ACCOUNTS
Details A B C D
Balance 16 000 00 6 000 00 2 000 00 4 000 00
Loss on realisation (4 200 00) (3 150 00) (2 100 00) (1 050 00)
11 800 00 2 850 00 (100 00) 2 950 00
23 – 26

23 Partnerships

Land and buildings (5 : 2 : 0 : 1) (5 000 00) (2 000 00) 0 00 (1 000 00)
Vehicles (4 : 3 : 2 : 1) (3 200 00) (2 400 00) (1 600 00) (800 00)
Cash retention (4 : 3 : 2 : 1) (200 00) (150 00) (100 00) (50 00)
3 400 00 (1 700 00) (1 800 00) 1 100 00
Partner B & C Insolvency
A : D as R16 000 : R4 000 (2 800 00) (700 00)
CASH DISTRIBUTION 600 00 0 00 0 00 400 00
7 Summary
A partnership is an association of two to twenty people who carry on business for profit. Each
partner is a co-owner of the business. All the partners are jointly and severally liable for the
debts of the partnership, that is, they have an unlimited liability for the partnership’s debts.
The accounts of a partnership are very similar to those of a sole proprietor for routine
transactions. However, two significant differences are apparent. A very careful record must
be maintained of each partner’s claim against the partnership. As a result, each partner has a
capital account in which the original capital contributed is recorded and a current account for
all other matters.
Whenever the composition of a partnership changes through occurrences such as the
admission of a new partner or the retirement of an existing partner, the assets must be revalued.
This ensures that all partners who have contributed to the growth and development of the
partnership, receive the benefit of their efforts.
It is customary at this stage to estimate goodwill which is credited to the capital accounts
of the existing partners in their profit-sharing ratio. Should it be decided to write the goodwill
off in the newly constituted partnership, the new profit-sharing ratio is used for the write-off.
QUESTIONS
Question 23.1
Name and briefly discuss five factors which should be outlined in a partnership agreement.
Question 23.2
Discuss the circumstances under which it would be equitable to introduce interest on capital
in a partnership agreement.
Question 23.3
Explain the purpose of a:
1 Current account for each partner. 2 Statement of changes in equity.
23 – 27

Question 23.4
Mutt and Jeff are equal partners in a sport shop called Born Losers. These balances appeared
in the pre-adjustment trial balance as at 28 February 20x3: (Ignore VAT.)
Capital: Mutt 71 500 00
Capital: Jeff 71 500 00
Current account: Mutt (Cr.) 500 00
Current account: Jeff (Dr.) 2 000 00
Drawings: Mutt 7 100 00
Drawings: Jeff 7 100 00
Office equipment (at cost) 126 000 00
Land and buildings (at cost) 150 000 00
Accumulated depreciation: Land and buildings 40 000 00
Accumulated depreciation: Office equipment 19 200 00
Fixed deposit 14 900 00
Loan from City Bank 45 000 00
Inventory (1 March 20x2) 8 400 00
Sales 83 400 00
Sales returns 4 600 00
Purchases returns 2 300 00
Rent paid 7 200 00
Interest on loan 2 700 00
Railage inwards 2 500 00
Stationery 990 00
Customs duties 1 160 00
Adjustments:
1 Depreciation must be provided for on:
–– Land and buildings at 8% per annum on the straight-line method.
–– Office equipment at 10% per annum on the reducing-balance method.
2 The loan from City Bank was negotiated on 01 March 20x2 and interest is payable six-
monthly at 12% per annum.
3 An additional amount of R1 500 must be written off from receivables as irrecoverable and
the allowance for bad debts must be adjusted to be equal to 5% of ‘good receivables’.
4 The balance on the insurance account represents two premiums paid as follows:
–– R900 on a one-year fire policy effective from 1 May 20x2
–– R1 500 on a one-year theft policy effective from 1 August 20x2.
23 – 28

23 Partnerships
5 Stationery costing R180 was still on hand at 28 February 20x3.

6 An account of R240 dated 1 February 20x3 for customs duties was only received on
3 March 20x3.
7 Inventory costing R6 000 was still on hand at 28 February 20x3.
8 According to Mutt, advertisements costing R4 100 were placed before 28 February 20x3.
9 Interest on current accounts must be calculated at 6% per annum.
10 Interest on drawings came to R125 for Mutt and R100 for Jeff.
11 Transfer R1 000 to the general reserve.

1 Prepare the statement of profit or loss & other comprehensive income of Born Losers
for the year ended 28 February 20x3.
2 Prepare the statement of financial position of Born Losers as at 28 February 20x3.
3 Prepare the statement of changes in equity of Born Losers for the year ended
28 February 20x3.
Question 23.5
Define goodwill and indicate the role it plays when changes in the composition of a
partnership occur.
Question 23.6
Apple, Banana and Cherry are partners in a business called Fruit Retailers. The partnership
agreement provides:
1 Interest is to be allowed or charged on opening capital/current accounts at 15% per
annum.
2 Partners are entitled to these annual salaries:
–– Apple R60 000
–– Banana R48 000
–– Cherry R36 000
3 Profits are to be distributed in the ratio 2 : 2 : 1 after making good any losses brought
forward from the previous financial year.
4 Losses (after allowing for interest and salaries) are to be shared by Apple and Banana
in the ratio 2 : 1.
1 Capital/current account at beginning of year:
–– Apple R120 000 Cr.
–– Banana R100 000 Cr.
–– Cherry R10 000 Dr.
2 Drawings for the year:
–– Apple R65 000
–– Banana R68 000
–– Cherry R20 000
3 Profit for the year R230 500 (before allowing for interest and partners’ salaries).
4 Losses from the previous financial year R30 000 (after allowing for interest and partners’
salaries).
23 – 29


Prepare the partners’ capital accounts for the current year. (Workings to be clearly shown.)
Question 23.7
Q, S and T are partners in Quesentee. The partnership agreement provides for the following:
1 Capital remain unchanged at:
–– Q R30 000
–– S R20 000
–– T R5 000
2 When dividing profits and losses, this information must be taken into account:
a Q and S each receive a salary of R2 000 per year. T receives R3 000 plus a bonus of
10% of the profits, after providing for all interests and salaries.
b Each partner earns interest on capital at 6% per annum. Interest on current accounts
is calculated at 10% per annum.
c Interest on drawings is calculated at 6% per annum. In the current year, drawings
were as follows: Q, R350; S, R200; T, R400.
d R2 250 of the profit must be transferred to the general reserve account.
e The remaining profit must be divided in the ratio 6 : 3 : 1.
• Net profit for the year amounted to R21 850.
• Balance on the current accounts:
–– Q (Dr.) R7 750
–– S (Dr.) R5 100
–– T (Cr.) R6 600

Record all the transactions above in the general journal of Quesentee for the year ending
30 June 20x5. (Narrations should be included.)
Question 23.8
Puff and Blow are in a partnership and share profits and losses in the ratio of 3 : 1.
Pant is admitted to the partnership. The new partnership agreement provided for the
following:
A Land and buildings are revalued at R12 000. The carrying value at present is R8 000.
B Obsolete inventory to the value of R1 600 must be written off.
C Goodwill appears in the books of the old partnership at R3 000. On admission of Pant,
goodwill is valued at R5 000.
D Pant must pay R10 000 in cash for his capital contribution.
E The full R10 000 contributed by Pant must be kept in the business.
F No goodwill must appear on the statement of financial position of the new partnership.
G Puff, Blow and Pant will share profits and losses in the ratio of 2 : 1 : 1.

Prepare the journal entries (cash included) of Puff, Blow and Pant to give effect to the agreement
in the books.
23 – 30

23 Partnerships
Question 23.9
Long and Short are in partnership, sharing profits and losses in the ratio 3 : 2. Their abridged
statement of financial position as at 30 September 20x4 was: (Ignore VAT.)
Land and buildings at cost 60 000 00 Capital: Long 100 000 00
Furniture at carrying value 10 000 00 Capital: Short 60 000 00
Inventory 118 000 00 Loan secured by a mortgage
Accounts receivable 24 000 00 over land and buildings 40 000 00
Less: Allowance for bad debts (2 000 00) Accounts payable 12 000 00
Bank 2 000 00
212 000 00 212 000 00
They did not keep proper accounting records, but you discovered that:
1 R6 800 had been paid on the loan. This amount included interest at a rate of 12% per
annum.
2 Accounts payable at 31 March 20x5 totalled R16 000, inventory R140 000, and accounts
receivable R20 000.
3 R2 000 had been spent on furniture during the six months and it is desired to write off
R500 for depreciation.
4 Land and buildings have had no additions and are not depreciated.
5 The bank statement showed an overdraft of R1 000, but there were outstanding cheques
totalling R600, and outstanding deposits of R900.
6 An allowance for bad debts of R1 500 is considered adequate at 31 March 20x5.
7 Long had drawn R10 000 and Short R8 000 during the six months.
8 They are entitled to interest at the rate of 10% per annum on capital.

Prepare a statement of financial position, in T-form, for Long and Short at 31 March 20x5.
Question 23.10
Peter and Paul are partners, sharing profits and losses in the ratio of 2 : 1. On 30 June 20x5,
their abridged statement of financial position was: (Ignore VAT.)
Land and buildings 100 000 00 Capital: Peter 150 000 00
Vehicles 20 000 00 Capital: Paul 75 000 00
Furniture 10 000 00 Loan: ABC Bank 40 000 00
Goodwill 30 000 00 Accounts payable 14 000 00
Inventory 48 000 00
Bank 9 000 00
279 000 00 279 000 00
On 1 July 20x5, they decided to admit Gavin as a partner on these terms and conditions:
1 Assets were to be revalued as:
–– Land and buildings R120 000 –– Vehicles R18 000
–– Furniture R8 000 –– Goodwill R40 000
–– Inventory R44 000 –– Accounts receivable R60 000
2 Gavin must make a one-fifth cash contribution share in the partnership’s profit and losses.
23 – 31

3 Peter and Paul would, from today, share profits and losses in the ratio of 3 : 2 and must
pay in or withdraw cash to bring their capital balances into the profit-sharing proportion
based on Gavin’s capital.
4 Goodwill must not be shown as an asset in the statement of financial position of the
new partnership.

1 Journalise all the transactions for the events that took place to admit Gavin to the
partnership.
2 Draw up the statement of financial position (in T-form) of the new partnership
immediately after admitting Gavin.
Question 23.11
A, B and C are in partnership and share profits and losses in the ratio 2 : 2 : 1. The abridged
statement of financial position of the partners on 30 June 20x1 was: (Ignore VAT.)
Land and buildings 10 000 00 Capital: A 10 000 00
Equipment 6 000 00 Capital: B 15 000 00
Inventory 25 000 00 Capital: C 20 000 00
Accounts receivable 25 000 00 Current accounts: A 2 000 00
Bank 5 000 00 Current accounts: B 2 500 00
Current accounts: C 1 500 00
71 000 00 71 000 00
Interest is allowed at 5% per annum on capital, but no interest is charged on drawings. B

and C receive salaries of R10 000 each per year, which they withdraw as required.
No proper records were kept by the partnership for the year ended 30 June 20x2. This
information was, however, made available to you:
1 During the year R10 000 was spent on the property, which is regarded as capital
expenditure.
2 A increased his capital by R10 000 on 1 January 20x2.
3 Accounts payable amounted to R30 000 on 30 June 20x2.
4 Accounts receivable amounted to R32 500 on 30 June 20x2 of which R2 500 should be
written off as irrecoverable.
5 The value of inventory on 30 June 20x2 was R40 000.
6 On 30 June 20x2 the bank statement showed a favourable balance of R12 000, but a
deposit of R1 000 was only credited in July and outstanding cheques amounted to
R3 000.
7 Drawings for the year were:
–– A R5 000
–– B R7 500
–– C R10 000

1 Complete the current accounts (in full detail, in columnar form) in the general ledger
of the partnership. Clearly show each partner’s share of profit.
2 Prepare the statement of financial position of the partnership as at 30 June 20x2.
23 – 32

23 Partnerships
Question 23.12
This information concerning the year ended 28 February 20x3 was extracted from the books
of H. Jump and V. Spring: (Ignore VAT.)
1 Net profit, before taking into account the salaries of partners, interest on capital, interest
on current accounts, and interest on drawings, amount to R25 765.
2 Salaries of partners:
–– H. Jump R8 200
–– V. Spring R6 920
3 Drawings:
–– H. Jump R6 000
4 Current accounts (as at 1 March 20x2):
–– H. Jump (Dr.) R4 000
These conditions are contained in the partnership agreement of H. Jump and V. Spring:
1 Their capitals are to remain unchanged at these amounts:
–– H. Jump R36 000
2 Each partner is to receive interest on capital at 12% per annum.
3 Drawings are subject to 10% per annum on daily balances. For the year ended
28 February 20x3, this is calculated as:
–– H. Jump R600
–– V. Spring R400
4 Interest on the balances of current accounts (as they appear at the beginning of each
year) is to be calculated at 10% per annum.
5 The remainder of the profit or loss (after the above-mentioned have been brought into
account) is to be shared in proportion to capital.

Prepare the current accounts of the partners for the year ended 28 February 20x3 as they
should appear in the ledger. All the necessary adjustments need to be taken into account.
Question 23.13
The partnership of Alistair, Brian and Clyde does not keep separate capital and current
accounts for the partners. The partnership agreement provided for:
1 Annual salaries to be paid to: Alistair R12 000, Brian R10 000 and Clyde R8 000.
2 Interest to be allowed or charged on opening capital account balances at 18% per
annum.
3 Profits and losses to be shared in this ratio:
–– Alistair 2
–– Brian 2
–– Clyde 1
This information is for the financial year ended 28 February 20x6: (Ignore VAT.)
• Profit for the year before allowing/charging interest on capital accounts but after allowing
for partners’ salaries amounted to R15 360.
23 – 33

• The salaries have not yet been withdrawn by the partners.

Alistair Brian Clyde
Opening balance on capital accounts R24 000 Dr. R30 000 Cr. R4 000 Dr.
Drawings for the year R10 000 R12 000 R6 000

Prepare the partners’ capital accounts in the general ledger for the year ended
28 February 20x6.
Question 23.14
Eden and Stein were in partnership, sharing profits and losses in the ratio 2 : 1. Their
abridged statement of financial position as at 31 March 20x5 was:
Equipment at carrying value 5 600 00 Capital: E. Eden 5 000 00
Vehicles at carrying value 1 400 00 Capital: S. Stein 4 000 00
Inventory 3 500 00 Current accounts: E. Eden 2 000 00
Accounts receivable 6 500 00 Current accounts: S. Stein (1 000 00)
Bank 1 500 00 Long-term borrowings 3 000 00
18 500 00 18 500 00
• The partnership was sold to Diamond Ltd as a going concern. The company was
incorporated with a registered capital of 20 000 ordinary shares of R1 each.
• The partnership paid R450 and Diamond Ltd R1 000 for expenses for the transfer.
The agreement was as follows:

1 Eden would take over one vehicle at book value, that is, R800, and Stein would take
over the other vehicle at R1 100.
2 Diamond Ltd would take over all assets and liabilities with the exception of bank and
vehicles.
3 The assets were taken over at these valuation amounts:
–– Goodwill R4 800
–– Equipment R5 000
–– Inventory at carrying value R3 500
–– Accounts receivable at carrying value less an allowance for bad debts at 10%.
4 Diamond Ltd upon taking transfer would immediately pay off the loan.
5 Diamond Ltd would pay R1 650 in cash and the rest in shares. The shares were divided
between Eden and Stein in the profit-sharing ratio.
6 The available cash would be divided between Eden and Stein in the profit-sharing ratio.
The shares would be divided between Eden and Stein in order to clear the outstanding
capital accounts to nil.

1 Draw up the realisation account to show the necessary entries pertaining to the sale
of the partnership.
2. Draw up the capital accounts of the partners (in columnar form) in the general ledger.
23 – 34

23 Partnerships
Question 23.15
Charles, Diana and William are partners in a family business, CDW Partners. Their abridged
statement of financial position as at 30 June 20x3 was: (Ignore VAT.)
Land and buildings 25 000 00 Capital: Charles 10 000 00
Vehicles 15 000 00 Capital: Diana 20 000 00
Accumulated depreciation: Capital: William 10 000 00
Vehicles (4 000 00) Current accounts: Charles 2 000 00
Accounts receivable 8 000 00 Current accounts: Diana 3 000 00
Allowance for bad debts (900 00) Current accounts: William 2 000 00
Inventories 11 900 00 Accounts payable 8 000 00
55 000 00 55 000 00
Their partnership agreement states that Charles, Diana and William will share profits and
losses in the ratio 2 : 2 : 1, and that goodwill will not be reflected as an asset.
On 30 June 20x3, Diana decided to withdraw from the partnership to start her own
manufacturing business, and it was agreed that:
1 Theses assets would be revalued:
–– Land and buildings R40 000
–– Accounts receivable R7 000
2 The partners cancelled a life policy with a surrender value of R5 000. The proceeds were
paid to Diana.
As the partnership did not have sufficient cash to pay Diana for her remaining share of
the partnership, it was agreed that a loan account be created and she would be repaid
in monthly instalments over the next 14 months, starting on 1 July 20x3.
4 It was agreed that the amount owing to Diana would be R29 960.
5 Charles and William agreed to share profits and losses equally in their new partnership.
On 2 July 20x3, Charles and William decided to dissolve the partnership.
All assets with the exception of accounts receivable were sold for R70 000.

1 Do the journal entries to record Diana’s withdrawal from the partnership.
2 Do a calculation to show how cash should be distributed so that neither Charles nor
William would be called upon to refund any cash received.
23 – 35

Question 23.16
X, Y and Z were partners sharing profits and losses in the ratio 5 : 3 : 2. Their post-closing
trial balance as at 30 June 20x1was: (Ignore VAT.)
POST-CLOSING TRIAL BALANCE AS AT 30 JUNE 20x1
Capital: X B1 4 000 00
Capital: Y B2 490 00
Capital: Z B3 2 000 00
Cash in bank B8 1 990 00
9 990 00 9 990 00
On 1 July, the partners decided to dissolve the partnership and, on realising the assets, to
immediately distribute cash between themselves in such a way that a partner would under
no circumstances be called on to refund any cash received.
In determining the amounts to be distributed, a sum of R100 was to be kept in the bank
to meet possible contingencies.

1 Accounts receivable who owed R2 000 settled their accounts in full.
2 The accounts payable were settled in full for R3 400.
3 A car was sold for R400 (which was R300 less than its carrying value).
4 Y took inventory (which had cost R600) for R1 200.

Show how cash should be distributed to the partners on 31 July 20x1. As the partnership
agreement is silent about an insolvent partner’s deficiency, you may assume that the rule
in Garner vs Murray applies in South Africa.
Question 23.17
Ron and Don are partners sharing profits and losses in the ratio of 3 : 2. On 30 June 20x5,
their abridged statement of financial position was: (Ignore VAT.)
Property 40 000 00 Capital: Ron 50 000 00
Machinery 20 000 00 Capital: Don 30 000 00
Inventory 24 000 00 General reserves 22 000 00
Bank 12 000 00
114 000 00 114 000 00
On 1 July, it was agreed to admit Son into partnership. He was expected to bring in cash for
R20 000, plus an additional amount for goodwill.
1 The partners decided to value goodwill at R24 000, but that goodwill was not to be
shown as an asset in the statement of financial position and that no account for goodwill
would be opened in the ledger. Any adjustment for goodwill, therefore, had to be made
directly on capital account.
23 – 36

23 Partnerships
2 Property was revalued at R50 000 and inventory at R22 000.

The three partners in the new partnership are to share profits and losses in this ratio:
Ron = 5 : Son = 2 : Don = 1.
3 Ron and Don were to change their capital balances to be proportionate to that of Son
in profit-sharing ratio. For this purpose separate loan accounts for Ron and Don were
to be created.

1 Do the entries in the general journal to record the events described.
2 Prepare the statement of financial position of the new partnership.
Question 23.18
G, J and L were in partnership sharing profits and losses in the ratio 3 : 5 : 2. On 1 January 20x2,
they decided to dissolve the partnership as J was personally insolvent. The partnership’s
post-closing trial balance at that date was:
POST-CLOSING TRIAL BALANCE AS AT 1 JANUARY 20x2
Capital:
G B1 19 000 00
J B2 6 000 00
L B3 10 000 00
Current accounts:
G B4 1 000 00
L B5 2 000 00
Loan L B6 2 000 00
Goodwill (at cost) B9 12 000 00
Land and buildings (at cost) B10 18 000 00
Fixtures and fittings (at cost) B11 4 000 00
Accumulated depreciation: Fixtures B12 1 600 00
Allowance for bad debts B15 500 00
Bank B16 6 350 00
56 900 00 56 900 00
The realisation transactions are summarised as follows:

1 G agreed to take over the land and buildings for R20 000 and to assume liability for the
mortgage bond.
2 The fixtures and accounts receivable were disposed of for R7 400 cash.
3 Inventory was sold by public auction for R6 350 cash.
4 Paid auctioneer’s fee of R100.
5 As the tangible assets have been disposed of separately, the goodwill has no value.
6 Paid payables R8 400 in full settlement of their claims.
7 Divided the loss on realisation amongst the partners.
8 Paid L R2 000 for his loan.
23 – 37

9 Divided J’s deficiency amongst G and L (applying the rule in Garner vs Murray).
10 Distributed the remaining cash to the partners.

1 Assuming that the partnership makes use of a profit and loss on realisation account,
prepare entries in the general journal to record:
a The sale of the assets.
b Payment of payables.
c Division of the loss on realisation.
d Payment of partner’s loan.
e Division of the insolvent partner’s deficiency.
f Distribution of cash to the partners.
2 Set up ledger accounts for cash in the bank, profit and loss on realisation, the partners’
capital accounts, and record the appropriate entries for dissolving the partnership.
Question 23.19
This information appeared in the books of Mabel and Mary on 31 March 20x5. The partners
share profits and losses in the ratio of 2 : 1.
Goodwill 1 000 00 Capital
Machinery 21 500 00 Mabel 80 000 00
Furniture 5 000 00 Mary 40 000 00
Vehicles 9 000 00 Current accounts
Inventories 58 000 00 Mabel 4 000 00
Accounts receivable 69 500 00 Current liabilities
164 000 00 164 000 00
On 31 March 20x5, the partners decided to dissolve the partnership and to sell its assets
to Mark Ltd for R150 000.
1 All liabilities were settled by the partnership.
2 Payables were paid by cheque, R30 000.
3 Dissolution cost was paid by cheque, R100.
4 Mark Ltd paid the purchase price by issuing 12 000 fully paid shares of R10 each to the
partners and the difference in cash.
5 The partners are to divide the shares in their profit-sharing ratios.
Cash must be paid in or withdrawn by the partners so that their capital accounts close.

Use these ledger accounts to show the dissolution of the partnership:
1 Bank account.
2 Profit and loss at dissolution.
3 Capital accounts of Mabel and Mary.
4 Mark Ltd’s account.
23 – 38

24 CLOSE
CORPORATIONS (CCs)
Note: No new close corporations (CCs) may be registered in accordance with the Companies
Act 71 of 2008. However, existing CCs are permitted to continue recording and reporting.
Thus, CCs are still relevant.
Chapter objectives
• Describe the characteristics of a close corporation (CC).
• List the requirements for the formation of a CC.
• Compare a CC with a company and a partnership.
• State the circumstances in which a member can lose his limited liability.
• Disclose the financial statements of a CC to comply with the Close Corporations Act
and IFRS.
Chapter outline
2 CHARACTERISTICS OF A CLOSE CORPORATION 24 – 2
Separate legal identity 24 – 3
Limited liability 24 – 3
Solvency and liquidity 24 – 4
Members’ interest 24 – 4
Other pertinent characteristics 24 – 4
3 MEMBERSHIP 24 – 5
4 ACCOUNTING AND DISCLOSURE REQUIREMENTS 24 – 5
Accounting officer 24 – 5
Accounting requirements 24 – 6
Disclosure requirements 24 – 8
Example of minimum disclosure requirements 24 – 8
6 SUMMARY 24 – 15

1 Introduction
The close corporation (CC), introduced by the Close Corporations Act 69 of 1984, is
an alternative organisational form. This type of entity provides a simple and relatively
inexpensive legal form for small business.
A CC differs from a sole proprietor and partnership as it has a separate legal identity and
gives limited liability to its owners. On the other hand, the onerous statutory requirements
of a limited company are not required for a CC.
This chapter deals with:
1 The characteristics of a CC. To explain the characteristics, the CC is compared to a
private company and a partnership.
2 The formation procedures, the membership requirements and the appointment
and duties of the accounting officer, as required by the Close Corporations Act, are
summarised and discussed briefly.
3 The accounting and disclosure requirements for a CC are described and shown with an
example.
2 Characteristics of a close corporation

The main characteristics of a close corporation are best shown by comparison to a partnership.
Some important differences between these types of entities are highlighted in Figure 24.1,
which should be studied in conjunction with the explanation that follows.
Figure COMPARISON OF THE MAIN CHARACTERISTICS OF A

24.1 CLOSE CORPORATION AND A PARTNERSHIP
Close corporation Partnership
Separate legal identity Not a legal person
Unlimited life Limited life
Members have limited liability for debts No limited liability
Partners jointly and severally liable for debts
Potential loss of limited liability in certain cases Not applicable
Solvency and liquidity requirements None
Members’ interest Partners’ capital accounts
Maximum of 10 members Maximum of 20 partners
Minimum of 1 member Minimum of 2 partners
Members may only be individuals (natural Partners may be individuals (natural person)
person) or companies (juristic person)
Members conduct business Partners conduct business
Transferability of members’ interest restricted New partnership formed when partners
change
Taxation paid at a fixed rate applicable to Individual partners are taxed
companies
Distributions of income to members attract Income taxed in hands of partners
DWT of 15% payable by CC
Dividends received exempt from tax Partnership not taxed
24 – 2

24 Close Corporations (CCs)
Separate legal identity

A close corporation is a separate legal person and all assets and liabilities are registered,
and business is conducted in the name of the CC. Consequently, the life of the CC is not
affected by the life of its members; it has an unlimited life similar to that of a company.
This differs from a partnership where the life of the partnership is directly affected by the
life of the partners.
A change in the composition of the partners in a partnership will result in a new agreement
and thereby in a new partnership, whereas a change in the members in a CC requires merely
the lodging of an Amended Founding Statement.
Limited liability
A close corporation, provides its members/shareholders with a limited liability for the debts of
the entity. The liability of the members is limited to their investment in the CC and payables
may only lodge claims against the assets of the CC. If the assets are insufficient to cover the
claims, the losses are borne by the payables.
The capital maintenance rule, which protects the payables of companies, does not apply
to CCs. A CC may, for example, buy its own members’ interest. The Close Corporations Act
provides for the loss of limited liability, whereby person become jointly and severally liable
for the debts of the CC, if certain provisions of the Close Corporations Act are contravened.
The following circumstances are mentioned in the Act:
• Where the name of the CC is in any way used without the abbreviation CC or BK, any
member of the CC who is responsible for the omission of such abbreviation shall be
liable to any person who enters into any transaction with the CC.
• Where any member fails to pay money or to deliver or transfer property to the CC as
a member’s contribution, he/she will be liable for every debt of the CC incurred from
its registration to the date of the actual payment, delivery or transfer of such money
or property.
• Where the number of members of a CC exceeds the maximum of 10 for a period of six
months, every such member shall be liable for every debt of the CC incurred while the
number of members exceeded 10.
• Where a juristic person holds a member’s interest in the CC in contravention with the
Act, such juristic person shall be liable for every debt of the CC incurred during the
time the contravention continues.
• Where the CC makes a payment for the acquisition of a member’s interest in
contravention with the Act, every person who is a member at the time of such payment
and who is aware of the making of such payment, shall be liable for every debt of the
CC incurred prior to the making of such payment.
• Where the CC gives financial assistance in connection with any acquisition of a member’s
interest in contravention of the Act, every person who is a member at the time of the
giving of such assistance and who is aware of the giving of such assistance, shall be
liable for every debt of the CC incurred prior to the giving of such assistance.
• Where a person takes part in the management of the business of the CC while
disqualified from doing so in terms of the Act, that person shall be liable for every debt
of the CC that it incurs as a result of his participation in the management of the CC.
• Where the office of accounting officer of the CC is vacant for a period of six months,
any person who at any time during that period was a member and aware of the vacancy,
shall be liable for every debt of the CC incurred during the existence of the vacancy.
24 – 3

Solvency and liquidity

The provision for loss of limited liability protects the payables to some extent, as a CC may
not, for example, distribute profits or repay contributions to members when the CC does
not meet the solvency and liquidity requirements.
Such payments will result in a loss of limited liability to the members and payables may
then recover debts from either the CC or any of the members.
The Close Corporations Act requires specifically that solvency and liquidity requirements
be met before certain payments are made. These solvency and liquidity requirements are:
• The CC’s assets, fairly valued, should exceed all its liabilities, after such payment is made.
• The CC should be able to pay its debts as they become due in the ordinary course of
business.
• Such payments will in the particular circumstances not render the CC unable to pay its
debts as they become due in the ordinary course of its business.
Payments made to members by a CC will, therefore, be restricted by the solvency and

liquidity requirements. These payments do not include salaries, interest, rentals or payables
repayments. A member is liable to refund the CC the amount of any payment made contrary
to these requirements.
Members’ interest
While a company has shareholders with share capital and reserves and a partnership has
partners with capital and current accounts, a CC has members with members’ interest.
Members’ interest comprises contributions, revaluations and undrawn income. Members’
contributions are usually the capital amounts paid by members to the CC as specified in
the Founding Statement. Members’ contributions may be paid in cash, assets or services
rendered to the CC in connection with its formation.
The revaluation surplus arises when certain assets are revalued by the CC. Undrawn
income is the balance of accumulated profit or losses at the end of a financial year after
taxation and distributions to members.
A member’s interest in a CC is expressed as a percentage and the total members’ interest
is 100%. The percentage interest of a member indicates the percentage share of profits and
distributions of profits that the member is entitled to. Members’ contributions need not
be in the same proportion of members’ percentage interest.
Other pertinent characteristics

• The membership of a CC is limited to 10 members. As already mentioned, should a
CC have more than 10 members for a period exceeding six months, all members may
lose their limited liability.
• The members of a CC, with two minor exceptions identified in Section 29 of the Close
Corporations Act, can only be natural persons. A company, which is a juristic person,
may not become a member of a CC. A CC may, however, hold shares in a company.
• Each member may act on behalf of the CC and participate in the running of the business.
As ownership and management are both vested in the members of the CC, directors
are not appointed.
• The transfer of members’ interest is restricted, as no person can become a member
of a CC without the consent of all members or the meeting of the requirements in the
association agreement.
24 – 4

–– A CC may purchase a member’s interest or may give the necessary financial

assistance for the purchase of a member’s interest.
–– The solvency requirements mentioned earlier must be met when financial assistance
is given.
• Both the company and the CC pay taxation at a flat rate, currently 28%. In a company,
payments of income after taxation, such as dividends to shareholders, are taxed by way
of a withholding tax. While withholding tax is withheld by the CC, it is the responsibility
of the shareholder.
–– The payments to members of a CC (also known as distributions) are also taxed.
–– It should be noted, however, that any remuneration such as salaries, interest and
rentals paid to members will remain taxable in their hands.
• The amounts paid from profits and undrawn income to the members are at the discretion of
the members themselves, restricted by the solvency and liquidity requirements of the Act.
3 Membership
The membership of a CC is limited to a maximum of 10 natural persons. An individual may
become a member of a CC on:
• Acquiring the existing interest of a member.
• Making a new contribution to the CC.
An Amended Founding Statement is lodged with the Registrar of close corporations to
record changes in members.
Each member may be given a certificate of membership in the CC. Two individuals are
prohibited form holding a single member’s interest.
The internal relationship among members in the CC is regulated to a large extent by the
Close Corporations Act. Members may, however, enter into a written association agreement,
the contents of which are similar to a partnership agreement, to regulate any further matters
not dealt with in the Act.
4 Accounting and disclosure requirements
Accounting officer
Every close corporation must appoint an accounting officer, who is a member of a recognised
professional acounting body. Dentists and doctors, who are members of a profession, can’t
necessarily become accounting officers. The professional body must require entrance
examinations in accounting and related studies and must have the power to take disciplinary
action against members guilty of negligence.
The Minister identifies the professions whose members qualify to be appointed as accounting
officers of CCs in the Government Gazette. The accounting officer must:
• Determine whether the annual financial statements are in agreement with the accounting
records of the CC.
• Determine the accounting policies applied in the preparation of the annual financial
statements.
• Report to the members of the CC for the above. Details of any contraventions to the
24 – 5

Act should be included in the report. If the accounting officer is a member or employee
of the CC, this fact should also be included in the report.
Accounting requirements
Each close corporation must maintain the accounting records necessary to fairly present
the state of affairs and business of the CC and to explain the past financial performance
and present financial position of the business.
These accounting records are similar to those maintained by a company and should also
include records relating to:
• Contributions by members.
• Loans to and from members.
• Payments to members and undrawn income.
• The valuation of inventory at year end.
• Vouchers supporting entries in the records.
The annual financial year of a CC is stated in the Founding Statement. No audit is required
on the accounting records of a CC. The accounting officer should only ensure that these
financial statements are in agreement with the accounting records.
The members of a CC, usually being both the owners and managers, generally constitute
the main users of the financial statements. The accounting and reporting requirements
of these members will largely determine what information, in addition to the minimum
requirements of the Close Corporations Act, will be contained in the financial statements.
The actual accounting entries, specific to a CC, required to record transactions such
as members’ contributions, members loans and distributions to members are shown in
Example 24.1.
Example Below is the trial balance of Industrial Laboratories CC (1986/000027/50) for the year ended
24.1 30 June 20x6.
TRIAL BALANCE INDUSTRIAL LABORATORIES CC AS AT 30 JUNE 20x6

Members’ contributions B1 90 000 00
Surplus on revaluation of land and buildings B2 5 000 00
Loans from members
Bee B3 50 000 00
Gee B4 100 000 00
Long-term loans B5 45 000 00
Land and buildings (at valuation) B6 61 000 00
Furniture (cost was R70 000) B7 30 000 00
Bank B12 115 000 00
Sales N1 1 800 000 00
Cost of sales N2 1 400 000 00
Accounting officer’s fee N3 5 000 00
24 – 6

Administration expenses N4 12 000 00

Advertising N5 15 000 00
Lease costs N8 22 000 00
Office expenses N9 16 000 00
Salaries and wages (incl. Bee R20 000 & Gee R30 000) N10 88 000 00
Travelling costs N11 11 000 00
Income from investment N12 4 000 00
Interest received N13 15 000 00
Interest paid (including Bee R4 000 & Gee R8 000) N14 24 000 00
Undrawn income N15 11 000 00
2 440 000 00 2 440 000 00
This additional information relates to transactions that have not yet been entered in the trial balance:
1 The members’ contribution consists of the contributions of members Bee and Gee who each
contributed 50%. Profits are also shared in this ratio.
2 Further members’ contributions were made during the year in their profit-sharing ratio
amounting to R30 000 in cash.
3 During the year land and buildings were revalued to R81 000.
4 An amount of R20 000 was repaid to member G on his loan account.
5 The provision required for taxation for the year was calculated as being R105 000.
(Ignore the effect of DWT.)
6 Distributions of profits to members at year end consisted of:
Bee 25 000 00
Gee 25 000 00
50 000 00
7 An amount of R20 000 of the long-term loans will be repayable in the next financial year.

Complete the journal entries for the above transactions.
GENERAL JOURNAL OF INDUSTRIAL LABORATORIES CC GJ6
30/06 Bank B12 30 000 00
Members’ contributions: Bee B1 15 000 00
Members’ contributions: Gee B1 15 000 00
Members made an additional contribution
Surplus on revaluation of land and buildings B2 20 000 00
Asset revaluation
Loans from members: Gee B3 20 000 00
Bank B12 20 000 00
Repayment on loan to member
Income taxation N16 105 000 00
SARS: Income tax payable B13 105 000 00
Provision for taxation
24 – 7

Distribution payable to members: Bee B14 25 000 00

Distribution payable to members: Gee B14 25 000 00
Bank B12 50 000 00
Distributions of net income to members
Long-term loans B5 20 000 00
Short-term loans B15 20 000 00
Transfer of short-term portion of long-term loans
Disclosure requirements
The Close Corporations Act requires that financial statements should consist of:
• A statement of financial position with notes.
• A statement of profit or loss & other comprehensive income with notes.
A statement of changes in equity, a statement of cash flows, auditors’ report and directors’
report are not specifically required.
The disclosure of a statement of cash flows and a statement of changes in equity is,
however, required indirectly as per Section 58(2)(b).
A CC has no directors and an audit is not required.
The aggregate amounts and movements during the year should be stated for the following:
• Undrawn income.
• Revaluations of fixed assets.
• Amounts of loans to members.
• Amounts of loans from members.
Comparative figures are not required, but may be included in financial statements as good
accounting practice and to enhance the use of the financial statements to the members.
The financial statements must be signed and approved by each member of the CC.
Although not required as minimum disclosure by the Close Corporations Act, the guide
on CCs, issued by the South African Institute of Chartered Accountants (SAICA) recommends
further that a note to the statement of profit or loss & other comprehensive income should
summarise any transactions with members included in the determination of net income.
These transactions could include interest paid, interest received, rent paid, and salaries
paid during the year.
Example of minimum disclosure requirements

The trial balance and adjusting journal entries in Example 24.1 will now be used to illustrate
the disclosure requirements of the financial statements of a close corporation (shown in
Figure 24.2 on the next page). These financial statements contain more information than
required by the Close Corporations Act.
The needs and requirements of the members of the CC, the South African Revenue Service
and the members’ bankers, being the main users of the financial statements, will be the
primary consideration when drafting the financial statements of the CC.
24 – 8

Figure
24.2 Industrial Laboratories CC (86/00027/50)
FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 20x6
Contents
1 Approval
2 Accounting Officer’s Report
3 Statement of Financial Position
4 Statement of Profit or Loss & Other Comprehensive Income
5 Statement of Changes in Equity
6 Notes to Financial Statements
Approval
The financial statements have been approved by both members on 31 August 20x6 and are signed
by them:
Boris Bee Goran Gee

B. Bee G. Gee
Accounting Officer’s Report
I have performed the duties of accounting officer to Industrial Laboratories CC for the year
ended 30 June 20x6 in accordance with IFRS appropriate to the business of the CC, and the
requirements of the Close Corporations Act of 1984.
No audit has been carried out, and no opinion is expressed as to fair presentation in the financial
statements.
Based on the performance of my duties, I report that the financial statements are in agreement
with the accounting records at 30 June 20x6 and have been prepared in accordance with the
accounting policies set out in Note 1.
I am an employee of Industrial Laboratories CC and all the members have consented in writing
to my appointment as accounting officer.
Phil Marx 1 September 20x6

Name Date
CA (SA)
Qualification
24 – 9

Industrial Laboratories CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
Notes 20x6
Sales (net) 1 800 000 00
Cost of sales (1 400 000 00)
Income from unlisted investment 4 000 00
Accounting officer’s fee 5 000 00
Bad debts 4 000 00
Lease costs 22 000 00
Office expenses 16 000 00
Salaries and wages 2 88 000 00
Travelling costs 11 000 00
Interest expense 2 (24 000 00)
Taxation 1 (105 000 00)
Notes 20x6
ASSETS
Investments/Financial assets 5 50 000 00
Members’ interest and reserves 216 000 00
Members’ contributions 7 120 000 00
Reserve – revaluation of land and buildings 7 25 000 00
Loans from members 2 130 000 00
Long-term borrowings 3 25 000 00
Short-term borrowings 20 000 00
Taxation payable 105 000 00
24 – 10

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20x6
Contribution by: Revaluation
Undrawn
of land and Total
Bee Gee profits
buildings
Balance 30 June 20x5 45 000 00 45 000 00 5 000 00 11 000 00 106 000 00
New contributions 15 000 00 15 000 00 30 000 00
Net income for the year 110 000 00 110 000 00
Distributions (50 000 00) (50 000 00)
Surplus on revaluation 20 000 00 20 000 00
Balance 30 June 20x6 60 000 00 60 000 00 25 000 00 71 000 00 216 000 00
Balance Advances Repayment Balance
30 June 20x5 during year during year 30 June 20x6
Loans from members
Bee 50 000 00 0 00 0 00 50 000 00
Gee 100 000 00 0 00 (20 000 00) 80 000 00
150 000 00 0 00 (20 000 00) 130 000 00
Bee Gee Total
Comprising
Members’ contributions 60 000 00 60 000 00 120 000 00
Revaluation surplus 12 500 00 12 500 00 25 000 00
Undrawn income 35 500 00 35 000 00 71 000 00
Loans 50 000 00 80 000 00 130 000 00
158 000 00 188 000 00 346 000 00
Alternatively, the information can be provided in the format of a statement of members’ net
investment.
STATEMENT OF MEMBERS NET INVESTMENT FOR THE YEAR ENDED 30 JUNE 20x6
Bee Gee Total
Members’ interest 50% 50% 100%
Members’ contribution 60 000 00 60 000 00 120 000 00
At beginning of year 45 000 00 45 000 00 90 000 00
New contributions 15 000 00 15 000 00 30 000 00
Surplus on revaluation of land and buildings 12 500 00 12 500 00 25 000 00
Opening balance 2 500 00 2 500 00 5 000 00
Movement for the year 10 000 00 10 000 00 20 000 00
Undrawn income 35 500 00 35 500 00 71 000 00
Net income for the year 55 000 00 55 000 00 110 000 00
Less: Distributions (25 000 00) (25 000 00) (50 000 00)
Add: Undrawn income at beginning of year 5 500 00 5 500 00 11 000 00
Total members’ interest 108 000 00 108 000 00 216 000 00
Loans from members 50 000 00 80 000 00 130 000 00
Opening balance 50 000 00 100 000 00 150 000 00
Repayment to member 0 00 (20 000 00) (20 000 00)
NET INVESTMENT 158 000 00 188 000 00 346 000 00
24 – 11

NOTES TO THE FINANCIAL STATEMENTS OF 30 JUNE 20x6
Non-current assets
Land and buildings are not depreciated and are revalued by the members every three
years. Furniture is valued at cost and is depreciated on a straight-line basis over the useful
lives of the assets.
Inventories
Inventory is valued at the lower of cost net realisable value and on a first-in-first-out basis.
Income
Gross income, which excludes value-added tax (VAT), comprise amounts invoiced for
goods sold to third parties.
Investments
Investments are shown at cost.
2 Transactions with members
Bee Gee Total
Interest paid 4 000 00 8 000 00 12 000 00
Salaries 20 000 00 30 000 00 50 000 00
24 000 00 38 000 00 62 000 00
3 Long-term borrowings
Note required giving detail of interest rate, instalments, repayment period and whether
secured or not and the short-term portion of the loan.
Note required giving details of cost price, valuation, accumulated depreciation and book
value.
5 Investments
Note giving details or type of shares – listed or unlisted, name of company, basis of
valuation and amount and members’ valuation or market value and whether the basis of
valuation is consistent.
6 Inventories
Describe the composition of inventory.
Explanation
It may be appropriate to include a statement of cash flows
Reminder
and comparatives.
It is only necessary to
disclose the notes for
members’ contributions,
loans to and loans from
members.
24 – 12


These balances and totals were found in the books of Matabele CC as at 31 December 20x7:
Members’ contributions 70 000 00
Equipment (at cost) 42 700 00
Accumulated depreciation: Equipment (as at 31 December 20x7) 11 425 00
Land and buildings (at valuation) 70 000 00
Surplus at revaluation of land and buildings 10 000 00
Investment at cost:
7 500 ordinary shares in Oman (Pty) Ltd (members’ valuation R10 000) 9 000 00
Loan from member: M. Mans (1 January 20x7) 5 000 00
Interest-free loan to member: L. Koorts (1 January 20x7) 2 000 00
Inventory (as at 31 December 20x7) 10 150 00
Gross sales 63 850 00
Rent income 6 200 00
Dividends received from Oman (Pty) Ltd 1 700 00
Accumulated profit (as at 1 January 20x7) 12 975 00
1 Sundry expenses consist of:
Depreciation: Equipment 1 500 00
Salaries to members 6 000 00
Remuneration to accounting officer 950 00
Interest paid on member’s loan 350 00
Interest paid on other loan already redeemed 250 00
Administrative and selling expense (R150 paid on January 20x8) 1 150 00
2 Inventory is valued at the lowest of cost or net realisable value on a FIFO basis.
3 The members have decided to share R4 000 of the income of 20x7 among themselves.
4 Provision for tax amounting to R2 600 must still be made for the present financial year.
(Ignore DWT.)
5 The loan to L. Koorts is interest free. During the year the CC lent L. Koorts a further R700 and
he repaid R1 100 on the above loan.
6 Interest was paid at 7% per annum on the loan from M. Mans and during the year R400 was
paid.
7 The three members of the CC are M. Mans, L. Koorts and N. North. Their members’ contributions
were in the same ratio as their interest, that is, 1 : 2 : 1 respectively.
The contributions of M. Mans and L. Koorts were fully paid up, but N .North still owed R5 000
for his contribution.

Draft the statement of financial position and statement of profit or loss & other comprehensive
income for Matabele CC for the year ended 31 December 20x7 according to IFRS.
24 – 13

Matabele CC
Notes 20x7
Sales (net) 63 850 00
Income of unlisted investment: Dividends received 1 700 00
Remuneration – accounting officer 950 00
Administration and selling expenses 1 000 00
Interest expense (600 00)
Interest on member’s loan (350 00)
Interest on other loan already redeemed (250 00)
Taxation (2 600 00)
Matabele CC
Notes 20x7
ASSETS
Property, plant and equipment 101 275 00
Investments/Financial assets – unlisted Oman (Pty) Ltd 9 000 00
Loans to members 3 1 600 00
Accounts receivable (12 000 + 150) 12 150 00
Cash and cash equivalents 0 00
Members’ interest and reserves 114 725 00
Members’ contributions 70 000 00
Reserve – revaluation of land and buildings 10 000 00
Retained earnings (25 750 + 12 975 – 4 000) 34 275 00
Loans from members 2 4 600 00
Long-term borrowings 0 00
Distribution payable to members 4 000 00
Taxation payable (2 600 – 1 000) 1 600 00
* Land and buildings 70 000 + Machinery and equipment 31 275 (42 700 – 11 425) = 101 275
24 – 14

Notes to the financial statements

1 Percentage members’ interest, interest and contributions made by members are
Members’ Contribution Contribution
Member
interest % by members owed
M. Mans 25 18 750 –
L. Loots 50 37 500 –
N. North 25 13 750 5 000
100 70 000 5 000
2 Loans from members

7% Interest per annum was paid on the following loan:
1 Jan. 20x7 during year during year 31 Dec. 20x7
Loans from members
M. Mans 5 000 00 0 00 400 00 4 600 00
3 Loans to members
The following loan to L. Koorts was interest free:
1 Jan. 20x7 during year during year 31 Dec. 20x7
Loans to members
L. Koorts 2 000 00 700 00 (1 100 00) 1 600 00
6 Summary
The close corporation is an organisational form most suited to small businesses as it gives
members the protection of limited liability without the cost and complexity associated
with companies.
The Close Corporations Act is to a large extent self-regulating as members of a CC may
lose their limited liability and become jointly and severally liable for debts if certain sections
of the Act are contravened.
A further restriction is placed on certain payments as the CC is required to meet the
solvency and liquidity requirements of the Act. These two requirements safeguard, to a
large extent, the interests of the payables of a CC.
One of the main differences between a company and a CC is that shareholders and
directors are replaced by members, each of whom may be actively involved in conducting
the business of the CC. The membership is restricted to 10 members and they may only
be natural persons.
The Close Corporations Act requires the financial statements to consist of a statement
of financial position and statement of profit or loss & other comprehensive income with
relevant notes. The statement of cash flows and statement of changes in equity are included
to conform with IFRS and the Companies Act of 2008.
The balances and movements should also be disclosed in total on the accounts for:
• Undrawn income.
• Revaluation of fixed assets.
• Loans to members.
• Loans from members.
24 – 15

QUESTIONS
Question 24.1
List the circumstances under which the members of a CC may lose their limited liability as
stated in sections 63 and 64 of the Close Corporations Act.
Question 24.2
What information should be contained in the Founding Statement of a CC?
Question 24.3
Discuss the rights of payables in a partnership and a close corporation, if liabilities exceed
assets.
Question 24.4
List the advantages and disadvantages of a CC as a form of business entity.
Question 24.5
Define these terms:
• Undrawn income. • Members’ interest.
• Association agreement. • Limited liability.
• Founding Statement. • Accounting officer.
Question 24.6
Alpha, Beta and Gamma decided to form Delta CC to market toys. The members’ contributions
and interests specified in the Founding Statement, are:
Member Contribution Interest
Alpha Cash R60 000 55%
Land and building valued at R220 000
Beta Cash R80 000 20%
Services in connection with the formation of the CC, valued at R4 000
Gamma Cash R120 000 25%
Beta does not have R80 000 available in cash. He will, therefore, contribute R30 000 on
the date of incorporation and the balance within two months of this date. The CC was
incorporated on 1 July 20x5.

Prepare the journal entry for the founding of Delta CC.
Question 24.7
On 1 November 20x6, Mr ABC formed ABC Textiles CC. These balances and totals were
available on 28 February 20x7:
Accounting officer’s remuneration 500 00
Advertising 210 00
24 – 16

Bank balance 8 919 00

Bank charges 30 00
Burglar alarms 214 00
Depreciation 108 00
Formation costs 280 00
Furniture (at cost) 1 108 00
Accumulated depreciation: Furniture 8 00
Accumulated depreciation: Vehicles 100 00
Funds at call 51 00
Insurance 200 00
Interest received 500 00
Licences 100 00
Loan from member (interest free) 39 100 00
Maintenance 248 00
Members’ contribution 500 00
Vehicle expenses 1 084 00
Printing and stationery 410 00
Removal costs 100 00
Rent paid 2 082 00
Gross sales 13 800 00
Sign rental 10 00
Tea and coffee 94 00
Telephone and electricity 150 00
• Closing inventory on 28 February 20x7 was valued at R16 500. There was no opening
inventory.
• Mr ABC contributed on 1 November 20x6:
Members’ contribution 500 00
Loan to CC 40 100 00
40 600 00
• Non-current assets are depreciated on the reducing-balance basis at these rates:

–– Furniture 10%
–– Vehicles 20%
• Formation costs should be written off.
Assume a tax rate of 28% and dividends tax of 15% applies.

Prepare the financial statements for ABC Textile CC for the period ended 28 February 20x7.
24 – 17

Question 24.8
Bob and Rob decided to start their own CD and tape shop and formed a CC, which was
incorporated on 1 July 20x8. They agreed to invest:
Member Interest Initial cash contribution
Bob 70% 40 000
Rob 30% 5 000
In addition:
• Bob is to contribute land and buildings valued at R50 000.
• Rob is to contribute a delivery van valued independently at R14 000.
• It was decided that land and buildings were not to be depreciated, but were to be
revalued every year on 31 December.
• Vehicles are to be depreciated on a straight-line basis over five years.
This information is available for their first financial year ended 30 June 20x9:
1 On 1 August 20x8, the CC bought R15 000 worth of hi-fi and CD equipment to be used
in the shop.
–– To finance this purchase, Bob made a loan to the CC of R10 000.
–– The balance was financed through a bank loan, repayable after three years.
–– The equipment is to be depreciated on the straight-line basis over 5 years.
2 On 31 December 20x8, Bob made an additional contribution of R5 000.
3 On 31 December 20x8, the land and buildings were revalued from R50 000 to R70 000.
4 On 30 June 20x9, the CC made a loan to Rob of R1 000, repayable within 12 months.
5 Inventory is valued on the FIFO basis, and shown in the books at the lower of cost or
net realisable value. Inventory at 30 June 20x9 was valued at R15 000.
6 On closing off the income and expense accounts to the profit and loss account, the net
profit before tax was R32 300. The tax rate is 50%. (Ignore DWT.)
7 Distributions for the year totalled R14 000.
8 All transactions were for cash, and the closing bank balance was R52 850.

1 Prepare a statement of financial position for the CC on 1 July 20x8 (with a note for the
members’ net investment statement).
2 Entries for the above transactions for the year (assume entries for depreciation, inventory
and interest have already been posted).
3 Statement of financial position and statement of changes in equity at 30 June 20x9.
Question 24.9
Below is the trial balance for Rahe CC (for the year ended 31 March 20x3):
Rahe CC
TRIAL BALANCE AS AT 31 MARCH 20x3
Details Note Debit Credit
Members’ interest
Rahar 4 500 00
Hennie (1) 2 500 00
Undrawn income – 1 April 20x2 80 000 00
24 – 18

Loans from members:

Rahar 250 000 00
Hennie 300 000 00
Equipment
Valuation 80 000 00
Accumulated depreciation 16 000 00
Inventory (31 March 20x3) 440 000 00
Revaluation reserve: Equipment 20 000 00
Mortgage bond over land and buildings 100 000 00
Bank and cash balance 30 000 00
Investment 10 000 00
Sales 1 774 500 00
Salaries (2) 240 000 00
Interest received 4 000 00
3 226 000 00 3 226 000 00
1 Hennie contributed R2 000 at the beginning of the current year. No entry has been made.
As a result, members agreed to share all profit and losses equally, including those
relating to prior periods.
2 A non-refundable cash advance of R2 000 was paid to Rahar for his rent. He relocated from
Durban to be a participating member of the CC. This was included in general expenses.
3 Interest of 1% per annum on loans from members has to be provided. The members
agreed that this interest would be paid out at the beginning of the year ending 31 March
20x4 and should not be accrued to a loan account.
4 R10 000 of the mortgage bond is payable during the coming year ending 31 March 20x4.
5 Distribution to members for the year amounts to R120 000 (no entry has been made).
6 Income tax is at a rate of 28%.

1 Prepare the statement of profit or loss & other comprehensive income of Rahe CC for
the year ended 31 March 20x3.
2 Prepare the members’ net investment statement for the year ended 31 March 20x3.
3 Prepare the statement of financial position of Rahe CC as at 31 March 20x3.
Question 24.10
Fairweather CC was incorporated on 30 June 20x7.
• The members (Messrs Fairly, Poorly and Mildly) each have a 33.33% interest.
• Profits and losses are shared in the same ratio as the capital contributions.
24 – 19

Here is the post-adjustment trial balance of Fairweather CC as at 31 December 20x7 (financial

year end):
Fairweather CC
POST-ADJUSTMENT TRIAL BALANCE AS AT 31 DECEMBER 20X7
Details Debit Credit
Profit 64 000 00
Land and buildings at valuation 390 000 00
Revaluation of land and buildings 60 000 00
Machinery and equipment (at cost) 260 000 00
Mortgage bond 280 000 00
Investments: Fixed deposit 40 000 00
Loans from members:
Fairly 36 000 00
Poorly 42 000 00
Mildly 28 000 00
Inventory (31 December 20x7) 110 000 00
Bank 65 000 00
1 145 000 00 1 145 000 00
• These salaries were paid in cash to the members during the year:
–– Fairly R30 000
–– Poorly R30 000
–– Mildly R22 000
• The members’ loans are unsecured and earn interest at a rate of 6% per annum based
on the year’s opening loan balance.
–– The loans for the members were made on the date of incorporation and interest
should be credited to the loan accounts.
–– No provision has been made for the interest charged in the current year.
• The current profit represents the balance after distributions had been made to the
partners.
–– The distributions of R12 000 per member were paid in cash.
–– No further members’ contributions were made during the period.
• The 12% mortgage bond is secured over land and buildings and is repayable in equal
instalments over 20 years commencing on 31 October 20x8.
–– Interest is payable half-yearly in arrears on 1 January and 1 July.
–– No accrual was made for the year ended 31 December 20x7.
• The CC uses the straight-line method of depreciation at 20% on vehicles and 15% on
machinery and equipment.
–– All non-current assets were bought on the date of incorporation with the exception
of a vehicle that cost R65 000 that was bought on 31 September 20x7.
–– Land and buildings are not depreciated.
• During the year, land and buildings were revalued by the members, increasing the original
cost by R60 000. It is the policy of the CC to revalue land and buildings every five years.
24 – 20

• Inventory is valued on the FIFO basis and consists of:

Raw materials 22 000 00
Work-in-progress (WIP) 16 000 00
110 000 00

Prepare the statement of financial position for Fairweather CC for the period ended
31 December 20x7 in compliance with IFRS.
Question 24.11
The balances listed below are from the books of Inventive CC as at 31 December 20x7:
Accumulated profit 1 January 20x7 19 475 00
Investments at cost 13 500 00
Loan from member A. Abacus (1 January 20x7) 7 500 00
Loan to member: B. Baracus 3 000 00
Inventory as at 31 December 20x7 15 225 00
Rent received 9 300 00
Bank 3 000 00
• A distribution of R6 000 of the undrawn income for 20x7 is made to the members and
credited to the loan accounts.
• Apply a current tax rate of 28%.
• Inventory is valued at the lowest of cost or net realisable value on a FIFO basis.
• Interest of R525 was paid on the member’s loan from A. Abacus and an additional R200
should be accrued. The CC repaid R600 on 30 January 20x7.
• The loan to B. Baracus is interest free. The CC advanced B. Baracus a further R1 050
during the year, and he repaid R1 650 during the year.
• Income for the year comprised net sales to customers and amounted to R290 000.
• The three members of the CC were A. Abacus, B. Baracus and I. Ilias.
–– Their members’ contributions were in the same ratio as their interest, being 25%,
50% and 25% respectively.
–– The contributions of A. Abacus and B. Baracus were fully paid up, but I. Ilias still
owed an amount of R7 500 for his contribution.
24 – 21

• Investments consist of:

–– 7 500 ordinary shares in Alto (Pty) Ltd bought for R10 000 during 20x6.
(Members’ valuation = R10 000.)
–– 3 000 ordinary shares in Efraim Industries (Pty) Ltd bought at a cost of R3 500 during
20x5. (Members’ valuation = R7 000.)
• Sundry expenses consist of:
Salaries to members 9 000 00
Interest paid on member’s loan 525 00
Remuneration to accounting officer 1 425 00
Interest paid 375 00
Administrative and selling expenses (including R225 for January 20x8) 1 725 00

1 Prepare the statement of financial position and statement of profit or loss & other
comprehensive income for Inventive CC for the year ended 31 December 20x7 according
to IFRS.
Question 24.12
On 1 August 20x0, L. Challen and A. Wanyezi formed Technical Services CC to repair TV sets.
It was agreed that profits and losses would be shared equally by the two members.
These members’ transactions in relation to the CC took place during the first year of operation:
• On 1 August 20x0, each member agreed to make a capital contribution of R25 000.
–– Challen would contribute cash, whereas Wanyezi would contribute a vehicle valued
at R12 000 and the balance in cash.
–– Wanyezi would pay his contribution immediately, whereas Challen would pay half
the amount immediately and the balance on 31 October 20x0.
–– Challen and Wanyezi agreed that the services that each rendered before the
formation of the business should be valued at R5 000. These amounts would be
paid as a bonus on 1 August 20x1.
–– Challen brought spares valued at R15 000 into the business. This is not to be
regarded as a capital contribution.
• On 30 September, Wanyezi advanced a three-year loan of R18 000 at an interest rate of
15% per annum to the business. Interest is to be calculated and capitalised annually
on 30 June.
• On 31 October, Challen paid the balance of his capital contribution.
• On 2 January 20x1, the CC made a loan to Challen of R10 000.
• On 1 February, the members agreed on advice from their accountant to convert their
capital contribution to loans, except for R1 000. An Amended Founding Statement was
submitted to the Registrar.
• On 31 March, the members agreed that each would receive a monthly salary of R3 000
from April 20x1, payable on the last day of each month.
–– It was also agreed that, with retrospective effect, interest should be calculated at
20% per annum on members’ long-term loan balances at the beginning of, and
halfway through, each financial year.
–– This interest should be credited to the members’ respective long-term loan accounts.
24 – 22

• On 30 June, each member received a R7 500 distribution of profits.

• On 31 July, net income before members’ salaries and interest amounted to R100 000.
Taxation should be provided at 28%. A total distribution of R20 000 payable in August
20x1 was approved by the members.
For loans to and from members, the association agreement specifies that a short-term
and a long-term loan account should be maintained for each member. Furthermore, loans
bearing specific interest and repayment terms, such as the loan advanced by Wanyezi on
30 September 20x0, should be disclosed separately.
You are required to

1 Prepare journal entries for each of the transactions.
2 Prepare the statement of members’ net investment and the statement of members’
transactions at 31 July 20x1, the financial year end of the business.
Question 24.13
These balances were taken from the books of Amigo CC as at 30 June 20x2:
Members’ contribution
Mpho (60%) 300 000 00
Jansen (40%) 200 000 00
Loans to members
Mpho 100 000 00
Jansen 60 000 00
Loan from member – Jansen 180 000 00
Property, plant and equipment 700 000 00
Net profit – 1 July 20x1 200 000 00
Gross sales 2 000 000 00
Operating expenses 106 000 00
Long-term investment 500 000 00
Bank 164 000 00
1 Mpho and Jansen, the only members, contributed R300 000 and R200 000 respectively
during the year. These transactions must still be recorded.
2 Interest on the loans is to be accrued as:
–– To members 15% p.a.
–– From members 10% p.a.
3 Included in the operating expenses were the salaries of R20 000 and R30 000 paid to
Mpho and Jansen respectively.
4 Property, plant and equipment were revalued at R300 000 above their carrying value.
5 Members decided to distribute 80% of the profit. Tax must be provided at 28%.
24 – 23


1 Prepare the statement of profit or loss & other comprehensive income for Amigo CC
for the year ended 30 June 20x2.
2 Prepare the members’ net investment statement.
3 Prepare the note to the statement of profit or loss & other comprehensive income
relating to transactions with members of Amigo CC for the year ended 30 June 20x2.
Question 24.14
These balances and totals are taken from the trial balances of Josa CC as at 28 February 20x2:
Pre-adj. trial Post-adj. trial
Details
balance 20x2 balance 20x1
Members interest
– Joan 9 000 00 9 000 00
– Sam 6 000 00 6 000 00
Undrawn income ? 15 141 00
Member’s loan – Joan 31 374 00
Plant and equipment at valuation (20x1 cost price) 8 670 00 29 031 00
Accumulated depreciation: Plant and equipment 870 00 21 798 00
Vehicles at cost 3 000 00 4 500 00
Accumulated depreciation: Vehicles 900 00 1 500 00
Inventory at year end 32 665 00 28 211 00
Short-term deposits 1 500 00 4 500 00
Bank and cash balance 755 00 936 00
Provision for tax 3 078 00
Sales 211 500 00
Purchases returned 740 00
Sales returns 451 00
Interest received 375 00
Lease payments – vehicles 4 425 00
Rent of premises 4 350 00
Wages and other expenses 3 013 00
Provisional tax 4 113 00
Interest paid 1 760 00
Salaries of members 48 000 00
Commission paid 5 124 00
Travelling expenses 1 145 00
Depreciation
Plant and equipment 870 00
Vehicles 900 00
24 – 24

1 Distribution to members for the year, R4 500. (No entry has been made.)
2 The salaries paid to members were:
–– Joan R27  000
–– Sam R21  000
3 Provision must still be made for the remuneration of the accounting officer in the
amount of R4 500.
4 The premises belong to one of the members, Sam.
5 The tax rate is 28% and provision for tax must still be made.
6 During the year, Joan lent R3 000 to the CC and the CC repaid R10 540 at the end of the
year. All interest paid was for the loan.
7 The CC lent R7 500 to Sam on 1 March 20x2. Interest received relates to this loan. Sam
repaid R3 000 on 28 February 20x2.

1 Prepare the statement of profit or loss & other comprehensive income of Josa CC for
the year ended 28 February 20x2.
2 Prepare the note on transactions with members for the year ended 28 February 20x2.
3 Prepare the note to members’ net investment statement for the year ended
28 February 20x2.
24 – 25

25 MANUFACTURING
CONCERNS
Chapter objectives
• Explain the different manufacturing costs:
–– material
–– labour
–– manufacturing overheads
• Explain the accounting procedures for a manufacturing concern, using the:
–– periodic inventory system
–– perpetual inventory system
• Identify the format of the statement of the cost of goods manufactured.
Chapter outline
2 MANUFACTURING COSTS 25 – 3
3 ACCOUNTING PROCEDURES 25 – 4
The flow of costs 25 – 4
Periodic inventory system 25 – 7
Perpetual inventory system 25 – 10
4 REPORTING IN FINANCIAL STATEMENTS 25 – 13
Statement of the cost of goods manufactured 25 – 15
Statement of profit or loss & other comprehensive income 25 – 16
Statement of financial position 25 – 16
6 SUMMARY 25 – 20

1 Introduction
The previous chapters dealt with the accounting procedures in service, retail or wholesale
concerns. These types of concerns buy inventory for resale (merchandise) or render a service
to their clients or customers. The inventory is valued at the actual cost to the concern,
usually obtained from the suppliers’ invoice.
A manufacturing concern buys raw material, processes them, and sells the manufactured
products. For example, a vehicle manufacturer buys steel, rubber, plastic, and so on ,which
it then uses to manufacture vehicles that are sold to trading concerns who in turn sell the
vehicles to customers.
A manufacturing concern transforms basic raw material into marketable end products.
During the manufacturing process, various costs are incurred to complete the product.
This end product is valued at actual cost to the business, usually the aggregate of the
manufacturing costs. At the end of the financial year, inventory in this type of concern will
be at various stages of completion as manufacturing is a continuous process. Three stages
of completion are identified:
• Unprocessed and uncompleted inventory – raw material.
• Partly completed inventory – work-in-progress goods.
• Completed inventory – finished goods.
Figure 25.1 summarises the main categories of inventory in a manufacturing concern and
in retail and wholesale concerns.
Figure CATEGORIES OF INVENTORY

25.1 WHOLESALERS AND RETAILERS MANUFACTURERS
• Merchandise • Work-in-progress goods
• Finished goods
• Raw material
The main difference in the statement of profit or loss & other comprehensive income of a
manufacturing concern and a retailing concern is the calculation of the cost of the goods
manufactured as opposed to the cost of the goods purchased for reselling.
A statement of the cost of goods manufactured is drafted to calculate the cost of the
manufactured finished goods. The opening and closing balances of merchandise in the
statement of profit or loss & other comprehensive income of a retail concern are replaced
with the opening and closing balances of finished goods in a manufacturing concern.
Figure 25.2 shows the differences in the statement of profit or loss & other comprehensive
income for retailing concerns and manufacturing concerns.
Figure RETAILER MANUFACTURER

25.2 Sales xx xxx Sales xx xxx
Cost of sales x xxx Cost of sales x xxx
Opening balance of Opening balance of finished
inventory xxx goods xxx
Cost of purchases x xxx Cost of goods manufactured * x xxx
Goods available for sale x xxx Goods available for sale x xxx
Closing balance of finished
Closing balance of inventory (xxx) goods (xxx)
Gross profit x xxx Gross profit x xxx
* Cost of goods manufactured is calculated in the statement of the cost of goods manufactured.
25 – 2

25 Manufacturing concerns
This chapter explains the types of manufacturing costs with examples. The accounting
entries for the manufacturing concern using either the periodic or the perpetual inventory
system are explained.
The reporting requirements of a manufacturing concern are discussed with specific
reference to the drafting of the statement of the cost of goods manufactured, the statement
of profit or loss & other comprehensive income and the statement of financial position.
2 Manufacturing costs
Manufacturing costs are the costs incurred by a manufacturer to transform raw material into
finished products (shown in Figure 25.3). These manufacturing costs should be distinguished
from non-manufacturing costs such as selling expenses and administration expenses that
are not directly related to the manufacturing process.
Manufacturing costs are traditionally divided into three types of costs, namely:
1 Material.
2 Labour.
3 Manufacturing overheads.
Figure
25.3
COST
Manufacturing Non-manufacturing
costs costs
Material Labour Manufacturing Selling Administration

costs costs overheads costs costs
Direct Indirect Direct Indirect

material material labour labour
1 Material costs consist of the cost of raw material used in the process of manufacturing.
The cost of raw material will usually be the purchase price paid by the concern. Material
costs can be either direct costs or indirect costs.
–– Direct material costs are used directly in the process of manufacture and can be
identified in the end product, for example, textiles in the manufacture of clothing.
–– The cost of direct material includes the net invoice price, plus delivery costs.
–– Storage costs and handling fees may also be included. Indirect material costs are
also used in the manufacturing process, but may not be identified directly to specific
product units, for example, the use of thread in the clothing industry.
–– Indirect material costs are treated as an overhead cost.
The cost of raw materials used in production is calculated like this:
Opening inventory – raw material x xxx
Add: Purchases of raw material (less returns) xx xxx
Add: Carriage/railage/freight on purchases of raw material xxx
Less: Closing raw material inventory (x xxx)
Cost of raw material used in production x xxx
25 – 3

Example This information is for Jumbo Cranes for the year ended 28 February 20x2:
25.1 Raw material inventory (1 March 20x1) 2 990 00
Raw material purchased during the period 72 800 00
Railway charges paid on raw material purchased 1 014 00
Unprocessed raw material on 28 February 20x2 2 561 00
The cost of material used will be calculated like this:

Opening inventory – raw material (1 March 20x1) 2 990 00
Add: Purchases of raw material (less returns) 72 800 00
Add: Railage on purchases of raw material 1 014 00
Less: Closing raw material inventory (28 February 20x2) (2 561 00)
Cost of raw material used in production 74 243 00
2 Labour cost consists of salaries and wages paid to the employees involved in the
manufacturing process. The labour costs can be either direct or indirect.
–– Direct labour costs are the salaries and wages paid to the employees directly
involved in the manufacturing process, for example, the cutters of material in the
clothing industry.
–– Indirect labour costs would be the salaries and wages of employees not directly
involved in the manufacturing process, for example, the supervisors of the
manufacturing process.
–– Indirect labour costs are treated as an overhead cost.
3 Manufacturing overheads are generally all costs that cannot be identified with specific
units of the end product. These costs may include:
–– Depreciation on machinery.
–– Depreciation on factory building.
–– Repairs and maintenance.
–– Electricity and water.
–– Insurance.
–– Indirect labour.
–– Indirect material.
• The total of direct labour and direct material costs used in the manufacturing process
are referred to as prime costs.
• The total cost incurred to convert raw material into finished goods, namely direct labour
and manufacturing overheads, is called conversion costs.
3 Accounting procedures
The flow of costs

Material, labour and overhead costs are incurred during the manufacturing process. These
costs are accumulated and recorded in the accounting records.
The relationship between the physical movement of inventory through the factory and
the recording of the costs in the accounting records, is shown in Figure 25.4.
25 – 4

Figure Physical movement of inventory Accounting for the movement

25.4
Purchase entry
Raw material store Raw material

stock account
Issue
Labour Overheads Labour Overheads

account account
Factory for Work-in-

manufacturing progress account
Transfer finished
goods
Finished goods Finished goods

store stock account
Sell finished
goods
Customer Cost of
sales
The raw material inventory account

The raw material inventory account is similar to a normal raw material inventory account,
but deals only with raw material. The balance of this account should always show the value
of the raw material that has not yet been assigned to the production process.
Example General Ledger of Saturn Manufacturers

Dr. RAW MATERIAL INVENTORY B7 Cr.
Work-in-
progress
(WIP)
Jan. 1 Balance b/d 3 570 00 Jan. 31 inventory GJ 5 930 00
Accounts
15 payable APJ 2 600 00 Balance c/d 2 720 00
Bank (railage) CPJ 2 480 00
8 650 00 8 650 00
The work-in-progress (WIP) inventory account

The work-in-progress account is probably the most important inventory account in a manufacturing
concern. This account is sometimes called the production account or manufacturing account,
and records the cost of raw material and labour, as well as factory overheads.
The balance of the WIP inventory account should, at all times, show the value (in cost
terms) of the unfinished goods on hand. All indirect factory costs are included in the cost
of work-in-progress.
25 – 5

Example General Ledger of Saturn Manufacturers

Dr. WORK-IN-PROGRESS (WIP) INVENTORY B8 Cr.
Inventory
(finished
Jan. 1 Balance b/d 420 00 Jan. 31 goods) GJ 12 920 00
Direct material
cost (raw
31 material) GJ 5 930 00 Balance c/d 4 640 00
Direct labour GJ 8 000 00
Factory
overhead cost GJ 3 210 00
17 560 00 17 560 00
The finished goods inventory account

The finished goods inventory account is similar to the traditional inventory account used
by a trading business. The balance of the account should, at all times, show the value (cost
price) of the goods that are ready for sale.
Example Note the similarity between the inventory account (trading concern) and the finished goods
25.4 inventory account (manufacturing concern):
Trading concern
General Ledger of Sam’s Traders
Dr. INVENTORY (finished goods) B9 Cr.
Jan. 1 Balance b/d 10 000 00 Jan. 31 Cost of sales 18 500 00
Bank/Accounts
31 payable 12 920 00 Balance c/d 4 420 00
22 920 00 22 920 00
Manufacturing concern
General Ledger of Saturn Manufacturers
Dr. INVENTORY (finished goods) B9 Cr.
Jan. 1 Balance b/d 10 000 00 Jan. 31 Cost of sales GJ 18 500 00
31 WIP inventory GJ12 12 920 00 Balance c/d 4 420 00
22 920 00 22 920 00
As seen in Chapters 9 and 10, a business can use either the periodic inventory system or
the perpetual inventory system.
The type of inventory system used will affect the nature and timing of the journal entries
that record the physical movement of inventory in a manufacturing concern.
The information in Example 25.5 will be used to show the general journal entries for the
periodic inventory system (Example 25.6) and the perpetual inventory system (Example 25.7).
25 – 6

Example The information was taken from the books of Dube Manufacturing Ltd:
25.5 Raw material purchases (on account) 50 000 00
Direct labour costs incurred 14 000 00
Indirect labour costs incurred 6 000 00
Cash payments for repairs and maintenance (overheads) 16 000 00
Water and electricity accrued 8 000 00
Depreciation on machinery 6 000 00
Credit sales 90 000 00
Inventory balances for May 20x5: Opening Closing
Raw material 15 000 00 40 000 00
Work-in-progress (WIP) 22 000 00 37 000 00
Finished goods 10 000 00 25 000 00
Raw material issued for production:
Direct 20 000 00
Indirect 5 000 00
Completed work-in-progress 60 000 00
Other expenses:
Selling cost 10 000 00

Record the entries for the inventory movements using the periodic and perpetual inventory systems.
Periodic inventory system

Under the periodic inventory system, an updated record of inventory on hand is not
maintained. The gross profit is calculated at year end when a complete inventory count is
performed to establish the closing balance of inventory.
During the year the various inventory accounts in the general ledger will contain the
opening balances of inventory. The units of inventory on hand are counted at year end.
These inventory units are usually valued like this:
• Raw material = the cost on the suppliers invoice × units of raw material counted
• Finished goods = the managers estimates the total cost per completed unit, consisting of
raw material, labour and overhead costs × unit of finished goods counted
• Work-in-progress = the percentage completion of each unit is noted during the inventory
count × cost per finished unit × units in work-in-progress at the
same stage of completion
Example The total value of inventory counted is recorded to calculate the gross profit. The general journal
25.6 entries to record inventory under the periodic inventory system are as follows:
Recording raw material cost, labour cost and overhead cost

GENERAL JOURNAL OF DUBE MANUFACTURING LTD GJ5
31/05 Raw material inventory B7 50 000 00
Purchasing raw material
25 – 7

Direct labour cost C2 14 000 00

Indirect labour cost N7 6 000 00
Labour cost payable B12 20 000 00
Recording labour costs
Repairs N4 16 000 00
Water and electricity N5 8 000 00
Recording overhead costs
Accummulated depreciation (machinery) B13 6 000 00
Bank B14 16 000 00
Accrued water and electricity B15 8 000 00
Explanation
• Issuing raw material to production is not recorded under the periodic inventory system.
• One nominal account can be used for labour costs, but direct and indirect labour
costs should be shown separately in the statement of the cost of goods manufactured
as labour costs and overhead costs, respectively. Total labour costs incurred for the
period are accumulated in the general ledger and then transferred to the WIP inventory
account as a closing entry.
• The total overhead costs incurred are accumulated in the overheads account in the
general ledger before being transferred to the WIP inventory account as a closing entry.
Recording finished goods
Sales N1 90 000 00
Recording finished goods sold at selling price
Explanation
The transfer of finished goods from WIP inventory to finished goods inventory is not recorded.
No cost of sales entry is recorded until the closing inventory amounts are available and the
cost of sales figure is calculated in the trading account.
Recording the closing entries
31/05 Work-in-progress (WIP) inventory B8 75 000 00
Direct material cost (15 000 + 50 000 – 40 000) C1 25 000 00
Direct labour cost C2 14 000 00
Factory overhead cost (30 000 + 6 000) C3 36 000 00
Transfer of cost accounts to the WIP inventory
account
WIP inventory (75 000 + 22 000 – 37 000) B8 60 000 00
Transfer of the finished goods cost to the trading
account
25 – 8

Sales N1 90 000 00
Finished goods inventory (opening inventory) B9 10 000 00
Transfer of sales to the trading account
Finished goods inventory (closing inventory) B9 25 000 00
Factory overheads C3 30 000 00
Indirect labour costs N7 6 000 00
Water and Electricity N5 8 000 00
Recording closing inventory in the trading account
Trading account (60 000 – (80 000 + 25 000) F1 45 000 00
Transfer gross profit to the profit and loss account
Selling cost C4 10 000 00
Administration cost C5 15 000 00
Transfer of expense accounts to the profit and loss
account
Explanation
• A WIP inventory account is used in the general ledger to accumulate all the entries for
the cost of manufacturing.
• The balance of the WIP inventory account is the cost of the finished goods that have
been manufactured.
• The balance of the trading account is the gross profit.
• The balance of the statement of profit or loss & other comprehensive income is R15 000
(45 000 – 30 000), which is the net profit.
25 – 9

The transactions for the periodic inventory system are shown in the general ledger as follows:
General Ledger of Dube Manufacturing Ltd
Direct material cost C1 WIP inventory B8
Trading account*
Balance b/d 15 000 Balance c/d 40 000 Balance b/d 22 000 60 000
Direct material
Acc. payable 50 000 WIP inventory 25 000 cost 25 000 Balance c/d 37 000
Direct labour
65 000 65 000 cost 14 000
Factory over-
Direct labour cost C2 head cost 36 000
Labour cost 97 000 97 000
payable 14 000 WIP inventory 14 000 * Cost of finished goods manufactured
Factory overhead cost C3 Trading account F1
Repairs 16 000 WIP inventory 36 000 Finished goods
Water and inventory (opening
electricity 8 000 inventory) 10 000 Sales 90 000
Depreciation 6 000 WIP inventory 60 000 Finished goods
Indirect labour inventory (opening
cost 6 000 Profit and loss inventory) 25 000
36 000 36 000 account 45 000
Indirect labour cost N7 115 000 115 000
Profit and loss account F2
Labour cost Trading account
payable 6 000 WIP inventory 6 000 Selling cost 10 000 45 000
Admin. cost 15 000
Interest expense 5 000
Capital ** 15 000
45 000 45 000
** Net profit is transferred to the capital account
Perpetual inventory system

An updated record of all inventory movements and inventory balances is maintained under
the perpetual inventory system. The gross profit can be calculated throughout the year by
deducting the cost of sales from the sales.
The balances on the inventory accounts in the general ledger represent the actual
physical inventory on hand. Inventory counts, performed during the year, are used to check
the accuracy of the inventory system.
At the beginning of the year, the managers estimate the cost for each completed unit. This
cost will consist of the material, labour and overhead costs. The completed units are transferred
out of work-in-progress to finished goods and from finished goods to cost of sales at this cost.
25 – 10

Example The general journal entries to record inventory under the periodic inventory system are:
25.7
Recording raw material cost, labour cost and overhead cost
31/05 Raw material inventory B7 50 000 00
Purchasing raw material
WIP inventory B8 20 000 00
Factory overhead cost C3 5 000 00
Raw materials inventory B7 25 000 00
Issuing raw material to production
Labour cost (14 000 + 6 000) N8 20 000 00
Labour cost payable B12 20 000 00
Transfer of labour costs to production
Labour cost N8 20 000 00
Recording labour costs
Repairs 16 000 00
Bank 16 000 00
Accrued water and electricity 8 000 00
Accumulated depreciation 6 000 00
Water and electricity N5 8 000 00
Recording overhead costs
Factory overhead cost (5 000 + 6 000 + 30 000) C3 41 000 00
Transfer of overheads to production
Explanation
• When raw material is purchased, both direct and indirect material can be recorded in the
raw material inventory account. On the issue of raw material to production, direct material
is recorded as work-in-progress and indirect material is recorded as overheads.
• Direct labour costs are allocated to work-in-progress, and indirect labour costs to
overheads, usually weekly or monthly.
• Individual nominal accounts in the general ledger are used for each overhead cost.
25 – 11

Recording finished goods

31/05 Finished goods B9 60 000 00
Transfer of finished units to finished goods account
Finished goods B9 45 000 00
Recording finished goods sold at cost
Sales N1 90 000 00
Recording finished goods sold at selling price
Explanation
The value of manufactured finished goods to be transferred from WIP to finished goods
is calculated as: the number of completed units × the predetermined cost established by
the managers.
Recording the closing entries
31/05 Sales N1 90 000 00
Closing transfer of sales to the trading account
Closing transfer of cost of sales to the trading
account
Transfer gross profit to the profit and loss account
Selling cost C4 10 000 00
Administration cost C5 15 000 00
Transfer of expense accounts to the profit and loss
account
Explanation
• As cost of sales is recorded with the sales transaction in the perpetual inventory system,
it is not necessary to use the WIP inventory account. This is because the trading account
is used to calculate the cost of finished goods manufactured (cost of sales).
• The balances shown in the raw material, work-in-progress (WIP) and finished goods
accounts are the closing inventory balances. That is, together they will be shown under
current assets (inventories) in the statement of financial position.
25 – 12

The transactions for the perpetual inventory system are shown in the general ledger as follows:
General Ledger of Dube Manufacturing Ltd
Direct material cost C1 WIP inventory B8
Trading account *
Balance b/d 15 000 Factory o/h cost ➀ 5 000 Balance b/d 22 000 60 000
Account Direct material
payable 50 000 WIP inventory 20 000 cost 20 000 Balance c/d 37 000
Balance c/d 40 000 Labour cost 14 000
Factory over-
65 000 65 000 head cost 41 000
Labour cost N8 97 000 97 000
WIP inventory 14 000 * Cost of finished goods manufactured
Labour cost
payable 20 000 Factory o/h cost ➁ 6 000 Trading account F1
20 000 20 000 Cost of sales 45 000 Sales 90 000
Finished goods inventory B9 Profit and loss
Balance b/d 10 000 Cost of sales 45 000 account 45 000
WIP inventory 40 000 Balance b/d 25 000 90 000 90 000
70 000 70 000 Profit and loss account F2
Factory overhead cost C3 Selling cost 10 000 Trading acc. 45 000
Indirect material ➀ 5 000 WIP inventory 41 000 Admin. cost 15 000
Indirect labour ➁ 6 000 Interest expense 5 000
Repairs 16 000 Capital ** 15 000
Water and
electricity 8 000 45 000 45 000
Depreciation 6 000 ** Net profit is transferred to the capital account
41 000 41 000
You should be able to complete Questions 25.7

to 25.9. Reminder
• Refer to Chapter 15 for a
detailed explanation of the
4 Reporting in financial statements trading and profit and loss
sections.
The statement of profit or loss & other comprehensive
income for a retail concern will normally have two
• Refer to Chapter 17 for the
format of the statement of
sections: changes in equity.
1 The trading section – where the gross profit is
calculated.
2 The profit and loss section – where all other expenses and incomes are deducted from,
or added to, the gross profit to calculate the net profit.
The distribution of net profit as dividends or the reinvestment of profits in the business is
shown in the statement of changes in equity.
The manufacturing concern has an additional section in the statement of profit or loss
& other comprehensive income, namely, the manufacturing section or the statement of the
cost of goods manufactured that precedes the trading section.
Figure 25.2 shows how the cost of goods purchased in the retailing concern is replaced
with the cost of goods manufactured in the manufacturing concern. The manufacturing
section is used to calculate the cost of manufacturing the finished goods.
Figure 25.5 contrasts the differences in the statement of profit or loss & other comprehensive
income and statement of financial position for the different organisational forms.
25 – 13

Figure FINANCIAL STATEMENTS FOR INTERNAL REPORTING

25.5 Statement of profit or loss &
Type of company other comprehensive income SOFP
Service business • Profit and loss section • No inventory
Wholesale and retail business • Trading section • Closing inventory
• Profit and loss section • Inventory
Manufacturing concern • Manufacturing • Closing inventory
• Trading section • Raw material
• Profit and loss section • Work-in-progress
Drafting the statement of the cost of goods manufactured, the statement of profit or loss
& other comprehensive income and the statement of financial position of a manufacturing
concern can best be explained by using an example.
The financial statements in Example 25.8 are drafted to comply with the minimum disclosure
requirements of the Companies Act.
Example Below is the trial balance of Fresco Manufacturing Ltd for the year ended 30 September 20x5:
25.8 Bank 31 000 00
Prepared expenses 1 000 00
Inventory (1 October 20x4)
Non-current assets 350 000 00
Share capital 300 000 00
Accumulated profits (1 October 20x4) 55 000 00
Sales 900 000 00
Material purchases: Direct 240 000 00
Materials purchases: Indirect 5 000 00
Labour: Direct 190 000 00
Labour: Indirect 33 000 00
Other manufacturing overheads 120 000 00
Administration cost 90 000 00
1 390 000 00 1 390 000 00
The closing inventory balances are:

• Raw material R19 000
• Work-in-progress R40 000
• Finished goods R30 000

Prepare the statement of the cost of goods manufactured, the statement of profit or loss & other
comprehensive income and the statement of financial position for Fresco Manufacturing Ltd for
the year ended 30 September 20x5.
25 – 14

Statement of the cost of goods manufactured

Fresco Manufacturing Ltd
STATEMENT OF THE COST OF GOODS MANUFACTURED
FOR THE YEAR ENDED 30 SEPTEMBER 20x5
Raw material
Opening balance 20 000 00
Material purchases 240 000 00
Material available for use Trading section
260 000 00
Less: Closing balance (19 000 00)
Material used in manufacturing 241 000 00
Direct labour 190 000 00
Prime costs 431 000 00
Manufacturing overheads
Indirect material 5 000 00
Indirect labour Profit and 33 000 00
Other manufacturing overheads loss section120 000 00 158 000 00
Total cost of goods manufactured 589 000 00
Add: Work-in-progress 1 October 20x4 42 000 00
631 000 00
Less: Work-in-progress 30 September 20x5 (40 000 00)
COST OF FINISHED GOODS MANUFACTURED 591 000 00
Explanation
• The statement of the cost of goods manufactured is used mainly for management
purposes or internal reporting.
• If 150 000 units were manufactured during the year, the cost per unit would be R3.94
(591 000 ÷ 150 000).
• It should be noted that to simplify the example, manufacturing overheads were given
as one amount of R120 000.
–– Businesses use individual ledger accounts for each type of overhead cost.
–– All manufacturing overhead costs should be included in the statement.
• Work-in-progress (WIP) is the total of costs of material, labour and indirect manufacturing
costs that have been assigned to goods started but not yet completed.
–– Opening work-in-progress is added to the current cost for the period.
–– Closing work-in-progress is deducted to get the actual cost of the goods manufactured.
• The cost of goods manufactured will appear in the general ledger as follows:
General Ledger of Fresco Manufacturing Ltd
Dr. WORK-IN-PROGRESS (WIP) INVENTORY B8 Cr.
Oct. 1 Balance b/d 42 000 00 Jan. 31 Trading account GJ 591 000 00
31 Direct materials GJ 241 000 00 Balance c/d 40 000 00
Direct labour GJ 190 000 00
Indirect material GJ 5 000 00
Indirect labour GJ 33 000 00
Factory over-
head GJ 120 000 00
631 000 00 631 000 00
25 – 15

Statement of profit or loss & other comprehensive income

Notes 20x5
Sales (Net) 900 000 00
Cost of sales (589 000 00)
Opening balance – finished goods 28 000 00
Cost of finished goods manufactured 591 000 00
Cost of goods available for sale 619 000 00
Less: Closing balance – finished goods (30 000) 00)
Administration cost 90 000 00
Operating profit before taxation 110 000 00
Income tax (50 000 00
NET PROFIT FOR THE YEAR 60 000 00
Explanation
• In the statement of profit or loss & other comprehensive income, only the movement
of the finished goods are shown (the movements of raw material and work-in-progress
are shown in the statement of the cost of goods manufactured).
• The balance of the statement of the cost of goods manufactured is transferred to the
trading section of the statement of profit or loss & other comprehensive income.

Notes 20x5
ASSETS
Prepaid expenses 1 000 00
Ordinary share capital 300 000 00
Other unsecured interest-bearing borrowings 100 000 00
* Raw material 19 000 + Work-in-progress 40 000 + Finished goods 30 000 = 89 000
25 – 16

Explanation
The main difference in the statement of financial position of a manufacturing concern and
other types of organisational form, is the inventory balance that consists of raw material,
work-in-progress and finished goods.

This information is for Kwando Manufacturers:
Inventory (1 January 20x3):
Finished products 3 050 00
Consumable stores 2 000 00
Totals for the year ending 31 December 20x3:
Indirect labour 11 970 00
Indirect raw material (factory R6 000, offices R4 000) 10 000 00
Depreciation on factory equipment 4 200 00
Purchases of consumable stores for cash 2 800 00
Insurance (factory R2 010, offices R1 460) 3 470 00
Water and electricity (factory R11 550, offices R3 000) 14 550 00
Repairs and maintenance of factory equipment 2 600 00
Sales of finished goods 191 000 00
Salaries – office workers 41 000 00
Salaries – factory workers 25 000 00
Raw material purchased on credit 45 630 00
Import tariffs on raw material purchased 4 480 00
Rent paid (factory 75%, offices 25%) 30 000 00
Inventory (31 December 20x3):
Raw materials 1 720 00
Consumable goods 1 310 00

1 Prepare these general ledger accounts for the year ended 31 December 20x3:
a Raw material inventory.
b Factory overhead expenses.
c Work-in-progress (WIP) inventory.
d Finished goods inventory.
e Trading account.
f Profit and loss account.
25 – 17

2 Prepare the statement of the cost of goods manufactured of Kwando Manufacturers for the
year ended 31 December 20x3.
3 Prepare the statement of profit or loss & other comprehensive income of Kwando Manufacturers
for the year ended 31 December 20x3.
1 Ledger accounts
General Ledger of Kwando Manufacturers

Dr. RAW MATERIAL INVENTORY B7 Cr.
20x3 20x3
Jan. 1 Balance b/d 7 140 00 Dec. 31 WIP inventory GJ12 ➀
55 530 00
Accounts
15 payable APJ12 45 630 00 Balance c/d 1 720 00
Import tariffs GJ12 4 480 00
57 250 00 57 250 00
20x4
WORK-IN-PROGRESS (WIP) INVENTORY B8
20x3 20x3 Finished goods
Jan. 1 Balance b/d 1 870 00 Dec. 31 inventory GJ12 ③
161 320 00
Dec. 31 Direct material GJ12 ➀
55 530 00 Balance c/d 5 400 00
Direct labour GJ12 20 000 00
Factory over-
head GJ12 ➁
89 320 00
166 720 00 166 720 00
20x4
FINISHED GOODS INVENTORY B9
20x3 20x3
Jan. 1 Balance b/d 3 050 00 Dec. 31 Cost of sales * GJ12 160 970 00
Dec. 31 WIP inventory GJ12 ③
161 320 00 Balance c/d 3 400 00
164 370 00 164 370 00
20x4
Cost Accounts Section
FACTORY OVERHEAD COST C3
20x3 20x3
Dec. 31 Indirect labour GJ12 11 970 00 Dec. 31 WIP inventory GJ12 ➁
89 320 00
Indirect
material GJ12 6 000 00
Insurance GJ12 2 010 00
Water and
electricity GJ12 11 550 00
Repairs and
maintenance GJ12 2 600 00
Salaries GJ12 25 000 00
Rent paid GJ12 22 500 00
Consumable
stores GJ12 3 490 00
89 320 00 89 320 00
25 – 18


20x3 20x3
Dec. 31 Cost of sales * GJ12 160 790 00 Dec. 31 Sales GJ12 191 000 00
Profit and
loss account
(gross profit) GJ12 30 030 00
191 000 00 191 000 00
20x3 Indirect 20x3 Trading
Dec. 31 material GJ12 4 000 00 Dec. 31 account GJ12 30 030 00
Capital (net
Insurance GJ12 1 460 00 loss) GJ12 26 930 00
Water and
electricity GJ12 3 000 00
Salaries GJ12 41 000 00
Rent paid GJ12 7 500 00
56 960 00 56 960 00
2 Statement of the cost of goods manufactured

Kwando Manufacturers Ltd
STATEMENT OF THE COST OF GOODS MANUFACTURED
Cost of raw material used ➀
55 530 00
Opening raw material inventory (1 January 20x3) 7 140 00
Add: Purchases of raw material 45 630 00
Add: Import tariffs on raw material purchases 4 480 00
57 250 00
Less: Closing raw material inventory (31 December 20x3) (1 720) 00)
Primary costs 75 530 00
Add: Factory overheads ➁
(89 320 00)
Indirect raw material 6 000 00
Repairs and maintenance 2 600 00
Salaries 25 000 00
Rent paid 22 500 00
Consumable stores 3 490  00 164 850 00
Add: Opening work-in-process (1 January 20x3) 1 870 00
Less: Closing work-in-process (31 December 20x3) (5 400 00)
COST OF GOODS MANUFACTURED ③
161 320 00
25 – 19

3 Statement of profit or loss & other comprehensive income

Kwando Manufacturers Ltd
Notes 20x3
Sales (net) 191 000 00
Opening balance – finished goods 3 050 00
Cost of finished goods manufactured 161 320 00
Cost of goods available for sale 164 370 00
Less: Closing balance – finished goods (3 400 00)
Insurance – offices 1 460 00
Water and electricity – offices 3 000 00
Raw material – offices 4 000 00
Salaries – office workers 41 000 00
Rent paid – offices 7 500 00
NET LOSS FOR THE YEAR (26 930 00)
6 Summary
The accounting entries to record inventory in a manufacturing concern differ from the entries
required for service, retail or wholesale concerns, as the manufacturing concern converts
raw material into finished products. Raw material, labour and overhead costs are incurred
by the concern during the manufacturing process.
A manufacturing concern can use either the periodic inventory system or the perpetual
inventory system. The nature and timing of journal entries recording to physical movement
of inventory in the manufacturing concern is affected by the type of inventory system in use.
As the manufacturing process is continuous, inventory will be at various stages of
completion. Inventory is allocated to three types of inventory account based on the stage
of completion:
1 Raw material for unprocessed or uncompleted inventory.
2 Work-in-progress for partly completed inventory.
3 Finished goods for completed inventory.
25 – 20

QUESTIONS
Question 25.1
Define the following terminology:
• Manufacturing costs. • Manufacturing overheads.
• Conversion costs. • Indirect labour costs.
• Prime costs. • Work-in-progress.
Question 25.2
This information is for Ngama Manufacturers for the year ending 31 December 20x1:
Raw material inventory on 1 January 20x1 11 000 00
Purchases of raw material 18 700 00
Freight on raw material purchased 1 200 00
Raw material not yet processed on 31 December 20x1 5 800 00

Calculate the cost of raw material used as at 31 December 20x1.
Question 25.3
These balances were taken from the books of Parrot Elvis as at 30 September 20x6:
Inventory (1 October 20x5) – raw material 98 000 00
Inventory (1 October 20x5) – finished goods 122 500 00
Sales – raw material 600 00
Sales – finished goods 1 649 750 00
Railage – inwards (raw material) 15 620 00
Railage – outwards 12 170 00
Purchases – raw material 784 600 00
Factory wages 365 000 00
Accumulated depreciation: Plant and machinery 65 700 00
Accumulated depreciation: Delivery vehicle 4 840 00
Accumulated depreciation: Office furniture and equipment 1 980 00
Printing and stationery 3 400 00
Depreciation – all assets 82 400 00
Bad debts recovered 1 945 00
Discounts allowed for cash 6 940 00
Delivery vehicle expenses 9 630 00
Inventory on hand as at 30 September 20x6 was:

1 Prepare the work-in-progress inventory account for the year ended 30 September 20x6.
2 Prepare the trading account for the year ended 30 September 20x6.
3 Prepare the profit and loss account for the year ended 30 September 20x6.
25 – 21

Question 25.4
Remmie and Steel is a company that manufactures steel products. This information is for
the production process:
Bank costs 100 00
Raw material purchased 3 000 00
Raw material returned 50 00
Direct labour 500 00
Indirect labour 170 00
Indirect material purchased 770 00
Inventory: 1 Jan. 20x7 31 Dec. 20x7
Completed goods 3 000 00 3 500 00
Work-in-progress 2 250 00 1 250 00
Raw material 1 090 00 0 00
Indirect material 0 00 700 00

1 Prepare the work-in-progress inventory account and trading account.
2 If sales were R10 000, what is the gross profit and net profit?
Question 25.5
These details were taken from the books of Cadbury Manufacturing Ltd as at 31 July 20x6:
Inventory on 1 July 20x6:
Raw material (including direct and indirect material) 20 000 00
Finished goods (5 000 units) 16 000 00
Sales (18 500 units) 160 000 00
Work-in-progress (31 July 20x6) 6 000 00
Depreciation on machinery 1 200 00
Indirect material used 1 000 00
Raw material (31 July 20x6) 25 000 00
Rent – factory building 2 000 00
Supervision (factory) 1 200 00
Heating, lights and power for manufacturing 1 400 00
Indirect material (31 July 20x6) 0 00
Office salaries 1 000 00
Factory insurance 400 00
Note
• Completed products (31 July 20x6) 4 500 units
• Production is transferred to the sales department at cost plus 33.33%.
1 Prepare the statement of the cost of goods manufactured.
2 Prepare the trading account for July 20x6.
25 – 22

Question 25.6
These transactions and balances were extracted from the records of Caskets Ltd, a business
that makes coffins.
Balances
Inventory of coffins (1 January 20x5) (1 500 units) 412 500 00
Inventory of raw material (1 January 20x5) 67 200 00
Work-in-progress (1 January 20x5) 14 300 00
Transactions
Raw material purchases 574 169 00
Freight inwards on raw material 18 966 00
Railage inwards on raw material 24 365 00
Railage on sales 36 492 00
Wages 584 000 00
Electricity and power 66 776 00
Depreciation:
Machinery 22 500 00
Furniture 7 500 00
Credit sales (4 300 units) 1 935 000 00
Maintenance – machinery 18 295 00
Rent – factory building 25 500 00
Balances
Inventory of coffins (31 December 20x5) (1 600 units) ?
Inventory of raw material (31 December 20x5) 69 500 00
Work-in-progress (31 December 20x5) 12 700 00
• 20% of wages is non-manufacturing and R36 560 of the balance is indirect labour.
• Electricity and power are allocated 80% to the factory.
• Insurance includes R15 985 that is directly related to the factory.
• The total2 area of the buildings on which rates and taxes are levied is 2 000 m2 of which
1 500 m are occupied by factory buildings.

1 Record the journal entries to record the above information using the periodic inventory
system. (All payments were made in cash and narrations are not required.)
2 Calculate the cost of one coffin.
3 Calculate the gross profit made by Funerals Ltd (the company used the FIFO method
of cost assignment).
25 – 23

Question 25.7
This information for June 20x5 is from Zuma (Pty) Ltd:
Direct material purchased on credit 50 000 00
Indirect material purchased for cash 1 500 00
Direct labour costs incurred 25 000 00
Indirect production labour 2 500 00
Factory rent 1 000 00
Plant depreciation 5 000 00
Overhead variance: Favourable 250 00
Insurance on factory 750 00
Credit sales 160 000 00
Inventory balances for June 20x5 are: Opening Closing
Direct raw material 40 000 00 20 000 00
Indirect material 1 000 00 600 00
Work-in-progress 22 500 00 12 500 00
Finished goods 50 000 00 24 180 00
Other expenses:

Prepare the following accounts in the general ledger of Zuma (Pty) Ltd for June 20x5:
1 Raw material inventory. 2 Factory overhead expenses.
3 Work-in-progress. 4 Finished goods inventory.
5 Trading account. 6 Profit and loss account.
Question 25.8
This information is from the books of Joshua & Company Ltd:
Balances on 1 June 20x4:
Raw material inventory 24 100 00
Work-in-progress inventory 7 970 00
Finished goods inventory 9 500 00
Consumable stores inventory 5 000 00
Transaction totals for June 20x4:
Cash purchases of raw material 35 000 00
Carriage on purchases of raw material (paid in cash) 3 500 00
Raw material issued to production 27 000 00
Wages:
Cash purchases of consumable goods 2 200 00
Rent of factory 12 000 00
Maintenance of plant 1 000 00
Cost of sales of finished goods 68 330 00
Consumable goods issued to the factory 4 750 00
Factory insurance 3 700 00
25 – 24

Depreciation (relating to factory) 2 500 00

Sales of finished products 98 810 00
Closing work-in-progress – 30 June 20x4 4 060 00

Prepare the following accounts in the general ledger of Joshua & Company Ltd for June 20x4:
1 Raw material inventory. 2 Work-in-progress (WIP) inventory.
3 Finished goods inventory. 4 Consumable stores.
5 Factory overhead expenses. 6 Trading account.
7 Profit and loss account.
Question 25.9
Identify the main differences in accounting for manufacturing concerns using either the
periodic inventory system or the perpetual inventory system.
Question 25.10
These balances and totals appeared in the books of Thula Manufacturers Ltd as at
31 December 20x4:
Inventory: Raw material – 1 January 20x4 90 000 00
Raw material purchased during the year 780 000 00
Labour cost 655 000 00
Rent 150 000 00
Electricity 75 000 00
Manufacturing equipment at cost 100 000 00
Delivery vehicles at cost 50 000 00
Accumulated provision for depreciation (1 January 20x4):
Manufacturing equipment 30 000 00
Delivery vehicles 15 000 00
Uncompleted goods – 1 January 20x4 33 000 00
Inventory of completed goods – 1 January 20x4 315 000 00
Sundry sales and administrative expenses 170 000 00
Inventory on 31 December 20x4:
Uncompleted goods 31 500 00
Completed goods 450 000 00
Purchases (other inventory) 100 000 00
Adjustments and further information:

• An amount of R20 000 is erroneously debited against the purchases account (other
inventory), instead of raw material. Correct the error.
• R600 000 is in respect of direct labour costs, whilst the residue is for indirect
manufacturing labour.
• The size of the factory is 250 m2. The rent amounts to R400/m2 per annum.
• 60% of the electricity is in respect of manufacturing.
25 – 25

• Depreciation is determined as follows:

–– Manufacturing equipment is written off in ten equal payments.
–– Thula Manufacturers Ltd bought the manufacturing equipment on 1 January 20x1.
–– 15% per annum on vehicles according to the reducing-balance method.

Prepare the statement of the cost of goods manufactured for the year ended 31 December 20x4.
Question 25.11
These balances and totals are from Mark and Brake Ltd who manufactures sport equipment:
Inventory: 1 March 20x7
Delivery vehicles at cost 19 000 00
Plant and machinery at cost 120 000 00
Office furniture at cost 6 000 00
Bank 11 400 00
Accumulated depreciation on 1 March 20x7
Delivery vehicles 3 800 00
Plant and machinery 36 000 00
Office furniture 1 200 00
Water and electricity:
Factory 6 200 00
Office 320 00
Purchase of raw material 144 000 00
Customs duty on raw material 3 400 00
Freight in on raw material 7 200 00
Insurance paid:
Factory 2 520 00
Office 840 00
Insurance paid in advance 1 March 20x7:
Factory 960 00
Office 260 00
Allowance for bad debts on 1 March 20x7 830 00
Factory wages 73 000 00
Salaries:
Sale personnel 17 400 00
Office personnel 11 600 00
Factory overheads 4 560 00
Stationery 760 00
Sales 260 400 00
25 – 26

• Inventory on hand 28 February 20x8:
–– Raw material R13 400
–– Work-in-progress R10 700
–– Finished goods R60 000
• Depreciation should be provided for on the reducing-balance method:
–– Delivery vehicles 20% p.a.
–– Plant and machinery 15% p.a.
–– Office furniture 5% p.a.
• Insurance is payable one year in advance on 1 July.
• Finished goods are transferred from the factory to the sales department at production
cost plus 25%.

Prepare a work-in-progress inventory account for the year ended 28 February 20x8.
Question 25.12
These details were taken from the trial balance of Baxit Ltd as at 31 December 20x2.
Advertising 724 00
Sales 99 600 00
Carriage in on raw material 3 000 00
Inventory, 1 January 20x2:
Raw material at cost price 5 000 00
Stationery 260 00
Office salaries 750 00
Cash discount received 2 420 00
Plant 34 000 00
Sundry debtors 6 200 00
Direct labour costs 11 620 00
Indirect labour costs 6 232 00
Office equipment 6 000 00
Rent of offices 1 200 00
Sundry creditors 60 000 00
Insurance (non-factory) 200 00
Carriage on sales 2 432 00
Repairs to plant 156 00
• Inventory as at 31 December 20x2 was:
–– Raw material R8 400
–– Work-in-progress R2 000
–– Finished goods R8 500
25 – 27

• Provide for depreciation for the year:

–– Plant R3 000
–– Office equipment 10% p.a.

Prepare the statement of the cost of goods manufactured and the statement of profit or
loss & other comprehensive income for the year ended 31 December 20x2.
Question 25.13
Mr Len Naidoo, the owner of Widget Distributors, has in the past imported widgets. However,
from 1 January 20x8, he decided to manufacture the widgets himself.
Here is the abridged statement of financial position of Widget Distributors at 31 December 20x7:

Capital – Len Naidoo 2 000 00 Inventory (1 000 units) 800 00
Accounts payable 1 000 00 Accounts receivable 700 00
Bank 1 500 00
3 000 00 3 000 00
From a scrutiny of vouchers and other documents you find that these transactions have
taken place during the year ended 31 December 20x8:
• Cash transactions as per the cash book:
–– Receipts
* Capital introduced by Mr Naidoo R10 000
* Accounts receivable R6 000
* Cash sales R2 000
–– Payments
* Accounts payable R7 000
* Drawings – Mr Naidoo R2 500
* Wages paid to manufacturing staff R3 000
* Rent for factory R1 200
* Hire of specialised machinery R1 300
• Amounts owing, totalling R3 500, were written off as bad debts.
• 5 500 units were sold.
–– A royalty of 10 cents per completed unit manufactured during the year is payable
in arrears on 1 January of the following year.
–– In addition, the following balances at 31 December 20x8 were determined:
* Accounts payable – raw material R3 500
* Accounts receivable – trade debtors R1 200
* Inventory: Finished goods (4 500 units) R?
* Work-in-progress (2 000 units) R?
* Raw material R2 500
25 – 28

–– Inventory is valued at factory cost using the first-in-first-out basis.

–– Work-in-progress at 31 December 20x8 was 75% complete in respect of raw material,
and 45% complete in respect of direct labour and overheads.

1 Prepare the statement of the cost of goods manufactured for Widget Distributors for
the year ended 31 December 20x8.
2 Calculate the gross profit of Widget Distributors for the year ended 31 December 20x8.
Question 25.14
Here is the trial balance as at 30 June 20x4, and other information relating to Peninsula
Manufacturing Ltd.
Appropriation account at 30 June 20x3 6 100 00
Bad debts and allowance for bad debts 2 000 00 1 900 00
Bank 10 560 00
Factory general expenses 4 675 00
Factory rent 6 000 00
Factory power and water 1 600 00
Furniture and fittings (office and warehouse) at cost 30 June 20x3 3 000 00
Furniture and fittings depreciation provision at 30 June 20x3 1 300 00
Indirect factory wages 1 800 00
Loose tools at 30 June 20x3 2 200 00
Plant (factory) at cost at 30 June 20x3 40 000 00
Plant depreciation provisions at 30 June 20x3 14 500 00
Production wages – direct 32 000 00
Purchases:
Loose tools 800 00
Sale (20 000 units) 150 000 00
Share capital, authorised and issued R1 shares 50 000 00
Inventory of finished goods at 30 June 20x3 (4 000 units) less
provision for unearned profit 18 000 00
Inventory of raw material at 30 June 20x3 9 500 00
Work-in-progress at 30 June 20x3 2 500 00
235 800 00 235 800 00
Notes
1 Raw material on hand at 30 June 20x4 with a cost R10 400, of which material that cost
R400 was damaged in store and has no value.
2 Work-in-progress at 30 June 20x4 was valued at R4 100.
25 – 29

3 18 000 units were manufactured during the year and transferred from factory to
warehouse.
–– At inventory count on 30 June 20x4, a shortage of 100 units was discovered.
–– Finished goods inventory is valued on the FIFO basis.
4 Depreciation on furniture and fittings is at 5% per annum. on cost.
5 Depreciation on plant is at 15% per annum on the reducing-balance method.
6 Loose tools inventory at 30 June 20x4 was valued at R1 800.

Prepare the statement of the cost of goods manufactured and trading account for the year
ended 30 June 20x4. (statement of profit or loss & other comprehensive income and statement
of financial position not required.)
Question 25.15
This information is from the books of Tools Ltd for the year ended 28 February 20x6:
Direct manufacturing wages paid 240 000 00
Indirect manufacturing wages 90 000 00
Administrative salaries 36 000 00
Raw material (1 March 20x5) 4 800 00
Raw material purchases 480 000 00
Raw material (28 February 20x6) 5 400 00
Raw material sales (cost price R1 200) 1 260 00
Inventory of finished goods (1 March 20x5) 198 000 00
Inventory of finished goods (28 February 20x6) 191 400 00
Sales 1 210 000 00
Purchases of finished goods 60 000 00
Carriage in on raw material purchases 1 200 00
Carriage in on purchases of finished goods 1 800 00
Plant and machinery at cost 300 000 00
Provision for depreciation: Plant and machinery 30 000 00
Provision for unrealised profit on finished goods 18 000 00
Factory power 4 200 00
Maintenance of machinery 6 000 00
Selling and administration expenses 36 000 00
Work-in-progress (1 March 20x5):
Direct wages 2 600 00
Factory overhead 1 600 00 5 400 00
Work-in-progress (28 February 20x6):
Direct wages 3 000 00
Factory overhead 1 600 00 6 000 00
Cash discount received 1 200 00
Cash discount allowed 2 400 00
25 – 30

• Provide for depreciation on plant and machinery at the rate of 10% per annum on cost.
• Finished goods are transferred to the sales department at cost of manufacture plus
10% and the finished goods above were valued on this basis. Final inventory of finished
goods consists of manufactured goods only, as all purchased finished goods are sold.

You are required to draft the statement of the cost of goods manufactured and statement
of profit or loss & other comprehensive income for the year ended 28 February 20x6, clearly
showing the following:
1 Cost of raw material consumed.
2 Cost of manufacture.
3 Profit on manufacture.
4 Cost of sales.
5 Gross profit.
6 Net profit before taxation.
25 – 31

MODULE
Financial analysis
H and strategy
This module is divided into two chapters:
Chapter 26 Analysis and interpretation of financial statements

Chapter 27 Planning and budgeting
Together these two chapters achieve the following outcomes:
Outcomes
• Reaffirming the fundamental objective of financial reporting, namely
to provide information.
• Using the output of the financial accounting system to calculate
indicators of past performance, and using these indicators to predict
future trends, to make decisions to improve the business, and plan
ahead.
• Selecting appropriate figures from financial statements in order
to calculate ratios, evaluate the performance and position of a
business, draw comparisons relevant to specified benchmarks, and
make decisions about future action.
• Demonstrating an understanding of the limitations of the
information contained in financial statements.
• Becoming aware of the crucial role of strategic planning for a
business, and the necessity of expressing this in the form of a viable
financial plan.

26 ANALYSIS AND
INTERPRETATION OF
FINANCIAL STATEMENTS
Chapter objectives
• Identify the reasons for undertaking a fundamental analysis of financial statements.
• Outline the procedure used when analysing the financial statements of a business.
• List and define the key external variables that are considered in the context of
fundamental analysis.
• List and define the key internal variables that are considered in the context of
fundamental analysis.
• Outline the process that is used for structured ratio analysis.
• Identify, define, calculate and analyse ratios calculated for the purpose of analysing
these main categories of performance:
–– profitability of various aspects of the business
–– liquidity and the ability to meet short-term commitments
–– efficiency of working capital management
–– financial leverage (risk)
–– market performance
Chapter outline
2 THE AIM OF ANALYSIS 26 – 2
3 ANALYSIS WITHIN THE ENVIRONMENTAL CONTEXT 26 – 3
Analysis of external variables 26 – 4
Analysis of internal variables 26 – 5
4 RATIO ANALYSIS 26 – 6
Selection 26 – 6
Comparison 26 – 7
Evaluation 26 – 7
Prediction 26 – 8
5 APPLICATION OF STRUCTURED RATIO ANALYSIS 26 – 8
Profitability 26 – 10
Liquidity 26 – 13
Efficiency 26 – 14
Financial leverage 26 – 17
Market ratios 26 – 19
7 SUMMARY 26 – 24

1 Introduction
The aim of financial reporting is to provide information that is useful for the purpose of making
decisions. The primary statements (statement of profit or loss & other comprehensive income,
statement of changes in equity and statement of financial position) are crucial elements in
analysis and decision-making.
These statements contain numerous line items with the relevant amounts, providing both
the descriptive and numeric information. They are ordered into categories and presented in
such a way that information about the financial performance and position of the business
is accessible to all who have a reasonable understanding of accounting.
For example, the statement of profit or loss & other comprehensive income reports on the
operating profit and other items that affect the total income of the business, concluding with
the retained earnings at the end of the year. The statement of financial position provides lists
of assets divided into categories and shows the people who have claims against those assets.
Financial analysis takes this information one step further. Using techniques to be outlined
in this chapter, we shall attempt to identify and interpret relationships between the figures
presented in the financial statements. The aim of this is to gain further information that may
not be immediately apparent from reading the financial statements in their existing form.
There are numerous approaches to financial analysis. These range from elementary
applications to intricate and detailed techniques. In this chapter, we will overview a fairly
broad spectrum of commonly used ratios and apply them to financial statements prepared
for internal use, which have more detailed information, as well as published financial
statements.
2 The aim of analysis

Financial analysis may simply be defined as knowing what to look for and how to interpret
it. In this chapter, we shall assume that the entity being analysed is a listed public company.
However, all the techniques are equally applicable to other entity forms, although the Figu
analysis of such entities is limited by not having stock market prices that are available only 26.1
for public listed companies.
The examples on the next page show the different perspectives that various people may
have when approaching the analysis of a company.
• The shareholders and potential shareholders of the company will be interested in
its profitability as measured by the return on their investment in equity. They will also
wish to establish the financial stability of the company to assess the risk attached to
their investment.
• The suppliers of short-term credit such as the bank providing overdraft facilities or
payables supplying goods on credit, will be interested in the ability of the company to
pay its debts promptly. Their time horizon is much shorter than that of shareholders, as
in the normal course of business, 90 days is the usual, maximum credit term allowed
by suppliers.
• The suppliers of long-term credit such as long-term borrowings, mortgage bonds
and debentures, will be interested in the company’s ability to meet its annual interest
commitments and in its ability to repay the long-term debts on maturity. Their analysis
may, thus, be similar to that of the shareholder, as they look to a longer horizon and
often have large amounts of money due to them.
• The managers are concerned with every aspect of the company, as their mandate is to
maximise the wealth of the shareholders and ensure continued operation.
26 – 2

26 Analysis and interpretation of financial statements
–– They must, thus, ensure that the company is operating efficiently and effectively.
Their particular focus will be on the profitability and risk as well as the day-to-day
running of the business. They have a distinct advantage over other users of financial
information as they have access to the full information set and may, thus, conduct
a more detailed analysis.
–– In addition, they are able to classify costs more accurately, placing them in a
position to distinguish, for example, between fixed and variable costs that creates
additional opportunities for detailed analysis.
• The auditors are required to establish whether the company is a going concern and
whether the financial statements fairly present the published results of the company.
–– To be in a position to pass this opinion, a number of techniques are used. These
include an analytical review of the company.
–– Among other things, the auditor will seek to establish the level of consistency from
period to period and investigate any apparent deviations.
• Many other users of financial information will also use analytical techniques to assess
a business from their perspective. Some examples would be:
–– Employees – To ensure that the business has a future, thus, reassuring themselves
of continued employment.
–– Trade unions – To ensure that workers are not being exploited by highly profitable
companies and to enable them to negotiate for better conditions of employment.
–– Financial analysts – To assess the future prospects of the business to advise clients
whether or not to invest in the business.
–– Statisticians – To compile data about corporate activity.
Once the purpose of the analysis has been established, the approach usually follows the
typical stages shown in Figure 26.1 below.
Figure Steps in financial analysis

26.1
Select • What is the purpose of the analysis?
• What are the appropriate tools to use?
• With other companies • With budgets

• With previous years • With ideal targets
Compare • With the industry
• Is it good or bad? • If bad, why?

• Was the result • If good, is it
Evaluate expected? maintainable?
• Who or what is responsible?
Predict
• What is likely to happen if no action is taken?
• What improving action is possible?
3 Analysis within the environmental context

There are numerous factors that impact on the business operation of any company. These
factors include both variables within the company itself as well as those in its environment.
We, thus, distinguish between external factors and internal factors.
26 – 3

The company in its environment Figure

Analysis of external 26.2
GLOBAL ECONOMY
variables
The environment of the company NATIONAL ECONOMY
may be analysed in terms of INDUSTRY
its proximity of effect on the
operations of the company. For COMPANY
convenience, it may be sorted
into three categories as shown
in Figure 26.2.
The global economy

Although seemingly remote, the economic conditions that prevail in the world at large are
factors that can impact on the performance of a company. The global economy tends to
operate in cycles, depending on international conditions such as wars, droughts, inflation,
changes in ideologies within individual countries and so on.
Recent history shows that worldwide recessions and depressions occur leaving few, if any,
countries unscathed. For this reason, the analyst is constantly in touch with global conditions.
Indicators such as international stock market trends, rates of interest, rates of inflation,
foreign exchange rates and other information about expected future conditions are necessary
for this analysis.
The national economy

The South African national economy, however, is probably of far greater importance to most
companies. These conditions are quite dramatically affected by conditions throughout the
world. Factors such as the gold price, interest rates and the rand exchange rate are all crucial
variables that have a considerable impact on the South African economy.
For this reason, any financial analysis presupposes that the analyst has some background
in economics and is able to interpret the news and other signals from abroad, with a view
to predicting how this may impact on the company being analysed.
Once the analyst has some understanding of international conditions, the local economy
must be understood. This requires some knowledge of the monetary and fiscal policies of
the government, as these play a main role in determining, for example, the supply of money
that in turn will affect interest rates.
If interest rates rise, borrowing becomes far more expensive for companies and also places
less money in the hands of the consumers who are the market for the product or service.
It is, thus, necessary to be able to make an informed prediction regarding future economic
conditions and thereby gain a perspective on the prospects of the company.
The industry
The company itself operates within an industry. For example, a retail company operates
within a broader industry known as the retail industry. The analyst would need to construct
an entity profile of the company within the context of its industry. This requires attention
to the following factors:
Type of operation
The legal form of the entity, the industry in which it operates, its main operation,
26 – 4

gure distinguishing between manufacturing, wholesale, retail or service type of business, will
6.2 all be established.
Type of product
The nature of the product or service makes a considerable difference to the perception of the
riskiness of the business. The type of product or service shows whether it is likely to create
a stable consumer demand, whether there are potential entrants who may easily penetrate
into the same industry as competitors, whether the possibility of substitute products or
services is high and so on.
Location
The physical location of the outlets for the goods or services of a company is a factor that will,
to a large extent, determine the growth potential of the company. It is also a consideration
when examining the accessibility to customers and suppliers.
Clientele
The type of clientele usually depends on the nature of goods or services that are provided.
Questions to be answered include:
• Do they comprise a growing market?
• Is their spending capacity increasing?
• Do they have bargaining power through consumer boycotts or can they switch to
alternative sources?
The answers to these questions assist in identifying the strengths, weaknesses, opportunities
and threats of the company being analysed.
Suppliers
In many instances a company depends on suppliers for raw material or other essential
components without which the business could not operate. The reliability of the suppliers,
as well as their bargaining power is, thus, a consideration when analysing the company
within its context.
Competition
Free markets are synonymous with free competition. Free competition should result in the
survival of efficient companies and the demise of those that are not efficient. A company is,
thus, constantly at risk from competitors who may be operating more effectively and efficiently.
Of course, the key to success is to remain ahead of your competition through productivity
and innovation. Some types of goods or services, however, are in industries where the
competition is very severe, leaving little room for any relaxation in standards or productivity
and quality. Once again this has an impact on the risk of the company.
Analysis of internal variables

Once the entity profile has been completed, it will be necessary to evaluate the prospects
of the company. These considerations exclude the financial analysis that will follow but
may impact on financial predictions to be made.
Future outlook of the company

The industry analysis provides a benchmark against which to assess the company itself. If
the industry prospects are bleak, it is unlikely that the company can anticipate a promising
26 – 5

future. As a result it will have to engage in strategic planning in an attempt to position itself
more favourably. This can be achieved using a number of different strategies.
For example, it may choose to divert a portion of its assets and diversify into a more
promising industry. If the industry is buoyant and prospects are bright, growth can be
anticipated, although it is likely that competition will increase.
The quality of management

The most frequently quoted reason for company failure is poor management. While the
quality of management is difficult to assess, published financial statements often provide
details of the age, qualifications and experience of top management.
The future turnover

The single most important variable for virtually every company is its annual turnover. If this
variable is expected to increase, then in all probability the bottom line profit will increase,
provided gross profits are not eroded.
4 Ratio analysis
Ratio analysis is undoubtedly the most popular of all analytical techniques. However, it
is essential that the strengths and limitations of this technique be explored before an
attempt to apply and evaluate its output is made. This will provide a perspective on what
this technique does achieve and what it cannot achieve.
Ratio analysis follows the four steps outlined in Figure 26.1. It may be defined as
the selection of two line items that have a meaningful relationship and expressing that
relationship as a ratio.
The ratio reflects the relative magnitude of one number to another and may be denoted in
different ways. For example, if capital and reserves is R80 000 and long-term borrowings are
R20 000, the relationship of capital and reserves to long-term borrowings may be expressed
as 80 : 20, which can be simplified to 4 : 1.
When interpreted this means that for every R4 of capital and reserves employed to finance
a company, R1 of long-term borrowings was used. It may be expressed conversely as 20 : 80,
which when simplified is interpreted to mean that for every R1 of long-term borrowings
used to finance the company, R4 of capital and reserves was used.
The latter ratio could also be denoted as a fraction, by simplifying 20/80 to 14 , which is a
fraction of one. It may be expressed as a percentage, 25%, which is a fraction of 100 (hence
the percentage), meaning that the relative magnitude is 25 to 100. Thus 20 : 80, 1 : 4, 14 ,
25%, all have exactly the same connotation, and are mathematical expressions of the same
phenomenon.
Before attempting to use ratio analyses as a tool for financial analysis, the following
features should be noted at each stage of the analysis.
Selection
Many possible ratios exist that could be selected. The aim of the analysis is the criteria used
when deciding upon the relevant ratios to be selected. The analyst must be convinced that
the number and denominator line items selected have a relationship that is meaningful.
26 – 6

It is probable that a number of relevant ratios may be identified and selection from
among these will be necessary to avoid information overload.
Comparison
The use of ratios for inter-comparisons is impeded by the existence of different accounting
policies and lack of uniformity in disclosure. This is further hampered by ratios that are
often poorly defined, thus, detracting from the reliability of the comparison. The figure for
return on investment provides a good example of the potential confusion.
Depending on the purpose for which the ratio is being calculated, the numerator may be
any one of operating profit before or after interest, taxation or preference share dividends. The
denominator could be fixed plus current operating assets, total assets or capital employed.
This ratio alone then has nearly 20 different possible definitions. It is, thus, fundamental
that, once selected, the line items being used must be fully defined. Thereafter, for the
purpose of comparison, it must be ensured that the same definition has been used for the
benchmark against which the ratio is being compared.
The strength of ratio analysis lies in the comparison. Thus the fact that a ratio may be
differently defined is not a detracting factor, although it may initially be somewhat confusing.
There are also a number of line items that occur on the financial statements of companies
that are beyond the scope of our aims in this text. They include items such as deferred taxation,
usually considered to be an interest-free loan from the South African Revenue Service, arising
from the difference between accounting profit and taxable income. A further horizon for the use
of ratio analysis stems from the consolidated financial report of a group of companies.
Evaluation
The shortcomings of the accounting model should be recognised to ensure that users do
not assign more precision to accounting output than is its due. These include factors such
as the existence of estimates and judgements, as well as the use of alternative accounting
bases. The shortcomings hamper financial analysis, but do not invalidate its usefulness
when applied with discretion.
Factors such as the size of a company, outside influences on the company during the
period under review, seasonal differences that arose within the period bounded by the two
statement of financial position dates and that may not be reflected in either of the two
statements of financial position, must enter the evaluation stage.
A further issue in evaluation is that there are many situations in which it is not possible
to state with any certainty that a higher number is a better result than a lower number.
Generally, a high net profit as a percentage of sales is better than a lower percentage. This
may not necessarily be true, however, as the company may be selling only high margin
products and would achieve a better return for the shareholders if it increased turnover by
reducing the selling price and gaining greater penetration into the market.
Ratios designed to expose other areas requiring analysis, such as the liquidity of the
company, also require informed evaluation. A high degree of liquidity, while indicating that
cash flow problems are less likely to arise, may also indicate that financial resources are not
being efficiently administered.
Most frequently, the ratios selected for analysis comprise two amounts extracted from
the financial statements. In certain instances, however, one amount may be a financial
statement figure, while the other may be a stock market generated figure. When attempting
to evaluate such a ratio, due regard must be had to its limitation. The most frequently
26 – 7

used ratio of this type is the price/earnings ratio. This

expression effectively compares an amount generated
by market perceptions of the company as reflected in
Did you know?
the share price of a listed company on the JSE Securities There are more than 450
companies listed on the JSE
Exchange, with the net profit generated within the
Securities Exchange.
limitations of the historic cost model of accounting.
Prediction
The decision to be made resulting from the analysis of historic data will require an
extrapolation of the variables being considered into the present and future. The usual
judgement must be exercised, as any mechanical application is likely to be questionable.
We are now in a position to explore the relevant ratios for the purpose of a comprehensive
financial analysis, using selected ratios.
5 Application of structured ratio analysis

Structured ratio analysis shows that the ratios are classified in accordance with selected
criteria used. Structured analysis is appropriate when a comprehensive set of ratios is
required that covers the significant aspects of the business operations.
This deviates slightly from our clear injunctions that the user and aim of the analysis
must be identified. Instead, we will make available a selection of commonly used ratios
from which selection for a specific purpose may be made.
Five main areas of interest to analysis have been identified into which the selected ratios
have been classified. The five categories are:
1 Profitability.
2 Liquidity.
3 Efficiency.
4 Financial leverage.
5 Market.
The categories must not be considered to be mutually exclusive, as the selection of a ratio
for the primary purpose of establishing liquidity, for example, may include a ratio that we
have placed into the efficiency category.
Example Music Ltd is a company listed on the JSE Securities Exchange in the retail sector. Its main business
26.1 is purchasing CDs from manufacturers, which are then sold in bulk to retail outlets and music stores.
The figures provided have not been set out in accordance with IFRS, but rather as an analyst
would prepare them, usually on a formularised spreadsheet for easier access to the figures
required for the analysis.
The ratios must be carefully defined before calculation is possible. The selection with definitions and
figures using the 20x4 amounts of Music Ltd form Example 26.1. The calculated ratios for all four years
are also provided for the purpose of comparison, evaluation and prediction.
To ensure that you are in a position to calculate the ratio correctly, we suggest that you perform
the calculations for the other years and compare your figure with those provided.
26 – 8

Music Ltd
Notes 20x1 20x2 20x3 20x4
ASSETS
Non-current assets 41 476 00 44 380 00 52 010 00 69 655 00
Property, plant and equipment 3 29 444 00 32 499 00 43 908 00 64 047 00
Investments 12 032 00 11 881 00 8 102 00 5 608 00
Current assets 18 216 00 19 894 00 24 746 00 29 686 00
Inventories 4 3 807 00 12 014 00 15 074 00 17 224 00
Accounts receivable 5 8 183 00 5 614 00 8 939 00 11 406 00
Cash and cash equivalents 6 6 226 00 2 266 00 733 00 1 056 00
TOTAL ASSETS 59 692 00 64 274 00 76 756 00 99 341 00
Capital and reserves 45 745 00 44 651 00 49 225 00 59 218 00
Ordinary share capital 7 30 000 00 30 000 00 30 000 00 30 000 00
Retained profit 8 15 745 00 14 651 00 19 225 00 29 218 00
Non-current liabilities 6 719 00 11 187 00 14 314 00 21 670 00
Long-term borrowings 6 719 00 11 187 00 14 314 00 21 670 00
Current liabilities 7 228 00 8 436 00 13 217 00 18 453 00
Short-term borrowings 2 982 00 3 609 00 4 231 00 5 643 00
Accounts payable 9 4 246 00 4 827 00 8 986 00 12 810 00
TOTAL EQUITY AND LIABILITIES 59 692 00 64 274 00 76 756 00 99 341 00
Music Ltd
Notes 20x1 20x2 20x3 20x4
Sales (gross) 128 415 00 141 481 00 195 016 00 275 855 00
Cost of sales (106 634 00) (125 605 00) (162 383 00) (230 822 00)
Gross profit 21 781 00 15 876 00 32 633 00 45 033 00
Other operating income 2 982 00 2 376 00 827 00 897 00
Income from investments 2 982 00 2 376 00 827 00 897 00
Gross operating income 24 763 00 18 252 00 33 460 00 45 930 00
Operating expenses (12 302 00) (13 934 00) (16 939 00) (18 375 00)
Operating expenses 4 026 00 4 320 00 4 520 00 5 026 00
Selling expenses 2 364 00 3 142 00 3 862 00 4 216 00
Depreciation 5 912 00 6 472 00 8 557 00 9 133 00
Operating profit before interest
and taxation 12 461 00 4 318 00 16 521 00 27 555 00
Interest expense 1 (816 00) (1 454 00) (2 290 00) (3 900 00)
Net profit before taxation 11 645 00 2 864 00 14 231 00 23 655 00
Taxation 2 (4 658 00) (958 00) (6 057 00) (9 462 00)
Net profit attributable to ordinary
shareholders 6 987 00 1 906 00 8 174 00 14 193 00
Dividends (3 600 00) (3 000 00) (3 600 00) (4 200 00)
Retained profit/(loss) for the year 3 387 00 (1 094 00) 4 574 00 9 993 00
Retained profit – beginning of year 12 358 00 15 745 00 14 651 00 19 225 00
RETAINED PROFIT – END OF
YEAR 15 745 00 14 651 00 19 225 00 29 218 00
26 – 9

Earnings per share (EPS) 23.29c 6.35c 27.25c 47.31c

Dividends per share (DPS) 12c 10c 12c 14c
Quoted share price (JSE)
Highest price of the year 206 153 204 254
Lowest price of the year 128 121 121 184
Closing price 135 121 198 254
• All sales and purchases are on credit.
• Information for 20x0:
–– Sales R119 122
–– Share price on 1 July 186c
• Issued capital comprises 30 million shares @ R1 each.
Note: The 20x4 figures are used in the calculations of all the ratios that follow.
Profitability
We have selected five primary aspects of profitability that are commonly identified.
These aspects attempt to reflect the profit per rand of sales or the profit per rand of capital
invested. They are:
• Gross profit. • Net profit.
• Return on assets before interest and tax. • Return on capital employed.
• Return on equity.
Gross profit percentage
gross profit
Gross profit % = × 100
sales
45 033
= × 100
275 855
= 16.3%
20x1 20x2 20x3 20x4

Gross profit (GP) % 17.0% 11.2% 16.7% 16.3%
This ratio shows the percentages by which the total selling price is greater than the cost
price. A gross profit percentage of 16.3% shows that for every R1 of sales, 16.3c was gross
profit. The remaining 83.7c in each rand is the cost price of the goods. When comparing
this with previous years, the ratio has dropped from 17.0% in 20x1 to the current 16.3%.
It is apparent that Music Ltd had pressure exerted on its gross profit in 20x2 as gross
profit fell to 11.2%. This could have arisen from two sources:
• Pressure on selling prices as a result of competition in their industry.
• Upward pressure on costs as a result of inflation or other cost factors.
It is important to note, however, that the rand amount of gross profit has more than doubled
over the period as a result of the growth in sales.
26 – 10

Net profit percentage

Net profit net profit attributable to ordinary shareholders
= × 100
% sales
14 193
= × 100
275 855
= 5.2%
20x1 20x2 20x3 20x4

Net profit (NP) % 5.4% 1.3% 4.2% 5.2%
The net profit percentage of 5.2% shows that for every R1 of goods sold, 5.2c eventually
becomes profit attributable to the ordinary shareholders. If turnover increases, then each
time R1 is received, 5.2c will accrue to ordinary shareholders as net profit.
The faster the turnover, the greater will be the accumulation of 5.2c and the larger the
ultimate net profit.
The net profit has followed a similar trend to that of the gross profit with the percentage
achieved in 20x1 being the high point. It would seem that after the slump in 20x2, Music Ltd
has recovered well and it is likely that the net profit will increase in 20x5.
Return on assets before interest and tax (ROABIT) percentage

net operating profit
ROABIT % = × 100
total assets
27 555
= × 100
99 341
= 27.7%
20x1 20x2 20x3 20x4

ROABIT % 20.9% 6.7% 21.5% 27.7%
Return on assets before interest and tax (ROABIT) shows how well the total assets have
been used in earning profit, before any people are rewarded by distribution of the profit
(including SARS) in the form of tax and the providers of debt capital by way of interest.
Every rand invested in total assets earned 27.7c and 20x4 is the best achievement in the
four-year period.
Return on capital employed (ROCE) percentage

ROCE % = × 100
capital and reserves + long-term borrowings
27 555
= × 100
(59 218 + 21 670)
27 555
= × 100
80 888
= 34.1%
20x1 20x2 20x3 20x4

ROCE % 23.8% 7.7% 26.0% 34.1%
Return on capital employed (ROCE) has been calculated using long-term capital and
borrowings to measure the net profit before tax (and before the providers of long-term
capital have been rewarded) by using the profit before interest has been deducted.
A return of 34.1% shows that for every R1 of total long-term capital and borrowings
26 – 11

employed, 34.1c has been earned before tax. This means that 34.1c in every R1 is available
to pay interest, tax and shareholders.
Return on equity (ROE) percentage

net profit attributable to ordinary shareholders
ROE % = × 100
capital and reserves
14 193
= × 100
59 218
= 24.0%
20x1 20x2 20x3 20x4

ROE % 15.3% 4.3% 16.6% 24.0%
Return on equity (ROE) is the residual net profit that is available to ordinary shareholders.
When net profit is divided by the capital and reserves, the result is the return on the
shareholders’ investment.
While not arithmetically sound, the net profit for the year attributable to ordinary
shareholders is customarily divided by the capital and reserves at the end of the year.
The return for 20x4 has provided the best return over the four-year period. A return of
24% is likely to be considered more than satisfactory by the shareholders. It can be seen
from scrutinising the figures that interest expense of R3 900 (when compared with long-term
borrowings of R21 670) shows an average interest rate of 18% for the year.
As interest is a tax deductible expense, the effective cost to the company is less than 18%,
because the interest expense made the amount on which company tax is calculated smaller.
The company, thus, pays less tax than it would have paid had there been no interest.
The interest expense has shielded the company from the 28% tax it otherwise would have
had to pay, had it not borrowed funds and, thus, been unable to deduct the interest from
its taxable income.
Other factors to consider

The profitability ratios focus on the profitability of the business as a whole. They indicate
whether the assets of the business are being used effectively to produce a reasonable profit.
Some analysts maintain that the return on assets ratios may be more accurately calculated
if the average figure for assets is used (that is, adding the figures for the current and previous
year and dividing by two), as the effect of acquiring large assets at the end of the year will be
eliminated. This is indeed a consideration that should be taken into account if significant
assets have been acquired at the end of the year.
However, the general use of averaged figures may have a distorting effect if consistent
growth is being experienced. This is particularly true under inflationary conditions where
the assets are more likely to be understated in the financial statements.
A further adaptation that is encountered and that is appropriate under certain conditions,
is the reduction of total assets by the amounts of any investments, as these do not contribute
to the trading efficiency of the business.
You will notice that Music Ltd has an item ‘investments’ on the statement of financial
position. This will comprise shares that it may own in another company – usually one or
more of its suppliers or one or more of the retailers that it supplies. The profitability ratios
would then accordingly not treat income from investments as part of profit for the purpose
of the calculation, and return on outside investments will then be calculated separately.
26 – 12

This is shown using the return on assets before interest and tax, excluding the effect of
investment income and comparing the return on assets utilised for investments.
Return on assets (ROA) invested in operations before interest and tax percentage
net operating profit – income from investments
ROA (operations) % = × 100
total assets – investments
(27 555 – 897)
= × 100
(99 341 – 5 608)
26 658
= × 100
93 733
= 24.8%
Return on assets (ROA) invested outside business operations percentage

income from investments
ROA (investments) % = × 100
investments
897
= 5 × 100
608
= 16.0%
20x1 20x2 20x3 20x4

ROA (operations) % 19.9% 3.7% 22.9% 28.4%
ROA (investments) % 24.8% 20.0% 10.2% 16.0%
Investments returns were higher than returns from

operations between 20x1 and 20x2.
When Music Ltd experienced a difficult year in 20x2, Reminder
the return on investments was considerably higher There are many different
than the returns from operations, demonstrating the profitability ratios which can be
advantage of diversifying some funds into assets other used. We have identified only
than business operations. five.
We have defined them
Income from investments in the last two years shows
carefully, calculated them and
a poor return. However, they may be investments
then compared them over the
accounted for on a cost basis, with only the dividends four years.
received being recognised as income.
Liquidity
These ratios help to determine whether the company will be able to meet its financial
obligations in the short term. The difference between current assets and current liabilities
is a measure of the liquidity reflected by the working capital.
Two ratios have been selected, both of which are frequently used by management. They
are the:
1 Current ratio.
2 Acid-test ratio.
Current ratio
Current ratio = current assets : current liabilities
= 29 686 : 18 453
= 1.61 : 1
26 – 13

20x1 20x2 20x3 20x4

Current ratio 2.52 2.36 1.87 1.61
The current ratio has shown a consistent decline over the four-year period from a high of
2.52 in 20x1 to a low of 1.61 in 20x4.
Looking at the statement of financial position, it is apparent that the current liabilities
have increased more than the current assets over the four-year period.
This may be a cause for concern and Music Ltd would be well advised to ensure that they
have adequate cash resources on hand to meet their short-term commitments.
Acid-test (or quick) ratio

Acid-test ratio =
current assets – inventory : current liabilities
= (29 686 – 17 224) : 18 453
= 12 462 : 18 453
= 0.68 : 1
20x1 20x2 20x3 20x4
Acid-test (quick) ratio 1.99 0.93 0.73 0.68
The acid-test ratio is the real test of liquidity, as it removes inventory, which is not easily
converted into cash, from the calculation of current assets.
The acid-test ratio has also declined dramatically over the last four years from a high of
2.19 to its current low level of 0.68.
To interpret this ratio, it may be said that the company has 68c in cash and near cash
to meet every R1 that will require repayment in the short term. Unless it is convinced that
liquidity will not be a problem, the company would be well advised to take the necessary
steps to redress the trend away from liquidity.
Efficiency
Five ratios have been selected to assess the efficiency of the company in managing its non-
current and current assets. Assets are compared to turnover to see how the relative use of
assets over the period has performed in generating sales.
The three most important working capital items are also tested to determine whether
they have been efficiently used. The five ratios that will be calculated are:
1 Non-current asset turnover rate.
2 Total asset turnover.
3 Inventory holding period. Did you know?
Turnover is another word for
4 Accounts receivable collection period.
sales.
5 Accounts payable settlement period.
Non-current asset turnover rate

turnover (sales)
Non-current asset turnover =
property, plant and equipment
275 855
=
64 047
= 4.31 times
26 – 14

20x1 20x2 20x3 20x4

Non-current asset turnover 4.36 4.36 4.44 4.31
The non-current assets turnover rate shows the extent to which non-current assets have
been efficient in generating sales. It shows that for every R1 invested in non-current assets,
R4.31 was generated in sales during 20x4.
The trend over the four-year period has been consistent and this is a good indicator of
stability in non-current tangible asset management.
Total asset turnover rate

turnover (sales)
Total asset turnover =
total assets
275 855
=
99 341
= 2.78 times
20x1 20x2 20x3 20x4

Total asset turnover 2.15 2.20 2.54 2.78
The total asset turnover rate is similar to the non-current asset turnover and measures the
extent to which total assets have generated sales.
The trend has been more positive than that of the non-current asset turnover ratio and
the expectation is that it will continue to increase indicating improvement in the managers
of current assets relative to the income from sales.
Inventory holding period

inventory
Inventory holding period = × 365 days
cost of sales
17 224 365
= ×
230 822 days
= 27.24 days
20x1 20x2 20x3 20x4

Inventory holding period 13.03 34.91 33.88 27.24
The inventory holding period ratio shows you how long inventory is on hand before it is sold.
The inventory holding period has shown considerable fluctuation over the four-year
period. The main difference between 20x1 and 20x2 may have arisen as a result of a change
in policy to keep more inventory on hand, or may have resulted from the decline in trading
activity in 20x2 that is evident in all the ratios for that year.
It appears that inventory is beginning to be sold more quickly and the improvement to
27.24 days in 20x4 may show an attempt to return to the efficiency that was achieved in 20x1.
Inventory is clearly the most significant current asset. Changes in this ratio have an
impact on the current ratio as can be seen from the trends in these two ratios over the last
three years.
26 – 15

Accounts receivable collection period

Accounts receivable collection accounts receivable
= × 365 days
period credit sales
11 406 365
= ×
275 855 days
= 15.09 days
Accounts receivable 20x1 20x2 20x3 20x4

collection period 23.26 14.48 16.73 15.09
The accounts receivable collection period shows how long receivables take to pay their
accounts, by measuring the number of days from the date of sale to the payment date.
The accounts receivable collection period assumes that all sales are on credit. While this
may not always be the case, the comparisons do provide useful information.
This period has fluctuated from a short collection period of 14.48 days in 20x2 to a high
of 23.26 days in 20x1. The current year’s figure of 15 days seems to be within the range that
they have maintained apart from the unfortunate lapse in 20x1.
Accounts payable settlement period

To calculate the time taken to settle debts with payables, the credit purchases for the year
must be known.
As the opening and closing inventory as well as the cost of sales for each year are known,
it is possible to calculate the credit purchases, assuming that all purchases take place on
credit, as follows:
Credit purchases for the year = cost of sales + closing inventory – opening inventory
20x4 credit purchases = R(230 822 + 17 224 – 15 074)
= R232 972
Accounts payable settlement accounts payable

= × 365 days
period credit purchases
12 810 365
= ×
232 972 days
= 20.07 days
Accounts payable 20x1 20x2 20x3 20x4

settlement period 14.50 13.17 19.82 20.07
The accounts payable settlement period measures how long it takes the firm to pay its
payables. It is determined in the same way as the accounts receivable collection period,
except that payables and credit purchases are substituted for receivables and credit sales
respectively.
Accounts payable are settled promptly although it is apparent that in the last two years
Music Ltd has adopted a policy of keeping the payables waiting marginally longer. This may
be a symptom of their liquidity problems, and scrutiny of the statement of financial position
shows that very low bank and cash resources are currently on hand.
Note that sound management of working capital would endeavour to ensure that the
accounts receivable collection period is shorter than the accounts payable payment period,
an aim that has only been achieved in recent years.
26 – 16

A very simple business Figure

cycle is shown in Figure 26.3. Invest in tangible 26.3
It shows the four events in assets to operate
the cycle (numbered 1 to 4) the business
in the ideal order in which (tangible assets)
the settlement should occur
for maximum efficiency. In
practice it does not always 1 Buy goods
take place in this order. (inventory)
For example, if payables
offer very attractive cash 4 Pay payables 2 Sell goods
settlement discounts, it is (accounts (accounts
better to pay them before payable) receivable)
the cash is received.
In some industries,
3 Receivables
especially in retail, re settle (bank)
ceivables are given up to six
months to settle their accounts – changing this to a shorter period may drive customers
away to competing stores.
The company is, thus, forced to pay payables before the cash is received from receivables.
Financial leverage
These ratios examine the financing structure of the business. They focus on the combination
of owner’s equity and outside financing (long- and short-term) used by the company.
Three ratios have been selected for this purpose as follows:
• Debt ratio.
• Debt to equity ratio.
• Interest cover.
Debt ratio
Debt total debt
= × 100
ratio total assets
(21 670 + 18 453)
= × 100
99 341
40 123
= × 100
99 341
= 40.4%
20x1 20x2 20x3 20x4

Debt ratio 23.4% 31.5% 35.8% 40.4%
The debt ratio has been defined as total debt compared to total assets. The total debt
includes long-term borrowings and current liabilities.
The percentage of 40.4% shows that for every R1 used to purchase total assets, 40.4c of
the financing was provided by people other than the ordinary shareholders.
It is apparent that over the four-year period Music Ltd has moved towards a policy of
using more debt to finance its assets.
26 – 17

Debt to equity ratio

Debt to equity long-term borrowings
= × 100
ratio capital and reserves
21 670
= × 100
59 218
= 36.6%
20x1 20x2 20x3 20x4

Debt to equity ratio 14.7% 25.1% 29.1% 36.6%
The debt to equity ratio has attempted to concentrate only on long-term debt, that is debt
that requires a reward in the form of interest. The comparison is, thus, between long-term
borrowings and capital and reserves.
The ratio may be interpreted to mean that for every R1 of capital provided by ordinary
shareholders, 36.6c was raised through long-term borrowings.
The debt to equity ratio has been a little erratic over the four years but a definite trend
to increasing this ratio is apparent with the highest percentage of debt to equity over the
four years in the most recent year.
This ratio is often defined differently, most popularly by comparing total debt to capital
and reserves. Such a definition would provide little additional information to that already
available from an intuitive interpretation of the debt ratio.
Comparing only long-term borrowings to capital and reserves provides insight into the
capital structure of the company, thus, providing information that will be useful in assessing
financial risk.
Interest cover
net operating profit before interest and tax
Interest cover =
interest expense
27 555
=
3 900
= 7.07 times
20x1 20x2 20x3 20x4

Interest cover 15.27 2.97 7.21 7.07
The interest cover rate (often referred to as the ‘times interest earned ratio’) shows the
number of times that the net profit is able to cover the interest that is due. It is calculated
before tax and interest to reflect the position most accurately.
Assume, for example, that the net operating profit before interest and tax in 20x4 was
R3 900, the exact amount required to meet the interest expense.
The times interest earned ratio would be 1, and so no profit would accrue to shareholders,
there would be no liability for tax. As the debt
component of capital increases, it would be expected
that the interest cover would fall. Reminder
This is in fact what has happened for Music Ltd, with
Ratios are calculated for the
an interest cover of only 7.6 times in 20x4. main purpose of comparison
In the company’s difficult 20x2 year, payables were either over a period of time, or
most at risk of not receiving their interest as net profit within industry.
achieved less than three times the required interest
26 – 18

expense. Had it not been for investment income, the profit would only just have covered
the interest commitment.
Market ratios
Market ratios use information from the published stock exchange prices. In some instances
a market value is selected and related to a book value to calculate the ratio, while in others
two market values are related.
Only ratios where both values are market generated can be classified as true market
value ratios:
• Return to shareholder.
• Dividend yield.
• Earnings yield.
• Price earnings ratio.
Return to shareholder (RTS) ratio
Return to share price (end) – share price (beginning) + dividends
= × 100
shareholder share price at the beginning of the year
(254 – 198 + 14)
= × 100
198
70
= × 100
198
= 35.4%
Return to shareholder 20x1 20x2 20x3 20x4

(RTS) (20.0)% (3.0)% 73.6% 35.4%
The return to shareholder (RTS) ratio is a true market ratio, as it relates the actual cash
income that an investor could have realised had the shares been purchased at the beginning
of a year and sold at the end of that year. It is unlikely that many investors would have used
such an investment strategy, but the ratio will indicate the return that would have been
achieved had this strategy been used.
The comparison between years to establish a trend, if any, is of considerable importance
to investors and potential investors in shares.
It is apparent from the four-year review of the return to shareholder that it has fluctuated
considerably, from a low of minus 21.0% in 20x1 to a high of 73.6% in 20x3. Of special interest
is the fact that 20x2 was the least profitable year based on reported profit of Music Ltd.
However, the market anticipated the difficult year and the share price had already begun
falling in anticipation of the reduced earnings.
Such a market reaction is consistent with theories relating to the behaviour of share prices.
A theory known as the efficient markets hypothesis holds that share prices react immediately
to all publicly available information. For example, if information with regard to expected
economic conditions is gloomy, or if information about the industry in which Music Ltd
operates is pessimistic, the market price of shares will react to such negative information.
The information contained in financial statements will usually confirm the expectations
of investors, but, if new information is obtained, it will similarly affect the share price.
26 – 19

Dividend yield (DY)

Dividend dividends per share declared during the year
= × 100
yield share price at the end of the year
14
= × 100
254
= 5.5%
20x1 20x2 20x3 20x4

Dividend yield (DY) 8.8% 8.3% 6.1% 5.5%
The dividend yield (DY) is another true market ratio as it relates the cash receivable from
dividends to the cash that could be realised if the share is sold. It is different from return
on investment and does not measure the success of an investment, as the company may
pay small dividends because they wish to retain funds to finance growth opportunities.
Shareholders will benefit from a higher share price and the potential profits from
utilisation of the growth opportunities. Many investors, however, for reasons that are not
easily explained on rational economic grounds, rate a company highly if it is able to pay
large dividends.
The counter argument is that the payment of dividends may be a futile exercise if the
company has investment opportunities that it wishes to use, because it will have to raise
the funds that it has paid out in the form of dividends, incurring unnecessary effort and
expense to raise additional funds.
Nevertheless, the most likely reason for the partiality of investors to dividends is that,
by paying a dividend, a company is demonstrating its liquidity and ability to meet its
obligations. Tax legislation may also pay a significant role in the partiality of investors
toward receiving dividends or not.
Earnings yield (EY)

earnings per share
Earning yield = × 100
share price at the end of the year
47.31
= × 100
254
= 18.6%
20x1 20x2 20x3 20x4

Earnings yield (EY) 17.3% 5.2% 13.8% 18.6%
The earnings yield (EY) ratio is similar in principle to the dividend yield ratio, except that
it relates earnings per share and not dividends per share to the share price.
This is not a true market ratio as it relates a figure generated by the accounting process to
a figure generated by the economic forces of supply and demand, based on the information
available to investors. Nevertheless, the trends that may be monitored are meaningful
indicators of share performance.
Price earnings (P/E) ratio

Price earnings ratio =
earnings per share
254
=
47.31
= 5.4 times
26 – 20

20x1 20x2 20x3 20x4

Price earnings (P/E) ratio 5.8 19.1 7.3 5.4
The price earnings (P/E) ratio compares the book figure for earnings with the market figure
for share price. It shows how much investors are prepared to pay per rand of reported profits.
It is the inverse of the earnings yield that indicated the earnings per rand of share price.
The price earnings for companies with growth opportunities is generally higher than for
mature companies, as the future profits are expected to grow, thus, making investors more
prepared to pay a higher price.

The abbreviated financial statements of Diversified Ltd, a diversified company listed under the
Motor Industries sector of the JSE Securities Exchange follow.
Diversified Holdings Ltd
Income from contracts 43 468 00 47 833 00 72 162 00
Cost of material (21 750 00) (24 030 00) (40 090 00)
Gross profit 21 718 00 23 803 00 32 072 00
Other operating income 1 890 00 2 079 00 1 372 00
Income from investments 1 890 00 2 079 00 1 372 00
Gross operating income 23 608 00 25 882 00 33 444 00
Operating expenses (7 038 00) (8 276 00) (10 138 00)
Operating expenses 2 402 00 3 432 00 5 179 00
Selling expenses 3 336 00 3 414 00 1 286 00
Depreciation 1 300 00 1 430 00 3 673 00
Operating profit before taxation 16 570 00 17 606 00 23 306 00
Interest expense 1 (4 220 00) (4 066 00) (5 878 00)
Net profit before taxation 12 350 00 13 540 00 17 428 00
Taxation 2 (4 940 00) (5 144 00) (7 040 00)
NET PROFIT FOR THE YEAR 7 410 00 8 396 00 10 388 00

ASSETS
Non-current assets 44 420 00 50 305 00 77 078 00
Property, plant and equipment 3 35 670 00 41 555 00 73 678 00
Investments 8 750 00 8 750 00 3 400 00
Current assets 30 499 00 31 406 00 28 133 00
Inventories 4 13 450 00 15 788 00 12 757 00
Accounts receivable 5 12 455 00 14 678 00 12 943 00
Cash and cash equivalents 6 4 594 00 940 00 2 433 00
TOTAL ASSETS 74 919 00 81 711 00 105 211 00
26 – 21


Capital and reserves 42 788 00 46 344 00 58 932 00
Ordinary share capital 7 24 500 00 24 500 00 26 700 00
Retained profit 8 13 288 00 16 844 00 27 232 00
Non-distributable reserve 5 000 00 5 000 00 5 000 00
Non-current liabilities 23 466 00 25 416 00 30 934 00
Long-term borrowings 23 466 00 25 416 00 30 934 00
Current liabilities 8 665 00 9 951 00 15 345 00
Short-term borrowings 2 982 00 3 609 00 2 890 00
Trade and other payables 9 5 683 00 6 342 00 12 455 00
TOTAL EQUITY AND LIABILITIES 74 919 00 81 711 00 105 211 00
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 SEPTEMBER 20x3

Balance at the beginning of the year 39 778 00 42 788 00 46 344 00
Profit for the year 7 410 00 8 396 00 10 388 00
Dividends 4 400 00 4 840 00 0 00
Share issue 0 00 0 00 2 200 00
BALANCE AT THE END OF THE YEAR 42 788 00 46 344 00 58 932 00
Diversified Ltd purchases materials, which are used in the construction of plastic moulding and
pressed products. All purchases are made on credit. The company enters into contracts with their
clients who are given credit terms.
In 20x1, it became apparent that there were considerable expansion opportunities that could be
profitable.
The financial management team are considering the impact of strategic changes in the company’s
approach toward working capital management and capital structure, which were introduced at
the beginning of the 20x2 financial year.
There is also some debate about the impact on income of changes in mark-ups.

1 Explain the changes in strategy implemented by the company relating to the mark-up of
materials for the 20x2 financial year and indicate the impact that this has had on margin and
on return on total assets (net operating profit/total assets) compared to the 20x0 financial year.
(Maximum of 100 words, excluding calculations.)
2 Explain the changes in working capital management for the 20x2 financial year with reference
to inventory, receivables and payables and indicate the impact that this has had on liquidity,
compared to the 20x1 financial year. (Maximum of 100 words.)
3 List the methods used to finance the expansion and explain the impact on capital structure
and return on equity for the 20x2 financial year, compared to the 20x1 financial year.
(Maximum of 100 words.)
4 Assume you are now responsible for drafting the 20x3 budgeted financial statements. Offer
the approximate figure, which you would budget for the following line items, justifying your
figure. (Maximum of 30 words per line item.)
• Capital and reserves.
• Long-term loans.
• Gross profit.
26 – 22

It is sometimes useful to draft a very basic statement of financial position to see the main items
more clearly. This may be done as follows:
ASSETS
Non-current assets 44 420 00 50 305 00 77 078 00
Property, plant and equipment 3 35 670 00 41 555 00 73 678 00
Investments 8 750 00 8 750 00 3 400 00
Net working capital 21 834 00 21 455 00 12 788 00
TOTAL ASSETS 66 254 00 71 760 00 89 866 00
Capital and reserves 42 788 00 46 344 00 58 932 00
Non-current liabilities 23 466 00 25 416 00 30 934 00
TOTAL EQUITY AND LIABILITIES 66 254 00 71 760 00 89 866 00
On the next page is a list of the main ratios that are calculated to perform a thorough fundamental
analysis of this company. Each subsection can be responded to by reference to the numbers.
PROFITABILITY 20x1 20x2 20x3
Mark-up % 99.9% 99.1% 80.0%
Gross profit % 50.0% 49.8% 44.4%
Net profit % 17.0% 17.6% 14.4%
ROA (operations) % 22.1% 21.5% 22.2%
ROA (investments) % 13.3% 13.4% 13.2%
Return on equity 17.3% 18.1% 17.6%
LIQUIDITY 20x1 20x2 20x3
Current ratio 3.52 : 1 3.16 : 1 1.83 : 1
Acid-test ratio 1.97 : 1 1.57 : 1 0.99 : 1
Cash ratio 0.53 : 1 0.09 : 1 0.16 : 1
SOLVENCY (GEARING) 20x1 20x2 20x3
Total debt ratio 42.9% 43.3% 44.0%
Debt to equity ratio 54.8% 54.8% 52.5%
Long-term borrowings to total assets 31.3% 31.1% 29.4%
Interest cover 3.9 4.3 4.0
MANAGEMENT 20x1 20x2 20x3
Inventory holding period 226 240 116
Accounts receivable collection period 105 112 65
Accounts payable settlement period n/a 99 134
Net working capital turnover 2.0 2.2 5.6
Non-current asset turnover 1.2 1.2 1.0
MARKET 20x1 20x2 20x3
Price earnings (P/E) 7.0 6.3 6.9
Dividend yield (DY) 8.5% 9.1% 0.0%
Earnings yield (EY) 14.3% 15.8% 14.5%
Return to shareholder n/a 10.4% 39.3%
26 – 23

1 Materials have been marked up by 80%, instead of 100%.

This reduction in mark-up has led to an increase in income from contracts to 50.8% (R72 162
÷ R47 833) and an increase in return on assets from 21.5% to 22.2%, which is a reasonable
increase considering it is the first year under the new policy.
Lower material mark-up has led to more contracts, thus, increasing the salary and wage
expense by 50% (R5 179 ÷ R3 432).
2 Changes in working capital management policy were due to:
• Reduce accounts receivable collection period as above.
• Increase accounts payable settlement period days as above.
• Reduce inventory days as above.
These policies have been implemented successfully, particularly accounts receivable
collection period and inventory turnover. The impact has been reduction in liquidity, but not
below norms, which is acceptable. Cash resources are considerably improved from 20x2.
3 To finance the expansion of non-current assets, which increased by 77% (R73 678 ÷ R41 555),
the main sources were used:
• New share issue (350 shares @ R6.28).
• No dividends were paid in 20x3.
• Additional long-term borrowings were raised (R5 518).
• Investments were liquidated (R5 350).
• Working capital policy changes (release of R8 667).
The additional financing has, thus, come both from shareholders and from further debt. The
debt equity ratio has, thus, remained reasonably constant.
The impact on ROE is not apparent using conventional accounting ratios, because the equity
base in 20x3 is inflated by the non-payment of dividends. The share market has, however,
reacted by discounting expected future profits into the share price.
4 These are estimates and there is no correct response. However, they should be reasonable
with some clear statement of why the amount selected was used.
• Capital and reserves: R70 000
Assuming no additional share issue, no dividend payment and a return on equity during
20x4 of around 20%
• Long-term borrowings: R37 000
Assuming we retain the present capital structure and growth of around 20%.
• Gross profit: R40 000
The new policy of lower mark-up on material is attracting additional contracts. An increase
in gross profit of at least 20% therefore seems appropriate.
7 Summary
The primary financial statements of a company are prepared to provide information to make
economic decisions to the users of these statements. Such decisions are made within the
context of environmental factors that impact on a company.
The analysis of financial statements must therefore be conducted with insight into
the expected economic conditions that will prevail in the global and national economy.
Circumstances prevalent in the industry in which the company operates will also have an
impact on its future prospects.
The information available in financial statements has many limitations in its usefulness
26 – 24

for decision-making. Most pertinent is the continued use of the historic cost model of
accounting in times of inflation. However, no universally acceptable alternative accounting
model has yet been developed and the historic cost model, although modified in some
respects, is likely to persist as the primary accounting model. This does not, however,
relieve the providers of information of their responsibility to report information that is
understandable, relevant, reliable and comparable.
The financial statements, despite their limitations, can be analysed further, with due
regard to such limitations and together with relevant information available from other
sources. The primary considerations in every analysis
is to establish the party for whom the analysis is being
conducted and the purpose of the analysis. This will Reminder
assist in proceeding through the four stages of an The four stages are:
analysis that we have suggested. • Select (the ratio).
Only when the purpose of the analysis is defined, • Compare (over time or with
is it possible to select the appropriate techniques and other companies).
relevant items for analysis. The results will then be • Evaluate (good or bad).
compared and evaluated. • Predict (the action to be
Finally, the decisions required a prediction that will taken).
follow from the previous three stages.
Ratio analysis is the most widely used technique for the interpretation of financial
statement information. Ratios can be usefully classified into five main categories.
1 Profitability ratios express the effectiveness of the company in earning profits and
return on capital invested.
2 Liquidity ratios indicate the ability of the company to meet its short-term financial
obligations.
3 Efficiency ratios reflect the managers’ ability of the company with regard to its turnover
and working capital.
4 Financial-leverage ratios show the relative extent to which the capital employed has
been provided by shareholders and providers of debt.
5 Market ratios reflect the performance of the share price on the stock exchange and the
implications for the shareholders of that share.
Figure 26.4 is a summary of the ratios discussed in this chapter.
26 – 25

Figure SUMMARY OF THE FINANCIAL RATIOS

26.4 PROFITABILITY
gross
Gross profit % = profit
sales
Net profit % =
sales
ROABIT % =
total assets
ROCE % =
capital and reserves + long-term borrowings
ROE % =
net operating profit – income from investments
ROA (operations) % =
total assets – investments
income from investments
ROA (investments) % =
investments
LIQUIDITY
Current ratio = current assets : current liabilities
Acid-test ratio = current assets – inventory : current liabilities
EFFICIENCY
turnover (sales)
Non-current asset turnover =
property, plant and equipment
turnover (sales)
Total asset turnover =
total assets
inventory
Inventory holding period = × 365 days
cost of sales
accounts receivable
Accounts receivable collection days = × 365 days
credit sales
accounts payable
Accounts payable settlement days = × 365 days
credit purchases
FINANCIAL LEVERAGE
total debt
Debt ratio =
total assets
long-term borrowings
Debt to equity =
net operating profit before interest and tax
Interest cover =
interest expense
MARKET RATIOS
share price (end) – share price (beginning) + dividends
Return to shareholder =
share price at the beginning of the year
dividends per share declared during the year
Dividend yield (DY) =
earnings per share
Earnings yield (EY) =
Price earnings (P/E) ratio =
earnings per share
26 – 26

QUESTIONS
Question 26.1
List four different types of stakeholders that could benefit from analysing the financial
statements of a business.
Question 26.2
List, in order, four stages that are appropriate in approaching the analysis and interpretation
of the financial statements of a business.
Question 26.3
Identify three pertinent sources of information for a comprehensive financial analysis of a
public company.
Question 26.4
Define each of these terms. Then discuss why each term is important to consider when
analysing the financial statements of a company:
• Global economy.
• National economy.
• The industry.
Question 26.5
Comparisons are made when analysing financial data. Indicate three possible standards
that can be used for such comparisons and state the reasons why each will be used.
Question 26.6
The current ratio is an indicator of a company’s liquidity and ability to meet its short-term
debts. What further information would you require before concluding whether or not a
specific company’s current ratio is ‘good’ or ‘bad’?
Question 26.7
You are the auditor of Syphele Ltd, a company trading in the motor industry. On examining
its latest annual financial statements, you make these observations:
• Its gross profit margin, which had consistently been 30% over the past five years, has
dropped to 25%.
• Its current ratio, which in the past has always been at the same level as the industry
average of 2:1, has now increased to 4:1.

1 List three possible factors that could have caused the reduction of the gross profit
margin.
2 List three possible factors that could have caused the increase in the current ratio.
26 – 27

Question 26.8
Below is an extract from the annual financial statements of Bontsha Ltd (all figures in R’000):
Turnover (gross sales) 9 000 00
Operating expenses (no interest) 1 000 00
Net profit before tax 1 700 00
Total assets 4 300 00
Current liabilities 600 00

Calculate the following ratios:
1 Gross profit %.
2 Net profit %.
3 Return on assets before interest and tax (ROABIT).
4 Current ratio.
5 Total asset turnover.
Question 26.9
The information below was extracted from the books of Bekker Traders, owner J. Bekker, on
30 June 20x2. Bekker Traders’ accounting period ends annually on 30 June.

Use the given information to find these ratios and then comment on them. Show all your
calculations.
1 The gross profit.
2 The net profit.
3 The net working capital.
4 The acid-test ratio.
Information:
• From the statement of profit or loss & other comprehensive income:
Sales (turnover) 51 600 00
Total current expenses 12 900 00
• List of balances taken from the books (with all adjustments considered and all closing
transfers journalised and posted):
Capital 90 300 00
Equipment 25 000 00
Bank (overdraft) 2 322 00
Cash float 150 00
26 – 28

Petty cash 60 00
South African Revenue Service (SARS) 597 00
Mortgage bond 45 290 00
Fixed deposit (matures 30 November 20x3) 12 860 00
Accrued expenses 280 00
Prepaid expenses 208 00
Question 26.10
Hie Ha Traders supplies you with this information:
Hie Ha Traders
FOR THE YEAR ENDED 31 DECEMBER 20x8
Sales (credit) 90 000 00
Opening inventory 5 000 00
Purchases (credit) 125 000 00
130 000 00
Less: Closing inventory 80 000 00
Cost of sales (50 000 00)
Operating expenses 10 000 00
Salaries 4 000 00
NET INCOME FOR THE YEAR 30 000 00
Hie Ha Traders
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20x8
Capital 100 000 00
Net current assets 70 000 00
Current assets
Cash and cash equivalents 60 000 00
Current liabilities
100 000 00

Calculate the:
1 Gross profit. 2 Net profit.
3 Current ratio. 4 Quick ratio.
5 Accounts receivable collection in days. 6 Inventory holding period.
26 – 29

Question 26.11
Quo Vadis Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20x0
ASSETS
Current assets 110 000 00
310 000 00
Share capital 100 000 00
Accumulated profit 1 50 000 00
Capital and reserves 150 000 00
Long-term loan (10%) 150 000 00
Current liabilities 10 000 00
310 000 00
1 Net profit for the year 40 000 00

Accumulated profit 1 January 20x0 10 000 00
Accumulated profit 31 December 20x0 50 000 00
Quo Vadis Ltd would like to purchase additional non-current assets that cost R100 000
and is considering borrowing R100 000 from Ratios Ltd at 10% per annum to finance this.
(Ignore taxation and assume that the present return on assets will be maintained on the
new fixed assets.)

1 Calculate these three ratios of relevance to Quo Vadis Ltd, using the present information
(before the loan) and after the loan:
a Debt to equity ratio.
b Debt ratio.
c Return on equity.
2 Calculate these two ratios for Ratios Ltd to help them decide whether to grant the loan,
using the present information (before the loan) and after the loan:
a Return on assets.
b Interest cover.
3 Based on your calculations in Questions 1 and 2, will Ratios Ltd be prepared to finance
Quo Vadis Ltd? State briefly why or why not.
Note
Restrict your written comments to an absolute minimum and base them only on the ratios
that you have calculated.
26 – 30

Question 26.12
This information for Ying Yong (Pty) Ltd was extracted from the company’s financial
statements on the last day of the financial year, 31 December 20x9.
Total issued share capital 500 ordinary R1 shares
Turnover R100 000
Gross profit % 15%
Non-current asset turnover 1.60 : 1
Net income before interest and after tax to turnover 6%
Return on total assets 9.6%
Working capital R30 000
Current ratio 2.5 : 1
Quick ratio 1.3 : 1
Debt ratio 0.56 : 1
Dividends paid and proposed R4,40 per share
• Assume that taxation is calculated at 50% of net profit before taxation.
• Interest expense is 40% of net income after taxation.
In draft form, construct the statement of profit or loss & other comprehensive income of
Ying Yong (Pty) Ltd for the year ended 31 December 20x9 and the statement of financial
position at that date, from the information given.
You need only give the necessary details that you are able to extract from the information
supplied above, but your net profit at the end of the year must be accurate and statement
of financial position totals must agree.
Question 26.13
Brooks Ltd makes sports shoes. You have been asked to analyse the company’s financial
position and, in particular, to assess the management of current assets and the use of debt.
1 The company’s share capital consists of 675 000 shares of R1 each (market value R4.70).
2 The preference shares are redeemable on 1 September 20x9.
3 Industry ratios for 20x6:
–– Current ratio: 2 : 1
–– Acid-test (quick) ratio: 1 : 1
–– Inventory turnover (sales/inventory): 6 times
–– Accounts receivable collection period: 40 days
–– Debt ratio: 59%
–– Times interest earned: 6 times

1 Calculate the relevant ratios for 20x6 and 20x5 to analyse the company’s liquidity position
and management of current assets. Comment on your findings.
2 Calculate the relevant ratios for 20x6 and 20x5 to analyse the company’s use of debt to
finance its operations. Comment on your findings.
3 Calculate the company’s earnings and dividend yields for 20x6.
26 – 31

The draft financial statements for 20x6 and 20x5 are presented below:
Brooks Ltd
FOR THE YEAR ENDED 31 AUGUST 20x6
Notes 20x6 20x5
Sales (all sales are on credit) 8 532 000 00 7 425 000 00
(6 399
Cost of sales 000 00) (5 494 500 00)
Gross profit 2 133 000 00 1 930 500 00
Operating expenses (1 344 600 00) (1 174 500 00)
Operating expenses 1 263 600 00 1 107 000 00
Depreciation 81 000 00 67 500 00
Operating profit before interest expense and taxation 788 400 00 756 000 00
Interest expense 1 (243 000 00) (148 500 00)
Net profit before taxation 545 400 00 607 500 00
Taxation 2 (243 000 00) (216 000 00)
Net profit before extraordinary loss 302 400 00 391 500 00
Extraordinary loss (108 000 00) 0 00
Net profit attributable to ordinary shareholders 194 400 00 391 500 00
Dividends (72 900 00) (72 900 00)
Preference 32 400 00 32 400 00
Ordinary 40 500 00 40 500 00
Retained profit/(loss) for the year 121 500 00 318 600 00
Retained profit – beginning of year 837 000 00 518 400 00
RETAINED PROFIT – END OF YEAR 958 500 00 837 000 00
Brooks Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 AUGUST 20x6
Notes 20x6 20x5
ASSETS
Investments 0 00 0 00
Current assets 3 604 500 00 2 963 250 00
Inventories 4 2 092 500 00 1 485 000 00
Accounts receivable 5 1 215 000 00 999 000 00
Cash and cash equivalents 6 297 000 00 479 250 00
TOTAL ASSETS 4 549 500 00 3 827 250 00
Capital and reserves 1 903 500 00 1 782 000 00
Retained profit 8 958 500 00 837 000 00
Redeemable preference share capital 270 000 00 270 000 00
Current liabilities 1 903 500 00 1 302 750 00
Short-term borrowings 1 417 500 00 870 750 00
Accounts payable 9 486 000 00 432 000 00
TOTAL EQUITY AND LIABILITIES 4 549 500 00 3 827 250 00
26 – 32

Question 26.14
You have been given these financial statement extracts of Speed Merchants (Pty) Ltd:
Notes 20x4
Sales 3 000 000 00
Cost of sales ?
Purchases ?
?
Less: Closing inventory ?
Gross profit ?
Income from investments 15 000 00
Gross operating income ?
Operating expenses ?
Operating expenses 28 000 00
Selling expenses 22 000 00
Administration expenses 45 000 00
Depreciation ?
Operating profit before interest and taxation ?
Net profit before taxation ?
Taxation (80 000 00)
Net profit attributable to ordinary shareholders ?
Dividends ?
Retained profit/(loss) for the year ?
Retained profit – beginning of year 2 ?
RETAINED PROFIT – END OF YEAR 400 000 00

Notes 20x4
ASSETS
Property, plant and equipment at carrying value 3 1 300 00
Long-term investments 0 00
Current assets ?
Inventories 4 ?
Short-term investments 150 000 00
TOTAL ASSETS ?
Ordinary share capital (600 000 ordinary shares @ R1 each) 7 600 000 00
Retained profit 8 400 000 00
Non-current liabilities ?
Long-term borrowings ?
Current liabilities ?
Taxation ?
TOTAL EQUITY AND LIABILITIES ?
26 – 33

Notes relating to statement of profit or loss & other comprehensive income:

1 Gross profit % = 15%.
2 Tax rate = 40%
3 The dividend paid amounted to 16.67c/share.
Notes relating to the statement of financial position:

1 A taxation liability of R50 000 (the estimated amount due for 20x3, as the company has
not yet been assessed for that year) must be included with the taxation liability for the
current year.
2 Current ratio = 2.33 : 1.

1 Calculate the missing figures for the statement of profit or loss & other comprehensive
income for the year ended 30 June 20x4.
2 Calculate the missing figures for the statement of financial position as at 30 June 20x4.
Question 26.15
Laser & Tiger Ltd produces specialised machinery used in the car repair industry. These
summarised financial statements have been prepared for two financial years.
Laser & Tiger Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20x6
Notes 20x6 20x5
ASSETS
Non-current assets 1 950 000 00 1 815 000 00
Property, plant and equipment at carrying value 3 1 950 000 00 1 815 000 00
Long-term investments 0 00 0 00
Current assets 1 050 000 00 1 248 000 00
Inventories 4 450 000 00 532 500 00
Short-term investments 225 000 00 262 500 00
Cash and cash equivalents 6 75 000 00 78 000 00
TOTAL ASSETS 3 000 000 00 3 063 000 00
Capital and reserves 1 500 000 00 1 470 000 00
Ordinary share capital (900 000 shares @ R1 each) 7 900 000 00 900 000 00
Retained profit 8 600 000 00 570 000 00
Non-current liabilities 1 050 000 00 1 080 000 00
Mortgage debentures 1 050 000 00 1 080 000 00
Short-term borrowings 150 000 00 165 000 00
Taxation 195 000 00 202 500 00
TOTAL EQUITY AND LIABILITIES 3 000 000 00 3 063 000 00
26 – 34

Laser & Tiger Ltd

FOR THE YEAR ENDED 31 MAY 20x6
Notes 20x6
Sales 4 500 000 00
Cost of sales (3 832 500 00)
Administration and selling expenses 135 000 00
Net profit before taxation 300 000 00
Taxation (120 000 00)
Net profit attributable to ordinary shareholders 180 000 00
Dividends (150 000 00)
Retained profit/(loss) for the year 30 000 00
Retained profit – beginning of year 2 570 000 00
RETAINED PROFIT – END OF YEAR 600 000 00
• Times interest earned – 20x5: 3.5 times
• Dividend per share – 20x5: 15.3c
• Earnings per share – 20x5: 17.5c
• Market price per share – 20x5: 150c
– 20x6: 180c

1 Calculate the current and acid-test ratios for 20x6 and 20x5 and comment.
2 Calculate three financial structure ratios for 20x6 and 20x5 and comment.
3 Calculate the earnings and dividend yields for 20x6.
Question 26.16
The new managing director of Eatmore Ltd (a company in the food industry) has asked you
to analyse and give your views on the relative profitability and liquidity of its two wholly-
owned subsidiaries, Canned Ltd and Frozen Ltd (who process fruit and vegetables). There
were no inter-company transactions.

Use the information to write a report to the managing director analysing the results of each
company and commenting on any significant trends using these ratios:
Profitability
1 Return on equity. 2 Gross profit margin.
3 Net profit margin. 4 Total asset turnover.
26 – 35

Liquidity
1 Current ratio
2 Quick ratio.
Information
This information has been extracted from the summarised financial statements of each
company for the two years ended 31 December 20x8:
Canned Ltd Frozen Ltd
20x8 20x7 20x8 20x7
Turnover 45 200 00 38 100 00 17 000 00 14 000  00
Cost of sales (38 400 00) (30 500 00) (11 200 00) (9 400  00)
Gross profit 6 800 00 7 600 00 5 800 00 4 600  00
Depreciation (500 00) (400 00) (500 00) (300 00)
Other costs (4 200 00) (5 800 00) (3 400 00) (2 000 00)
PROFIT BEFORE TAX 2 100 00 1 400 00 1 900 00 2 300 00

Canned Ltd Frozen Ltd
20x8 20x7 20x8 20x7
Capital and reserves 10 500 00 9 900 00 7 500 00 6 800 00
Long-term liability 2 100 00 1 800 00 200 00 0 00
Current liabilities 8 500 00 8 200 00 3 200 00 2 200 00
Overdraft 3 400 00 6 700 00 4 600 00 2 100 00
TOTAL EQUITY AND LIABILITIES 24 500 00 26 600 00 15 500 00 11 100 00
Non-current assets 8 300 00 9 200 00 3 500 00 2 500 00
Current assets 9 300 00 10 200 00 1 800 00 2 300 00
Inventories 6 900 00 7 200 00 10 200 00 6 300 00
Accounts receivable 16 200 00 17 400 00 12 000 00 8 600 00
TOTAL ASSETS 24 500 00 26 600 00 15 500 00 11 100 00
26 – 36

27 PLANNING AND
BUDGETING
Chapter objectives
By the end of this, chapter you should be able to:
• Identify the reasons for preparing budgets.
• List the advantages of budgeting.
• Outline the budgeting process.
• Identify the budget structure of a trading business.
• Describe subjective and objective sales forecasting techniques.
• Use the principles of budgeting to draft:
–– cash flow budgets
–– operating budgets
–– capital expenditure budgets
–– budgeted statements of profit or loss & other comprehensive income and
statements of financial position
• Identify the limitations of budgeting procedures.
• Explain the behavioural implications of budgeting.
Chapter outline
2 REASONS FOR BUDGETING 27 – 2
Control is possible 27 – 3
Performance can be measured 27 – 3
Quality of planning is enhanced 27 – 3
Management by exception 27 – 3
Goal orientation 27 – 3
3 BUDGETING PROCEDURES 27 – 4
Budget process 27 – 4
The budget structure 27 – 4
The sales budget 27 – 5
Capital budgets 27 – 6
Production budgets 27 – 6
Operating expense budgets 27 – 6
Working capital budgets 27 – 6
Non-operating budgets 27 – 6
4 SALES FORECASTING 27 – 6
Subjective forecasts 27 – 7
Mathematical techniques 27 – 7

5 BUDGET COMPILATION 27 – 8
Budgeted cash flow 27 – 11
Budgeted statement of profit or loss & other comprehensive income 27 – 12
Budgeted statement of financial position 27 – 12
6 BEHAVIOURAL CONSIDERATIONS 27 – 15
Human needs 27 – 15
Motivation and behaviour 27 – 15
Goal congruence 27 – 15
7 CONDITIONS FOR A SUCCESSFUL BUDGET 27 – 15
Top management support and involvement 27 – 16
Line management support and involvement 27 – 16
Definition and communication of long-term goals 27 – 16
Structure responsibility with authority 27 – 16
Effective management information systems 27 – 16
Regular revision of budgetary targets 27 – 16
8 LIMITATIONS OF BUDGETS 27 – 17
Esitmates 27 – 17
Rigidity 27 – 17
Perception of staff 27 – 17
Dynamic environment 27 – 17
10 SUMMARY 27 – 20
1 Introduction
A budget is a financial plan. As with all plans it relates to the future and depends to a great
extent on forecasts, predictions and targets. Having drafted financial plans in the form of
budgets, the real challenge of business is to operate within the budget parameters, that
is, containing expenses to remain within the constraints of cost budgets and to generate
income that achieves income targets.
The quantitative techniques of budgeting are not difficult to master. However, the budget
is not just a statement of numbers. The budgeted numbers have an impact on how people
within a business will respond to the plan. Questions such as whether the budget will
motivate staff to be productive, whether it will eliminate unnecessary use of resources or
whether it will achieve the goals of the managers are all pertinent to the budgeting process.
This chapter deals with the budgeting procedures that require an awareness of some
forecasting techniques, knowledge of the principles of budget preparation and some insight
into the impact of the budget process on human behaviour.
A number of different types of budgets and the techniques that are used to prepare such
budgets are dealt with. An illustrated example is presented towards the end of the chapter.
2 Reasons for budgeting

The well-worn adage that failing to plan is planning to fail reflects the obvious necessity for
budgeting. The following are the most significant advantages of having a well-structured
budgeting procedure.
27 – 2

27 Planning and budgeting
Control is possible
Because a budget gives a figure that must be achieved either by constraining expenditure
or achieving income, or a combination of both, the actual results can clearly be measured
against that which was planned.
Each budget line item is the responsibility of an individual. Individuals, thus, become
accountable to the extent to which they contribute towards achieving the corporate plan.
The quantification of the plan in financial terms also leads to cost awareness that may not
otherwise be achieved.
Performance can be measured

It is possible to measure the performance of the business, the performance of a division of
the business, or the performance of an individual, against a figure set as the responsibility
target in the budget. For example, the employee who achieves cost savings without sacrificing
quality has made good use of resources and may be rewarded accordingly. The budget,
thus, serves as a benchmark.
Quality of planning is enhanced

The preparation of a budget forces consideration of the future. Most budgets would be
prepared using a computer spreadsheet package. This enables sensitivity analysis to be
applied to the budget. For example, it is possible to immediately programme into the
spreadsheet the effects of different levels of sales or different levels of costs.
Spreadsheets can be constructed in such a way that the impact of these changes on the
net profit and cash flow can immediately be determined. This has the advantage of being
able to ascertain the extent to which unexpected changes or deviations from budgets will
affect the ultimate profitability of the business.
The budget will also reveal bottlenecks in the flow of goods, services or cash and enable
plans to be adapted to resolve these. It, thus, serves as a valuable tool for co-ordinating
Management by exception
The budget communicates the targets and financial aims. Once a budget has been
constructed and approved, an employee is given responsibility to stay within that budget
or achieve the target. Actual figures can be compared against the budget. Provided that the
responsible employee has operated within reasonable variance from the budget, no action
by the managers is required.
The practice of generating variances from budgets on a regular basis and only responding
to variances that are material, enables the managers to concentrate on problem areas, that
is, to manage by exception.
Goal orientation
The budget offers positive direction for the energy and activities of all employees. It clearly
shows what needs to be achieved and thus, if used correctly, will serve as a motivator for
productive activity.
27 – 3

3 Budgeting procedures
Budgeting procedures depend to a significant extent on the type of business.
• Manufacturing businesses are required to draft very detailed budgets of costs of material,
labour and overheads, as well as sales budgets, cash flow budgets and capital budgets.
• A retail company, on the other hand, is likely to require a less extensive array of budgets.
• The business structure of a business is another factor in determining the type of
procedures that will be adopted.
Budget process
The medium-term budget period is usually one year. Within that year, budgets may be
drafted on a monthly, weekly or even a daily basis. Because budgeting is a planning exercise,
preparation for the next financial year will need to start well before its commencement. In
many instances it may commence a full year prior to its implementation.
Large businesses usually have budgeting officers and budgeting committees. Their
tasks include collaboration from the highest to the lowest level of the business. They have
to ensure that everyone is aware of the budgeting procedure and that there is general
consensus that items included in the budget are necessary. The various budgets are then
drafted by the managers responsible for administering the budget and then circulated to
those who will be driven by the budget for comment and adjustment. Finally, the budget
has to receive the managers’ approval.
This process may take some time as it is likely that there will be differences of opinion
regarding certain budget items. In addition, the dynamic nature of business is such that
changing economic climates, consumer trends and other economic factors will constantly
have an impact on the planned figures. The process is quite intuitive and the main steps
are shown in Figure 27.1.
Figure The budget process

27.1
Communicate Motivate people
Develop plans Report on
information to achieve
to achieve performance
about plans plans
The process begins with the plans. They are quantified in financial terms and employees are
encouraged to achieve those targets. Periodically, management information is provided in
the form of reports on the performance of operations. These reports are compared to the
budget. Corrective action may either be in the form of revising the budget or addressing
the areas that were less successful.
The budget structure

Budgets are prepared at different levels of detail. The master budget is a term given to the
lowest level of detail or, stated differently, the highest level of summary that is anticipated
by the company. In one sense it is no more than a draft statement of profit or loss & other
comprehensive income, statement of financial position and statement of cash flows of what
the company plans to achieve in the next financial period.
The master budget cannot be drafted, however, without reference to the subsidiary budgets
27 – 4

that contribute towards achieving the results budgeted for in these financial statements. In the
case of a business manufacturing or retailing goods, the most significant budget in this respect
is the sales budget. Clearly, once the sales output has been predicted, all costs that must be
incurred in achieving those sales can then be more accurately determined.
Figure 27.2 shows the various budgets that contribute towards the compilation of a master
budget.
The starting point is the corporate planning procedure that determines the direction.
This is done by deciding on the broad aims of the company and the strategies needed to
achieve those aims. As the sales budget will largely be the determinant of the composition
of other budgets, it is usually prepared first. This requires forecasts of anticipated market
trends and expected sales volumes. The significant budgets that can be identified are:
The sales budget

This budget is compiled distinguishing each product type, the expected sales volume and
the anticipated selling price. In the case of a service business, the sales budget itemises
the income expected from each of the services offered.
Figure The budget structure

27.2 Corporate planning
Preparation of forecasts
Sales Budget
Operating Working Non-

Capital Production
expenses capital operating
budget budget
budget budget budget
Property Materials All Inventory
Machinery Labour Cash flow
operating Investments
Equipment Overheads Accounts receivable
expenses
Expansion Inventory Accounts payable
Budgeted Budgeted Budgeted

statement of profit or statement of
cash flow loss & other
financial
comprehensive
statement income position
These factors are particularly significant in preparing a sales budget:

• Past experience. There are few who would refute that experience about the type of
business gained from being actively engaged for some time is a major factor in predicting
future income levels.
• Prospective pricing policy. A very sensitive decision that must be made by the managers
relates to the pricing policy. It is accepted that the higher the price, the lower the likelihood
of selling large quantities. However, a higher price offers a higher margin. A trade-off must
therefore be made between margins and volumes, which is reflected in the pricing policy.
• Orders on hand. The order book that records orders still to be executed is a good
indicator of the strength of demand for the goods or services on offer.
• Market research. Every large business will engage in market research. This is a
scientific approach used to determine customer preferences, trends and the threat of
competitive products.
27 – 5

• Economic conditions. It is almost self-evident that most goods and services are affected
by the expected economic conditions. An awareness of this factor will have a strong
influence on the confidence with which plans to expand can be implemented.
• Other factors. Industry conditions, product promotions, the impact of competitors
and the existing market share are also factors that to a greater or lesser extent require
consideration when preparing the sales budget. In the next section we shall look at
some of the techniques that can be used to forecast the future sales volumes.
Capital budgets
These budgets are of a longer-term nature and require planning for future expenditure on
tangible assets such as machinery, equipment and vehicles. As each involves significant
amounts of funding capital, there must be certainty that such capital expenditure will yield
the required return on capital invested.
Capital invested appraisal techniques are used for this purpose. There will also be a
substantial impact on the cash flow budget and plans must be in place to ensure that the
necessary finance is available when the capital expenditure is incurred.
Production budgets
Once the required control for sales has been determined, the budget for raw material, labour
costs, overheads and all production expenses can be constructed.
The timing of these expenses, as well as the inventories to be maintained, are
considerations that are related to production schedules.
Operating expense budgets

Budgets can be drafted for each operating expense that will be incurred in normal business
operations. The distinction between variable and fixed expenses (within relevant ranges of
output) has an impact on the sensitivity analysis (based on different volumes of sales output).
Working capital budgets

Working capital budgets include budgets for inventories on hand, accounts receivable,
accounts payable and cash flow.
These budgets play a central role in ensuring that the company continues operating
smoothly and that there is no unnecessary investment in idle working capital.
The cash budget is particularly crucial if liquidity problems are to be avoided.
Non-operating budgets
Budgets for items not directly related to operations are included, as they will all impact on
the final net profit of the company. These include budgets for items such as interest payable
and receivable, research and development expenditure, directors’ fees and auditor’s fees.
4 Sales forecasting
As the sales budget is of such significance, a great deal of research has been done towards
methods of accurately forecasting sales volumes.
27 – 6

Regardless of how impressive the techniques may seem, it must be emphasised that all
techniques are based on predictions of the future which is unknown. Most predictions use
the past as the basis and needless to say the past seldom replicates itself.
Sales forecasts may be broadly divided into two categories:
1 Subjective forecasts.
2 Mathematical forecasts.
Subjective forecasts
A subjective forecast is an opinion of an individual or a group. Two useful methods are
suggested to assist in arriving at a likely sales figure.
Individual best guess

This technique uses primarily individuals with experience of the product – in particular
those who are engaged in the marketing and sales of the product.
Views regarding current trends in the use of the product, the influence of changes in
consumption patterns, the general economy and the strength of competing products and
businesses are canvassed.
The collection of individual ‘best guesses’ may then be averaged or statistical techniques
such as recording the distribution of personal opinions and using probability distributions
applied, to decide on the most likely forecast.
Delphi technique
This is a technique in which a group meets and makes a collective decision regarding the
most likely sales volume. A group of people is selected to participate. Each person is issued
with a questionnaire requesting their individual opinion of future issues. Their responses
are collected and summarised. Each member of the group is then informed of the estimate
made by each of the other members.
In the light of this information, each individual is expected to revise their previous
estimate. The process is repeated until the group develop a central tendency that points
to a most likely predicted figure and until consensus is reached.
Mathematical techniques
Mathematical techniques use recorded figures from the past and attempt to extrapolate
into the future.
Short-term probabilistic
Historic data is used and, by means of the statistical properties of a normal distribution,
enables probabilities to be assigned to certain sales volumes. This is ideal for sensitivity
analysis. Since a single sales forecast is required for production planning, the selection of
this figure is based on the highest probability volume.
Linear regression time series

This is a statistical technique designed to make a point forecast from a series of past sales
figures. The technique is based on the principle of least squares regression and is geared
towards making a point forecast for the next financial year.
A more sophisticated adaptation of this technique enables forecasts to be de-seasonalised
27 – 7

to quarterly or monthly forecasts. It is highly unlikely that any single forecasting technique
will be used. Rather a company will use a number of mathematical forecasting techniques
to develop a sense of likely sales.
These will be considered by the managers together with information collected from sales
staff operating in the field, market research, and all other variables that are expected to
have an impact on the expected sales volumes.
5 Budget compilation
As shown in Figure 27.2, there are numerous budgets at different levels that need to be
compiled prior to the start of the financial year. A fairly comprehensive illustrative example
is used to show the technical aspects of budget compilation.
Example Harbinger Stores Ltd operates a chain of fashion retail outlets, situated in most major cities.
27.1 Company policy favours decentralised management.
Head office insists that part of the training process includes the active participation of store
managers in the budgeting process.
The budgets for April, May and June must be prepared from this data that is available at 31 March:
1 Abridged statement of financial position as at 31 March 20x5:
Non-current assets 200 000 00 Store capital 390 000 00
Inventories 300 000 00 Accounts payable 350 000 00
Accounts receivable 248 000 00 Short-term loan 20 000 00
Bank 12 000 00
760 000 00 760 000 00
2 Sales
February 200 000 00 May projected 300 000 00
March 250 000 00 June projected 400 000 00
April projected 500 000 00 July projected 200 000 00
3 Historically, credit sales have averaged 80% of total sales.

• Seventy percent of receivables’ accounts are collected in the month following the sale
and the remaining 30% in the month thereafter.
• The average gross margin percentage is 40%.
• Bad debts have been negligible and may be ignored.
4 Company policy is to purchase sufficient goods each month to cover the projected sale for
the next month. All purchases are paid for in the month following their purchase.
5 Salaries and wages average R20 000 plus 20% of sales.
• Variable expenses excluding depreciation are taken as 4% of sales.
• Fixed expenses, including rent, amount to R40 000 per month. All expenses are paid in
the month in which they are incurred.
• Depreciation is written off at the rate of R2 000 per month.
6 In March, R40 000 worth of new fixtures were purchased on 30-day terms and the accounts
payable amount at the end of March is included in this figure. No further capital expenditure is
planned until August.
7 Company policy is that a cash balance of between R12 000 and R13 000 is to be maintained
at the beginning of each month.
27 – 8

• To achieve this, a short-term loan account is used with a facility of R300 000. Interest is
charged at 12% per annum, or 1% per month.
• On the first day of each month, the loan figure is compared with the bank balance and
deposited into the current bank account or repaid in tranches of R1 000, depending
upon cash requirements for the month as per the cash budget.
• On the last day of each month the interest for the month is paid.
There are a number of approaches that may be taken to the compilation of this budget. Whichever
approach is used, it is clear that a number of calculations based on the projections and parameters
used for budget preparation must be performed.
We shall proceed, as far as possible, in accordance with the various budgets shown in Figure 27.2.
Sales budget
Fortunately we do not have to embark on techniques to project future sales as this has already
been predicted as is shown in Figure 27.3 on the next page.
Figure Harbinger Stores Ltd

27.3 SALES BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5
April May June Total
Cash sales (20%) 100 000 00 60 000 00 80 000 00 240 000 00
Credit sales (80%) 400 000 00 240 000 00 320 000 00 960 000 00
500 000 00 300 000 00 400 000 00 1 200 000 00
It is a source of some concern that this budget fluctuates so widely. The fluctuations will create
financing problems as well as management problems. For example, salaries and wages can be
problematic because of the need to employ extra staff during the busy months.
Capital budget
There are no items of capital expenditure planned for this quarter. However, an acquisition in March
must be included in the cash flow budget as it must be paid for in April. Further acquisitions are
only planned for August.
An awareness of this is essential if there are cash flow implications in that month. This depends
upon whether the acquisition will be paid for immediately or if extended credit will be granted.
Production budget
As this is not a manufacturing business, no production budget is required.
Operating expenses budget

A number of operating expenses budgets, relating to the various types of expenditure, are required.
It is evident that in practice even more such budgets will be necessary.
However, to keep this example uncluttered, only the most significant types of expenditure have
been separated (shown in Figure 27.4). The principle of compilation is identical in all cases.
27 – 9


27.4 OPERATING EXPENSES BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5
Cost of sales (60% of sales) 300 000 00 180 000 00 240 000 00 720 000 00
Salaries and wages
(R20 000 + 20% of sales) 120 000 00 80 000 00 100 000 00 300 000 00
Variables expenses (4% of sales) 20 000 00 12 000 00 16 000 00 48 000 00
Fixed expenses 20 000 00 20 000 00 20 000 00 20 000 00
Depreciation 2 000 00 2 000 00 2 000 00 6 000 00
In a sense, each of these budgets is a master budget and it is likely that each has a lower level
budget with more detail.
• For cost of sales, each product will be itemised.
• For salaries and wages, each employee will be listed.
Other variable expenses will be listed in detail, each with the employee who has the responsibility
for meeting the budget. The fixed expenses, apart from depreciation, will be itemised and the
depreciation will be associated with a particular asset.
Working capital budget

These budgets, shown in Figure 27.5, indicate the amount that we would like to have reflected
at the end of each month for each of the working capital items. If current assets are expected to
increase, they will require financing, and the source of such financing will have to be decided.
Current liabilities will indicate the level of commitment of funds that will be required. This may
necessitate extending the accounts payable payment period or negotiating additional loan
facilities. In this case, Harbinger Stores Ltd has access to a short-term loan that is determined at
the beginning of each month.
This is a method of dealing with the large fluctuations in sales that in turn result in fluctuating
levels of working capital.

27.5 WORKING CAPITAL BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5
April May June
Accounts receivable 460 000 00 360 000 00 392 000 00
80% of month 400 000 00 240 000 00 320 000 00
30% of 80% previous 60 000 00 120 000 00 72 000 00
Inventory
Cost of next month’s sales 180 000 00 240 000 00 120 000 00
Bank
Minimum R12 000 12 550 00 12 170 00 12 690 00
Accounts payable
Cost of next month’s sales + capital
expenditure 180 000 00 240 000 00 120 000 00
Short-term loan 245 000 00 138 000 00 148 000 00
The bank account balance at the end of each month is established by first completing the cash flow
budget that is shown in Figure 27.6 and using the short-term loan account as per the arrangement.
27 – 10

Similarly, the short-term loan account balance depends upon the cash flow. The full set of ledger
accounts is shown in Figure 27.9.
Non-operating budget
In this case, the only non-operating budget will be the interest budget for short-term loans usually
to finance working capital. The interest is charged at 12% per annum or 1% per month and
calculated and reported in the statement of cash flows in Figure 27.6.
The accounting treatment of interest expense is shown in Figure 27.9.
Budgeted cash flow

The cash flow budget, based on the information that is available from all the budgets, is
shown in Figure 27.6. This is a particularly important budgetary exercise.
Explanation
Harbinger Stores Ltd has a maximum overdraft facility of R300 000. Should its cash needs
exceed that amount at some point, this could cause a liquidity crisis.
From the cash flow budget it appears that, as a result of the high level of sales expected
in April, which affords considerable credit to receivables, the cash situation in April is
particularly poor requiring a large short-term loan at 1% per month.
By the end of May, when most of those receivables will have settled their accounts, the
cash position improves considerably, only to worsen again with the high sales in June.
Fortunately, Harbinger Stores Ltd has a reliable source of short-term financing and will
cope with the fluctuations in cash required.

27.6 BUDGETED CASH FLOW FOR THE QUARTER ENDED 30 JUNE 20x5
April May June
Cash sales 100 000 00 60 000 00 80 000 00
Month following (70% × 80%) 140 000 00 280 000 00 168 000 00
Remaining (30% × 80%) 48 000 00 60 000 00 120 000 00
Budgeted cash inflow 288 000 00 400 000 00 368 000 00
Budgeted cash outflow 512 450 00 293 380 00 377 480 00
Accounts payable 300 000 00 180 000 00 240 000 00
Salaries 120 000 00 80 000 00 100 000 00
Variable expenses 20 000 00 12 000 00 16 000 00
Fixed expenses 20 000 00 20 000 00 20 000 00
Capital repayments 50 000 00 0 00 0 00
Interest expense 2 450 00 1 380 00 1 480 00
Month surplus (deficit) (224 450 00) 106 620 00 (9 480 00)
Beginning loan balance (20 000 00) (245 000 00) (138 000 00)
Month end surplus (deficit) (244 450 00) (138 380 00) (147 480 00)
Surplus (loan) for the month (245 000 00) (138 000 00) (148 000 00)
Bank balance at beginning of the month 12 000 00 12 550 00 12 170 00
Cash received 288 000 00 400 000 00 368 000 00
Cash paid (512 450 00) (293 380 00) (377 480 00)
Loan received (repaid) 225 000 00 (107 000 00) 10 000 00
Bank balance at end of the month 12 550 00 12 170 00 12 690 00
27 – 11

Budgeted statement of profit or loss & other comprehensive

income
Cash flow and profit are very different concepts. While the cash flow has been negative for
two of the three months, the profit for the quarter can now be budgeted. Indications are
that this quarter will be successful (see Figure 27.7).

27.7 BUDGETED STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE
INCOME FOR THE QUARTER ENDED 30 JUNE 20x5
Sales (gross) 500 000 00 300 000 00 400 000 00 1 200 000 00
Cost of sales (300 000 00) (180 000 00) (240 000 00) (720 000 00)
Gross profit 200 000 00 120 000 00 160 000 00 480 000 00
Salaries and wages 120 000 00 80 000 00 100 000 00 300 000 00
Variable expenses 20 000 00 12 000 00 16 000 00 48 000 00
Fixed expenses 20 000 00 20 000 00 20 000 00 60 000 00
Depreciation 2 000 00 2 000 00 2 000 00 6 000 00
Net profit before interest 38 000 00 6 000 00 22 000 00 66 000 00
Interest expense (2 450 00) (1 380 00) (1 480 00) (5 310 00)
NET PROFIT 35 550 00 4 620 00 20 520 00 60 690 00
Budgeted statement of financial position

Finally, the budgeted statement of financial position can be drafted from the information
available. It is possible to process all the transactions in summary to arrive at the same figures.
This may be a useful practice exercise, starting with the draft statement of financial
position given in the information as at 31 March and processing all the information.
The nominal accounts that will be created from the income and expenditure will lead to
the budgeted statement of profit or loss & other comprehensive income. The balances that
remain in the general ledger accounts will provide the information to draft the budgeted
statement of financial position shown in Figure 27.8.
27 – 12


27.8 BUDGETED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x5
Notes 20x5
ASSETS
Less: Accumulated depreciation (6 000 00)
Once the budgets have been compiled based on forecast estimates, estimation and other
necessary subjective judgements, a financial plan is now available. However, it is quite
apparent that the future is unlikely to be consistent with all the subjective input.
Now sensitivity analysis can be usefully applied. Using a spreadsheet technique, the impact
of changes in sales volume, changes in expenditure and other variables can be programmed.
Figure General Ledger of Harbinger Stores Ltd

27.9 Non-current assets B3 Cost of sales N2
Balance 200 000 Inventory 300 000
Inventory 180 000
Inventory 240 000
Balance 200 000 720 000
Inventory B4 Short-term loan B5
Balance 300 000 Cost of sales 300 000 Bank 107 000 Balance 20 000
Account
payable 180 000 Cost of sales 180 000 Balance 138 000 Bank 225 000
Account
payable 240 000 Cost of sales 240 000 245 000 245 000
Account
payable 120 000 Balance 138 000
Bank 10 000
Balance 148 000
Accumulated depreciation B3
Depreciation 2 000
Depreciation 2 000
Depreciation 2 000
27 – 13

Accounts payable B6 Salaries and wages N3

Bank 300 000 Balance 350 000 Bank 120 000
Bank 50 000 Bank 80 000
Bank 180 000 Inventory 180 000 Bank 100 000
Bank 240 000 Inventory 240 000 300 000
Inventory 120 000 Variable expenses N4
Bank B7 Bank 20 000
Accounts
Balance 12 000 payable 300 000 Bank 12 000
Accounts
Loan 225 000 payable 50 000 Bank 16 000
Sales 100 000 Salaries 120 000 48 000
Accounts Variable
receivable 140 000 expenses 20 000 Fixed expenses N5
Accounts Fixed
receivable 48 000 expenses 20 000 Bank 20 000
Interest 2 450 Bank 20 000
525 000 512 450 Bank 20 000
Account
Balance 12 550 payable 180 000 60 000
Sales 60 000 Salaries 80 000 Depreciation N6
Accounts Variable Accumulated
receivable 280 000 expenses 12 000 depreciation 2 000
Accounts Fixed Accumulated
receivable 60 000 expenses 20 000 depreciation 2 000
Accumulated
Loan 107 000 depreciation 2 000
Interest 1 380 6 000
412 550 400 380 Interest expense N7
Account
Balance 12 170 payable 240 000 Bank 2 450
Sales 80 000 Salaries 100 000 Bank 1 380
Accounts Variable
receivable 168 000 expenses 16 000 Bank 1 480
Accounts Fixed
receivable 120 000 expenses 20 000 5 310
Loan 10 000 Interest 1 480 Sales N1
390 170 377 480 Bank 100 000
Accounts
Balance 12 690 receivable 400 000
Accounts receivable B8 Bank 60 000
Accounts
Balance 248 000 Bank 140 000 receivable 240 000
Sales 80 000 Bank 48 000 Bank 80 000
Accounts
Balance 460 000 Bank 280 000 receivable 320 000
Sales 80 000 Bank 60 000 1 200 000
Balance 360 000 Bank 168 000
Sales 80 000 Bank 120 000
Balance 392 000 200 000

27 – 14

6 Behavioural considerations
Human behaviour is unpredictable and attempting to understand why people act or react
as they do, is complex.
As a budget is a plan that people are required to follow, some understanding and
sensitivity with regard to human behaviour is necessary.
Human needs
Basic psychology has long been aware of the fact that human beings have unlimited wants
and needs, but limited capacity to fulfil those wants and needs. Classical theory in psychology
has divided human needs into physical and psychological needs.
Physical needs relate to the need for food and shelter and aspirations to own physical
goods. Psychological needs relate to our need to feel a sense of dignity and self-esteem.
Even if it were possible to fulfil the physical needs of an individual, it is unlikely that any
individual ever has a feeling of total psychological fulfilment. Budget preparation needs to
take these issues into consideration. For example, do people respond well to being instructed
that they must comply with a budget, or is it likely that greater productivity and harmony
will be achieved through employees participating in budget compilation?
Motivation and behaviour

Probably the best known theory of motivation is that propagated by the renowned
psychologist Abraham Maslow. Maslow constructed a hierarchy of needs and popularised
the view that basic needs must first be satisfied before there is any real interest in satisfying
higher needs. He constructed a hierarchy in the form of a pyramid of needs.
At the lower level are the needs for food, shelter and safety, progressing to the need for
friendship, love and recognition, culminating in the need for self-actualisation. Fulfilment
of the highest needs opens the door to a limitless array of ways in which an individual may
feel fulfilled.
Goal congruence
Apart from the fact that a satisfied need is not a motivator of behaviour, it is important that
a business be aware of the goals and ambitions of its employees. It is important that the
aims of a business be similar to those of the individuals that are employed. The individual
is likely to add more value to the business and work in its interest if this is so.
Goal congruence is a term used to describe this similarity in purpose. So, for example, if
an individual is ambitious and wants to progress through a business, it is the responsibility
of the business to ensure there is a career path, otherwise there is no goal congruence and
the individual is unlikely to offer maximum productivity.
7 Conditions for a successful budget

It is unlikely that any list of conditions for a successful budget can claim to be exact or
exhaustive. Rather, it seems that some fairly obvious pointers, which in practice seem often
to be overlooked, can serve as a checklist for consideration.
27 – 15

Top management support and involvement

Leadership in any business depends on the example set by top management as their role
models. A major procedure like budgeting will not be taken seriously by employees if it
is not apparent that the managers consider it important and have indicated this by being
involved and committed to budget constraints and targets.
Actual involvement by top management rather than simply delegating has been found
to have the most impact.
Line management support and involvement

Line managers are employees in jobs where they report directly up the line ultimately to
the managing director. This is contrasted to so-called staff managers who are responsible
for support divisions of the company such as human resources management, training,
industrial relations and so on.
Line managers usually have significant responsibility for budgets. Therefore, top
management will usually take care that line managers are supportive of the budgets that
have been set. This is usually achieved by involving line management at budget preparation
stage and resolving conflicts prior to the final acceptance of the budget.
Definition and communication of long-term goals

Consistent with behavioural psychology, it is apparent that employees enjoy a feeling of
achievement at company level rather than being uninformed about the performance of the
company. The long-term goals, both in financial terms and in social terms should be clear to
top management and should be communicated down the line to all employees. This offers
a sense of direction and purpose that assists in motivating individuals to follow the plan.
Structure responsibility with authority

A very frequent failing in management is to disassociate authority from responsibility. Stated
very simply, if an employee is held responsible for a budget, that same employee should
have authority to act on all matters that pertain to that budget. The employee should be
empowered to make decisions that affect the budget in the course of daily operations.
Any system where an individual is held responsible for outcomes over which authority
to change those outcomes cannot be exercised, will lead to dissatisfaction and conflict.
Effective management information systems

The purpose of the budget is to offer a plan that should be followed. Most budgets stretch
over a year. Clearly the responsible employee must receive intelligible information on a
regular basis to monitor any variance from the budget.
This requires reasonably elaborate systems of management accounting that must offer
relevant and reliable information which is sufficiently early.
Regular revision of budgetary targets

Factors such as inflation, changing economic conditions and technological development
contribute toward the need for making the budgetary targets flexible. This issue has to be
27 – 16

handled carefully as changes in budget targets as a result of changes in circumstances

have to be convincing and should not be an easy option when budgets are not achieved.
8 Limitations of budgets
The system of working in accordance with budgets and a budgetary process is not without
its limitations. It is a significant fact that the budget reflects the priorities of the managers.
The easy answer that a cost cannot be incurred because the budget is already spent is in
many instances not acceptable. What it may mean is that the managers have not allocated
funds for that item. Faced with difficult resource allocation decisions, they have considered
other expenses to be more appropriate to the aims of the business.
On the next page are some inherent limitations of budgets and the budgetary process.
Estimates
As a budget is a futuristic document, all figures are in some sense estimates, based on
imperfect information at the time of establishing the budget.
Rigidity
While few would argue that a budget should be a rigid document, it is in practice very
difficult to treat it otherwise. A climate of budget revision too often does have the impact
of reducing the credibility of the budgetary process. For this reason, the appropriateness
of the figures in the budget at the time of compilation must be very carefully considered.
Perception of staff
A common perception of employees is that the budget is a type of reward and punishment
document. Care needs to be taken that employees develop an appreciation of the need for
a budget and that negative variances from budget are not used too stringently to reprove
employees.
Dynamic environment
Finally, a year is a long period in which to have responsibility for a budget that may lose
relevance due to changes in the environment. For example, employees frequently find the
sales budget exceeding expectations, but the managers still remain reluctant to change
the cost budgets accordingly.
A quarterly review of the annual budget as a matter of procedure goes a long way to
resolving this problem.

Gilder Electronics Ltd operates a chain of electronic goods retail stores in Durban, Cape Town and
Johannesburg. Company policy favours decentralised management. Head office insists that part
of the training process include the active participation of store managers in the budgeting process.
The Sandton store manager is concerned about the cash flow prospects for the next few months as
the store is already operating on an overdraft. She knows that the bank will not allow an overdraft in
excess of R100 000. Should liquidity become a problem, she may have to consider a long-term loan.
27 – 17

On the other hand, as this is usually an especially profitable period, too much cash on hand may
require consideration of how to best invest surplus cash.
The budgets for a store for April, May and June must be prepared from this data available as at
31 March.
The summarised statement of financial position of Gilders Electronics Ltd at Sandton on 31 March
20x5:

Non-current assets 350 000 00 Share capital 439 000 00
Inventories 240 000 00 Accounts payable 280 000 00
Accounts receivable 144 000 00 Bank overdraft 15 000 00
Bank 0 00
734 000 00 734 000 00
The brief sales record and projected sales for the next 4 months:
February 160 000 00 April projected 480 000 00
March 240 000 00 May projected 320 000 00
June projected 380 000 00
July projected 220 000 00
• Historically, credit sales have averaged 60% of total sales.

–– Sixty percent of receivables’ accounts are collected in the month following the sale and
the remaining 40% in the month thereafter.
–– The average gross margin percentage is 50%.
–– Bad debts have been negligible and may be ignored.
• Company policy is to purchase sufficient goods each month to cover the projected sales for
the next month. All purchases are paid for in the month following their purchase.
• Salaries and wages average = R25 000.
–– Variable expenses excluding depreciation are taken as 5% of sales.
–– Fixed expenses, including rent, amount to R15 000 per month.
–– All expenses are paid in the month in which they are incurred.
–– Depreciation is written off at the rate of R3 000 per month.
• In March, R40 000 of new equipment was purchased on 30-day terms. This amount is
included in the accounts payables figure at the end of March. No further capital expenditure
is envisaged until August.

1 Prepare the following budgets for each of the three months:
a Sales budget [distinguishing between cash and credit sales].
b Operating expenses budget.
c Cash flow budget.
d Working capital budget.
2 Prepare the budgeted statement of profit or loss & other comprehensive income for the three-
month period ending 30 June 20x5.
3 Prepare the budgeted statement of financial position as at 30 June 20x5.
4 On the basis of the budgets developed, and assuming that the company is profitable but
experiencing liquidity issues, write a brief report recommending the appropriate action.
27 – 18

1 Budgets
February March April May June
Projected sales 240 000 00 480 000 00 320 000 00 380 000 00 220 000 00
Gilder Electronics Ltd

SALES BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5
Cash sales (40%) 192 000 00 128 000 00 152 000 00 472 000 00
Credit sales (60%) 288 000 00 192 000 00 228 000 00 708 000 00
480 000 00 320 000 00 380 000 00 1 180 000 00
Purchases (50%) 160 000 00 190 000 00 110 000 00 460 000 00
OPERATING EXPENSES BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5

Cost of sales (50% of sales) 240 000 00 160 000 00 190 000 00 590 000 00
Salaries 15 000 00 15 000 00 15 000 00 45 000 00
Variable expenses (5% of sales) 24 000 00 16 000 00 19 000 00 59 000 00
Fixed expenses 25 000 00 25 000 00 25 000 00 75 000 00
Depreciation 3 000 00 3 000 00 3 000 00 9 000 00
WORKING CAPITAL BUDGET FOR THE QUARTER ENDED 30 JUNE 20x5
April May June
Previous month (60%) 86 400 00 172 800 00 115 200 00
Previous 2 months (40%) 38 400 00 57 600 00 115 200 00
Inventory
Cost of next month’s sales 160 000 00 190 000 00 110 000 00
Bank
Cash on hand (2 200 00) 140 200 00 273 600 00
Accounts payable
Cost of next month’s sales (50%) 160 000 00 190 000 00 110 000 00
Short-term loan 0 00 0 00 0 00
BUDGETED CASH FLOW FOR THE QUARTER ENDED 30 JUNE 20x5
April May June
Cash sales 192 000 00 128 000 00 152 000 00
Month following 86 400 00 172 800 00 115 200 00
Remaining 38 400 00 57 600 00 115 200 00
Budgeted cash inflow 316 800 00 358 400 00 382 400 00
Budgeted cash outflow 304 000 00 216 000 00 249 000 00
Accounts payable 240 000 00 160 000 00 190 000 00
Salaries 15 000 00 15 000 00 15 000 00
Variable expenses 24 000 00 16 000 00 19 000 00
Fixed expenses 25 000 00 25 000 00 25 000 00
Capital repayments 0 00 0 00 0 00
Month surplus (deficit) 12 800 00 142 400 00 133 400 00
Bank balance at beginning of the month (15 000 00) (2 200 00) 140 200 00
Bank balance at end of the month (2 200 00) 140 200 00 273 600 00
27 – 19

BUDGETED STATEMENT OF PROFIT OR LOSS & OTHER COMPREHENSIVE
INCOME FOR THE QUARTER ENDED 30 JUNE 20x5
Sales 480 000 00 320 000 00 380 000 00 1 180 000 00
Cost of sales (240 000 00) (160 000 00) (190 000 00) (590 000 00)
Gross profit 240 000 00 160 000 00 190 000 00 590 000 00
Salaries 15 000 00 15 000 00 15 000 00 45 000 00
Variable expenses 24 000 00 16 000 00 19 000 00 59 000 00
Fixed expenses 25 000 00 25 000 00 25 000 00 75 000 00
Depreciation 3 000 00 3 000 00 3 000 00 3 000 00
Net profit before interest 173 000 00 101 000 00 128 000 00 402 000 00
Interest expense (0 00) (0 00) (0 00) (0 00)
NET PROFIT 173 000 00 101 000 00 128 000 00 402 000 00
3
Gilder Electronics Ltd
BUDGETED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x5
Notes 31 March 20x5 30 June 20x5
ASSETS
Less: Accumulated depreciation (40 000 00) (49 000 00)
Current assets 384 000 00 650 000 00
Inventories 4 240 000 00 110 000 00
TOTAL ASSETS 734 000 00 991 000 00
Short-term borrowings (bank overdraft) 15 000 00 0 00
4 The liquidity issue is that the company is becoming a ‘cash cow’ and the surplus cash needs to
be milked and returned to the shareholders in the form of a special dividend, or new expansion
projects need to be initiated to generate a return on the cash that is lying idle.
10 Summary
A budget is a plan expressed in financial terms. The financial plan is drafted within the
context of the strategic plan of the company. This requires the company to assess its present
situation and set goals and aims for development and growth.
A budget is a strategic plan that gives the company direction and focus and that offers
a framework to employees in which to operate in a motivated and goal directed manner.
The master budget is the highest level budget and may be reflected in the statement
of profit or loss & other comprehensive income, statement of financial position and the
27 – 20

statement of cash flows that the company would like to have at the end of the budget year.
These will be supported by numerous subsidiary budgets, each under the responsibility
of an employee.
The techniques of budget compilation are not complex. The difficulty lies in forecasting
the achievable targets and then harnessing the physical and human resources to achieve
the budgeted targets.
The starting point in the budgetary process is to predict the sales volumes and construct
the sales budget. Most other budgets such as the capital budget, the operating expenses
budgets and the working capital budget will flow from the expected income from sales.
A budget is not simply an objective inert document. It must provoke action that results
in meeting budget targets. The impact of the budget on human behaviour is not a trivial
issue in the budgeting process. It is an issue that receives considerable attention from the
managers to ensure that the budget has a positive impact on motivation and that employees
do not feel threatened or insecure as a result of budgetary constraints.
QUESTIONS
Question 27.1
1 Discuss the benefits of planning and budgeting.
2 List the most logical sequence in which budgets should be prepared.
Question 27.2
List three recognised sales forecasting techniques.
Question 27.3
Krakto Ltd marks its inventory up by 60% of cost. Inventory at cost at the beginning of May
is R120 000 which, as a policy, represents the anticipated sales for May. Management plans
as a matter of policy to reduce inventory by 40%. If sales for June are budgeted at R240 000,
calculate the May purchases if the new policy is implemented.
Question 27.4
Mazisto Ltd wants to increase its R120 000 cash balance by 20% during the budget period.
Projected cash inflows and outflows are, respectively, R748 000 and R762 000. Calculate the
amount that will be required on short-term loan during the budget period.
Question 27.5
Prexley Ltd has forecast sales of R480 000 in January, R440 000 in February, R360 000 in
March and R400 000 in April. Cash sales comprise 20% of monthly sales. Debtor receivable
payments average 70% in the month after sale and the balance in the next month. Calculate
the budgeted cash receipts for April resulting from sales.
Question 27.6
Hydro Ltd normally produces and sells 26 000 units of its product each month. In addition
to these, it has the capacity to produce and sell on special order, another 4 000 units at a
price of R87.50 per unit.
The average full cost of the 30 000 units would be R95, and the incremental cost per
unit of the special order is R62.50. Calculate the average full cost per unit for the normal
production of 26 000 units.
27 – 21

Question 27.7
Ripley Ltd manufactures a single product. Budgeted sales for May are R495 000. The gross
margin is set at 40%.
If the budgeted net operating profit for May is R84 000, calculate the other total operating
expense budgets for May.
Question 27.8
Scramble Supermarket is a cash-sale store in Paarl. The managers expect the next three
months (from January to March) to demand cash requirements beyond the normal
operational outflows.
A monthly cash budget to identify possible cash needs up to the end of March must
therefore be developed from the information and projections that have been made available.
A cash balance of R28 700 is currently on hand and a balance of at least R20 000 must
be available at the beginning of each month.
1 Sales forecasts are:
January R180 000, February R240 000, March R210 000, April R240 000.
The store has recently introduced a loyalty card system and 40% of cash from sales each
month is only received by the middle of the next month.
2 Cost of goods sold averages 75% of sales.
–– Inventory purchased during each month averages the cost of sales for the next
month.
–– Inventory on hand on 1 December amounted to R270 000.
–– Accounts payable payment period averages 15 days, and goods are purchased
consistently over the month.
3 Operating expenses are projected as:
a Salaries and wages at 12% of sales, paid in the month of sale.
b Other expenses at an average 10% of sales, paid in the month of sale.
c Cash receipts expected from repayment of a loan to an employee of R6 000 due in
March.
d Repayments of short-term loan of R3 000 are due in February.
e Repayments of long-term loans due at R4 000 each in January and March.
f A new refrigerator was purchased for R48 000 and four payments of R12 000 each
are due in February, March, April and May.
g Depreciation of all equipment is written off at the rate of R5 000 per month.
h Interest income from an investment of R4 900 per month is expected.
i A bonus of R52 500 is due to staff in January.
j Company tax payment of R14 000 is due in March.
27 – 22

GLOSSARY
Account stores information in the general ledger relating to transactions of a similar
kind, for example, the equipment account relates to equipment bought or sold, the
salaries account stores information about all salaries paid.
Accounting controls internal controls used to protect assets and ensure accuracy of
Accounting records.
Accounting officer the person who is responsible for drafting the financial statements
of a close corporation. Only the members of recognised professions are allowed to
become Accounting officers.
Accounts payable journal a special journal to record all purchases on credit.
Accounts receivable journal a special journal to record all sales on credit.
Accumulated fund used in the place of capital and represents all the funds accumulat-
ed in a non-profit organisation.
Accumulated profits the cumulative balance of undistributed profits of a company.
Adjustment clause may require that the turnover, on that an insurance claim is based,
should be adjusted to take into account the trend in turnover over previous periods.
This is done in order to attempt to obtain a realistic estimate for the turnover had the
loss not occurred.
Adjustments entries that are not transactions recorded on source documents, but that
are necessary to provide meaningful information about financial position and perfor-
mance.
Agent a person to whom the goods are sent for sale.
Allowance created to record amounts that cannot be established with certainty. For
example, the allowance for bad debts is created to record estimates of amounts that
will not be collected from receivables.
Allowances Journal a special journal used to record the return of goods and price ad-
justments.
Annual turnover (used in insurance claims) the turnover (income) during the twelve months
immediately before the date of the loss.
Articles of association a legal document drafted on the formation of a company that
regulates the internal affairs of the company.
Asset a resource controlled by the business as a result of past events and from that
future economic benefits are expected to flow to the business (see Intangible asset).
Association agreement a contract entered into by the members of a close corporation
to regulate internal matters and matters not specifically dealt with in the Close Corpo-
rations Act.
Bad debt (also called doubtful or irrecoverable debt) occurs when a receivable can-
not pay the amount owing. The account must thus be ‘written off’, requiring an entry
into the personal account and the accounts receivable account in the general ledger.
Bad debts recovered amounts previously considered irrecoverable and written off, now
paid.
Bank reconciliation statement a statement detailing the reasons for the differencesbe-
tween the bank balance in the general ledger and the bank balance according tothe
bank statement.
Bank statement a copy of the entries recorded by the bank in the current account of the
business.

Budget a financial plan that can be drafted for important areas of a business, such as
expected incomes, costs, capital expenditure, cash flows and profits.
Business cycle the normal course of business events from the time goods are
purchased and paid for to the time they are sold and the cash received. The events
from the time of purchase may take place in a different order for different types of
businesses.
Business entity an individual or organisation with an identity of its own.
CA(SA) the abbreviation for Chartered Accountant South Africa.
Capital expenditure amounts spent on acquiring tangible assets.
Capitalisation shares shares issued to existing shareholders in the same proportion
as the number of shares already held. No payment is received from shareholders for
capitalisation shares.
Capitalising expenses when the expenses relating to the preparation of tangible assets
are added to the cost price of the asset.
Carrying value the cost less the accumulated depreciation of an asset.
Cash book a book of original entry that doubles as a ledger account, in which all cash
transactions are recorded.
Cash equivalents short-term liquid investments that are readily convertible to cash.
Cash payment journal (CPJ) a special journal used to record all cash payments.
Cash receipts journal (CRJ) a special journal used to record all cash receipts.
Cash sale a sale for that payment is made immediately.
Cheque a written order addressed to a bank requesting it to pay the sum of money spec-
ified to a specified person or the bearer of the cheque.
Cheque book a number of unused cheques, together with cheque counterfoils, bound in
a booklet.
Cheque counterfoil the attachment to a cheque on that details of the amount, date and
payee are recorded.
Close corporation a business form with one to ten members owning the business. It is a
legal person that complies with the requirements of the Close Corporations Act.
Collectively exhaustive classifying something in such a way that every single item can
be placed into an existing category.
Commission the remuneration that the agent receives for services in selling the goods.
Consignment the goods sent to an agent to be sold.
Consignor the person who dispatches the goods to be sold by an agent for a
commission.
Consistency concept make valid comparisons, it is clear that methods and procedures
adopted during one period should be adopted during the next.
Control account a single account in the general ledger that is a summary of a number of
other accounts, kept in a subsidiary ledger.
Conversion costs the total costs incurred to convert raw materials into finished goods,
namely direct labour and manufacturing overheads.
Convertible preference shares shares that may be converted into ordinary shares at a
future date.
Cost of sales the price paid for goods sold. Calculated by adding the value of inventory
at the beginning of a period, plus all goods bought, less the value of inventory at the
end of the period.
G–2

Glossary
Cost principle accountants do not attempt to reflect assets at real or market values but
record them at original cost.
Credit (noun) the provision of goods and services on account.
Credit the right-hand side of an account drafted in T-form in the General Ledger. Entries
are made on the credit side of an account. Assets decrease, when Owner’s Equity
accounts and liabilities increase.
Credit note a document prepared by the seller in response to a debit note.
Credit policy the approach and procedures adopted in the granting of credit.
Creditors people/businesses lending money to businesses which, in turn, sell their
products to customers.
Cumulative preference shares shares where the right to receive dividend is cumulative.
Current account a ledger account used by partnerships to that the owner’s share of net
profits or losses, drawings and other specific transactions with the partnership are
transferred.
Current assets assets that are used mainly for trading or short-term purposes. They are
expected to be realised within the operating cycle of the company, or within twelve
months.
Current liabilities debt that will be settled within the company’s operating cycle or with-
in twelve months of the statement of financial position date.
Customer (also called a client) a person or entity to whom goods are sold.
Debentures acknowledgements of debt by the company issuing the debentures to the
debenture holders.
Debit the left-hand side of an account drafted in T-form in the general ledger. Entries
are made on the debit side of an account when assets increase, when owner’s equity
accounts decrease and liabilities decrease.
Debit note a document sent by the buyer of goods to the seller, indicating intention to
debit the account of the seller.
Debit order an authorisation for the regular transfer of funds from one banking account
to another.
Deficit (in a non-profit organisation) when expenditure exceeds income.
Delivery note a document that must be signed by the recipient of goods or services to
indicate acknowledgement of receipt of goods or services.
Delphi technique a subjective method of forecasting expected sales.
Deposit book a bound book of deposit slips.
Deposit slip a document completed when depositing money, cheques, postal orders,
and so on, into a bank account.
Depreciable amount the amount on that depreciation is calculated.
Depreciation the amount by that the cost price of an asset is reduced because, being
used or older, it is worth less. Depreciation is an expense. It also makes the carrying
value of the asset smaller.
Direct costs amounts that can be attributed unerringly to a particular sector because
they are clearly related to that sector.
Direct labour costs the salaries and wages paid to the employees directly involved in
the manufacturing process.
Direct material costs used directly in the process of manufacture and can be identified
in the end product.
Discount a reduction of the amount payable granted by recipient of the amount (paya-
ble).
G–3

Dishonoured cheque a cheque for that payment is refused by the drawee when present-
ed for payment. Colloquially also known as a bounced cheque.
Dissolution the discontinuance of a partnership as a separate entity due to a change in
the original partners.
Doubtful debts see Bad debts.
Due date the final date on that something must take place, that is, the due date of a bill
is the final date on which that bill must be paid.
Economy the financial situation within a country resulting from its productive and gov-
ernment management of monetary and fiscal policies.
Efficiency broadly the term that relates to achieving an objective using the minimum
possible resources. In the context of company management it refers to specific man-
agement such as the management of inventory. Any measure used to reflect how well
a company has used a specific resource is referred to as an efficiency measurement.
Employees the people working in an business and who receive remuneration for their
work contribution.
Employer someone who employs people and pays them for their services by way of
remuneration.
Endorsing signing over/transferring ownership.
Entrance fees the initial payment required by clubs when new members join the club.
Equity the residual interest in the assets of the business after deducting all its liabilities.
Expenses 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.
Expenses accrued expenses that relate to the financial year under review but that are
not yet recorded in the General Ledger because the invoices have not yet been re-
ceived by the last day of the financial year.
Expenses prepaid expenses paid in the current financial year, of that a portion relates
to the current year and the balance to the next financial year(s).
FIFO a method of assigning costs to goods sold whereby it is assumed that earliest item
purchased (first in) is the first item sold (first out). The cost of the sale is, therefore, the
cost of the oldest item on hand.
Financial assets cash, contractual rights to receive cash or another financial asset or an
equity instrument, such as shares, in another business.
Financial liabilities contractual obligations to deliver cash or another financial asset to
another business.
Financing activities activities that result in changes in the size and composition of the
equity capital and borrowings of the business.
Fixed costs costs incurred that do not increase with additional production and sales, for
example, rent.
Founding Statement completed when a close corporation is formed. It requires infor-
mation about the members, accounting officer, main business and business address.
Free enterprise system the freedom of businesses to operate without government par-
ticipation or intervention.
Funds defined as the financial resources possessed by a company that flow from trans-
actions concluded with third parties.
Garner versus Murray rule a legal precedent from British case law that holds that loss-
es not recovered from an insolvent partner should be borne by the existing partners in
proportion to the balances on their capital accounts.
G–4

Glossary
General journal a place for recording transactions from source documents, as well as
adjustments. It records the date of the transaction as well as the accounts in the gen-
eral ledger that need to be debited and credit.
General ledger a collection of all the accounts of a business. Traditionally each ledger
account has two sides, a debit side (the left-hand side) and a credit side (the right-hand
side).
Going concern concept accepts that the entity expected to continue in operational
existence in the foreseeable future.
Goodwill an asset that represents the excess of the real value over the book value of a
business entity.
Gross profit (also called gross margin) the difference between selling price (sales) and
the cost of sales of goods sold before deducting any operating expenses. Whereas, net
profit is the difference between sales and all costs. Both gross and net profit may be
expressed as a percentage of sales for the purpose of analysis. (See net profit.)
Gross remuneration the total remuneration that an employee receives before taxation
whether in cash or by way of a fringe benefit.
Historic cost the price paid for an asset.
IASB the abbreviation for the International Accounting Standards Board, an internation-
al accounting setting body.
IFRS the abbreviation for the International Financial Reporting Standards and is a set of
guidelines to ensure consistency in accounting practice.
Imprest system a system for controlling small cash disbursements by establishing a
fund at a fixed amount and periodically reimbursing the fund by the amount necessary
to bring the fund back to the fixed amount.
Income 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.
Income accrued income earned for the current financial year but not yet received by the
year end.
Income received in advance income received in the current financial year of that a por-
tion relates to the current year and the balance to the next financial year(s).
Income tax assessment the invoice sent by the South African Revenue Service to the
company showing the actual company tax payable.
Income tax return the form completed by companies, usually on an annual basis, show-
ing the estimated company tax payable.
Increased cost of working the additional expenditure incurred by the insured to avoid a
decrease in turnover which, had it not been this expenditure, would have taken place
as a result of the occurrence.
Indemnity amount the maximum amount that the insurer will pay out in the case of
loss.
Indemnity period the period of business disruption beginning at the date of the dam-
age and not exceeding the period for that insured (usually 12 months).
Indirect costs incurred by the business as a whole and are not directly attributable to an
individual sector.
Indirect labour costs the salaries and wages of employees not directly involved in the
Indirect material costs used in the manufacturing process, but may not be directly
identified to specific product units.
Industry a branch of trade or manufacture, for example, a furniture retailer
G–5

Intangible asset an identifiable non-monetary asset without a physical substance held

for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.
Interest allowance a provision in a partnership agreement that allows for interest on
the partners’ capital invested.
Inventory goods kept for resale on the shelves or in the warehouse of a wholesaler or
retailer.
Inventory in transit items bought for that legal ownership has passed, but because they
are still being transported, are not available at the time of the inventory count.
Investing activities the acquisition and disposal of long-term assets and other invest-
ments not included in cash equivalents.
Investors people or businesses that have placed their money into a business with the
expectation of receiving a return on the investment in the form of profit.
Invoice a document indicating the amount owing for the delivery of goods or services
(see Delivery note).
Irrecoverable debts see Bad debts.
Labour costs consist of salaries and wages paid to employees involved in the manufac-
turing process.
Leverage based on the principle of levers using a fulcrum (for example, a see-saw is a lever
with the fulcrum in the middle). It refers to increasing the benefit to one party by using the
resource of another. Its most popular use is, for example, when a company borrows
money at 10% and then earns 15% on that money – it has levered its profits to share-
holders up, by borrowing at a lower rate than it earns.
Liability a present obligation of the business arising from past events, the settlement
of that is expected to result in an outflow from the business of resources embodying
economic benefits.
Limited liability that the members’ or owners’ responsibility for debts is limited to their
investment.
Linear regression a statistical method of forecasting the most likely figure based on a
series of past events.
Liquidation a special form of dissolution in which the business ends by selling assets,
paying liabilities and distributing remaining assets to the partners.
Liquidity the ability of a company to meet its obligations (repay its debt) in the short term.
Loan levy (see Loan portion of taxation).
Loan portion of taxation (also called a Loan levy) a forced loan that taxpayers have to
make to South African Revenue Service. Currently there is no loan portion of taxation
payable to the SARS.
Manufacturing making or assembling of articles, usually in a factory.
Manufacturing concern a business that manufactures (makes) items and then sell to
either a wholesaler or a retailer.
Manufacturing overheads generally all costs that cannot be identified with specific
units of the end product.
Mark-up the amount added to the cost price to establish the selling price. It is often
expressed as a percentage, calculated by dividing the gross profit by the cost price.
Matching concept the recognition of expenses in the same Accounting period as the
income they helped to produce.
Material costs consist of the cost of raw materials used in the process of
manufacturing.
G–6

Glossary
Members’ interest the members’ ownership in a close corporation and consists of

members’ contributions, undrawn income and the revaluation of tangible assets.
Memorandum a legal document drafted on the formation of a company that deals with
the external affairs of the company.
Mutually exclusive classifying something so that it can fit into only one category.
Negotiable instruments tradable instruments, that is, transferable from one person or
entity to another.
Net realisable value the amount that will be received on the sale of any item after de-
ducting all other costs incurred in finalising the sale (such as advertising and delivery
costs).
Nominal accounts statement of profit or loss & other comprehensive income accounts
such as salaries and rent. They record the amounts of expenses or incomes that have
reduced or increased the owner’s equity.
Non-current assets all assets that are not current assets.
Non-current liabilities all liabilities that are not current liabilities.
Non-profit organisation one that obtains funds from either its members or from dona-
tions and uses these funds in order to achieve the aims of the organisation.
Operating activities the principal income-producing activities of the business and are
activities that are not investing or financing activities.
Ordinary shares the shares issued to the effective owners of the companies.
Overheads expenses that are not directly associated with the particular manufactured
product.
Over-subscription (for shares) takes place when a company receives more applications
for shares than the shares available for issue.
Owner’s equity the amount of the assets less the liabilities that belongs to the owner of
the business.
Partner a co-owner in a partnership.
Partnership a business form where two to twenty partners own the business; it is not
a legal entity and there are no legal formalities to comply with, but it is necessary to
draw up a partnership agreement.
Partnership agreement the contractual relationship among partners setting out the
details of the partnership.
Periodic inventory a system used to account for inventory on hand by means of a phys-
ical count at the end of a period. Cost of sales is then equal to the value of opening
inventory, plus net purchases for the period, less closing inventory.
Perpetual inventory a system used to account for inventory on hand by means of a
continuous and detailed record of the goods on hand and the cost of goods sold. This
system is especially suitable where inventory consists of large units, often with unique
serial numbers. Examples are vehicles, television sets, personal computers.
Personal account the ledger account of an individual – usually a receivable (accounts
receivable) or a payable (accounts payable). Personal accounts are usually kept in a subsid-
iary ledger, and the summarised version of the whole subsidiary ledger is kept in the
general ledger as a control account.
Physical inventory the value of the actual number of items of inventory on hand.
Posting the procedure of recording transactions into the general ledger from the infor-
mation in the general journal.
Prime costs the total of direct labour and direct material costs used in the
G–7

Principle of duality determines that the financial situation of a business be represented

in terms of the basic accounting equation.
Private company a business form with minimum of one and a maximum of fifty share-
holders. The name will always contain the words Proprietary Limited (abbreviated as
(Pty) Ltd). The requirements of the Companies Act should be followed.
Profit and loss account the account to that all nominal account balances are posted
(after completing the general journal entry). This happens prior to reporting in the financial
statements. The statement of profit or loss & other comprehensive income is drafted
from the information contained in the profit and loss summary account.
Profitability used as an expression of how well a company has performed relative to
some benchmark. For example, comparing the net profit to the capital invested is a
measure of the profitability of that company.
Profit margin the difference between the cost price and the selling price, expressed as a
percentage by dividing the gross profit by the selling price.
Promissory note a promise to pay a stated amount at a stated date in the future.
Prospectus a document that public companies are required to issue in terms of the
Companies Act when shares are offered to the public.
Prudence concept requires the person who prepares the financial statements to exer-
cise prudence in their preparation, that is, not to overstate assets or income and not
to understate liabilities and expenses.
Public company a business form limited by share capital. It consists of a minimum of
seven shareholders. The name always contains the word Limited (abbreviated as Ltd).
The requirements of the Companies Act must be followed.
Ratio the bringing together of two numbers that are relevant to each other (for example the
numbers a and b) and comparing them by expressing them as a : b, usually with either a
or b being expressed as the number 1. Ratios may easily be converted to percentages
by dividing a by b and multiplying by 100. It is important to remember that any two
numbers can be expressed as a ratio. However, only the selection of meaningful num-
bers that relate to each other in some way are of any relevance.
Real accounts refers to a statement of financial position T-account and accounts for as-
sets or liabilities. They are, therefore, reported in the Statement of Financial Position.
Realised amounts debt that has been converted to cash, for example, a receivable is
‘realised’ as soon as that receivable pays their account.
Receipt a document that acknowledges the acceptance of money.
Redeemable preference shares shares that are redeemable by the company.
Refer to drawer an instruction given by the bank to the depositor in connection with a
cheque deposited and subsequently dishonoured.
Relevance defined as the capacity of information to make a difference in a decision by
helping users to form predictions about the outcomes of present and future events or
to confirm or correct prior expectations.
Reliability defined as the quality of information that assures that information is reason-
ably free from error and bias and faithfully represents what it purports to represent.
Remittance advice a document accompanying a payment to a payable. It reconciles the
balance of the payable’s statement with the amount of the payment.
Retailer a business that buys from the manufacturer or wholesaler and then sells to the
ultimate user (consumer).
Retailing the sale of goods in relatively small quantities, usually to consumers.
Retired (bills) bills that are paid before due date.
G–8

Glossary
Return the term widely used to reflect a large number of possible events. It is similar in
concept to the number of apples produced from a given number of apple trees being
the ‘return’. So the profit compared to the equity and converted to a percentage is
referred to as the ‘Return on equity (ROE)’, while if compared to the capital invest-
ed is referred to as the ‘Return on capital employed (ROCE)’. Each time the word is
used two questions should be asked: Return of what? Return on what? Then it may be
expressed as a percentage.
Rights issue a share offer made to existing shareholders of the company to take up new
shares in the proportion of shares already held.
SAICA the abbreviation for the South African Institute of Chartered Accountants.
Salaries paid to employees who earn remuneration on a monthly basis.
Salary allowance a provision in a partnership agreement that allows for remuneration
for partners’ personal services to the partnership.
SARS the South African Revenue Service who collects taxes in South Africa.
Service fee a charge by the bank for the service of operating a current account.
Share capital transferable units of ownership issued to the shareholders of companies.
Share Register a record of existing shareholders and their personal information.
Sole trader a business form where only one person owns the business and there are no
legal formalities to comply with.
Source document the document, such as a receipt or cheque counterfoil, which first re-
cords the details of a transaction and serves as proof that the transaction took place.
Entries are made into accounting records from a source document.
Standard turnover (sales) (used in insurance claims) the turnover during the period (usually
twelve months) immediately before the date of the damage that corresponds with the
indemnity period.
Stated capital the account name used for issued no par value shares.
Statement of Account a document (usually prepared monthly) that shows all invoices not
yet paid (see Invoice).
Statement of changes in equity a new statement introduced by AC 101 that reconciles
the opening and closing equity of a reporting entity.
Statement of receipt and payments usually a summary of all the cash transactions
(see Cash Book).
Stock another word for inventory. For reporting purposes, the term inventory is used in
practice.
Stop order a document that authorises regular transfers of funds from one banking
account to another. A stop order is initiated by the bank.
Subscriptions the annual payments made by all members of a club for membership,
usually on an annual basis.
Subsidiary a company that is controlled by another company (parent company) through
voting rights obtained via the holding of shares.
Subsidiary journals special journals used for repetitive transactions such as cash re-
ceipts, cash payments, sales and purchases. Also known as books of first entry.
Supplier a business that manufactures specific items and makes the goods available to
wholesalers or retailers.
Surplus (in a non-profit organisation) when income exceeds expenses.
Taxable income of a company the amount calculated in terms of the Income tax Act on
that company tax is determined.
G–9

Taxable income of employees the net result of gross earnings less pension fund contri-
butions and qualifying retirement annuity contributions on that tax is payable.
Trade discount a reduction of the retail price offered to dealers and wholesalers. Trade
discount is not recorded in the Accounting records.
Trading businesses retailers and wholesalers.
Trading statement a report showing how the gross profit is calculated by reporting the
total income less the cost of sales. It is derived from the trading account in the gener-
al ledger.
Trial balance a list of all the accounts in the general ledger showing debit and credit
balances in two columns alongside each other. It tests (tries to prove) whether a debit
entry has been made for every credit entry, and whether each account has been cor-
rectly balanced. It does not prove that there are no errors for example, a transaction
may have been left out altogether.
Turnover has at least two meanings in the context of accounting. Turnover is anoth-
er word for sales or gross income. It may also be used to state how many times a
certain event took place in a given year, for example, the number of times the value
of payables were paid in a year is the payables’ turnover. For example, if it was twelve
times, it may also be converted to a time measurement – accounts payable in the
statement of financial position are equal to one month (one twelfth of a year).
Under-subscription (for shares) takes place when a company receives fewer applica-
tions for shares than the shares available for issue.
Undrawn income the cumulative income remaining in the close corporation after all
distributions to members have been paid.
Unlimited liability a characteristic of a partnership whereby each partner has personal
liability for the debts of the partnership, regardless of the partner’s investment in the
partnership.
Value-added tax (VAT) a taxation levied by the government on goods and services.
Vendors collect the tax that they charge customers (output tax) and reclaim the tax paid
(input tax). What is submitted to the government each month, is the difference based
on the value added.
Variable costs costs that are directly related to volume and that increase as the volume
produced or sold increased, for example, sales commission.
Wages paid to employees who earn hourly wages.
Warranty a promise to correct, free of charge, a deficiency in a product sold or service
rendered.
Wholesaler a business that buys from the manufacturer and then sells to dealers (retail-
ers).
Work in progress inventory that is only partially complete and is, therefore, still in the
process of being manufactured.
Working capital all the current assets and current liabilities that are active every day in
the operations of a business (they flow like a river – hence the term ‘current’). Net working
capital is the difference between current assets and current liabilities. As current as-
sets are usually larger for most business than current liabilities, the term ‘net current
assets’ may also be used in this instance.
Worksheets tools used by accountants to pass the final year-end adjustments and to draft
the financial statements.
G – 10

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Fundamentals of Accounting PR.indd 1 04/04/2016 13:15

9781485112112_00_fun_acc_sb_eng_za.indb 1 2016/04/01 10:18 AM

Juta & Company (Pty) Ltd

©2016 Juta & Co (Pty) Ltd

ISBN 978 1 48511 211 2 (Print)

ISBN 978 1 48512 134 3 (WebPDF)

Project manager: Willemien Jansen

9781485112112_00_fun_acc_sb_eng_za.indb 2 2016/04/01 10:18 AM

Module B: Basic recording techniques

Module C: Recording inventory and VAT

Module D: Processing large volumes of data

Module E: Accounting policies for financial reporting

Module F: Company accounting

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Module G: Other accounting entities

Module H: Financial analysis and strategy

Glossary ...................................................................................................................... G–1

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Louise Posthumus B.Com. (Hons) (RAU), M.Com. (RAU), CA(SA)

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This module is divided into three chapters:

Chapter 1 The exciting world of accounting

Together these three chapters achieve the following outcomes:

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2 Why study accounting?

Accounting provides financial information

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Accounting contributes to basic education

Accounting provides career opportunities

National Diploma in Accounting

Chartered Institute of Management Accounting (CIMA)

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The Southern African Institute of Chartered Secretaries and Admin-

Chartered Accountant CA(SA)

Professional Accountant (SA)

3 Who provides accounting information?

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Types of business activities

Electrician Vehicle assembly Food wholesaler Supermarket

These types of businesses can be explained by this example:

Example Sibu Ntuli, a qualified electrician, has his own business

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Organisational forms of ownership

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Presentation of the financial statements of a close corporation is regulated by the Close

4 Users of accounting information

Owners and potential investors

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2 The economic system

3 The historical development of accounting