MOUNT KENYA UNIVERSITY

SCHOOL OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

UNIT CODE: MAF5101

UNIT NAME: FINANCIAL ACCOUNTING

Instructions Answer ALL THE QUESTIONS

QUESTION ONE
(a) Explain how assets and liabilities are recognized in financial statement. [4 marks]

(b) Differentiate between capital expenditures and revenue expenditures, giving an example
in each case. [4 marks]

(c) Accounting is an art and a science. Discuss. [6 marks]

(d) Mr. Njoroge opened a Kinyozi shop at Chogoria town. The following are the transactions
relating to his business for the month of May 2012.

(i) On 1st May opened a bank account with KCB for the business and deposited ksh.
300,000
(ii) On 8th May, he paid rent of ksh. 50000 for two months in advance for a small
room at Chogoria plaza.
(iii) On 15th May, he furnished the store by installing new furniture worth ksh. 120000
sold to him on credit by Chuka furniture store, the amount being payable after 3
months
(iv) On 20th May, received electricity bill for the month amounting to ksh 10,000,
payable by 10th of the following month
(v) On 31st May, he withdrew ksh. 90,000 from the business account for his personal
use

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 Required:
Show the effect of the above transactions on the accounting equation.
[10 marks]

(e) Explain the concept of substance over form and illustrate two cases in which this concept
is applicable. [4 marks]

(f) Explain the reason for provision for depreciation on Non-current assets. [2 marks]

QUESTION TWO

(a) The following information was extracted from the financial statements of Mulima ltd and
Ponde ltd in respect of the year ended 30 September 2005.

Income statement extracts

For the year ended 30th September 2005

Mulima ltd Ponde ltd

Sh ‘000’ Sh ‘000’
Sales 497,000 371,000
Cost of sales 258,000 153,000
Operating profit 138,000 79,000
Interest expense 19,000 -

Balance sheet Extracts

As at 30 September 2005

Mulima ltd Pombe ltd

Sh ‘000’ Sh ‘000’
Non -current assets 142,000 92,000
Current Assets:
Inventory 100,000 87,000
Debtors 46,000 42,000
Cash at bank 40,000 44,0000
Current liabilities 98,000 108,000
Long term loan 33,000 -
Shareholders’ funds 197,000 157,000

Required
For each company, compute the following accounting ratios

(i) Acid Test Ratio [1 marks]

(ii) Inventory turnover [1 marks]
(iii) Average collection period [1 marks]
(iv) Return on capital employed [1 marks]
(v) Return on Equity [1 marks]
 (vi) Gearing ratios [1 marks]
(vii) Debtors turnover [1 marks]

(b) On the basis of ratios calculated in (a) above, comment on profitability liquidity and
efficiency of the two firms. [2 marks]

(c) Explain the need for control accounts. [3 marks]

(d) Differentiate between errors of principle and errors of commission, giving an example in
each case. [3 marks]

QUESTION THREE

(a) The following trial balance has been extracted from the ledgers of N.Ombija who
operates a confectionery in Embu town.

Ksh Ksh
Sales 169,000
Purchases 82,350
Commission received 5,070
Carriage 5,144
Drawings 7,800
Rent, Rates & Insurance 6,622
Motor repairs 10,000
Advertising 1,330
Proceeds on sale of equipment 900
Legal charges 10,000
Bad debts 877
Debtors 12,120
Provision for bad debts 601
Creditors 6,000
Cash in hand 5,177
Equipment at cost 40,000
Provision for depreciation on equipment 3,100
Cash at Bank 10,423
Stock as at 1 June 2005 40,000
Building at cost 53,000
Capital 72,091

256,770 256,770

The following additional information is provided as at 31 May 2006

1. Rent is accrued by sh 210 while commission receivable due amounts to ksh. 522
2. Rates have been prepaid by ksh 880
3. Ksh. 2,211 of carriage represents carriage on purchases
4. Stock at the close of business has been valued at ksh. 13,551
 5. Legal charges include ksh. 5,000 for the cost of stamps and registration of a new
building acquired during the year
6. Motor repairs include repairs for proprietor’s personal car which costed sh. 4,800
7. Further bad debts of ksh 2000 to be written off
8. Provision for bad debts is to be created at 2% of net amount outstanding from
trade debtors.
9. Depreciation has been and is to be charged on equipment at an annual rate of 20%
on cost. Depreciate buildings at ksh 5,000

Required:

Prepare an income statement for the year ended 31 May 2006 and a statement
of financial position as at that date. [10 marks]

(b) Explain the qualitative characteristics relating to content, that the accounting
information should have in order to meet the needs of various users of the accounting
information.
[5 marks]

QUESTION FOUR
(a) Chogoria wholesalers which is owned and managed by Mr. George Siro, presented the
following financial statements for the years ended 31st December 2003 and 2004

Chogoria wholesalers
Income statements for the years ended 31 December

2003 2004
Sh. Sh.
Sales 1,000,000 700,000
Cost of sales (400,000) (280,000)
Gross profit 600,000 420,000
Operating expenses (520,000) (486,000)
(including depreciation)
Loss on sale of investments - (2,000)
80,000 (68,000)

Chogoria wholesalers
Balance sheet as at 31 December
2003 2004
Sh. Sh.
Non- current Assets 600,000 578,000
Equipment & furniture 40,000 10,000
Investments
Current assets: 240,000 244,000
Stock 80,000 46,000
Debtors 20,000 120,000
 Cash 340,000 410,000
Current Liabilities:
Trade payables 100,000 146,000
Expense creditors 34,000 28,000
134,000 174,000
Net current Assets 206,000 236,000
Net Assets 846,000 824,000
Financed by:
Owner’s capital 240,000 270,000
Retained Earnings 116,000 48,000
356,000 318,000
Long term liabilities
Loans 490,000 506,000
Owners’ equity and 846,000 824,000
liability

Additional information:

1. Furniture costing ksh. 48000 was acquired during the year ended 31 December
2004. Chogoria suppliers paid ksh. 12,000 in cash and signed a loan agreement
with the seller for the balance. The loan was still outstanding as at 31 December
2004 and is included with other loans under long term liabilities.

2. All sales and purchases are on

credit Required:
Prepare a statement of cashflows for Chogoria wholesalers for the year ended 31
December 2004 using direct format. [12 marks]

(b) State any three uses of the general journal. [3 marks]

Tipp enterprises commenced their manufacturing operations four years ago. They
bought a manufacturing plant as a cost of ksh 20,000,000 when they commenced
operations. Tip enterprises have so far provided an aggregate amount of ksh 14,000,000
as depreciation in their accounts. You are required to ascertain the amount to be written
off in the profit and loss account of the current year under the following methods
assuming 10% per annum rate of depreciation in each case.

(a) Straight-line method [5

marks]
(b) Diminishing balance method. [5
marks]
(c) Discuss any five accounting assumptions [5marks]
(a) Income Statement for the year ended 31 May 2006:

Ksh Sales 169,000 Less: Cost of Goods Sold: Opening Stock 40,000 Purchases
82,350 Carriage on Purchases 2,211 Less: Closing Stock (13,551) 111,010
Gross Profit 57,990

Less: Expenses: Rent, Rates & Insurance 6,622 Motor Repairs 5,200 (10,000 -
4,800) Advertising 1,330 Legal Charges 5,000 (10,000 - 5,000) Bad Debts 877
+ 2,000 Depreciation - Equipment 8,000 (40,000 * 20%) Depreciation - Building
5,000 (37,029) Net Profit Before Tax 20,961

Less: Provision for Income Tax (X) Net Profit After Tax 20,961

(b) Qualitative Characteristics of Accounting Information:

1. Relevance: Accounting information should be relevant to the decision-

making needs of the users. It should provide information that has
predictive or feedback value and helps users evaluate past, present, and
future events.
2. Reliability: Accounting information should be reliable, meaning it is free
from material error or bias and can be depended upon by users. It should
be verifiable, faithfully represent the underlying transactions, and be
neutral, without intentionally favoring any particular interest.
3. Comparability: Accounting information should be presented in a manner
that allows users to compare it with similar information from other
periods or entities. Consistency in accounting policies and practices
enables meaningful comparisons and enhances the usefulness of the
information.
4. Understandability: Accounting information should be presented in a clear
and concise manner that can be understood by users who have a
reasonable knowledge of business and economic activities. Complex
financial information should be explained in a way that facilitates
comprehension.
5. Timeliness: Accounting information should be available to users in a
timely manner to be relevant and useful for decision-making. Delays in
reporting can reduce the effectiveness of the information.

These qualitative characteristics help ensure that accounting information is

useful, reliable, and understandable to meet the diverse needs of users such as
investors, creditors, managers, and regulatory authorities.

To prepare the income statement and statement of financial position, we need

to consider the adjustments and additional information provided. Here are the
calculations:
Income Statement for the year ended 31 May 2006:

Ksh Sales 169,000 Less: Cost of Goods Sold: Opening Stock 40,000 Purchases
82,350 Carriage on Purchases 2,211 Less: Closing Stock (13,551) 110,010
Gross Profit 58,990

Less: Expenses: Rent, Rates & Insurance 6,622 + 210 Motor Repairs 5,200
(10,000 - 4,800) Advertising 1,330 Legal Charges 10,000 - 5,000 Bad Debts 877
+ 2,000 Depreciation - Equipment 8,000 (40,000 * 20%) Depreciation - Building
5,000 (38,239) Net Profit Before Tax 20,751

Statement of Financial Position as at 31 May 2006:

Assets: Current Assets: Cash in Hand 5,177 Cash at Bank 10,423 Debtors
12,120 - 601 (Bad Debts) - 2,000 (Additional Bad Debts) 9,519 Stock 13,551
Total Current Assets 38,670

Non-Current Assets: Equipment at Cost 40,000 - 3,100 (Depreciation) 36,900

Building at Cost 53,000 - 5,000 (Depreciation) 48,000 Total Non-Current Assets
84,900

Total Assets 123,570

Liabilities: Current Liabilities: Creditors 6,000 Total Current Liabilities 6,000

Net Assets 117,570

Capital: Capital 72,091 Add: Net Profit After Tax 20,961 93,052

Less: Drawings 7,800 Total Capital 85,252

Total Liabilities and Capital 117,570

Note: The statement of financial position assumes that no further adjustments

are required for the provision for bad debts, as no information is provided
regarding its adjustment.

Please note that these calculations are based on the information provided, and
an

o compute the accounting ratios for Mulima Ltd and Ponde Ltd, we'll use the
given financial information. Here are the calculations:

(i) Acid Test Ratio: Acid Test Ratio = (Current Assets - Inventory) / Current
Liabilities
For Mulima Ltd: Acid Test Ratio = (46,000 + 40,000) / 98,000 = 0.867

For Ponde Ltd: Acid Test Ratio = (42,000 + 44,000) / 108,000 = 0.796

(ii) Inventory Turnover: Inventory Turnover = Cost of Sales / Average Inventory

For Mulima Ltd: Inventory Turnover = 258,000 / (100,000/2) = 5.16 times

For Ponde Ltd: Inventory Turnover = 153,000 / (87,000/2) = 3.52 times

(iii) Average Collection Period: Average Collection Period = (Debtors / Sales) *

365 days

For Mulima Ltd: Average Collection Period = (46,000 / 497,000) * 365 = 33.75
days

For Ponde Ltd: Average Collection Period = (42,000 / 371,000) * 365 = 41.41
days

(iv) Return on Capital Employed (ROCE): ROCE = Operating Profit / (Non-

Current Assets + Current Assets - Current Liabilities)

For Mulima Ltd: ROCE = 138,000 / (142,000 + 186,000 - 98,000) = 41.33%

For Ponde Ltd: ROCE = 79,000 / (92,000 + 173,000 - 108,000) = 28.03%

(v) Return on Equity (ROE): ROE = Net Profit / Shareholders' Funds

Since the net profit information is not provided, we cannot calculate ROE.

(vi) Gearing Ratios: Gearing Ratio = Long-term Debt / (Long-term Debt +

Shareholders' Funds)

For Mulima Ltd: Gearing Ratio = 33,000 / (33,000 + 197,000) = 14.35%

For Ponde Ltd: Gearing Ratio = 0 / (0 + 157,000) = 0% (As there is no long-

term debt)

(vii) Debtors Turnover: Debtors Turnover = Sales / Debtors

For Mulima Ltd: Debtors Turnover = 497,000 / 46,000 = 10.80 times

For Ponde Ltd: Debtors Turnover = 371,000 / 42,000 = 8.83 times

(a) Statement of Cash Flows for Chogoria Wholesalers for the year ended 31
December 2004 (direct format):

Chogoria Wholesalers Statement of Cash Flows For the Year Ended 31

December 2004

Cash Flows from Operating Activities: Cash collections from debtors 120,000
Cash payments to trade payables 146,000 Cash paid for operating expenses
(486,000) Net Cash Used in Operating Activities (216,000)

Cash Flows from Investing Activities: Purchase of furniture (48,000) Proceeds

from sale of investments 2,000 Net Cash Used in Investing Activities (46,000)

Cash Flows from Financing Activities: Proceeds from long-term loans 506,000
Owner's capital increase 30,000 Net Cash Provided by Financing Activities
536,000

Net Increase in Cash for the Year 274,000 Cash at Beginning of Year 340,000
Cash at End of Year 614,000

(b) Uses of the general journal:

1. Adjusting Entries: The general journal is used to record adjusting entries

at the end of an accounting period to bring accounts up to date and
reflect accurate financial information. These entries include accruals,
deferrals, estimates, and corrections.
2. Opening Entries: When a new accounting period begins, the general
journal is used to record opening entries to transfer balances from
temporary accounts to permanent accounts. This helps maintain
continuity in the financial records.
3. Correcting Entries: If an error is discovered in the accounting records, the
general journal is used to record correcting entries to rectify the mistake.
This ensures that the financial statements present accurate information.

(c) Calculation of Depreciation:

(a) Straight-line method: Depreciation Expense = (Cost - Accumulated

Depreciation) / Useful Life

Depreciation Expense = (20,000,000 - 14,000,000) / 4 = 1,500,000

(b) Diminishing balance method: Depreciation Expense = Book Value *

Depreciation Rate

Year 1: Depreciation Expense = 20,000,000 * 10% = 2,000,000 Book Value =

20,000,000 - 2,000,000 = 18,000,000
Year 2: Depreciation Expense = 18,000,000 * 10% = 1,800,000 Book Value =
18,000,000 - 1,800,000 = 16,200,000

Year 3: Depreciation Expense = 16,200,000 * 10% = 1,620,000 Book Value =

16,200,000 - 1,620,000 = 14,580,000

Year 4: Depreciation Expense = 14,580,000 * 10% = 1,458,000

(c) Five Accounting Assumptions:

1. Going Concern Assumption: The assumption that a business will continue

its operations in the foreseeable future, enabling it to fulfill its obligations
and realize its assets.
2. Accrual Assumption: The assumption that financial transactions are
recorded and recognized when they occur, regardless of when the related
cash flows take place. This allows for the accurate measurement of
income and expenses.
3. Consistency Assumption: The assumption that accounting methods and
principles will remain consistent over time within an entity. This promotes
comparability and reliability in financial reporting.
4. Historical Cost Assumption: The assumption that assets and liabilities are
initially recorded at their historical cost, which represents the actual
amount paid or received at the time of acquisition or incurrence.