Financial Reporting

SUBJECT NO. 9

Study Pack

STRATHMORE
UNIVERSITY
DISTANCE LEARNING CENTRE

P.O. Box 59857,

00200, Nairobi,
KENYA.

Tel: +254 (02) 606155

Fax: +254 (02) 607498

Email [email protected]

Copyright
ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval
system or transmitted in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise without the prior written permission of the copyright owner. This
publication may not be lent, resold, hired or otherwise disposed of by any way of trade without
the prior written consent of the copyright owner.

© THE REGISTERED TRUSTEES STRATHMORE EDUCATION TRUST 1992

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STRATHMORE UNIVERSITY● STUDY PACK
 Acknowledgement ii

ACKNOWLEDGMENT

We gratefully acknowledge permission to quote from the past examination papers of the following
bodies: Kenya Accountants and Secretaries National Examination Board (KASNEB);
Chartered Institute of Management Accountants (CIMA); Chartered Association of
Certified Accountants (ACCA).

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STRATHMORE UNIVERSITY ● STUDY PACK
iii Instructions for Students

INSTRUCTIONS FOR STUDENTS

This study guide is intended to assist distance-learning students in their independent studies. In addition,
it is only for the personal use of the purchaser, see copyright clause. The course has been broken down
into eight lessons each of which should be considered as approximately one week of study for a full time
student. Solve the reinforcement problems verifying your answer with the suggested solution contained at
the back of the distance learning pack. When the lesson is completed, repeat the same procedure for each
of the following lessons.

At the end of lessons 2, 4, 6 and 8 there is a comprehensive assignment that you should complete and
submit for marking to the distance learning administrator.

SUBMISSION PROCEDURE
1. After you have completed a comprehensive assignment clearly identify each question and number
your pages.
2. If you do not understand a portion of the course content or an assignment question indicate this
in your answer so that your marker can respond to your problem areas. Be as specific as possible.
3. Arrange the order of your pages by question number and fix them securely to the data sheet
provided. Adequate postage must be affixed to the envelope.
4. While waiting for your assignment to be marked and returned to you, continue to work through
the next two lessons and the corresponding reinforcement problems and comprehensive
assignment.

On the completion of the last comprehensive assignment a two-week period of revision should be carried
out of the whole course using the material in the revision section of the study pack. At the completion of
this period the final Mock Examination paper should be completed under examination conditions. This
should be sent to the distance-learning administrator to arrive in Nairobi at least five weeks before the
date of your sitting the KASNEB Examinations. This paper will be marked and posted back to you
within two weeks of receipt by the Distance Learning Administrator
.

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FINANCIAL ACCOUNTING III
 iv

CONTENTS

ACKNOWLEDGMENT.................................................................................................. ii
INSTRUCTIONS FOR STUDENTS ............................................................................ iii
FINANCIAL REPORTING COURSE DESCRIPTION ...............................................v
LESSON ONE .................................................................................................................. 1
Partnerships ....................................................................................................................... 1
LESSON TWO ................................................................................................................70
Preparation of Published Financial Statements .............................................................70
LESSON THREE ......................................................................................................... 125
Branches ........................................................................................................................ 125
LESSON FOUR ............................................................................................................ 166
Group Accounts ............................................................................................................. 166
LESSON FIVE .............................................................................................................. 247
Bankruptcy and Liquidation ......................................................................................... 247
LESSON SIX ................................................................................................................. 309
Executorship Law and Accounts .................................................................................. 309
LESSON SEVEN .......................................................................................................... 359
Trust Law and Accounts ............................................................................................... 359
LESSON EIGHT .......................................................................................................... 405
Pension Fund ................................................................................................................ 405
LESSON NINE ............................................................................................................ 419
Revision Aid .................................................................................................................. 419

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STRATHMORE UNIVERSITY● STUDY PACK
 v Course Description

FINANCIAL REPORTING COURSE DESCRIPTION

The study pack is comprehensively prepared for the students of C.P.A Section 3 to adequately attempt
the Financial Accounting 3 paper set by the Kenya Accountants and Secretaries National Examination
Board (KASNEB). To cover the course material sufficiently, the student needs to not only study the
course materials, but also to practice as much as possible using the past paper questions, the
comprehensive assignments and reinforcement questions provided.
The Financial Accounting 3 paper covers the following areas:

i) Partnership Accounts
Partnerships were introduced in financial accounting 1. More advanced issues especially in
changes of partnerships are covered here and this include admission, retirement, dissolutions,
amalgamations and conversion into a company.
ii) Preparation of Published Financial Statements
The student is introduced to the preparation of financial statements for public use. Such
financial statements are prepared under the provisions of the Companies Act as well as other
relevant regulatory bodies and the requirements of the relevant International Financial
Reporting Standards. More emphasis is placed on international Financial Reporting
standards.
iii) Branch Accounts
Preparation of branch accounts is another important aspect of Financial Accounting III. This
borrows slightly from departmental accounts and involves consideration of the various types
of branches a business has including foreign branches.
iv) Group Accounts
This is the core area in Financial Reporting and has been examined in almost all sittings. It
involves the preparation of financial statements of companies that are related in a group and
lays emphasis on the requirements of International Financial Reporting standards.
iv) Bankruptcy and Liquidation
The section covers what constitutes bankruptcy and receivership, and the legal processes
involved for individuals and body corporate. The process of distributing the assets of a body
entity that is liquidated is also addressed. The bankruptcy of partners in a partnership is
described in this section. It is very important that the student notes the accounting issues
raised here, especially the preparation of the statement of affairs and the deficiency account.
v) Executorships and Trust Accounts
Executorship is mainly concerned with the disposal of the assets of the deceased using the
provisions of the Succession Act or the will of the deceased, as the case may be. Issues of the
validity of wills are addressed here. The order in which the beneficiaries are satisfied and the
reasons that may make beneficiaries not receive their dues are important to note. Last but
not least, the preparation of the executorship accounts is described and illustrated.

We hope the students will enjoy going through this course and will develop important insights into
accounting and have a firm foundation for advanced accounting and its related subjects in other areas
of the academic world.

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FINANCIAL ACCOUNTING III
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 Lesson One 1

LESSON ONE

PARTNERSHIPS

OBJECTIVES
At the end of this lesson, you should be able to:

 Deal with the more complex aspects of partnership accounting dealing with realignments and
dissolutions;
 Deal with accounting for the conversion of a partnership into a limited liability company;
 Know the provisions of the Partnership Act.

Much of what you need to know at the end of this lesson has already been covered in Financial
Accounting I in CPA Section I (see Lesson 5 of Strathmore University Distance Learning Centre
Study Pack).

CONTENTS
1.1 Introduction to Partnerships
1.2 Goodwill, revaluations and life policy.
1.3 Admission and retirement.
1.4 Dissolutions.
1.5 Amalgamations.
1.6 Conversion into a limited labiality company

Attempt reinforcing questions at the end of the lesson and compare them with solutions given in
lesson 9.

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STRATHMORE UNIVERSITY● STUDY PACK
 2 Partnerships

1.1 INTRODUCTION:
This chapter covers the more complex aspects of dealing with partnerships. At this level partnerships
may be examined from every possible angle, therefore this chapter will be considering partnerships to
the maximum possible depth.

Much of what you need to know by the end of this lesson has already been covered in Financial
Accounting 1 in CPA 1. Thus, only a basic revision of these concepts will be undertaken at the
beginning of this chapter.

Definition:
A partnership is defined as ―the relationship that subsists between two or more persons carrying on a
business in common with a view to making a profit.‖ (Partnership Act).

Membership:
There may be a minimum of two and a maximum of twenty members in a partnership. In the U.K
however, the Partnership Act 1934 CAP 29 provides that the maximum number of partners in a firm
that offers personal/professional services may be up to 50 if each partner is professionally qualified,
e.g. Accountants, Lawyers, architects doctors, surgeons etc.

Types of Partners:
Partners may be classified into the following categories:

a) Active or dormant;
b) Limited or Unlimited;
c) Adult or Minor;
d) Real or Quasi.

Legal Formalities for the Formation of a Partnership.

There are no legal formalities if the partners carry on business in their own names. However, if they
carry on business in another name, then the business must be registered with the registrar of business
names.

The Partnership Deed:

It is the agreement that regulates the partners actions in undertaking the partnership business.

This may or may not have been drawn up. It usually contains, amongst others:

 Name of the firm, names of the partners, their addresses and their occupations;
 The status/type of each partner, e.g. active/dormant, limited/unlimited etc
 The capital to be contributed by each partner
 Their profit sharing ratio
 Salaries to partners, if any
 Interest, if any on capital/drawings.

Provisions of the Partnership Act

In the event of absence of a partnership agreement/deed or in the event of ambiguity therein, the
provisions to the partnership Act will apply. The provisions state that, unless the partnership deed
indicates otherwise,

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 3

 Every partner has a right to take part in the conduct of business;

 All profits/losses are to be shared equally;
 No interest on capital is to be allowed;
 No partner is entitled to a salary;
 No interest on drawings is to be charged;
 6% per annum is to be allowed on amounts contributed by each partner exceeding the agreed
capital amounts;
 normal business decisions can be taken by a majority vote;
 Major business decisions e.g. major business changes must obtain the full consent of all partners.

Dissolution of a partnership:
A partnership is dissolved when:

 It is temporary (maybe set up for a given period which has lapsed);

 One partner notifies the others in writing, of his intention to retire;
 A partner dies, becomes insane or bankrupt;
 The partnership becomes unlawful.

Accounting for Partnerships

The owners‘ interests in the business are divided into long term and short-term interests. (Long-term
interests refer to original capital commitments and changes thereon. Short-term interests refer to
shares of annual profit and amounts therein withdrawn). The long-term interests are shown in a
capital account whereas short-term interests are shown in a current account.

These accounts are kept in a T-form for examination purposes, a separate column being kept for each
partner.

Example of a current account where there are 3 partners A, B and C:

Current Account
A B C A B C
Bal b/d (Note 1) X Bal b/d (Note 1) X X
Interest on drawings (Note 2) X X X Interest on capital (Note 3) X X X
Drawings X X X Salaries (Note 4) X X X
Interest on loan X - -
Share of profit (Note 5) X X X
Bal c/d (Note 6) X X - Bal c/d (Note 6) - - X
XX XX XX XX XX XX
- - X Bal b/d X X -

Example of a capital account where there are 3 partners A, B, and C:

A B C A B C
Goodwill written off X X X Bal b/f X X X
Deficit on revaluation X X X Additional capital brought in as
per agreement X X X
Goodwill X X X
Bal c/d X X X Surplus on revaluation X X X
XX XX XX XX XX XX
Bal b/d X X X

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FINANCIAL ACCOUNTING III
 4 Partnerships

Format for Trading Profit and Loss A/CS:

The trading section remains identical to that of a sole proprietorship, and so does the profit and loss
section. However an additional section is now brought in (called the appropriation account) in which
profits are divided amongst partners.
The appropriation account is a continuation of the P&L account in a similar situation to which the
P&L account is a continuation of the trading account.

Example of a P&L Appropriation A/C where there are 3 partners A, B and C:

Sh Sh Sh
Net profit (as per trading, profit & loss a/c) X
Add: Interest on drawings: A X
B Note 2 X
C X X
X

Less: Interest on capital: A X

B X
Note 3
C X
X

Salaries: A X
B Note 4 X
C X X (X)
Balance shared according to agreed profit sharing ratio X

Share of profits A X
Note 5 B X
C X X

Note 1: (See current A/C)

The opening balances for the current accounts can be extracted from the trial balance. These balances
may be debit balances b/d or credit balances b/d. A credit balance b/d is a favorable balance for the
partner, i.e he has not yet withdrawn all his dues from the firm. A debit balance means the partner has
overdrawn his ―account‖.

Note 2: (See current A/C and appropriations A/C)

Ideally, the partner should wait until the end of the year when the profit is ascertained and divided up
before he can take his share. However, commitments may arise partway through the year thus forcing
the partner to withdraw money earlier. The firm will treat this as a ―loan‖ extended to the partner
until the end of the year. This will attract interest (known as interest on drawings), which is income to
the firm and is added to the net profit.

It is a ―loss‖ to the partner and is therefore debited to his current account.

Note 3: (See current A/C and appropriation A/C)

In a partnership, the partners need not contribute equal capital to go into business. Therefore, in
order to prevent dissatisfaction amongst partners (i.e ―why should I bring in more capital than you?‖)
Some of the profits of the firm are given to partners in the name of ―interest on capital‖. This is a

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 5

percentage of fixed capital and therefore the larger the capital contribution by the partner, the larger
his share of profit will be.

Note 4: (See Current A/C and appropriation A/C)

Some of the partners may remain in the business on a full time basis to oversee the day to day
running/management of the business, instead of seeking alternative employment elsewhere (thus
earning some more income elsewhere). Part of the available profit will be awarded to them in the
name of ―salaries‖ to compensate them for loss of income elsewhere.
Note 5: (See Current A/C and appropriations A/C)
If any profit remains after some has been given to partners in the names of ―interest on capital‖ and
―salaries‖, then this will be divided amongst partners in profit sharing ratio. NB: If this was a loss,
then it will appear on the debit side of the current A/C.

Note 6: [See current A/C and statement of financial position format (below)]
The final balance computed in the current A/C represents the owners‘ short term interests at the end of
the year. Once again, if the balance b/d is a debit figure, then it is favorable to the partner. If the balance
b/d is a debit figure, this is unfavorable to the partner (he has drawn more than his profit share) and this
entry will appear as negative in the statement of financial position.

FORMAT FOR STATEMENT OF FINANCIAL POSITION

The non current assets, current assets and current liabilities sections remain identical to those of a sole
proprietorship. However, the ―capital section will change to reflect the capital contribution by each
partner..

Example of statement of financial positionwhere there are 3 partners A, B and C.

(Name)
Statement of financial position as at (date)
Cost (Shs) Depreciation (Shs) NBV (Shs)
Non Current assets
Land & Buildings X X X
Fixtures & Fittings X X X
Plant & Machinery X X X
Motor Vehicles X X X
XX XX XX
Investments, goodwill etc X

Current Assets
Inventory X
Receivables X
Less provision for bad and doubtful debts (X) X
Prepayments X
Bank X
Cash X
X

Current Liabilities
Payables X
Accruals X (X)

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FINANCIAL ACCOUNTING III
 6 Partnerships

Working capital (C.A – C.L) X

XX
Financed by:
Capitals: A X
B X
C X
X
Current A/Cs: A X
B See Note 6 X
C (X) X
X
Long term loans X
XX

Note: If a partner extended a loan to the partnership (over and above the capital) then the interest on
such will be an expense in the P&L (before the net profit is computed), and not an appropriation.
The amount will be credited to the partner‘s current a/c as due to him. (See Current A/C format)

Example one
The following list of balances as at 30 September 20X9 has been extracted from the books of Brick
and Stone, trading in partnership, sharing the balance of profits and losses in the proportions 3:2
respectively.

Kshs.
Printing, stationery and postages 3,500
Sales 322,100
Inventory in hand at 1 October 20x8 23,000
Purchases 208,200
Rent and rates 10,300
Heat and light 8,700
Staff salaries 36,100
Telephone charges 2,900
Motor vehicle running costs 5,620
Discounts allowable 950
Discounts receivable 370
Sales returns 2,100
Purchases returns 6,100
Carriage inwards 1,700
Carriage outwards 2,400
Fixtures and fittings: at cost 26,000
Provision for depreciation 11,200
Motor vehicles: at cost 46,000
Provision for depreciation 25,000
Provision for doubtful debts 300
Drawings: Brick 24,000
Stone 11,000
Current Account balances at 1 October 20x8:
Brick 3,600
Stone 2,400
Capital account balances at 1 October 20x8:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 7

Brick 33,000
Stone 17,000
Receivables 9,300
Payables 8,400
Balance at bank 7,700

Additional information:
1. Kshs.10,000 is to be transferred from Brick‘s capital account to a newly opened Brick Loan
Account on 1 July 20X9. Interest at 10 per cent per annum on the loan is to be credited to
Brick.
2. Stone is to be credited with a salary at the rate of Kshs.12,000 per annum from 1 April 20X9.
3. Inventory in hand at 30 September 20X9 has been valued at cost at Kshs.32,000.
4. Telephone charges accrued due at 30 September 20X9 amounted to Kshs.400 and rent of
Kshs.600 prepaid at that date.
5. During the year ended 30 September 20X9 Stone has taken goods costing Kshs.1,000 for his
own use.
6. Depreciation is to be provided at the following annual rates on the straight line basis:

Fixtures and fittings 10%

Motor Vehicles 20%

Required:
(a) Prepare income statement for the year ended 30 September 20X9.
(b) Prepare statement of financial positionas at 30 September 20X9 which should include summaries
of the partner‘s capital and current accounts for the year ended on that date.

Note: In both (a) and (b) vertical forms of presentation should be used.
Solution:
a)

Brick and Stone

Income statement for the year ended 30 September 20X9
Kshs. Kshs. Kshs.
Sales 322,100.00
Less sales returns (2,100.00)
320,000.00

Less cost of sales

Opening inventory 23,000.00
Purchases 207,200.00
Carriage inwards 1,700.00
208,900.00
Less purchases returns (6,100.00) 202,800.00
225,800.00
Less closing inventory (32,000.00) (193,800.00)
Gross Profit 126,200.00
Discounts receivable 370.00
126,570.00
Less Expenses:
Printing, stationery and postages 3,500.00

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FINANCIAL ACCOUNTING III
 8 Partnerships

Rent and rates 9,700.00

Heat and light 8,700.00
Staff salaries 36,100.00
Telephone charges 3,300.00
Motor vehicle running costs 5,620.00
Discounts allowable 950.00
Carriage outwards 2,400.00
Depreciation: Fixtures and fittings 2,600.00
Motor vehicles 9,200.00
Loan – Brick 250.00 (82,320.00)
Net profit 44,250.00
Less Salary – Stone (6,000.00)
38,250.00
Balance of profits shared in PSR
Brick 22,950.00
Stone 15,300.00 (38,250.00)
b)
Brick and Stone
Statement of financial position as at 30 September 20X9
Cost Accumulated NBV
Depreciation
Kshs. Kshs. Kshs.
Non Current assets
Fixtures and fittings 26,000.00 (13,800.00) 12,200.00
Motor vehicles 46,000.00 (34,200.00) 11,800.00
72,000.00 (48,000.00) 24,000.00

Current Assets
Inventory 32,000.00
Receivables 9,300.00
Less provision for doubtful debts (300.00) 9,000.00
Prepaid expenses 600.00
Balance at bank 7,700.00
49,300.00

Current liabilities
Payables 8,400.00
Accrued expenses 400.00 (8,800.00)
Net working capital 40,500.00
64,500.00
Capital accounts
Brick 23,000.00
Stone 17,000.00 40,000.00

Current Account
Brick 2,800.00
Stone 11,700.00 14,500.00
54,500.00
Loan Account 10,000.00
64,500.00

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 9

Current Account
Brick Stone Brick Stone
Kshs. Kshs. Kshs. Kshs.

Drawings 24,000.00 12,000.00 Balance b/f 3,600.00 2,400.00

Interest/salary 250.00 6,000.00
Bal c/d 2,800.00 11,700.00 Profit share 22,950.00 15,300.00
26,800.00 23,700.00 26,800.00 23,700.00

Example two
A and B are in partnership as manufacturers of high quality wheelbarrows, A being responsible for the
factory and B being responsible for sales. Completed wheelbarrows are transferred from the factory to
the warehouse at agreed prices. A and B are credited with interest on capital balances at 5% and an
annual salary of sh.100, 000 each. The balance of the profits is shared as follows between the partners.

i) A gets one third of the manufacturing profit.

ii) B gets 10% of the gross profit and
iii) The balance is shared equally.

Interest is charged on drawings at 10% based on the total drawings at the end of the year.
All wheelbarrows are sold at Sh.6, 800.00 each
The following trial balance was extracted on 31 March 2004.

Sh. Sh
Capital Accounts
A 4,500,000.00
B 5,000,000.00
Current Accounts
A 320,000.000
B 76,000.000.00
Drawings
A 1,060.000.00
B 974,000.00
Freehold factory (including land Sh. 3,000.000.00) 7,088,000.00
Factory plant at cost 3,264.000.00
Delivery van cost 820,000.00
Provision for depreciation
Freehold factory 3,070,400.00
Factory Plant 1,101,600.00
Delivery van 384,000.00
Inventory on April 2003
Raw materials 420,000.00
Work in progress 402,000.00
Wheelbarrows (1,220 at Sh.4, 400) 5,368,000.00
Sales 12,376,000.00

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FINANCIAL ACCOUNTING III
 10 Partnerships

Returns inwards 136,000.00

Purchase of raw materials 2,916,000.00
PAYE 88,000.00
Factory wages 1,654,000.00
Office salaries 230,000.00
Expenses factory 1,268,000.00
Office 1, 009,000.00
Provision for unrealized profit 488,000.00
provision for doubtful debts 192,000.00
Accounts receivables and payables 2,176,000.00 1,302,000.00
Bank 113,000.00
28,898,000.00 28,898,000.00

Additional information
a) 1540 wheelbarrows at Sh.4, 800 each were transferred to the warehouse during the year.
Wheelbarrow in stock being balance of the current year‘s production, were valued at agreed price
of Sh.4, 800 each.
b) The stock of raw materials was Sh.340, 000 and work in progress is valued at Sh.536, 000.00.
c) Accrued expenses on 31st March 2004 amounted to 624,000 (including office Sh.328, 000.00) and
prepaid rates Sh.32, 000(including office Shs.12, 000.00)
d) Provision for depreciation is to be made as follows

Factory buildings 2% p.a.

Factory plant 10% p.a.
Motor vehicles 25% p.a.

e) The general provision for doubtful debts is to maintain at 10% of the trade debtors.

Required
A manufacturing, trading and profit and loss Accounts for the year ended 31 March 2004 and
statement of financial positionas at the date.

A and B
Manufacturing, Trading and Profit and Loss Account
For the year ended 31 March 2004
£ £
Opening inventory raw materials 420,000
Purchases of raw materials 2,916,000
3,336,000
Less: closing stock raw materials (340,000)
Raw materials consumed 2,996,000
Direct expenditure: factory wages 1,654,000
PRIME COST 4,650,000

Factory overheads – factory expenses 1,544,000

Depreciation on factory building 81,760
Depreciation on factory plant 326,400 1,952,160
Total cost of production 6,602,160
Add: Opening W.I.P 402,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 11

7,004,160
Less: Closing W.I.P (536,000)
Factory cost of finished goods 6,468,160
Factory profit 923,840
Finished goods at transfer price 7,392,000
Sales 12,240,000

Cost of sales
Opening inventory of finished goods 5,368,000
Finished goods at transfer price 7,392,000
12,760,000
Less: Closing stock of finished goods (4,608,000) (8,152,000)
Gross profit 4,088,000
Factory profit 923,840
5,011,840

Expenses
Decrease in provision for unrealised profit 88,000
Decrease in provision for bad debts 25,600
Depreciation of delivery van 205,000
Office salaries 230,000
Office expenses add accrued 1,009,000
Add: Accrued 328,000
Less: Prepaid (12,000) 1,325,000 (1,873,600)
Net profit 3,138,240

Profit and Loss Appropriation

Net profit 3,138,240
Add: interest on drawings A 106,000
B 97,400 203,400
3,341,640

Less: Interest on capital A 225,000

B 250,000 (475,000)
2,866,640

Less: Salaries A 100,000

B 100,000 (200,000)
Balance shared in PSR 2,666,640
Profit share: Factory A 1,282,893.5
Gross B 1,383,746.5 2,666,640

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FINANCIAL ACCOUNTING III
 12 Partnerships

A and B
Statement of financial position as at 31 March 2004
COST DEPRECIATION NET BOOK VALUE
NON-CURRENT ASSETS
Freehold factory and land 7,085,000 (3,152,160) 3,935,840
Factory plant 3,264,000 (1,428,000) 1,836,000
Delivery van 820,000 (589,000) 231,000
11,172,000 5,169,160 6,002,840

CURRENT ASSETS
Inventory: Raw materials 340,000
Work in progress 536,000
Finished gods 4,608,000
Less unrealised profits (576,000) 4,032,000
Receivables 2,176,000
Less: Provision for bad debts (217,600) 1,958,400
Prepaid expenses 32,000
Bank 113,000
7,001,400

CURRENT LIABILITIES
Trade payable and other payables 1,390,000
Accruals 624,000 2,014,000
Net current assets 4,997,400
NET ASSETS 11,000,240

FINANCED BY:
Capital A 4,500,000
B 5,000,000
9,500,000
Current accounts A 761,893.5
B 738,346.5 1,500,240
11,000,240

1. Workings: Factory expense

Reported expense 1,268,000
Add accrued expense 296,000
Less prepaid expense (20,000)
1,544,000

2. Closing stock of finished goods

Opening inventory units 1,220
Units transferred/purchased/produced 1,540
2,760
Units sold(12,240,000/6,800) (1,800)
960 units x sh.4,800 = 4,608,000

3. Unrealized profits
Factory profit/units produced 923,840/1,540
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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 13

= Sh.600 x 960 units closing stock

= 576,000

Or cost of each wheelbarrow produced =4,800

6,468,160/1,540 units (4,200)
Sh.600

4. Factory profit 1/3 307,947

Gross profit 10% 408,800
Shared 307,947 408,800 806,747
Balance 974,946.5 947,946.5 1,949,893
1,282,893.5 1,383,746.5

1.2 GOODWILL, REVALUATIONS AND LIFE POLICY.

A) GOODWILL

This is defined as ―the difference between the value of a business as a whole and the fair value of its
net separable assets‖.

Goodwill in practical sense is the advantage that an existing business may have over a newly
established business. This advantage may be in the form of profits or revenue that the business
generates and customer loyalty. Goodwill may arise due to several factors including:

 The location of the business

 The quality of products, services or employees and
 The marketing

In practice, it is normally agreed that many established businesses have created goodwill but
unfortunately it is difficult to determine the actual value of goodwill. Therefore, unless goodwill
arises from the acquisition of another company, it is normally excluded from the accounts. For
the purpose of accounting for partnerships, goodwill is important in the following three main
areas.

i) When there is a change in the profit sharing ratio

ii) On admission of a new partner
iii) On retirement of a partner

i) Change in profit sharing ratio

When there is a change in profit sharing ratio, it means that some of the partners will get higher
profits based on the new ratios in the future while others will loose or will get lower profits.

Those who will get higher profits therefore need to pay for the higher profits whereas those who
will get lower profits thus need to be compensated for the reduction in their profit share.

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FINANCIAL ACCOUNTING III
 14 Partnerships

To achieve this objective, goodwill is normally introduced in the accounts by crediting the
partners capital accounts according to their old profit sharing ratio (PSR) and written off again by
debiting the partners capital accounts according to their new PSR.

Example;
A, B and C have been trading as equal partners having capital contributions of £400,000,
£300,000 and £200,000 respectively. They deaded to change their profit sharing ratio to 3:2:1.
Goodwill was agreed at £150,000.

Required:
Prepare their capital accounts to show their new capital balances assuming that goodwill in not to be
retained in the accounts.

Capital account
A B C A B C
Goodwill 75,000 50,000 25,000 Bal. b/d 400,000 300,000 200,000
Bal. c/d 375,000 300,000 225,000 Goodwill 50,000 50,000 50,000
450,000 350,000 250,000 450,000 350,000 250,000

ii) Admission of a new partner

When a new partner joins the firm/partnership, the new partner will enjoy the benefits arising as a
result of goodwill created by the old existing partners. This is because; the new partner will get
his share of profits which he may not have received had he decided to start a new business.

It is thus fair that the new partner pays into the firm not only his capital contribution but also his
share of the goodwill.

In some situations, the new partner will pay cost directly for his share of goodwill while in most
cases, goodwill will be deducted from his total contributions to the business. However, the new
partner pays in cash or not for his share of goodwill, the following entries are normally passed in
the partners current accounts.

DR. Goodwill
CR. Partners capital accounts (old partners)
(With the goodwill according to old PSR)

To write off goodwill:

DR. Partners capital accounts (all partners including new one)
CR Goodwill
Goodwill should be debited in partners capital accounts according to the new PSR.

Example:

XYZ have been trading as equal partners having capital contributions of £300,000, £250,000 and
£200,000 respectively. They agreed to admit W who agrees to pay capital of £350 which is
inclusive of his share of goodwill. The new profit sharing ration will not be X:Y:Z:W : 4:3:2:1.
Goodwill has been agreed at £200,000.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 15

Required:
Prepare the partners capital accounts to record admission of W and assuming that Goodwill is not
to be retained in the accounts.

Capital account
X Y X W X Y Z W
Goodwill 80 160 40 20 Bal. b/d 300 250 200 -
Bal c/d 286.667 256.667 226.666 330 Goodwill 66.667 66.667 66.666 -
bank 350
366.667 316.667 266.666 350 366.667 316.667 226.667 350

iii) Retirement of a partner

When one of the partners retires ante the others will continue trading, the n it is important that he
gets a share of the goodwill that he helped create in addition to the total amounts due to him
from the partnership.

To ensure that this objective is achieved, the following entries are normally passed in the partners
capital accounts.

DR. Goodwill
CR. Partners capital accounts
(With the value of goodwill to all the partners capital accounts according to old PSR)

To write off the goodwill:

DR. Partners capital accounts

CR. Goodwill
(With the total value of goodwill and in only capital accounts of remaining partners using
new PSR)

To get the total due to a retiring partner, we find out the balance in the current accounts and any
loans advanced in the partnership and the balances in these accounts are transferred to the capital
accounts.

Incase the partner has retired partway during the financial year, then we update the current
account first with the partners share of the profits as per profit and loss appropriation account up
to the date of retirement.

The partnership may not have sufficient cash to pay the retiring partner and thus may agree with
the retiring partner that his total dues from the partnership be converted into a loan paying a
certain interest per annum. However, if the partnership is able to pay the amount due, the retiring
partner then the following entry is passed:

DR. Retiring partners capital accounts

Cr. Cash book

Example:
A, B and C have been trading as equal partners having capital contributions of £500,000 and
£400,000 and £300,000 respectively as at 1 st January 2005. On the same date, B Deared to leave
the partnership and A and C were to continue trading as partners sharing profits in the ratio of

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FINANCIAL ACCOUNTING III
 16 Partnerships

2:1. The total amounts due to B could not be paid immediately and thus the remaining partners
agreed with B that they will pay 25% of the total due in cash and the balance will be left as a loan
earning interest at a rate of 8% per annum.

Meanwhile, goodwill has agreed at £180,000 and B had a credit balance on his current account of
£40,000. Goodwill was not to be retained in the books.

Required:
Prepare partners capital accounts record the retirement of B

Capital account
A B C A B C
Goodwill written 120,000 - 60,000 Bal. b/d 500,000 400,000 300,00
off
Cash book - 125,000 - Goodwill 60,000 60,000 60,000
8% loan a/c 375,000 Current a/c 40,000
Bal c/d 440,000 - 300,000 ______ ______ ______
560,000 500,000 360,000 560,000 500,000 360,000

Revaluations:

Partners rarely revalue their assets and any revaluations may be carried out when a new partner is
being admitted or an old partner is retiring.

To facilitate the process a revaluation account is opened whereby any revaluation gains are credited to
he account while revaluation losses are debited to the account. The balance in this account represents
a profit or loss on revaluation, which is now transferred or closed off to the partners‘ capital accounts
according to their Profit Sharing Ratio (PSR)

NOTE:
On the profit or loss on revaluation

i) If the revaluation is carried out when a new partner is being admitted, then the new partner is not
entitled to receive any share of the gain nor bear any loss.

Entries for the gain or loss are made only in the old partners‘ capital accounts according to the old
PSR.

ii) If the revaluation is carried out on retirement of a partner, then the retiring partner is still entitled
to a share of profit or loss. Therefore, the gain or loss will be adjusted for in all the partners‘
capital accounts including the retiring one according to the old PSR.

iii) In any other situation, e.g. the revaluation is carried out when there is a change in PSR then any
gain or loss will be adjusted for in all the partners capital accounts but still the old PSR.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 17

Example

The outline statement of financial position of Scanlon, Wimbourne and Guthrie trading as Bentinck
Merchants on 31 March 19-5 was:

Bentinck merchants
Statement of financial position as at 31 march 19-5
£ £ £
Non Current assets
Premises 30,000
Equipment 7,200
Fixtures and fittings 8,100
45,300
Current assets
Inventory 17,800
Accounts receivables 4,300
Cash 1,100
23,200
LESS
Current liabilities
Accounts payables 6,400
Bank overdraft 9,700
(16,100)
Working capital 7,100
Net assets 52,400
Financed by
Capital
Scanlon 20,000
Winbourne 20,000
Guthrie 10,000
50,000
Current accounts
Scanlon 3,600
Winbourne (2,100)
Guthrie 900
2,400
52,400

Up to this date the partners had shared profits and losses equally, it had been agreed,
however, that from 1 April 19-5 this would change to Scanlon ½ Winbourne1/3 Guthrie 1/6.
At the same time the assets were revalued at the following amounts.

£
Premises 55,000
Equipment 6,000
Fixtures & fittings 8,000
Inventory 16,500
Accounts receivables 4,100
Goodwill 12,000

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FINANCIAL ACCOUNTING III
 18 Partnerships

Required
Prepare the Revaluation and capital accounts and statement of financial position on the assumption
that the above revaluations are to be retained in the books of Bentinck Merchants but goodwill is to
be written off.

Solution

Capital account
Scanlon Winbourne Guthrie Scanlon Winbourne Githrie
Goodwill 6,000 4,000 2,000 Bal b/d 20,000 20,000 10,000
written off
Bal c/d 25,400 27,400 19,400 Goodwill 4,000 4,000 4,000
_____ _____ _____ Revaluation gain 7,400 7,400 7,400
31,400 31,400 21,400 31,400 31,400 21,400

____________________________________Revaluation a/c____________________________
Fixtures and fittings 100 Premises 25,000
Equipment 1,200
Inventory 1,300
Account receivables 200
Capital accounts 22,200 _____
25,000 25,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 19

BENTINCK MERCHANTS
Statement of financial position as at 31 March 19-5
£ £ £

NON-CURENT ASSETS
Premises 55,000
Equipment 6,000
Fixtures and fittings 8,000
69,000

CURRENT ASSETS
Inventory 16,500
Accounts receivables 4,100
Cash 1,100
21,700

CURRENT LIABILITIES
Account payables
Bank overdraft 6,400
Net current assets 9,700 (16,100) 5,600
NET ASSETS 74,600

FINANCED BY
Capital: Scanlon 25,400
Winbourne 27,400
Gulthrie 19,400
72,200
Current accounts: Scanlon 3,600
Winbourne (2,100)
Gulthrie 900 2,400
74,600

SURVIVORSHIP POLICY
The partners may take out a survivorship policy to safeguard against future cashflow problems incase
a partner dies or the business is dissolved. E.g. incase a partner dies, then the remaining partners may
wish to continue business but they may experience cashflow problems because they have to pay the
estate of the deceased partner.

On dissolution, again the partners may not be able to sell off all the assets on time and thus pay off
the creditors.

Therefore, under a survivorship policy the insurance will pay the partners the sum assured on the
death of a partner or the surrender value when the policy is terminated because the business is being
dissolved.

The premiums paid on such a policy may be treated in several ways.

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FINANCIAL ACCOUNTING III
 20 Partnerships

1. As an asset
The argument for this statement is that the survivorship policy is an investment because
eventually the partnership will receive either the surrender value or the sum assured an thus the
premium should not be expensed but carried as an asset.

Relevant entries

DR. Life policy asset account

CR. Cash book

2. As an expense and an asset

This approach tries to resolve the differences between the two methods by ensuring that we
show an asset that may materialize or crystallize and at the same time we charge an expense in the
profit and loss for the premium.

A new account called life policy fund is normally set up to facilitate the process.

Relevant entries are:

DR. Life policy asset account
CR. Cash book

DR. Profit and loss

CR. Life policy fund account
(With the premium paid for both of the two journal entries)

At the end of the financial period, the life policy asset account and fund account are normally
adjusted to reflect the surrender value. The asset and fund account must be equal but directly
opposite and incase the surrender value is higher than the premiums (total) paid to date are:-

DR. Life Policy asset account

CR. Life Policy fund account
(With the difference)

When the insurance company pays the sum assured or surrendered value, then we:
DR. Cash book
CR. Life Policy asset account

The life policy fund account should be closed off to the partners capital accounts according to
their profit sharing ratio.

1.3 ADMISSIONS AND RETIREMENTS

The major focus on admission or retirement involves making adjustments for goodwill as discussed
above. The next section will just deal with illustrative examples.

Example

Jim and Ken have been trading in partnership for several, sharing profits or losses equally after
allowing for interest on their capitals at 8% p.a. At 1 September 19-7 their manager, Len, was admitted
as a partner and was to have a one-fifth share of the profits after interest on capital. Jim and Ken
shared the balance equally but guaranteed that Len‘s share would not fall below £6,000p.a. Len was
not required to introduce any capital at the date of admission but agreed to retain £1,500 of his profit

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 21

share at the end of each year to be credited to his capital account until the balance reached £7,500,
until that time no interest was to be allowed on his capital. Goodwill, calculated as a percentage of the
profits of the last five years was agree at £15,000 at September 19-7, and Len paid into the business
sufficient cash for his share. No goodwill accounts were to be left in the books. Land and building
were professionally valued at the same date £28,400 and this figure was to be brought into the books,
whilst the book value of the equipment and vehicles was, by mutual agreement, to be reduced to
£15,000 at the date. Len had previously been entitled to a bonus of 5% of the gross profit payable
half-yearly, the bonus together with his manager‘s salary were cease when he became a partner. It was
agreed to take out a survivorship policy and the first premium of £1,000 was paid on 1 September 19-
7.
The trial balance at the end of the 19-7 financial year is given below. No adjustments had yet been
made in respect of lens admission, and the amount he introduced for goodwill had been put into his
current account. The drawings of all the partners have been changed to their current account. It can
be assumed that the gross profit and trading expenses accrued evenly throughout the year.
Depreciation on the equipment and vehicles is to be charges at 20% p.a. on the book value.

£ £
Capital accounts Jim 30,000
Ken 15,000
Current accounts Jim 7,800
Ken 7,100
Len 1,800
Land and buildings 18,000
Equipment and vehicles 21,000
Inventory 9,200
Gross profit 42,000
Trading expenses 15,000
Managers salary 4,000
Managers bonus 1,050
Accounts receivables & Payables 4,850 3,100
Premium on survivorship policy 1,000
Bank balance 2,900
91,900 91,900

Required:
(a) Prepare the income statement and the partner‘s capital and current accounts for the year ended 31
December 19-7 and statement of financial positionas at that date.

Solution

Capital account
JIM KEN LEN JIM KEN LEN
Goodwill written off 6,000 6,000 3,000 Bal b/d 30,000 15,000 -

Current a/c – capital

- - 15,000
Goodwill 7,500 7,500 -
Current a/c –
goodwill - - 3,000
Bal c/d 35,100 20,100 1,500 Revaluation gain 3,600 3,600 -
41,100 26,100 4,500 41,100 26,100 4,500

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FINANCIAL ACCOUNTING III
 22 Partnerships

Current account
JIM KEN LEN JIM KEN LEN
Balance b/d 7,800 7,100 - Balance b/d 30,000 15,000 -
Capital a/c –capital - - 1,500 Accrued bonus - - 1,500
Capital a/c-goodwill - - 3,000 Interest on capital 7,500 7,500 -
Balance c/d 200 Profit share - - 3,000
Balance c/d 3,600 3,600 -
8,000 7,100 4,500 8,000 7,100 4,500

Revaluation account

Equipment and vehicles 3,200 Land and building 10,400

Capital account – JIM 3,600
KEN 3,600 7,200
10,400 10,400

Jim, Ken and Len

Partnership, Profit and Loss and Appropriation account
For the year ended 31 December 19-7
1st 8 months 2nd 4 months TOTAL
£ £ £ £ £ £
Gross profit 28,000 14,000 42,000
Expenses
Depreciation on equipment &
vehicles 2,800 1,000 3,800
Trading expenses 10,000 5,000 15,000
Managers‘ salary 4,000 - 4,000
Manager bonus 1,400 - 1,400
Premium on survivorship policy - (18,200) 1,000 (7,000) 1,000 (25,200)
NET PROFIT 9,800 7,000 16,800
Less: Interest on capital J 1,600 936 2,536
K 800 536 1,336
L - (2,400) - (1,472) - (3,872)
Balance of profits share in PSR 7,400 5,528 12,928
J 3,700 1,764 5,464
K 3,700 1,764 5,464
L - (7,400) 2,000 (5,528) 2,000 (12,928)

Jim, Ken and Len Partnership

Statement of financial position as at 31 December 19-7
Cost revaluation Depreciation to Net book value
date

NON-CURRENT ASSETS
Land and buildings 28,400 - 28,400
Equipment and vehicles 15,000 (1,000) 14,000
43,400 (1,000) 42,400

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 23

Life policy asset account 1,000

43,400

CURRENT ASSETS
Inventory 9,200
Account receivables 4,850
Bank 2,900
16,950

CURRENT LIABILITIES
Trade payables (3,100)
Net current assets 13,850
57,250
FINANCED BY:
Capital: J 35,100
K 20,100
L 1,500
56,700
Current account J 200
K (300)
L (350) (450)
Life policy fund account 1,000
57,250

Example 2

Kijiko and Sahani, who prepare their accounts annually to 30 September, are partners in retail business
sharing profits and losses in the ratio of 3:2 respectively.

On 31 March 2003, Kijiko retired and Mwiko was admitted as a partner, profits and losses from that
date being shared between Sahani and Mwiko in the ratio of 2:1 respectively. For the purpose of these
changes, the value of the firm‘s goodwill was agreed at Sh. 900,000. No account for goodwill is
maintained in the books, adjusting entries for the transactions between the partners being made in
their current accounts.

Interest on fixed capitals is allowed at 6% per annum but no interest is charged or allowed on current
accounts. The amount due to a retiring partner is payable as to Sh. 250,000 on retirement, the balance
being payable in five equal annual instalments commencing on the first anniversary of his retirement.
The amount due to retiring partner attracts interest at the rate of 8% per annum.

The trial balance of the partnership as at 30 September 2003 was as follows:

Sh. ―000‖ Sh. ―000‖

Leasehold premises (bought on 1 October 2002) 800
Purchases 2,040
Motor vehicles at cost (30 September 2002) 420
Provision for depreciation – motor vehicles (30 September 2002) 180
Shop fittings at cost (30 September 2002) 180
Provision for depreciation – shop fittings (30 September 2002) 60
Balance at bank 148
Salaries 640

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FINANCIAL ACCOUNTING III
 24 Partnerships

Stock (30 September 2002) 510

Sales (Sh. 1,393,300 for six months to 31 March 2003) 3,800
Cash paid to Kijiko 250
Debtors 80
Creditors 360
Professional charges 54
Wages 380
Rates and lighting 168
General expenses (Sh. 172,000 for six 31 March 2003) 410
Cash introduced by Mwiko 400
Capital accounts: - Kijiko 500
- Sahani 300
Current accounts: - Kijiko 220
- Sahani _____ 260
6,080 6,080

Additional information:
1. It was agreed that of the Sh. 400,000 introduced into the firm by Mwiko on 1 April 2003, Sh.
100,000 should form his fixed capital, the balance being credited to his current account
2. The stock as at 30 September 2003 was valued at Sh. 560,000.
3. Provision is to be made for depreciation on motor vehicles and shop fittings at the rates of
20% per annum and 10% per annum respectively on cost at the end of the year.
4. A motor vehicle which had cost Sh. 120,000 and on which depreciation of Sh. 48,000 had
been provided, was taken over by Kijiko on his retirement at its down value.
5. The following drawings by partners are included in salaries:

Sh.
―000‖
Kijiko 60
Sahani 40
Mwiko 20

6. As at 30 September 2003, rates paid in advance amounted to Sh. 22,000 and provision of Sh.
8,000 for general expenses was required.
7. A difference in the books of accounts of Sh. 10,000 had been written off at 30 September
2003 to general expenses but had later been found to be due to an undercast of similar
amount in the purchases journal
8. Professional charges include Sh. 20,000 paid in respect of the acquisition of the leasehold
premises. The total cost of the lease is to be written off over a period of 50 years.

Required:
(a) The income statement for the year ended 30 September 2003, (Gross profit is to be
apportioned on the basis of turnover. Unless otherwise indicated, expenses are to be
apportioned on a time basis). (10 marks)

(b) The partner‘s current accounts as at 30 September 2003. (4 marks)

(c) The statement of financial position as at 30 September 2003. (6 marks)

(Total: 20 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 25

Solution

Kijiko, Sahani and Mwiko Partnership

Income statement for the year ended 30/9/2003
1st 6 months 2nd 6 months TOTAL
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Sales 3,800
Cost of sales
Opening inventory 510
Purchases 2,050
2,560
Closing inventory (560) (2,000)
Gross profit 660 1,140 1,800
Expenses
Depreciation on motor
vehicles 42 30 72
Amortization of lease 8.2 8.2 16.4
Depreciation on fittings 9 9 18
Salaries 260 260 520
Professional charges 17 17 34
Wages 190 190 380
Rates and lighting 73 73 146
General expenses 172 236 408
Interest on loan by K - (771.2) 33 (856.2) 33 (1,627.4)
NET LOSS (111.2) 283.8 172.6
Less: interest on capital: K 15 - 15
S 9 9 18
M - (24) 3 (12) 3 (36)
Share of loss/profit in PSR (135.2) 271.8 136.6
K (81.12) - (81.12)
S (54.08) 181.2 127.12
M - (135.2) 90.6 271.8 90.6 136.6
- -

Current account
K S M K S M
Goodwill written off 600 300 Balance b/d 220 260 -
Loss share 81.12 - Interest on capital 15 18 3
Drawings 60 40 20 Goodwill 540 360 -
Bank – capital - - 300
Profit share 127.12 90.6
Balance c/d 633.88 125.12 73.6 Balance c/d
775 765.12 393.6 775 765.12 393.6

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FINANCIAL ACCOUNTING III
 26 Partnerships

Capital account
K S M K S M
Motor vehicle 60 - - Balance b/d 500 300 -
Bank 250 - - Bank (capital) - - 100
Loan 823.88 - - Current account 633.88 - -
Balance c/d - 300 100
1,13.88 300 100 1,133.88 300 100

SAHANI AND MWIKO PARTNERSHIP

Statement of financial position as at 30 September 2003

NON-CURRENT ASSETS
COST DEPRECIATION NET BOOK VALUE
Shs 000 Shs 000 Shs000
Leasehold premises 820 (16.4) 803.6
Motor vehicles 300 (192) 108
Shop fittings 180 (78) 102
1,300 286.4 1,013.6

CURRENT ASSETS
Inventory 560
Debtors 80
Prepayments 22
Bank 148
810

CURRENT LIABILITIES
Payables 360
Accruals – general expenses 8
Accrued (due to K) 197.776 (565.776)
Net current assets 244.244
NET ASSETS 1,257.824

FINANCED BY:
Capital: Sahani 300
Mwiko 100
400
Current: Sahani 125.12
Mwiko 73.6 198.72
598.72
NON-CURRENT
LIABILITIES
Loan to K 659.104
1,257.824

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 27

Workings:

‗000‘
General expenses
As per trial balance 410
Less: Purchases add general accrued (8) (10)
408
1st 6 months (172)
236

1.4 DISSOLUTIONS
A partnership may be dissolved due to various reasons which include:

i) Poor trading that has led to losses

ii) A partner dying or leaving the firm
iii) The time period for which the partnership was formed has elapsed.

The main objective of accounting for dissolutions is to ensure that the dissolution transactions are
recorded properly. These transactions involve;
Selling the assets of the business and thereafter paying off dissolution expenses and liabilities of the
partnership. The remaining costs are now paid off to the partners.

In the process of selling off the assets, the assets may be sold off at a profit or loss this profit or loss
is supposed to be shared by the partners according to the profit sharing ratio before the final
payments are made to them.

To facilitate the process of dissolution, a new account called realization account in which the assets
being sold are transferred and the cash proceeds received on the sale of the assets. Generally, the
realization account is supposed to record all profits or losses in return to dissolution and therefore
dissolution expenses will also be posted here discounts received from creditors, and also discounts
allowed to debtors.

The balance on the realization account is the profit or loss on dissolution that is closed off to the
capital accounts.

The following journal entries are relevant for the purpose of recording all dissolutions:

1. DR.Revaluation account
CR. Asset account
(With the book value of the assets being sold / or being realized)

2. DR.Cash book
CR. Realisation account
(With the cash received on the assets being realized)
3. DR.Realisation account
CR. Cash book
(With the dissolution expenses paid)

4. DR.Creditors account payables

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FINANCIAL ACCOUNTING III
 28 Partnerships

CR. Cash book

(With payment made to the creditors)

5. DR.Creditors
CR. Realization account
(With the discount received from account payable or creditors)

6. Dr. Realization account

CR. Capital accounts
(With the profit on realization being the balancing figure and according to PSR)
Incase it is a loss, then the entries are received.

7. DR.Current account
CR. Capital accounts
(To transfer the accounts due to the partners on their current accounts to the capital account)

8. DR Capital accounts
CR. Cash book
(To close off the capital accounts with the cash book)

There are two situations that need to be considered under dissolutions. These are:-

i) Where the assets are sold at once (one single transaction)

ii) Assets are sold on piece meal basis.

i) Where assets are sold off at once

Under this situation, the partners are able to get a single buyer who buys al the assets in a single
transaction. The buyer could be an individual, sole trader, another partnership or a company. this
kind of situation is straightforward because the partners can be able to determine profit or loss on
dissolution immediately.

Example:

X, Y and Z have been trading as partners sharing profits and losses in the ratio of 2:2:1 on the 1 st July
2005, they decided to dissolve the partnership and all the assets were sold in a single transaction in the
market. The statement of financial position as at 1s July 2005 was as follows:

X, Y and Z
Statement of financial position as at 1.7.2005
£ £

NON-CURRENT ASSETS
Freehold property 60,000
Equipment 30,000
90,000
CURRENT ASSETS
Inventory 16,000
Account receivables 9,000
Cash at bank 4,200
29,200
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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 29

CURRENT LIABILITIES
Account payables (6,000)
Net current assets 23,200
NET ASSETS 113,200

FIANCNED BY:
Capital accounts X 78,000
Y 26,000
Z 4,000
108,000

Current accounts X 1,400

Y (600)
Z 400 1,200
109,200

NON-CURRENT LIABILITIES
Loan from bank 3,000
Loan from Y 1,000 4,000
113,200

The current assets sold on the market fetched the following assets:

£
Freehold property 62,000
Equipment 9,600
Inventory 5,800

The receivables paid their amounts in full while payables gave discounts of £200. The dissolution
amounts to £1600.

Required:
Prepare the relevant accounts to record the dissolution.

Solution

Realization account
£ £
Freehold property 60,000 Cash book equipment 9,600
Equipment 30,000 Property 6,200
Inventory 16,000 Inventory 8,800
Debtors 9,000 Debtors 9,000
Cash book dissolution expenditure 1,600 A/c payables discounts 200
Loss on dissolution X 12,000
Y 12,000
______ Z 6,000
116,600 116,600

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FINANCIAL ACCOUNTING III
 30 Partnerships

Cash book account

£ £
Balance b/d 4,200 Realizable dissolution expense 1,600
Realisation – equipment 9,600 Accounts payables 5,800
Freehold property 62,000 Loan from bank 3,000
Inventory 5,800 Loan from Y 7,000
Accounts receivables 9,000 Capital X 67,400
Capital account Z 1,600 Y 13,400
92,200 92,200

Capital account
X Y Z X Y Z
£ £ £ £ £ £
Realisation account – loss 12,000 12,000 6,000 Bal b/d 78,000 26,000 4,000
Current account - 600 - Current account 1,400 - 400
Cash book (bal. Fig) 67,400 13,400 _____ Cash book (Bal. Fig) _____ _____ 1,600
79,400 26,000 6,000 79,400 26,000 6,000

In the current example, we have assumed that partner Z is solvent and therefore he is in a position to
bring in the cash required from him so that full distribution is made to the other partners.

However, in certain situations, a partner/some partners may not be able contribute the additional cash
required and thus they are said to be insolvent.

According to the rule in Gurner V. Murray, if some of the partners are insolvent, then their loss
appearing in the capital balances should be bourne by the solvent partners according to the initial
capital balances (and NOT their Profit Sharing Ratio)

In the given example therefore, if we assume that Z is insolvent, and will therefore not be in a position to
contribute the £1,600 due from him, then it will be shared between X and Y in the ratio of 78,000:26,000.

Capital account
X Y Z X Y Z
£ £ £ £ £ £
Realisation account – loss 12,000 12,000 6,000 Bal b/d 78,000 26,000 4,000
Current account - 600 Current account 1,400 - 400
Contra - Z 1,200 400 X 1,200
Cash book 66,200 13,000 - Y _____ _____ 400
79,400 26,000 6,000 79,400 26,000 6,000

These balances transferred to the cash book shall change i.e. be different from the previous one.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 31

If the rule in Guvner V. Murray in excluded as per requirements of the examiner, then the loss or
balance due from the insolvent partner will be shared by the remaining solvent partners according to the
profit sharing ratio.

In the given example, therefore, if the rule in Guvner V. Murray was excluded, then the loss of £1,600
due from Z would be shared in the ratio of 2:2 by X and Y i.e. £800 and £800.

The partners may sell off the assets of the partnership to a company and instead of being paid by cash
the purchase consideration may be made up of shares or loan stock. The purchase consideration may
have a combination of several items i.e. shares (ordinary and preference), loan stock and balance inform
of cash.

The determination of profit or loss on Realisation ill be done the same way as before an instead of only
the cash being credited in the Realisation account, we may also have the shares and loan stock issued to
the partners.

A separate account may be opened for the ordinary shares and the loan stock issued and the following
entry will be passed.

DR. Loan stock or shares

CR. Realisation account
(With the value of the shares and the loan stock issue)

once we determine how much is due to the partners, then the shares and the ban stock account will be
closed off as follows:

DR. Capital accounts

CR. Shares or loan stock accounts
(With the amounts due to each of the partners)

In most cases, the shares and loan stock may be issued to the partners according to some agreed ratio and
any balances remaining in the partners capital accounts will be settled by way of cash.

Example

Amis, Lodge and Pym were in partnership sharing profits and losses in the ratio 5:3:2. The following
trial balance has been extracted from their books of account as at 31st March 19-8:

£ £
Bank interest received 750
Capital accounts (as at 1 April 19-7)
Amis 80,000
Lodge 15,000
Pym 5,000
Carriage inwards 4,000
Carriage outwards 12,000
Cash at Bank 4,900
Current accounts
Amis 1,000
Lodge 500

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FINANCIAL ACCOUNTING III
 32 Partnerships

Pym 400
Discounts allowed 10,000
Discounts received 4,530
Drawings:
Amis 25,000
Lodge 22,000
Pym 15,000
Motor vehicles
at cost 80,000
Accumulated depreciation (at 1 April 19-70 20,000
Office expenses 30,400
Plant and machinery
At cost 100,000
Accumulated depreciation (at 1 April 19-7) 36,600
Provision for bad debts
(at 1 April 19-7) 420
Purchases 225,000
Rent, rates, heat and light 8,800
Sales 404,500
Inventory (at1 April 19-7) 30,000
Trade payables 16,500
Trade receivables 14,300 _______
£583,300 £583,300

Additional information:

1. Inventory as at 31 March 19-8 was valued at £5,000;

2. Depreciation is to be charged as follows:

Motor vehicles- 25% on the reduced balance
Plant and machinery -20% on the original cost

There were no purchases or sales of property, plant and equipment during the year to 31
March 19-8.

3. The provision for bad and doubtful debts is to be maintained at a level equivalent to 5%
of the total trade debtors as at 31 March 19-8

4. An office expense of £405 owed at 31st March 19-8, and some rent amounting to £1,500
had been paid in advance as at that date. These items had not been included in the list of
balances shown in the trial balance.

5. Interest on drawings and on the debit balance on each partner‘s current account is to be
charged a follows:

£
Amis 1,000
Lodge 900
Pym 720

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 33

6. According to the partnership agreement, Pym is allowed a salary of £13,000 per annum.
This amount owed to Pym for the year to 31 March 19-8, and needs to be accounted for.

7. The partnership agreement also allows each partner interest on his capital account at a
rate of 10% per annum. There were no movements on the respective partners accounts
during the year to 31 March 19-8, and the interest had not been credited to them about
that date.

Note: The information given above is sufficient to answer part a) i) and ii) of the question,
and notes 8) and 9) below are pertinent to requirements b) i) and ii) of the question.

8. On 1 April 19-8 Fowles Limited agreed to purchase the business on the following terms:

a) Amis to purchase one of the partnership‘s motor vehicles at an agreed value of

£30,000:

b) The company agreed to purchase the plant and machinery at a value of £ 35,000 and
the stock at a value of £ 38,500;

c) The partners to settle the trade payables; the total amount agreed with the creditors
being £16,000;

d) The trade receivables were not to be taken over by the company, the partners
receiving cheques on 1 April 19-8 amounting to £12,985 in total from the trade
debtors in settlement of the outstanding debts;

e) The partners paid the outstanding office expenses on 1 April 19-8, and the landlord
returned the rent paid in advance by cheque on the same day;

f) As consideration for the sale of the partnership, the partners were to be paid
£63,500 in cash by Fowles Limited, and to receive 75,000 in £1 ordinary shares in
the company, the shares to be apportioned equally amongst the partners;

9) Assume that all the matters relating to the dissolution of the partnership and its sale to
the company took place on 1 April 19-8.

Required

a) Prepare:
i. Amis, Lodges and Pym‘s trading, profit and loss appropriations account for the
year to 31 March 19-8;
And
ii. Ami‘s, Lodge‘s and Pym‘s current accounts ( In Columna format) for the year to
31 March 19-8 ( the final balance on each account is to be then transferred to
each partner‘s respective capital account
And

b) Compile the following accounts:

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FINANCIAL ACCOUNTING III
 34 Partnerships

i. The partnership realization account for the period up to and including 1 April
19-8;

ii. The partner‘s bank account for the period up to and including 1 April 19-8;

and

iii. The partner‘s Capital accounts (in column format) for the period up to and
including 1 April 19-8.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 35

Solution

Amis, Lodge and Payne

Trading, Profit and Loss account
£ £ £
Sales 404,500
Cost of sales
Opening stock 30,000
Purchases 225,000
Add carriage in 4,000 229,000
259,000
Closing stock (5,000) (254,000)
Gross profit 150,500
Bank interest received 750
Discount received 4,350 5,280
155,780
Expenses
Increase in provision for bad debts 295
Carriage outwards 12,000
Discount allowed 10,000
Depreciation on plant 20,000
Depreciation on motor vehicles 15,000
Office expenses 30,400
Add accrued 405 30805
Rent, rates, light and heating 8,800
Less prepaid (1,500) 7,300 95,400
NET PROFIT 60,380

ADD: Interest on drawings: Amis 1,000

Lodge 900
Payne 720 2,620
63,000

Less Interest on capital: Amis 8,000

Lodge 1,500
Payne 500 (10,000)
53,000
Salaries to Payne (13,000)
Profit shared in PSR 40,000
Amis 20,000
Lodge 12,000
Payne 8,000 (40,000)
-

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FINANCIAL ACCOUNTING III
 36 Partnerships

Amis, Lodger and Payne

Statement of financial position as at 1st April 19-8
COST DEPRECIATION NET BOOK
VALUE
NON-CURENT ASSETS
£ £ £
Property and plant 100,000 (56,600) 43,400
Motor vehicles 80,000 (35,000) 45,000
180,000 91,600) 88,400
CURRENT ASSETS
Inventory 5,000
Receivables 14,300
Less provision for bad debts (715) 13,585
Prepayments 1,500
Cash at bank 4,900
24,985
CURRENT LIABILTIES
Payables 16,500
Accruals 405 (16,905)
Net current assets 8,080
NET ASSETS 96,480

FINANCED BY
Capital accounts: Amis 80,000
Lodge 15,000
Payne 5,000
100,000
Current accounts: Amis 3,000
Lodge (1,900)
Payne 5,380 (3,520)
96,480

Current account
Amis Lodge Payne Amis Lodge Payne
£ £ £ £ £ £
Balance b/d 1,000 500 400 Interest on capital 8,000 1,500 500
Drawings 25,000 22,000 15,000 Salary 13,000
Interest on drawings 1,000 900 720 Profit share 20,000 12,000 8,000
Balance c/d 1,000 _____ 5,380 Balance c/d _____ 9,900 _____
28,000 23,400 21,500 28,000 23,400 21,500

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 37

Cash book account

£ £
Balance b/d 4,900 Creditors 16,000
Realisation account dep 12,985 Accrued expenses 405
Realisation account prep 1,500 Capital accounts A 63,500
Realisation from company 63,500 L 2,600
P 380
82,885 82,885

Realization account
£ £
Plant and equipment 43,400 Capital account – A 30,000
Motor vehicle 45,000 Creditors discount 500
Inventory 5,000 Cash book account – received 12,985
Debtors 13,585 Cash book prepayment 1,500
Prepayments 1,500 Cash book 63,500
Capital accounts Ordinary shares 75,000
Profit share A 375,000
L 225,000
P 15,000 ______
183,485 183,485

Capital account
Amis Lodge Payne Amis Lodge Payne
£ £ £ £ £ £
Realization 36,000 - - Balance b/d 80,000 15,000 5,000
Current accounts - 9,900 - Realisation a/c 37,500 22,500 15,000
Ordinary share 25,000 25,000 25,000 Current a/c 1,000 - 5,380
Cash book 63,500 2,600 380 ______ _____ _____
118,500 37,500 25,380 118,500 37,500 25,380

Ordinary share capital account

£ £
Realization 75,000 Capital account A 25,000
L 25,000
_____ M 25,000
75,000 75,000

Piecemeal Realizations and Distributions

Partnership dissolutions may take a substantial number of days 9even months) so it is unlikely that all cash
generated will be simultaneous, unless the business is sold off as a going concern, i.e. a single unit.

The partners may not be willing to wait for such long durations for the process to be complete before
receiving their repayments of capital.

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FINANCIAL ACCOUNTING III
 38 Partnerships

It is therefore common practice to make interim distributions to partners as soon as a reasonable

amount of cash is available. However, all liabilities must have been paid off by the time any
distribution is made to a partner.

These interim distributions give rise to two problems:

i) Partners have not always contributed capitals in the same ratio as that in which they share
profits;
ii) There will always be uncertainty of future realizations

These two problems point in the same direction: how does one pa cash to partners in such amounts
that the partner will never be asked to return any at a later date as excess?
The distribution has to be made in such a way each partner only receives cash after considering all
possible gains and losses attributable to that partner at that stage. Two methods have been developed
to accomplish this;
i) The maximum possible loss method
ii) The surplus capital method

The maximum possible loss method

Under this method, a table is set up to compute the amounts payable to each partner. The results of the
computation may be then posted into the capital and other relevant accounts. The computation works on
the basis that capital accounts take the following form:
Capitals
Sh Sh Sh Sh
Cashbook X X Bal b/d X X
Realisation loss X X
XX XX XX XX

Therefore: Capital – Cash = Realisation Loss

OR
Capital – Realisation Loss = Cash to be paid.

The table takes the following form: [Assume 3 partners A, B and C].

Schedule of distribution
Total A B C Distribution
Capitals X X X X
Available cash (X)
Maximum possible loss X (X) (X) (X)
XX XX XX XX

In the initial stages, the cash received may be little, and this may result in a large ‗Maximum possible loss‘.
When this is divided amongst partners in profit sharing ration and deducted from capitals, the resultant
figure is negative (same as a debit in the capital account – see illustrations 6 & 7). Assuming a maximum
possible loss situation, the partner with a negative figure will be deemed bankrupt, and the negative figure
uncollectible. This will be divided amongst the other partners in profit sharing ratio or the ratio in which
capitals are held. It will depend upon whether the ruing in Garner Vs Murray is to be excluded or applied.
Whichever the case, the table will now take the following form:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 39

Schedule of distribution
Total A B C Distribution
Capitals X X X X
Available cash (X)
Maximum possible loss X (X) (X) (X)
X X (X)
XX XX XX XX
It is important to realize that the loss in the table is not real; it will only become real if no further cash
is collected. The loss is only for the cash collected this far.

Illustration 8
XYZ
Statement of financial position
Sh Sh
Freehold property 30,000 Capitals: X 40,700
Equipment 15,000 Y 13,700
45,000 Z 5,200
Stock 8,000
Debtors 4,500
Bank 2,100
14,600 _____
59,600 59,600

This is the statement of financial position of X, Y and Z who are sharing profits and losses in the ratio
2:2:1 immediately prior to dissolution.

The partners were unable to sell the business as a going concern and disposed of the assets separately
for the following sums:

Freehold property Sh 28,900

Equipment Sh 5,300
Stock Sh 2,400

Debtors paid their dues in full (after the sale of stock) and dissolution expenses totaled Ksh 700.
These were paid on the last day, after collections from debtors.

Required:
i) A distribution schedule (also know as statement of distribution) assuming the application of the
ruling in Garner Vs Murray is required;
ii) Ledger accounts to record the dissolution.

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FINANCIAL ACCOUNTING III
 40 Partnerships

Statement of distribution
Total Amount
Total X (Sh) Y (Sh) Z (Sh) Distribution
Sh (Sh)
Capitals 59,600 40,700 13,700 5,200
Available cash (31,000)
Maximum possible loss 28,600 (11,400) (11,440) (5,720)
29,260 2,260 (520)
Reapportionment of z‘s (389) (131) 520
balance
28,871 2,129 _- 31,000

Capitals 28,600 11,829 11,571 5,200

Available cash (5,300)
Maximum possible loss 23,300 (9,320) (9,320) (4,660)
2,509 2,251 (540) 5,300

Capitals 23,300 9,320 9,320 4,660

Available cash (2,400)
Maximum possible loss 20,900 (8,360) (8,360) (4,180)
960 960 480 2,400

Capitals 20,900 8,360 8,360 4,180

Available cash (3,800)
17,100 6,840 6,840 3,420
1,520 1,520 760 3,800

Tutorial notes and workings:

1) In the first table:

i) Available cash was arrived at by:

Cash at bank Sh 2,100

From sale of property Sh 28,900
Sh 31,000

ii) The maximum possible loss (sh 28,600) was divided amongst partners in profit sharing
ratio;
X (2/5) Sh 2,100
Y (2/5) Sh 11,440
Z (2/5) Sh 5,720
Sh 28,600

iii) The debt due from Z (SH 520) was transferred as an uncollectable loss to X and Y on the
basis of their capitals:

X: 40,700 x 520 = 389

40,700 + 13,700

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 41

Y: 13,700 x 520 = 131

40,700 + 13,700

2) In the second table, the opening values are computed by reference to the previous (in this case,
first) table.

The opening capital in the first table less any cash distributed as per that table gives the balance
of capital with which to commence the second table.

For X, 40,700 – 28,871 = 11,829

Y, 13,700 –2,129 = 11,571
Z, 5,200 – 0 = 5,200

3) In the last table, the available cash is computed as:

Cash collected from debtors Sh 4,500

Less: Used for dissolution expenses Sh 700
Sh 3,800

4) The table will be easier to follow if it can be understood that its sole purpose is to compute
amounts distributed to partners, i.e. IT ONLY DEALS WITH CASH FOR PARTNERS.

End of tutorial notes

Property
Sh Sh
Bal b/d 30,000 Realisation 30,000

Equipment
Sh Sh
Bal b/d 15,000 Realisation 15,000

Stock
Sh Sh
Bal b/d 8,000 Realisation 8,000

Debtors
Sh Sh
Bal b/d 4,500 Realisation 4,500

Realisation a/c
Sh Sh
Freehold property 30,000 Cash book 28,900
Equipment 15,000 Cash book 5,300
Stock 8,000 Cash book 2,400
Debtors 4,500 Cash book 4,500
Cashbook: Expenses 700 Capitals: Loss
X 6,840
Y 6,840
Z 3,240
17,100
58,200 58,200

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FINANCIAL ACCOUNTING III
 42 Partnerships

Cashbook
Sh Sh
Bal b/d 2,100 Capitals; X 28,871
Realisation 28,900 Y 2,129
Realisation 5,300 X 2,509
Realisation 2,400 Y 2,251
Realisation 4,500 Z 540
X 960
Y 960
Z 480
Realisation 700
Capitals: X 1,520
Y 1,520
_____ Z __760
43,200 43,200

Capitals
X Y Z X Y Z
Cashbook 28,871 2,129 - Bal b/d 40,700 13,700 5,200
Cashbook 2,509 2,251 540
Cashbook 960 960 480
Cashbook 1,520 1,520 760
Realisation loss 6,840 6,840 3,420
40,700 13,700 5,200 40,700 13,700 5,200

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 43

Illustration 9
A, B and C have been partners for several years, sharing profits and losses in the ratio 2:2:1. They decided
to dissolve the firm on 31 October 2002, on which date the statement of financial position was as follows:

Statement of financial position as at 31 October 2002

ASSETS Ksh Ksh
Non Current Assets
Property plant and equipment:
 Land and buildings 150,000
 Plant and machinery 77,200
 Fixtures and fittings 17,000
 Motor vehicles 8,000
252,200
Goodwill 100,000
352,000
CURRENT ASSETS
Stock 64,000
Debtors 59,000
Cash 160
123,160
475,360
EQUITY AND LIABILITIES
Capitals: A 100,000
B 60,000
C 40,000
200,000
Current accounts A 40,000
B 30,000
70,000
270,000
NON CURRENT LIABILITIES
Loan – A 20,000
CURRENT LIABILITIES
Creditors 57,000
Bank overdraft 128,360
185,360
475,360

1) The assets were duly sold and monies received as follows:

2002
November 17th: Freehold land and buildings Sh 259,000
December 19th: Debtors (Part) Sh 30,000
Stock (Part) Sh 20,000

2003
January 23rd: Plant and machinery Sh 51,000
Fixtures and fittings Sh 12,000

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FINANCIAL ACCOUNTING III
 44 Partnerships

Motor vehicles Sh 5,000

March 18th: Stock (Remainder) Sh 36,000
Debtors (Remainder) Sh 42,000
2) Provision was made for dissolution expenses Sh 2,400.
3) As soon as sufficient money was available to pay all outstanding creditors, this was done,
discounts being received amounting to Sh 1,000.
4) Dissolution expenses amounted to Ksh 3,400, and these were paid on 31 March 2003.

Required:
a) Statements showing how the dissolution proceeds would be distributed to partners; ignoring the
ruling in Garner Vs Murray.
b) The creditors account, realization account, capital accounts and cashbook.

Solution:
A, B and C
Statement of distribution
Total A B C Distribution
(Sh) (Sh) (Sh) (Sh) (Sh)
Capitals 200,000 100,000 60,000 40,000
19th December: Available cash 70,000 40,000 30,000 _-
Maximum possible loss 270,000 140,000 90,000 40,000
(52,400)
217,600 (87,040) (87,040) (43,520)
52,960 2,960 (3,520)
(1,760) (1,760) 3,520
51,200 1,200 __- 52,400

Capitals 217,600 88,800 88,800 40,000

19th December: Available cash 50,000
Maximum possible loss 167,600 (67,040) (67,040) (33,520)
21,760 21,760 6,480 50,000

Capitals 167,600 67,040 67,040 33,520

23rd January: Available cash (68,000)
Maximum possible loss 99,600 (39,840) (39,840) (19,920)
27,200 27,200 13,600 68,000

Total A B C Distribution
(Sh) (Sh) (Sh) (Sh) (Sh)
Capitals 99,600 39,840 39,840 19,920
18th March: Available cash (77,000)
Maximum possible loss 22,600 (9,040) (9,040) (4,520)
30,800 30,800 15,400 77,000

Tutorial notes and workings:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 45

1) In the first table, the available cash has been computed as follows:
Sh
Cash in hand 160
Received on 17th November 259,000
Set aside for dissolution expenses (2,400)
Payments to creditors (56,000)
Repayment of bank overdraft (128,360)
Repayment of A‘s loan (200,000)
52,240

2) Since the ruling in Garner Vs Murray is to be excluded, the amount due from C (at that time
assumed to be uncollectable) of Sh 3,520 was divided between A and B based on their profit
shares, which ere 2/5 and 2/5. Thus the loss was divided equally at Ksh 1,760 per person.
3) In the final table, the available cash was computed as follows:

Sh
Collected from sale of stock 36,000
Collected from debtors 42,000
Less: Additional amounts required for dissolution expenses (1,000)
77,000
Creditors A/c
Sh Sh
Cash book 56,000 Bal b/d 57,000
Realisation: Discounts 1,000 _____
57,000 57,000
Realisation
Sh Sh
Land and buildings 150,000 Cash book 259,000
Pant and machinery 77,200 Cash book 50,000
Fixtures 17,000 Cash book 68,000
Vehicles 8,000 Cash book 78,000
Stock 64,000 Creditors A/c 1,000
Debtors 59,000 Capitals: Loss
Cashbook: Expenses 3,400  A 9,040
Goodwill 100,000  B 9,040
 C 4,520
______ 22,600
478,600 478,600

Capitals
A (Sh) B (Sh) C (Sh) A (Sh) B (Sh) C (Sh)
Cash book 51,200 1,200 - Bal b/d 100,000 60,000 40,000
Cash book 21,760 21,760 6,480 Current accounts 40,000 30,000 -
Cash book 27,200 27,200 13,600
Cash book 30,800 30,800 15,400
Realisation loss 9,040 9,040 4,520
140,000 90,000 40,000 140,000 90,000 40,000

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FINANCIAL ACCOUNTING III
 46 Partnerships

Cashbook
Sh Sh
Bal b/d 160 Creditors 56,000
Realisation 259,000 Bank overdraft 128,360
Realisation 50,000 Loan: A 20,000
Realisation 68,000 Capitals: A 51,200
Realisation 78,000 : B 1,200
Capitals: A 21,760
:B 21,760
:C 6,480
Capitals: A 27,200
:B 27,200
:C 13,600
Capitals: A 30,800
:B 30,800
:C 15,400
______ Realisation 3,400
455,160 455,160

THE SURPLUS CAPITAL METHOD:

Under this method, the initial amounts repaid to partners are in order to reduce their capitals to amounts
such that these are now in the same ratio as that in which they share profits and losses. The amounts so
repaid are referred to as ―repayment of surplus capital‖.

For example, if there are three partners who share profits and losses equally, and have capitals of Ksh
100,000 Ksh 60,000 and Ksh 40,000, the surplus capitals will be as follows:

100
Surplus Capital

Sh ‗000‘

0
A B C

Once the surplus capital has been paid to partners the remaining capital, known as ‗base capital‘ can
be repaid. The base capital is in the same ratio as that in which profits and losses are shared. In the
illustration, it is 1:1:1(equal). Any cash collected can also be distributed in profit sharing ration – 1:1:1.
This will allow capital balances to fall uniformly as more and more cash is paid to partners.

As a final example to this, assume that there are three partners with capitals of Ksh 60,000, Ksh
75,000 and Ksh 120,000 who share profits and losses in the ratio 3:2:1 respectively. Their surplus
capitals can be illustrated as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 47

120

Surplus Capital
Sh ‗000‘

Of course, there will be a priority payment of surplus capital between the two partners who have
surplus capital. The partner who will receive the first payment is said to have been repaid his ‗surplus
surplus capital‘.

The computation of surplus capital (and surplus surplus capital) requires a table that takes the
following form:

Statement of surplus capital

A (Sh) B (Sh) C Total
(Sh) (Sh)
Capitals (1) X X X X
Profit sharing ratio (2) X X X X
Capital per unit of profit (1)  (2) X X X X

Capital in profit sharing ratio (3) (X) (X) (X) (X)

Surplus Capital (1) – (3) -
X X X

Capitals X - X X
Profit sharing ratio X - X X
Capital per unit of profit X - X X
Capital in profit sharing ratio (X) - (X) (X)
Surplus Capital - - X X

The table is repeated again and again until only one partner has surplus surplus capital. Every
consecutive table eliminates one partner.
Another table known as ‗statement of actual distribution‘ is now necessary to ascertain the amount
from each collection to be paid to individual partners. It will take the following form:

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FINANCIAL ACCOUNTING III
 48 Partnerships

Statement of actual distribution

A (Sh) B (Sh) C (Sh) D (Sh)
1st Realisation: Part X (1) X
Balance X (2) _____ X (2) X
X X X
2nd Realisation: Part X (3) X (3) X
Balance X (4) X (4) X (4) X

X X X X
X X X X
3rd Realisation
X X X X
X X X X
1) The surplus as per the last section in the statement of surplus capital is the first to be paid off.
2) If the cash collected is sufficient to pay off the entire surplus and some excess remains, such
excess is used to pay the surplus in the last but one section of the statement of surplus capital.
3) Cash collected is used to settle any outstanding balances on the last but one section of the
statement of surplus capital.
4) From this point on all cash is divided amongst all partners in profit sharing ratio.

Tutorial notes:
a) The above statement of actual distribution may have variations in formats and positioning of
values. It will depend highly on the amount of cash collected and the amount of surplus
awaiting repayment.
b) Provided cash is to be paid to more than 1 partner it must be paid out in PROFIT SHARING
RATIO. This is irrespective of whether the repayment is surplus capital or base capital.
c) Do not worry if the explanations seem confusing. The next two illustrations will help to clarify
matters.]

Illustration 10
We will now solve illustration 8 using this method of ascertaining the interim distributions to partners.
You are advised to revisit the illustration and familiarize yourself with the facts.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 49

Statement of Surplus Capital

X(sh) Y(sh) Z (sh) Total
(sh)
Capitals 40,700 13,700 5,200 59,600
Profit sharing ratio 2 2 1 5
Capital per unit of profit 20,350 6,850 5,200 N/A
Capital in profit sharing ratio (10,400) (10,400) (5,200) (26,000)
Surplus Capital 30,300 3,300
- 33,600

Capitals 30,300 3,300 - 33,600

Profit sharing ratio 2 2 - 4
Capital per unit of profit 15,150 1,650 - N/A

Capital in profit sharing ratio (3,300) (3,300) - (6,600)

Surplus Capital 27,000 -
- 27,000

Statement of actual distribution

X (Sh) Y (Sh) Z (Sh) Total (Sh)

1st Realisation: Part 27,000 - - 27,000
Balance 2:2 2,000 2,000 4,000
29,000 2,000 - 31,000
2nd Realisation: Part 1,300 1,300 - 2,600
Balance 2:2:1 1,080 1,080 540 2,700

2,380 2,380 540 5,300

31,380 4,380 540 36,300
3rd Realisation 2:2:1
960 960 480 2,400
4Th Realisation 2:2:1 1,520 1,520 760 3,800
33,860 6,860 1,780 42,500

Tutorial notes and workings:

a) In the statement of surplus capital, the following steps have been applied:

 The capital per unit of profit is computed by dividing the capitals by profit shares. This is not
done for the totals column.
 The lowest capital per unit of profit is selected. In the first table it is Sh 5,200 (for partner Z).
 For each partner this is multiplied by the profit share to get the capitals in profit sharing ratio,
e.g.
 For X: 5,200 x 2 = 10,400
 For Y: 5,200 X 2 = 10,400
 For Z: 5,200 X 1 = 5,200

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FINANCIAL ACCOUNTING III
 50 Partnerships

 For Total: 5,200 X 5 = 26,000.

 This can now be deducted from the capitals above the boxes in order to ascertain surplus
capitals.

b) In the statement of actual distribution the following steps have been applied:

 Reference is made to the statement of surplus capital, starting from the BOTTOM, going
towards the TOP.
 For starters, Sh 27,000 should be paid to X. Show this in the columns for X and the Totals.
 The total cash available at the time was Sh 31,000; this leaves Sh 4,000 to be distributed.
 Reference is once again made to the statement of surplus capital, but to the table before the
last.
 This shows that CUMULATIVELY, X should receive Sh 30,300 and Y should receive Sh
3,300. Any cash is distributed in profit sharing ratio, so the Sh 4,000 is distributed at Ksh
2,000 each to X and Y. (Their profit sharing ratio is 2:2).
 From the second realization, (Sh 5,300) X and Y are each given Sh 1,300 so as to complete
their surplus capital repayments at:

X: 27,000 Y: -
: 2,000 : 2,000
: 1,300 : 1,300
30,300 30,300

 All the balance of cash from the second collection and future realizations are distributed in
full profit sharing ration to al partners.

End of tutorial notes and workings

Capitals
X (Sh) Y (Sh) Z (Sh) X (Sh) Y (Sh) Z (Sh)
Cash book 29,000 2,000 - Bal b/d 40,700 13,700 5,200
Cash book 2,380 2,380 540
Cash book 960 960 480
Cash book 1,520 1,20 760
Realisation loss 6,840 6,840 3,420
40,700 13,700 5,200 40,700 13,700 5,200

Illustration 11
We will now solve illustration 9 using the surplus capital method of ascertaining the interim
distributions to partners. You are once again advised to revisit the illustration and familiarize yourself
with the facts.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 51

Statement of Surplus Capitals

A (Sh) B (Sh) C (Sh) Total

(Sh)
Capitals 140,000 90,000 40,000 270,000
Profit sharing ratio 2 2 1 5
Capital per unit of profit 70,000 45,000 40,000 N/A
Capital in profit sharing ratio (80,000) (80,000) (40,000) (200,000)
Surplus Capital 60,000 10,000
- 70,000

Capitals 60,000 10,000 - 70,000

Profit sharing ratio 2 2 - 4
Capital per unit of profit 30,000 5,000 - N/A
Capital in profit sharing ratio (10,000) (10,000) - (20,000)
Surplus Capital 50,000 -
- 50,000

Statement of actual distribution

A (Sh) B (Sh) C (Sh) Total (Sh)
17th November: Part realisation 50,000 - - 50,000
Realisation Balance 1,200 1,200 - 2,400
51,200 1,200 - 52,400
19th December: Part realisation 8,800 8,800 - 17,600
Realisation Balance 12,960 12,960 6,480 32,400

21,760 21,760 6,480 50,000

72,960 22,960 6,480 50,000
23rd January: Realisation proceeds
27,200 27,200 13,600 68,000
18th March: Realisation proceeds 30,800 30,800 15,400 77,000
130,960 80,960 35,480 247,400

Capitals
A (Sh) B C (Sh) A (Sh) B (Sh) C (Sh)
(Sh)
Cash book 51,200 1,200 - Bal b/d 100,000 60,000 40,000
Cash book 2,760 21,760 6,480 Current accounts 40,000 30,000 -
Cash book 27,200 27,200 13,600
Cash book 30,800 30,800 15,400
Realisation loss 9,040 9,040 4,520
140,000 90,000 40,000 140,000 90,000 40,000

Note: The realisation loss has simply been copied in from the realisation account. This has not been
drawn up again; it would have been exactly as the one in illustration 9.
Example

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FINANCIAL ACCOUNTING III
 52 Partnerships

The trial balance extracted from the books of Newa, Omae, Pekka and Omar on 30 April 2000 was as
follows.

Sh. ‗000‘ Sh. ‗000‘

Freehold property (Net book value 6,000
Plant and Equipment (NBV) 1,395
Office equipment (NBV) 2,030
Vehicle (NBV) 1,075
Stock 3,405
Debtors 1,590
Creditors 785
Bank overdraft 210
Capital accounts Newa 6,750
Omae, 4,050
Pekka 2,700
Omar 250 2,700
Current accounts: Newa 1,350
Omae, 300
Pekka
Omar 17,395 17,395
The business has steadily declining in the past few years. The partners have been trying to sell the
business as a going concern but have been unable to do so. They decided to sell the assets on a piece
meal basis and cash would be distributed to partners as soon as possible in amounts which would
ensure that no partner would be called upon to repay any moneys he had received. In the partnership
agreement profits and losses were shared between Newa, Omae, Pekka and Omar in the ratio 4:3:2:1
respectively and the application of the rule in Garner Murray was excluded.

Transactions have taken place as follows.

15 May 2000 All the motor vehicles were sold at the Car Bazaar for Sh.975,000 net of selling
cost. The money was put into the bank account.

31 May 2000 Cash collected from debtors Sh.122,000 and stock sold to realize Sh.1,070,000
after cost. All creditors were paid and the cash distribution made.

30 June 2000 Cash collected from debtors Sh.248,000 and stock sold to realize Sh.955,000 net.
Second cash distribution was made.

31 July 2000 Cash collected from debtors Sh.1,100,000 from sale of stock (net) Sh.1,465,000.
Third cash distribution was made.

31 August 2000 Office equipment sold for Sh.1,950,000 (net) and plant and equipment sold for
Sh.1,610,000. Fourth cash distribution was made.
31 October 2000
The freehold property was sold for Sh.6,600,000 various distribution expenses of
Sh.200,000 were paid the final distribution of cash took place

Required:
(a) A partnership distribution schedule: (12 marks)
(b) Summary bank realization and partners‘ capital accounts. (8 marks)
(Total: 20 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 53

Solution

2. Actual cash distribution schedule

TOTAL N O P Q
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
31 May Cash available;
Motor vehicles 975
Debtors 122
Inventory 1,070
2,167
Less: Dissolution expenses (200)
Bank overdraft (210)
Creditors (785)
Cash available for 1st distribution 972
1st distribution (-: -: -: -1) (972) - - - 972
1st payment - - - - 972
30th June cash available:- Debtors 248
Stock 955
1,203
Balance of 1st distribution (-: :- :- 1) (303) - - - 303
2nd distribution (4: 0: 0: 1) 900 720 - - 180
2nd cash payment - 720 - - 483
31st July cash available Debtors 1,100
Stock 1,465
2,565
Balance of 2nd distribution (4: 0: 0:1) (1,225) 980 245
3rd distribution (4: 0: 2:1) 1,340 766 - 383 191
3rd cash payment - 1,746 - 383 436
31st August: Cash available; Equipment 1,950
Plant 1,610
3,560
Balance of 3rd distribution (4: 0: 2: 1) (760) 434 - 217 109
4th distribution (4:3:2:1) 2,800 1,120 840 560 280
4th cash payment - 1,554 840 777 389
31st October Cash available: Property 6,600
4th distribution (4: 3: 2: 1) 6,600 2,640 1,980 1,320 660
Final cash payment (5th) - 2,640 1,980 1,320 660

TOTAL CASH PAID 6,660 2,820 2,480 2,940

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FINANCIAL ACCOUNTING III
 54 Partnerships

Maximum possible loss method

TOTAL N O P Q
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Capital account 16,200 6,750 4,050 2,700 2,700
Current account (1,700) (250) (1,350) (300) 200
TOTAL 14,500 6,500 2,700 2,400 2,900
31st May: Cash available (972)
Max. possible loss (in PSR) 13,528 (5,411.2) (4,058.4) (2,705.6) (1,352.8)
1,088.8 (1,358.4) (305.6) 1,547.2
Revaluation of loss (PSR) (1,331.2) 1,358.4 305.6 (332.8)
(242.4) - - 1,214.4
Reallocation of loss (PSR) 242.4 - - (242.4)
1st cash per payment - - - 972
Bal b/d 13,528 6,500 2,700 2,400 1,928
20th June: Cash available (1,203)
Max. possible loss (PSR) 12,325 (4,930) (3,697.5) (2,465) (1,232.5)
1,570 997.5) (65) 695.5
Reallocation of loss (PSR) (850) 997.5) 65 (212.5)
2nd cash payment 720 - - 483
Bal b/d 12,325 5,780 2,70 2,400 1,445
31 July Cash available (2,565)
9,760 (3,904) (2,928) (1,952) (1,976)
1,876 (228) 448 469
Reallocation of loss (130) 228 (65) (33)
3rd Cash payment 1,746 - 383 436
Balance b/d 9,760 4,034 2,700 2,017 1,009
31st August: cash available (3,560)
6,200 (2,480) (1,860) (1,240) (620)
4th cash payment 1,554 840 777 389
Bal b/d 6,200 2,480 1,860 1,240 620
31st October: Cash available (6,600)
Max. possible profit (400) 160 120 80 40
2,640 1,980 1,320 660

Realization account
Freehold property 6,000 C B Motor vehicles 975
Plant and equipment 1,395 Equipment 1,950
Office equipment 2,030 Plant 1,610
Vehicles 1,075 Property 6,600
Stocks 3,405 Debtors 7,470
Debtors 1,590 Inventory 3,490
Bank dissolution exp. 200
Capital account
Gain on realization dissolution N 160
O 120
P 80
Q 40 _____
16,095 16,095

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 55

Bank account
Realization: Motor vehicles 975 Realization dissolution exp. 200
Equipment 1,950 Bank overdraft 210
Plant 1,610 Creditors 785
Property 6,600 Capital accounts N 6,660
Debtors 1,470 O 2,820
Inventory 3,490 P 2,480
_____ Q 2,940
16,095 16,095

Capital account
N O P Q N O P Q
Current a/c 250 1,350 300 - Bal b/d 6,750 4,050 2,700 2,700
Cash book 6,660 2,820 2,480 2,940 Realization gain 160 120 80 40
____ ____ ____ - Current a/c - - - 200
6,910 4,170 2,780 2,940 6,910 4,170 2,780 2,940

1.5 AMALGAMATIONS

Two sole traders and a partnership,two or more partnerships or a sole trader and other partnerships may
combine or join together to forma a single partnership.

The benefit of amalgamation includes:

i) An expansion of the capital base

ii) Wider pool of experts

In accounting, for amalgamation, the process involves closing off the books of the individual
partnerships or businesses and preparing the opening statement of financial position of the newly
combined business. The process of closing the books of individual businesses follows the same
procedure as that of dissolutions but instead of assets being sold, they are being taken over in the new
business.

Therefore a realization account is opened whereby the book values of the assets are debited and newly
agreed values are credited. The balance of the realization account represents a profit or loss on
amalgamation which is closed off to the capital accounts according to the old profit sharing ratio.

The capital required by each partner in the new business should be balance carried down (c/d) in the
partners capital accounts. The balancing figures it the capital accounts will be the cash that will be
either paid out or introduced by a partner.

The remaining cash in an individual business will now be transferred to the newly combined business.

Example
On the 1st January 19-8 the partners of Gee and Co and Bee & Co agreed to amalgamate their
business. The new firm is to be called Beegee & Co. The initial capital of £18,000 is to be shared as
to one half share to the individual partners of Bee & Co.

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FINANCIAL ACCOUNTING III
 56 Partnerships

The division of the one half share to the individual partners is to be in the ratio of their capital in the
former partnerships. Any adjustments in the old partnerships are to be made personally between the
partners. The statement of financial positions on 31st December 19-7 showed the following.

Gee & Co Bee &Co

£ £ £ £
Capital Accounts
Alan 4,000 Desmond 4,000
Brian 3,000 Ernest 2,000
Colin 2,000 ____
9,000 6,000
Current Accounts
Alan 800 Desmond 1,350
Brian 620 Ernest 1,250
Colin 180 ____
1,600 2,600
900 1,100
11,500 9,700
Non Current assets
Goodwill 1,500 1,750
Fixtures & Fittings 1,250 1,000
2,750 2,750
Current Assets
Receivables 7,000 6,000
Work in progress 900 750
Cash 850 200
8,750 6,950
11,5000 9,700

For the purposes of the amalgamation it was agreed as follows:

1. Goodwill in the new firm is to be £4,000.

2. Fixtures and fittings are to be taken over from Gee & Co at a value of £600 from Bee &
CO at a value of £500.
3. Receivables are to be taken over at the amounts shown in the old firms‘ statement of
financial positions on 31st December 19-7 less a discount of 5%. Work in progress is to
be valued at 10% of the net debtors taken over. Responsibility for the creditors of both
firms is to be assumed by the new firm.
4. The balance required for the initial capital is to be provided in cash.
5. All partners in the new firm are to receive a salary at the rate of £4,000 per annum,
interest on capital at 8% per annum, and share in the balance of profits/losses in
proportion to their capital in the firm. No interest is to be given on current accounts.
6. The only drawings by each partner against his share of the profits were monthly
payments of £300 and an additional payment equal to 5% of his capital at the end of each
quarter.

On 1st October 19-8 Desmond was killed in a motor accident. A repayment of capital
amounting to £1,000 was made immediately to his estate but no further payments were
made in 10-8. Interest on the outstanding capital account was agreed at 10% per annum
but this should be based on the initial capital less the amount paid. No adjustments were

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 57

made to the remaining partners‘ capital accounts and the profit sharing ratios between the
individual partners did not change.

Profits for the year ended 31st December 19-8 amounted to £37,472 before charging
interest on amounts due to Desmond.

You will be required to prepare:

a) The initial statement of financial position of Beegee &Co immediately after the
amalgamation, and
b) Partners‘ current accounts in columnar form for the year ended 31st December 19-8.

Solution
(a)
Even though the question does not require the books of the old firms to be closed this can be done
done by preparing the realization account, the capital accounts and the cashbook of the firms before
preparing the opening statement of financial position.

Realization a/c
Gee & Co Bee &Co Gee & Co Bee &Co
£. £. £. £.

Goodwill 1500 1750 To new firm

Fix.& fittings 1250 1000 Goodwill 2000 2000
Receivables 7000 6000 Fix & Fitti 600 500
Workin progress 900 750 Receivables 6650 5700
WIP 665 570
Loss to Cap
Alan - 4 327
Brian - 3 245
Colin - 2 163
Desmond - 4 487
_____ ____ Ernest -2 _____ 243
10650 9500 10650 9500

Capital Accounts (this will be presented in columnar form)

Alan Brian Colin Desmond Ernest

Credits £ £ £ £ £
Balance b/f 4000 3000 2000 4000 2000
Current accounts 800 620 180 1350 1250
Cash brought in by paertner (bal fig) 1137
Total for credits 4800 3620 2180 6487 3250

Debits
Loss on Realization 327 245 163 487 243
Cash paid out to the partner (bal fig) 473 375 17 7
Total for debits 800 620 180 487 250

Balance carried down to the new business 4000 3000 2000 6000 3000

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FINANCIAL ACCOUNTING III
 58 Partnerships

Cashbook
Gee & Co Bee &Co Gee & Co Bee &Co
£. £. £. £.

Balance b/f 850 200 Capital

Capital- Desmond 1137 Alan 473
Brian 375
Colin 17
Ernest 7
To new firm 15 To new firm 1330
10650 9500 10650 9500

Beegee & Co.

Statement of financial position as at 1 January 19-8
Non Current assets £ £
Fixtures and fittings (600+500) 1,100
Goodwill 4,000
5,100
Current assets
Receivables (7000+6000 less provision at 5%) 12350
Work in progress (at 10% of receivables) 1235
Cash (1330-15) 1,315
14,900
Current liabilties
Payables (2000) 12,900
18,000
Capital Accounts: Alan 4000
Brian 3000
Colin 2000
Desmond 6000
Ernest 3000
18,000

(b) To prepare the current account we will need to prepare the appropriation account to account for
the distribution of profits before and after Desmonsd Death.

The profits will be split based on months such that for the first nine months it is £28,104
(9/12X28,104) and for the last three months £9,368 (3/12X 37472). But please not that Desmond is
entitled to interst at 10%during the last three months based on the initial capital less the amount paid.
Therefore we will deduct this interest from the profits of the last three months. The amount deducted
is (10% X (6000- 1000))X 3/12) = 125. Therefore the profits for the last three months will be £ 9,368
– £128 =£ 9,243.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 59

Profit and loss appropriation account 1st nine months 2nd

3moths Total
£ £ £ £ £ £
Net profit 28,104 9243 37347
Less Interest on Capital
Alan 240 80 320
Brian 180 60 240
Colin 120 40 160
Desmond 360 360
Ernest 180 (1080) 60 (240) 240 (1320)
27024 9003 36,027
Salaries
Alan 3000 1000 4000
Brian 3000 1000 4000
Colin 3000 1000 4000
Desmond 3000 3000
Ernest 3000 (15,000) 1000 (4000) 4000 (19000)
12024 5003 17027
Share of profits
Alan 2672 1667 4339
Brian 2004 1251 3255
Colin 1336 834 2170
Desmond 4008 4008
Ernest 2004 (12024) 1251 (5003) 3255 (17027)

Current accounts (this will be presented in columnar form)

Alan Brian Colin Desmond Ernest

Credits £ £ £ £ £
Interest on Capital 320 240 160 360 240
Salaries 4000 4000 4000 3000 4000
Profits 4339 3255 2170 4008 3255
Total for credits 8659 7495 6330 7368 7495

Debits
Drawings: Normal (30 September) 2700 2700 2700 2700 2700
(9 X 300)
Extra ( 5% X Capital X 3 600 450 300 900 450
quarters)
Drawings : normal (31 December ) 900 900 900 900
(3 X 300)
Extra (5% X Capital X 200 150 100 150
1 Quarter)
To the Executors 3768
Total for debits 4400 4200 4000 4200
Balance carried down to the 4259 3295 2330 3295
statement of financial position (CR)

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FINANCIAL ACCOUNTING III
 60 Partnerships

1.6 CONVERSION INTO A COMPANY

The partners may convert their business and trade in form of a company. this may be due to some of
the advantages a company has over a partnership. E.g. Limited liability of members and the number
of members of a company can be more than twenty with an exception to professional firms.

The objective of accounting for conversions is to ensure that nay profit or loss on conversion is
reported and shared between the partners and the opening position of the company is ascertained.

The procedure therefore involves closing off the books of the partnership and preparing the opening
statement of financial position of the company. A realization account thus used to facilitate the process
and the balance on the realization account is the profit or loss on conversion which is closed off to the
partners capital accounts.

The book values of the assets being taken over by the company will be posted to the debit side and
the liabilities will be posted to the credit side. The purchase consideration paid by the company to the
partners will be posted on the credit side of the realization account. If the expenses of formation are
to be borne of the partners or the partnership, then this will be posted to the debit side of the
realization account.

NOTE: If the formation costs are to be bourne by the company then the profit or loss on realization
will be the same as the company then the new company (being the difference between purchase
consideration and the net assets acquired)

If the conversion takes place partway during the year, then it is important to update the partners
capital and current accounts before closing off the books of the partnership. This means that the
income statement for the year should be split between the two periods i.e. when the business was run
as a partnership and when the business was run as a company.

The income statement relating to the partnership period will include the profit and loss appropriation
account showing how profits have been shared between the partners.

The income statement for the company will also have the profit and loss appropriation but this time it
will only be for dividends and retained profits that will be taken to the statement of financial position.

The amounts due to the partners according to the balances in their capital accounts after making
adjustments for profit or loss on conversion will be satisfied by payments made from the company in
form of shares (ordinary or preference) and loan stock. The shares and loan stock will be shared
between partners according to the some agreed ratio and the balance may be by way of paying or
being paid cash.

However different approaches may also be use to close off the books of the partnership and
preparing the opening statement of financial position of the company.

Example
Kamau Maneno and Rotino have carried on partnership for several years, sharing profits and losses
equally after allowing for annual salaries as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 61

Sh.
Kamau 1,500,000
Maneno 900,000
Rotino 900,000

They decided to convert the partnership into limited company; Kamaro Ltd.as at 30 November 2001,
the following terms:
1. Goodwill to be valued at Sh.13,500,000
2. Other assets to be valued as follows:

Sh.
Freehold property 27,000,000
Furniture and fittings 2,400,000
Motor Vehicles 6,000,000

3. Each partner is becoming director of the company at the same salary as that previously allowed
in the partnership.
4 Maneno‘s loan is to be converted into share capital at par.
5. Shares are to be issued to each partner at parin respect of the amounts of their equity holdings
at 30 November 2001.
6. The financial year of partnership ends on 30 May .No action has been taken to carryout the
terms of conversionof partnership into the limited company in the books of accounts. On 31
May 2002, the trial balance showed the following position:

Sh ‗000‘ Sh ‗000‘
Capital accounts at 1 June 2001
Kamau 18,000
Maneno 9,000
Rotino 6,000
Stock -31 May 2002 14,400
Cost of sales 36,000
Sales 60,000

Administrative expenses 6,000

Selling expenses 3,000
Accounting &Audit expense 1,200
Incorporation expenses 600
Drawings:
Kamau 1,500
Maneno 900
Rotino 900
Freehold property at cost 25,800
Furniture and fittings at cost 6,000
Accumulated depreciation 3,600
Debtors and Creditors 9,000 7,200
Prepayments and Accruals 600 300
Loan from Maneno(10% interest per annum) 9,000
Motor Vehicles at cost 12,000
Accumulated depreciation 3,600
Bank balance ______ 1,200

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FINANCIAL ACCOUNTING III
 62 Partnerships

117,900 117,900

Additional information;
i. The sales during the second half of the year were 60% of the total sales though the gross profit
percentage remained the same throughout the year.
ii. The selling expenses were proportional to the sales for each period. All the expenses were incurred
evenly throughout the year.
iii. Salary drawings were made evenly. Drawing made after incorporation were to be treated as
director‘s salaries.
iv. There were no purchases or sales of fixed assets during the year .Depreciation is to be provided
on cost as follows;
Furniture and fittings 10% per annum
Motor vehicles 20% per annum
v. No dividends are paid or proposed but it is decided to write off the incorporation expenses and
also Sh.3,500,000 of the goodwill.

Required
(a) Income statement for Kamaro Ltd. for the six months ended 31 May 2002
(8 marks)
(b) Calculation showing the value of shares to be issued to each partner. (4 marks)
(c) Statement of financial position as at 31 May 2002. (8 marks)

Solution
KAMARO LTD.
Trading, Profit and Loss account

For the year ended 31 May 2002

1st month 2nd month
Sh. ‗000‘ Sh. ‗000 Sh. ‗000‘ Sh. ‗000‘
Sales 24,000 36,000
Cost of sales (14,400) (21,600)
Gross profit 9,600 14,400

Expenses
Depreciation on furniture 300 120
Depreciation on motor vehicles 1,200 600
Administrative expenses 3,000 3,000
Selling expenses 1,200 1,800
Audit expenses 600 600
Incorporation expenses - 600
Directors salaries – Kamau - 750
Maneno - 450
Rotino - 450
Loan interest 450 -
Goodwill written off (6,750) 3,500 (11,870)
Profit to be shared in PSR 2,850 2,530
Less: Salaries: Kamau 750
Maneno 450
Rotino 450 (1,650)
Profit share: 1,200
Kamau 400
Maneno 400

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 Lesson One 63

Rotino 400 (1,200)

-

Capital account
Kamau Maneno Rotino Kamau Maneno Rotino
Balance c/d Bal b/d
ordinary share 23,000 23,450 11,000 18,000 9,000 6,000
Goodwill 4,500 4,500 4,500
Ordinary share
capital 9,000
Current a/c 400 850 400
Revaluation gain 100 100 100
23,000 23,450 11,000 23,000 23,450 11,000

Current account
Kamau Maneno Rotino Kamau Maneno Rotino
Drawings 750 450 450 Salaries 750 450 450
Capital a/c 400 850 400 Profit share 40 400 400
Interest on capital ____ 450 ___
1,150 1,350 850 1,150 1,300 850

Revaluation account
Motor vehicle 1,200 Property 1,200
Capital gain Furniture 300
K 100
M 100
R 100 ____
1,500 1,500

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FINANCIAL ACCOUNTING III
 64 Partnerships

KAMARU
Statement of financial position as at 31 May 2002

Sh. ‗000 Sh. ‗000 Sh. ‗000

NON- CURRENT ASSETS COST DEPRECIATION NET BOOK
VALUE
Freehold property 27,000 - 27,000
Furniture and fittings 2,400 (120) 2,280
Motor vehicles 6,000 (600) 5,400
34,680
Goodwill 10,000
44,680

CURRENT ASSETS
Inventory 14,400
Receivables 9,000
Prepayments 600 24,000
68,680

Ordinary share capital 57,450

Retained earnings 2,530
59,980

CURRENT LIABILTIES
Bank overdraft 1,200
Payables 7,200
Accruals 300 8,700
68,680

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 65

REINFORCEMENT QUESTIONS
QUESTION ONE

Abincha, Bichage and Chomba are in a partnership and make up their accounts to 31 October each
year. Their partnership agreement states that interest should be allowed at 15% per annum on their
opening balance of their capital accounts each year, but no interest should be charged on drawings.
Abincha, Bichage and Chomba are credited with salaries of Sh.600,000, Sh.600,000 and Sh.800,000
respectively per annum. The remaining profit up to the amount of Sh.800,000 is to be shared in the
proportion of their capital balances as at the commencement of the year, and any further profit is to
be shared two-fifths to Abincha, tow-fifths to Bichage and one-fifth to Chomba. The partnership
does not maintain current accounts and drawing accounts are transferred to capital accounts at the
end of each year.

The balances on the capital accounts of Abincha, Bichage and Chomba were Sh.1,500,000,
Sh.1,200,000 and Sh.1,300,000 respectively on 1 November 1996. In the year ended 31 October 1997,
the partnership profit was Sh.4,025,000, drawings by Abincha, Bichage and Chomba were
Sh.1,075,000, Sh.870,000 and Sh.1,080,000.

In the year ended 31 October 1998, the partnership profit was Sh.3,950,000; drawings by Abincha,
Bichage and Chomba were Sh.1,222,000, Sh.856,000 and Sh.976,000 respectively.

Abincha decided to retire from the partnership on 31 October 1998, the fair value of the identifiable
net assets at this date were agreed to equal the book values. Goodwill was valued at Sh.3,000,000.
Bichage and Chomba each introduced Sh.1,800,000 into the business on that day and Abincha was
paid the balance on his capital account. Bichage and Chomba agreed to remain the partnership under
the terms of the original agreement as between themselves. Goodwill is not to be carried in the books
of the new partnership and is to be eliminated on 31 October 1998. In all years since the signing of
the original partnership agreement, the profits of the partnership after interest on capitals and
partners‘ salaries have exceeded Sh.800,000.

In the year ended 31 October 1999, the partnership profit was Sh.3,340,000; drawings by Bichage and
Chomba were Sh.945,000 and Sh.795,000.

On 1 November 1999, Bichage and Chomba decided to dissolve their partnership and sell the assets
on a piece meal basis: all their creditors had been paid by 31 October 1999. Any profit or loss on
disposal was to be shared in the same ratio they shared any excess over Sh.800,000 after interest and
salaries.

On 15 November 1999, they had collected Sh.3,200,000. They shared this between themselves on that
day in amounts such that they would not have to make any adjustments later. By 30 November 1999,
they had sold all the other assets for Sh.4,500,000 and they made a final distribution among
themselves.
Required:
Write up the partners‘ capital accounts from 1 November 1999 (20 marks)
QUESTION TWO
Kioko, Licha and Mengo had started a partnership on 1 April 1992 when they contributed capital of
Sh.9 million, Sh.3 million from Kioko, Sh.2 million from Licha and Sh.4 million from Mengo. No
salaries were to be paid to any of the partners, but interest would be credited at 20% per annum –
computed on these amounts – and any remaining profit was to be shared equally amongst the
partners.

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FINANCIAL ACCOUNTING III
 66 Partnerships

As at 31 March 2002, the statement of financial position of the partnership was as follows (shown
horizontally for conciseness):

Assets: Capital and Kioko Lich Mengo Total

Liabilities
Property, plant and equipment Capital Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Cost Depreciation NBV Fixed Capital
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Accounts 3,000 2,000 4,000 9,000
Freehold land 2,000 Nil 2,000 Current Accounts 3,190 2,000 1,500 6,600
Buildings 3,000 900 2,100
Plant and machinery 12,000 3,000 9,000 Current Liabilities
Motor vehicles 4,000 3,000 1,000 Trade payables 7,360
21,000 6,900 14,100
Current assets:
Inventory 4,400
Trade receivables 3,400
Cash at bank 1,150 8,950 ____
23,050 23,050

The business was run by the partners to 31 March 2003. They decided to convert the partnership into
a limited company with effect from 1 April 2003. This was to be achieved as follows:

1. Property, plant and equipment had been depreciated on opening cost (no assets had
been bought or sold in the year to 31 March 2003) by 3% on buildings, 12½% on plant
and machinery and 12½% on motor vehicles. The company would take over the land,
buildings, plant and machinery at Sh.5 million, Sh.4 million and Sh.10 million
respectively. The partnership owned three motor cars which had all be bought at the
same time: the one Kioko uses cost Sh.1.6 million; the one Licha uses cost Sh.1.4
million; the one Mengo uses cost Sh.1 million; all the cars have a useful life of eight
years and a residual value of nil. Each partner was to take over the motor car he uses –
Kioko‘s for Sh.400,000, Licha‘s for Sh.260,000 and Mengo‘s at Sh.205,000.

2 Inventory valued at cost for Sh.5.2 million was to be transferred to the company for
Sh.5.7 million. One trade receivable for Sh.1.2 million was to be collected personally
by Kioko; the partners estimated that only Sh.840,000 would be collected from this
debtor. Sh.2.9 million, the balance of trade receivables, would be transferred to the
company at book value. Trade payables in the partnership at 31 March 2003 stood at
Sh.5.1 million. If payment could be made by 30 April 2003, this liability could be
settled for Sh.4.5 million. It was agreed by the three partners that they would introduce
Sh.3.22 million immediately to raise the cash in the business to an amount just
sufficient to clear this liability immediately so that trade payables could be transferred at
Sh.4.5 million. The actual payment to creditors was made by the company a few days
later. Kioko paid Sh.1,225,000 into the partnership bank account; Licha paid in
Sh.355,000 and Mengo paid in Sh.1,640,000.

3. The new company, Kiligo Limited, had an authorized share capital of 2 million shares
of Sh.10 each. These shares would be issued to the partners at a premium of 50% in
satisfaction of the purchase consideration.

4. Kioko had made drawings of Sh.1,440,000 in the year, Licha Sh.960,000; Mengo
Sh.1,200,000.
Required:
(a) Prepare the realization account of the partnership as at 31 March 2003 (8 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 67

(b) Prepare the partners‘ capital accounts for the year ended 31 March 2003 (current accounts should
be closed off to the capital accounts as early as possible) (8 marks)

(c) Prepare the opening Statement of financial position of Kiligo Limited. (4 marks)
(Total: 20 marks)
QUESTION THREE
Emojong, Barmoi and Kimani have been partners sharing profits and losses in the ratios 2:2:1.
Accounts have been prepared on an annual basis to 31 December of each year Emojong the only
active partner, died on 31 May 2002 and the remaining partners decided to cease business from that
date. The assets are to be realized, outstanding debts paid and the remainder to be shared by the
partners (including the executors of Emojong‘s estate) in an equitable manner, distributions of cash
being made as soon as possible.

Statement of financial positionprepared as at 31 May 2002 revealed the following position:

Emojong, Barmoi and Kimani

Statement of financial position as at 31
May 2002
Accumulated Net Book
Cost Depreciation Value
Sh.‗000‘ Sh.‗000‘ Sh.‗000‘
Non Current assets
Goodwill - 12,500
Freehold land and buildings 12,500 - 18,750
Plant and machinery 18,750 6,975 9,650
Fixtures and fittings 16,625 1,625 2,125
Motor vehicles 3,750 3,000 1,000
4,000 11,600 44,025
Current assets: 55,625
Stock 8,000
Debtors
Less: provision for doubtful debts 8,125 7,375
Cash 750 20
15,395
Current liabilities:
Creditors
Bank overdraft 23,170 (7,775)
7,125 36,250
Financed by: 16,045
Capital income:
Emojong 12,500
Barmoi 7,500
Kimani 5,000
25,000
Current accounts:
Emojong 5,000
Barmoi 3,750 8,750
33,750

2,500

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FINANCIAL ACCOUNTING III
 68 Partnerships

Long term liabilities: 36,250

Loan – Emojong
Additional information:
1. Premiums have been paid on life assurance policies for each partner to provide the firm with cash
on death. The premiums have been charged to insurance expense and the cash payable on death
of any partner is Sh.5,000,000.

2. The assets were duly sold and the monies received as follows:
Sh.
‗000‘
14 June 2002 Life policy on Emojong‘s life 5,000
Life policy on the lives of Barmoi and Kimani
surrendered 2,500
16 July 2002 Freehold land and buildings 25,000
Debtors (part) 3,750
Stock (part) 2,500
20 August 2002 Plant and machinery 6,375
Fixtures and fittings 1,500
Motor vehicles 625
15 October 2002 Stock (Remainders) 4,500
Debtors (Remainders) 5,250

3. Provision was to be made for dissolution expenses of Sh.300,000.

4. As soon as sufficient money was available to pay all outstanding creditors, this was done,
discounts being received amounting to Sh.125,000.

5. Dissolution expenses amounted to Sh.250,000 and this was paid on 31 October 2002.

Required:
(a) Statement showing how the proceeds of the dissolution would be shared between the partners(12
marks)
(b) Realisation account (5 marks)
(c) Capital accounts 3 marks)
(Total: 20 marks)
QUESTION FOUR
Three firms of accounts decided to amalgamate into a new firm Cheloti Gusera Kandie & Co. with
effect from 1 April 1999. Until 31 March 1999 Apopo. Cheloti and Chuma were partners in Apopo
Cheloti & Co. sharing capital and profits equally. Guserwa. Kurgat and Ochieng were partners in
Guserwa & Co. sharing capital and profits in the ratio 4:4:1. Kandie was a sole practitioner.

The statement of financial positions of the firms as at 31 March 1999 were as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson One 69

Apopo Cheloti & Co. Guserwa & Co. Kandie

Sh. ‗000‘ Sh. ‗000‘ Sh.‗000‘ Sh. ‗000‘ Sh. ‗000‘

Fixed assets: Office equipment 450 420 150
Intangible assets: Goodwill 1,500 1,065 240
1,950 1,485 390
Current assets: Work-in- progress 1,800 1,050 240
Debtors 5,250 2,625 225
Cash 750 300 165
7,800 3,975 630
9,750 5,460 1,020

Capital accounts
Current accounts: Apopo 270 8,550 4,050 900
Cheloti 360
Chuma 120 Guserwa 600
Creditors 750 Kurgat 390 1,050
450 Ochieng 60 360 120
9,750 5,460 1,020
The terms of amalgamation were as follows:
1. Apopo retired on 31 March 1999.
2. The capital of the new firm Cheloti Guserwa Kandie & Co. was to be Sh.15 million and profit sharing ratios
and capital contributions were to be Cheloti 30%, Chuma 30%, Guserwa 15%, Kurgat 15%, Ochieng 5%
and Kandie 5%.
3. In the opening statement of financial position of the new firm, office equipment was to be bought at the
old book values except for that from Apopo Cheloti and Co. where the value was agreed at Sh.300,000.
Work-in-progress was agreed at book value and goodwill for three firms at Sh.3 million. Debtors were
taken in at book values less 20% discount. Creditors were paid by the old practices. Apopo and Kandie
took any cash remaining in their old practices and Guserwa contributed the necessary cash in his old
practice. The total goodwill acquired from old partnerships was in the ratio in which they share profits in
the new.
4. Partners introduced their balances of capital in cash
5. A salary of Sh.600,000 per annum per partner was given the new partnership. Drawings of Sh.45,000 per
month per partner were allowed: at the end of each half year, partners were allowed to draw Sh.30,000 for
each 2½ % share of the partnership profit attributable to that partner.
6. On 1 October 1999, it was agreed to take Maina into the partnership on similar terms as to salary and
drawings, with a 2½ % share. The capital and profit sharing ratios were altered to Cheloti 22½ %, Chuma
22½ %, Guserwa 20%, Kurgat 20%, Ochieng 5% and Kandie 7 ½%. Kandie and Maina could only bring in
two thirds of what was required. It was agreed that the remaining one third should remain in a debit in their
current accounts to be cleared against future profits. Cheloti and Chuma withdrew equally the cash capital
introduced on 1 October 1999 by Guserwa, Kurgat, Kandie and Maina.
7. The profit of the partnership for the year ended 31 March 2000, after deducting partners‘ salaries was
Sh.4,800,000: this profit was deemed to have accrued evenly over the year as opposed to total profit. The
partners made all allowable drawings in full.

Required:
(a) The opening journal entries of Cheloti Guserwa Kandie and Co. (7 marks)

(b) The capital and current accounts of each partner (in columnar form)
i. In the old practices, so as to indicate the resultant indebtedness between the partners: (8 marks)
ii. In the new practice, so as to indicate the balances on 1 April 1999 and 31 March 2000.(10 marks)
(Total: 25 marks)

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FINANCIAL ACCOUNTING III
 Lesson Two 70

LESSON TWO

PREPARATION OF PUBLISHED FINANCIAL

STATEMENTS
CONTENTS
 International Financial Reporting standards relevant to preparation and presentation of financial
statements of limited companies
 Formats of financial statements

OBJECTIVES
 Know the preparation of financial statements in accordance with the provisions of the
Companies Act, and Legislation relating to other accounting entities
 Source, authority and use of accounting standards

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 71

PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS OF LIMITED

COMPANIES
This is a chapter dealing with company financial statements, a topic frequently examined.
Do not be put off by the large volume of detail in the chapter. You will gradually acquire the required
knowledge through persistent repetitions of the build up illustrations provided throughout the chapter
and frequent attempts at the practice questions provided at the end of the chapter.

The preparation of published financial statements involves preparing and preventing financial
statements to external users especially shareholders in a form prescribed by the law (Companies Act)
and the International Reporting Standards (IFRSs).

The Companies Act gives the guidelines on preparation of the financial statements, then registration
with the registrar of companies, auditing and certain disclosures such as directors salaries.

The requirements of the Companies Act as pertaining to accounts can be found in

SI47: Keeping proper books of account;

SI48: Laying final accounts before the members at the AGM;
SI49: Compliance with financial statements presenting a true and fair view:
S150 – SI54: Presentation of group accounts to members at the AGM and related matters
S155: Signing the statement of financial position
S156 – 157: Constitution of documents to be presented at AGM.
S158: Sending statement of financial positions and annexed documents to members and
debenture holders
before the AGM
S197: Directors emoluments disclosure requirements
S198: Disclosure requirements for loans to directors

Sixth schedule to the Companies Act: Accounts

IFRSs Gives the guideline on the content and the accounting statements of certain events and
transactions in the financial statements. The following IFRSs are relevant for the purpose of
preparing published financial statements;

IAS 1: - Presentation of Financial Statements

IAS 7: - Cashflow statements
IAS 8: - Accounting policies, changes in accounting estimates and errors
IAS 10: - Events after the statement of financial position date (not examined)
IAS 12: - Income Tax
IFRS 5 - Non-current assets held for sale and discontinued operations. (Not examined)

IAS 1: Presentations of Financial Statements

The objective is to give guidance regarding the preparation of published financial statements and
prescribe the content of the published financial statement.
The following information should be prominently displayed and repeated when it is necessary for a
proper understanding of the information presented:
(a) The name of the reporting enterprise and other means of identification.
(b) Whether the financial statements cover an individual enterprise or a group of enterprises.

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FINANCIAL ACCOUNTING III
 72 Lesson Two

(c) The statement of financial position date or the period covered by the financial statements
whichever is appropriate to that component of the financial statements.
(d) The reporting currency.
(e) The level of precision used in the presentation of figures in the financial statements (e.g. Shs. ‗000‘
or millions of Shs.)

IAS 1 requires companies to observe the following rules in preparing published financial statements:
1. The financial statements should reflect a true and fair view of the company ‗s financial position
and performance. Where transactions are reported faithfully and the financial statements comply
in all aspects with IFRSs then the true and fair view objective is achieved.
2. The company should apply its accounting policies consistently form one financial period to the
next and incase there is a change in the accounting policy then, adequate disclosure should be
made.
3. The Financial statement should be prepared on a going concern basis incase the going concern
basis isn‘t suitable; adequate disclosure should be made.
4. The financial statements should be made on an annual basis (should related to a period of 12
months) and incase the period covered is more or less than 12months then, this fact should be
disclosed.
5. The financial statement should be presented on a comparable basis i.e. the current years‘ and
previous years‘ financial results unless it is the first year of trading.
6. [financial statements should disclose the date when they were approved for issue by the directors.

IAS 1 prescribes the contents of published financial statements. The major reports that are
included as part of the published financial statements is:-

i) The income statement.

ii) The statement of financial position.
iii) The statement of changes in equity.
iv) The Cashflow statement.
v) The notes to the accounts/financial statements.

The most cases, companies that prepare published financial statements include the following additional
reports (that are not financial statements).

i) Corporate information (Company‘s address, lawyers. Location, bankers and others).

ii) Chairman‘s report (principle business activities of the firm, directors to be elected or retiring,
summary results for the year and dividends).
iii) Auditors report.
iv) Corporate governance (I.T systems, internal audit, audit committees and other systems in place to
ensure good management).
v) Statistical information (major highlights of the company‘s performance, over a period of time e.g.
5 years).

THE INCOME STATEMENT

It shows the financial performance of the company during the given financial period. It discloses
the income and expenses and thus the net profit for the period.

IAS 1 recommends that the income statement can be presented in 2 ways or formats

a) By classifying by function

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 73

Under this format, the expenses of the company are classified into 5 major categories i.e.

i) Cost of sales [(opening stock + purchases – closing stock) and deprecation]

ii) Distribution costs (transport costs, selling expenses, commission, provision for bad debts etc)
iii) Administration expenses (salaries and wages, telephone, rates, postage, rent etc, goodwill
amortization)
iv) Other expenses (all other not falling under the above) groups of expenses)
v) Finance cost (interest on loan and bank overdraft, interest on finance lease, dividends on
redeemable preference shares)

b) Classifying expenses by nature

Under this format, expenses are not classified by their nature i.e. referred to specifically according
to their type and the major categories of expenses are:-

i) Changes in finished goods and work in progress

ii) Raw materials consumed
iii) Depreciation and amortization
iv) Employee benefits (staff costs)
v) Other expenses
vi) Finance costs

NOTE: Classification of expenses by function is the most common format used and classification of
expenses by nature is more appropriate for manufacturing firms.

There are certain types of incomes and expenses that do not face within the trading activities of the
business but are within the ordinary activities of the firm. E.g. disposal of property, plant and equipment
and other non-current assets.

The standard requires that if the above incomes and expenses are material, they can either be classified
as part of the other expenses or shown separtely on the face of the income statement.

The company should give additional information about such items in the notes to the accounts.

Examples:
a) Profit/Loss on disposal of non-current assets
b) Material write down or reversal of write down on assets e.g. PPE inventory and debtors.
c) Restructuring and re-organization cost e.g. redundancy payments
d) Litigation costs – payments made as a result of court decisions

The format of the income statement is given as follows:

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FINANCIAL ACCOUNTING III
 74 Lesson Two

a) By function

ABC LTD
INCOME STATEMENT FOR THE YEAR ENDED 31/12/
£ £
Revenue x
Cost of sales (x)
Gross profit x
Other incomes (e.g. investment income) x
x
Expenses
Distribution costs x
Administration costs x
Other expenses x
Finance costs x (x)
Profit before x
Income tax expense (x)
Profit for the period xx

b) By Nature

ABC LTD
INCOME STATEMENT FOR THE YEAR ENDED 31/12/
£ £
Revenue x
Other incomes x
x
Expenses
Raw materials consumed x
Changes in finished goods and work in progress x
Depreciation and armortisation x
Employee benefits x
Other expenses x
Finance costs x (x)
Profit before tax x
Income tax expenses (x)
Profit for the period xx

THE STATEMENT OF FINANCIAL POSITION

It shows the financial position of the company as at the end of a given financial period. The
standard requires that assets and liabilities should be classified between current and non-current
portions.

Currently, the standard requires the first part of the statement of financial position to show the
total assets (i.e. non-current assets + current assets) and the second part of the statement of
financial position to show equity and liabilities. Equity is the shareholders funds while liabilities
are the total of non-current and current liabilities.

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 Preparation of published Financial Statements 75

The format of the statement of financial position is given as follows:

ABC LTD
STATEMENT OF FINANCIAL POSITION AS AT 31/12/
£ £
NON-CURRENT ASSETS
Property, plant and equipment x
Goodwill x
Other intangible assets x
Investment Longterm x
x

CURRENT ASSETS
Inventory x
Accounts receivables and prepayments x
Short-term investment x
Cash at bank and in hand x x
TOTAL ASSETS xx

EQUITY AND LIABILTIES

Preference share capital x
Ordinary share capital x
x

RESERVES
Share premium x
Revaluation reserve x
General reserve x x
Retained profits x
Shareholders funds x

NON-CURENT LIABILITIES
Loan stock/debentures x
Redeemable preference shares x
Deferred tax x
Other long-term provisions x x

CURRENT LIABILITIES
Bank overdraft x
Trade and other payables (accruals) x
Current tax (tax payable) x
Current portion of loan stock x
Prepared dividends (and shares or preference shares) x x
TOTAL EQUITY AND LIABILITY xx

NOTE:

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FINANCIAL ACCOUNTING III
 76 Lesson Two

Most of the statement of financial position items are shown in totals and the breakdown of the figures is
given by way of notes to the accounts. E.g. property, plant and equipment which is made up of land,
buildings, plant and machinery and motor vehicles is given in the statement of financial positions at the
total net book values of all there assets and part of the notes to the accounts will explain the make-up of
the assets and movements during the year.

No workings should be given/shown in the statement of financial position for most of the items and
only the total or the net figures should be presented e.g. accounts receivables should be net of
provision for doubtful debts.

IAS 32 requires that redeemable preference shares should be treated as a non-current liability just like
any other loan. Therefore, the preference dividends are shown as part of finance costs in the income
statement, and other accrued interest and shown as part of current liabilities.

If the company proposes dividends on ordinary and preference share capital before the year end then,
this will be provided for in the statements of changes in equity and shown as part of current liabilities
in the statement of financial position. However, even the proposed dividends on disclosed after the
financial year end, then they will be mentioned only by the way of notes to he accounts and not
provided for in the financial statement.

THE STATEMENT OF CHANGES IN EQUITY

This is a very important report because it explains the movements in the shareholder funds during the
year and also acts as a link between the income statement and the statement of financial position.

The report also shows the total gains or losses made by the company during the year. Some of these
gains or losses may not be included in the income statement e.g. gains or losses on revaluation or PPE
and investments (long -term)

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 77

The format of the statement of changes in equity is given as follows:

Preferen Ordinar Share Revaluati Gener Retaine TOTA

ce share y share premiu on al d L
capital capital m reserve reserv profits
e
£ £ £ £ £ £ £
i) Balance at 1.1 x x x x x x x
ii) Changes in a/c
policy/correction of - - - - - (x) (x)
error
iii) Balance as restated (i x x x x x x x
+ii)
iv) Gain/losses on
revaluation PPE - - - x - - x
v) Transfer to retained
profits on sale of - - - (x) - x -
PPE
vi) Gain losses on
investment - - - x - - x
revaluation
vii) Foreign currency
exchange gain/losses - - - x - - x
viii) Net gains/losses
directly reported in
equity (iv + v +vi + - - - x - x x
vii)
ix) Profit for the period - - - - - x x
x) Total gains/losses
recognized during the
year (viii + ix) - - - x - x x
xi) Issue of shares x x x - - - x
xii) Transfer to general
reserve - - - - x (x) -
xiii) Dividends: interim - - - - - (x) (x)
paid
xiv) Final proposed (If
prop before year - - - - - (x) (x)
end)
xv) Balance as at 31.12 (
x + xi + xii + xiii) x x x x x x x

The final value of the total should be the same as the shareholder funds in the statement of financial
position.

D. THE NOTES TO THE ACCOUNTS

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FINANCIAL ACCOUNTING III
 78 Lesson Two

The notes to the accounts provide additional information on the a/c policies that the company has
adopted the make-up of some of the items appearing on the face of the financial accounts and
additional information on items not provided for in the accounts.

IAS 1 does not give the standard format of the notes to the accounts and that this would vary from
one company to another. However, the standard requires the following approach to be used when
presenting the notes to the accounts.

1. The company should state the basis of financial statement (most cases historical basis of
accounting)
2. The company should present the significant policies adopted
3. The make-up of some of the items appearing on the face of the final accounts e.g. PPE and
inventory.
4. Explanation of items not provided for in the final accounts (e.g. Dividends)

An example of the notes to the accounts examined within the scope.

NOTE 1: Accounting Policies.

These financial statements have been prepared under the historical cost basis of accounting which is
modified to accommodate the revaluation of certain property, plant and equipment.

Property, plant and equipment are stated in the accounts of cost or revalued amount less accumulated
depreciation. Depreciation is based on the estimated useful life of the asset and is provided at the
following rates:

Assets Rate
Land No depreciation
Buildings 2 % on cost
Plant and machinery 20% on cost
Fixtures, furniture and fittings 25% on cost
Motors vehicles 30% on reducing balance

Inventory is stated at the lower of cost and net realizable value. Cost represents the purchase price or
production cost and other expenses incurred to get the inventory ready for sale. Net realizable value
is the selling price of the inventory less other expenses that will be incurred to get he inventory ready
for sale.

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 79

NOTE 2: Profit for the period

The profit for the period has been arrived at after charging the following expenses:

£ £
Depreciation x
Amortization (impairment of good will ) x
Directors emoluments:
Salaries x
Fees x
Re-imbursment of expenses x
Pension x
Compensation for loss of office x x
Other employee benefits
Salaries and wages x
Pension costs x
NHIF x x
Auditors remuneration x
Loss on disposal of PPE x
Restructuring /Re-organization costs x

NOTE 3: Property, plant and equipment

Land Building Plant & Fixture, Motor TOTAL

Machinery furniture vehicle
& fittings
£ £ £ £ £ £
Balance as at 1.1 x x x x x x
Additions (purchase) x x x x x x
Revaluation gain x x - - - -
Disposal (x) (x) (x) (x) (x) (x)
Balance as at 31.12 x x x x x x

Depreciation
Balance as at 1.1 - x x x x x
Change in the year - x x x x x
Eliminated in disposal - (x) (x) (x) (x) (x)
Eliminated in revaluation - (x) (x) (x) (x) (x)
- x x x x x

Net book value

As at 31.12 x x x x x x
As at 1.1 x x x x x x

NOTE 4: Inventory

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FINANCIAL ACCOUNTING III
 80 Lesson Two

Inventory is made up as follows:

£
Raw materials x
Work in progress x
Finished goods x
xx

NOTE 5: Dividends

During the year, the company paid a dividend of Sh.2 per share on the ordinary share s outstanding
and Sh.1 on the preference shares outstanding. The company is now proposing a final dividend of
Sh.3 per share on ordinary shares and sh.1 on preference shares.

NOTE 6: Capital Commitments

The company has contracted X constructors to construct a warehouse a total cost of £200,000.
Construction is to begin on 1st June.

Example 1
The accountant of Wislon Co has prepared the following list of account balances as at 31 December
2005

£ ‗ 000‘
50p ordinary shares (fully paid) 350
7% £1 preference shares (fully paid) 100
10% Loan stock 200
Retained earnings 1.1.2005 242
General reserve 1.1.2005 171
Land and buildings 1.1.2005(cost) 430
Plant and machinery 1.1.2005 (cost) 830
Aggregate depreciation
Buildings 1.1.2005 20
Plant and machinery 1.1.2005 222
Inventory 1.1.2005 190
Sales 2,695
Purchases 2,152
Preference dividend 7
Ordinary dividend (interim) 8
Interest on Loan stock 10
Wages and salaries 254
Light and heat 31
Sundry expenses 113
Suspense account 135
Trade accounts receivable 179
Trade accounts payable 195
Cash 126

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 Preparation of published Financial Statements 81

Additional information

a) Sundry expenses include £9,000 paid in respect of insurance for the year ending 1
September 2005. Light and heat does not include an invoice of £3,000 for electricity for
the three months ending 2 January 2006, which was paid in February 2006. Light and
heat also includes £20,000 relating to salesmen‘s commission.

b) The suspense account is in respect of the following items.

£ ‗ 000‘
Proceeds from the issue of 100,000 ordinary shares 120
Proceeds from the sale of plant 300
420
Less consideration for the acquisition of Mary & Co 285
135

c) The net assets of Mary & Co were purchased on 3 March 2005. Assets were valued as
follows:

£ ‗ 000‘
Investments 231
Inventory 34
265

The entire inventory acquired was sold during 2005. The investments were still held by Wislon at
31.12.05. Any goodwill arising from the acquisition is considered to be impaired at the rate of
20%.

d) The property was acquired some years ago. The buildings element of the cost was
estimated at £100,000 and the estimated useful life of the assets was fifty years at the time
of purchase. As at 31 December 2005 the property is to be revalued at £800,000.

e) The plant which was sold had cost £350,000 and had a net book value of £274,000 as on
the date of disposal. £36,000 depreciation is to be charged on plant and machinery for
2005.

f) The 50p ordinary shares all rank for dividends at the end of the year.

g) The management wish to provide for:

i) A final ordinary dividend of 2p per share.

ii) A transfer to general reserve of £16,000.
iii) Audit fees of £4,000
The proposed dividends were declared before the year end

h) Inventory as at 31 December 2005 was valued at £220,000 (Cost).

i) Taxation is to be provided at £30,000. Assume a corporation tax rate of 30%

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FINANCIAL ACCOUNTING III
 82 Lesson Two

Required
Prepare the published financial statement of Wislon Co as at 31 December 2005.
Solution
Wislon Co
Income statement for the year ended 31 December 2005.
£ ‗000‘ £ ‗000‘
Revenue 2,695
Cost of sales (2,194)
Gross profit 501
Other income
Gain on disposal of plant 26
527

Expenses
Distribution expenses 20
Administration expenses 276
Other expenses 107
Finance costs 20 (423)
Profit before tax 104
Less income tax expense (30)
Profit for the period 74

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Lesson Two 83

Wilson and Company

Statement of changes in equity for the year ended 31/12/2005

Pref. Share Ord. Share Share Reduction General Retained

Capital Capital Premium Reserve Reserve Profits TOTAL
£ £ £ £ £ £ £ ‗000‘
Balance as at 1.1.05 100 350 - - 171 242 863
Correction of error - - - - - - -
Balance of restated 100 350 - - 171 242 863
Gain on revaluation of
PPE - - - 392 - - 392
Transfer to retained profits -
on sales of PPE
Gain on revaluation of -
investment
Foreign exchange
losses/gains ______ _______ _______ ______ ______ ______ -
Net gains directly reported
in equity - - - 392 - - 392
Profit for the period - - - - - 74 74
Total gains for the year - - - 392 - 74 466
Issue of shares - 50 70 - - - 120
Transfer to general reserve - - - (16) (16) -
Dividends Interim paid
- Ordinary. (8) (8)
- Preference (7) (7)
Final proposed - -
Balance as at 31.12.05 100 400 70 392 187 285 1,434

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Two 84

Wilson Company
Statement of financial position as at 31/12/2005
£ ‗000‘ £ ‗000‘

NON-CURRENT ASSETS
Property, plant and equipment 1,098
Goodwill 16
Investment 231
1,345

CURRENT ASSETS
Inventory 220
Trade receivable 179
Prepayments 6
Cash 126 531
TOTAL ASSETS 1,876

EQUITY AND LIABILITIES

Preference share capital 100
Ordinary share capital 400
500

RESERVES
Share premium 70
Revaluation reserve 392
General reserve 187 649
Retained profits 285
Shareholders funds 1,434

NON-CURRENT ASSETS
10% stock 200

NON-CURRENT LIABILITIES
Trade payables 195
Accrued expense 17
Current tax 30 242
TOTAL EQUITY AND LIABILITY 1,876

Notes to the Accounts

a) NOTE 1: Accounting Policies

These financial statements have been prepared under the historical cost basis of accounting which
is modified to accommodate the revaluation of certain property. The financial statements comply
with the applicable IFRSs.

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 85

b) Property, plant and equipment is stated in the accounts at cost or revalued amount less
accumulated depreciation. Depreciation is based on the estimated useful life of the assets.

c) Inventory is stated at the lower of cost an net realizable value Cost includes the purchase price or
production cost and other expenses incurred to get the inventory ready for sale. Net realizable
value is the selling price less expenses increased to complete the sale.

NOTE 2: Profit for the period (Profit before tax)

The profit for the profit has been arrived at changing the following expenses:

£ ‗000‘
Depreciation 38
Impairment of goodwill 4
Employee benefits:
Salaries and wages 254
Salesman commission 20 274
Auditors remuneration 4

Profit has been arrived after creating gain on proposal on disposal.

NOTE 3: Property, Plant and Equipment

Cost/Valuation Land & Building Plant & Machinery TOTAL

£ ‗000‘ £ ‗000‘ £ ‗000‘
Balance as at 1.1.2004 1,260
Additions (purchases) 430 830 -
Revaluation gain - - 370
Disposal 370 - (350)
Balance as at 31.12.2004 800 (350) 1,280

Depreciation
Balance as at 1.1.2004 20 222 242
Charge in the year 2 36 38
Eliminated in disposal - (76) (76)
Eliminated in revaluation (22) - (22)
Balance as at 31.12.2004 - 182 182

Net book value

As at 31.12.2004 800 298 1,098
As at 1.1.2004 410 608 1,018

NOTE 4: Dividends

During the year, the company paid an interim dividend of £1.14 per shares on the ordinary shares
outstanding and up ton the preference shares. The directors are now proposing a final dividend of
2% per share on the ordinary shares outstanding at the end of the year.

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FINANCIAL ACCOUNTING III
 86 Lesson Two

WORKINGS
£ ‗000‘ £ ‗000‘
1. Cost of sales
Opening inventory 190
Purchases 2,152
Investment in Mary & co. 34 2,186
2,376
Less: closing inventory (220)
2,156
Add: Depreciation on building (100,000 /50) 2
Plant 36 38
2,194

2. Other income
Gain on disposable of plant

Disposal account
Plant 350 Depreciation 76
Profit and loss 26 Suspense 300
376 376

3. Expenses:

Distribution Administration Finance

Other
Interest on loan stock 20
Wages and salaries 254
Light and heat 20 14
Sundry expenses 107
Goodwill impaired 4
Audit fees 4
TOTAL 20 276 107 20

4. Goodwill impairment

Disposal account
Suspense 285 Interest (statement of 231
financial position)
Purchases (stock) 34
___ Goodwill 20
285 285

5. PPE
£ ‗000‘
Land and buildings 800
Plant and machinery 298
1,098

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 87

Land and building account

Balance b/d 430
Revenue reserve 370 Bal c/d 800
800 800

Revaluation account
Land and building 370
Balance c/d 392 Land and building depr. 22
392 392

Plant and machinery account

Balance b/d 630 Disposal 350
Balance c/d 480
830 830
Land and building depreciation account
Revenue reserve 22 Balance b/d 20
Profit & Loss – 4 yr 2
22 22

Plant & Machinery depreciation account

Disposal depreciation 76 Balance b/d 222
Balance c/d 182 Profit and Loss – 4 yr 36
258 258

Accrued expenses

£ ‗000‘
Interest on loan stock (20 – 10) 10
Light and heat 3
Audit fees 4
17
Example 2

Auto Transmissions manufactures electrical equipments. The following trial balance as at 31 March
2005 has been extracted from the books of the company:

£ £
Ordinary shares of 50 p each 400,000
10% Redeemable Preference shares of £1 each 200,000
Retained profits as at 1 April 2004 42,475
Office block (Land £40,000) 170,000
Plant and machinery 730,000

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FINANCIAL ACCOUNTING III
 88 Lesson Two

Office equipment 110,000

Motor vehicles 200,000
Provision for depreciation – Plant and Machinery 224,500
- Office equipment 24,500
- Motor vehicles 80,000
Accounts receivables/Payables 500,000 356,226
Provision for doubtful debts 1,000
Manufacturing wages 501,400
Inventory as at 1 April 2004 – raw materials 70,000
- Work in progress 126,000
- Finished goods 250,000
Transport expenses 85,013
Returns inwards 15,106
Purchases of raw materials 518,600
Sales 2,600,147
Bank balance 60,020
Directors salaries 60,114
Maintenance of plan t 30,102
Rent 40,063
Advertising 190,048
Rates 50,171
Insurance 20,116
Office salaries 166,013
Light and heat 46,027
Factory power 30,014
Bank interest 7,070
Interim dividends on preference shares 10,000
General administration expenses 63,011 _________
3,988,868 3,988,868

Further information is as follows:

(1) Depreciation is to be provided as follows:

Plant and machinery 15% on cost. (Production expense)

Office equipment 10% on cost (administration expense)
Motor vehicles 25% on WDV (distribution cost)
New office blocks 2% on cost (Administration expense).

(2) Prepayment of rates at 31 March 2005 was £3,140.

(3) An insurance premium for public liability cover amounting to £3,360 was paid for the year to
30 June 2005.
(4) The amount owing for light and heat is £1,214 and rent is £2,321 as at 31 March 2005.
(5) Rent, rates, light and heat and insurance are to be apportioned in the ratio of 5:1 in relation to
factory and office expenses.
(6) The provision for doubtful debts is to be maintained at 1% of the accounts receivables.
(7) The production director acts as a factory manager, his salary is £20,000.Office salaries include
amounts paid to salesmen of £64,237.
(8) The corporation tax of £100,000 is to be provided,
(9) During the year 1,500 electrical equipments were transferred from the factory to the
warehouse. Only 100 equipments were in hand at the end of the year.
(10) Inventory at cost as at 31 March 2005 was as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 89

Raw materials £56,200.

Work in progress £47,190.
Finished goods ?

Required:

Prepare the published income statement for the year ended 31 March 2005 and statement of financial
positionas at the same date. (20 marks)

Note: Do not prepare the statement of changes in equity and the notes to the accounts.

Solution

a) Classifying expenses by function

Auto transmission
Income Statement for the year ended 31/03/2005
£ £
Revenue 2,585,041
Cost of sales (1,586,692)
Gross profit 998,349

Expenses
Distribution expenses 373,298
Administration expenses 244,489
Finance costs 27,070 (644,857)
Profit before tax 353,492
Income tax expense (100,000)
Profit for the period 253,492

b) Classifying expenses by nature

Auto Transmission

£ £
Revenue 2,585,041

Expenses
Raw materials consumed 532,40
Changes in finished goods and work in progress 233,332
Depreciation 153,100
Employee benefits 727,527
Other expenses 558,120
Finance costs 27,070 2,231,549
Profit before tax 353,492
Income tax expense (100,000)
Profit for the period 253,492

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FINANCIAL ACCOUNTING III
 90 Lesson Two

Auto Transmission
Statement of financial position as at 31/03/2005
£ £

NON-CURRENT ASSETS
Property, Plant and Equipment 727,900

CURRENT ASSETS
Inventory 198,868
Accounts receivables 495,000
Prepayments 3,980 697,848
TOTAL ASSETS 1,425,748

EQUITY AND LIABILITIES

Ordinary share capital 400,000

RESERVES
Retained profits 295,967
Shareholders funds 695,967

NON-CURRENT LIABILITIES
10% Redeemable preference shares 200,000

CURRENT LIABILITIES
Bank overdraft 60,020
Trade payables 356,226
Accruals 13,535
Current tax 100,000 529,781
Total Equity and Liabilities 1,425,748

Workings
£
1. Revenue 2,600,147
Less return inwards (15,106)
2,585,041

2. Cost of sales
Opening inventory : Finished goods
Cost of finished goods 250,000
1,682,170
Less: closing inventory of finished goods (95,478)
1,586,692
Factory cost of finished goods

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 91

Manufacturing account
£ £
Opening inventory : raw materials 70,000
Purchases of raw materials 518,600
588,600
Less: Closing stock inventory raw materials (56,200)
Raw materials consumed 532,400
Direct labour: Manufacturing wages 501,400
PRIME COSTS 1,033,800

Factory overheads
Directors‘ salaries : Factory manager 20,000
Maintenance of plant 30,102
Rent 35,320
Rates 39,192.50
Insurance 16,063
Light and hear 39,376.50
Factory power 30,014
Depreciation on plant 109,500 319,560
Total cost of production 1,353,369
Add: Opening WIP 126,000
1,479,360
Less: Closing W.I.P 47,190
Factory cost of finished goods 1,42,170

Value of closing stock/finished goods: 1,432,170 x 100 = 95,478 =95,478

1500

3. Expenses Distribution Administration Finance costs

i) Transport 85,013
ii) Directors‘ salaries 40,114
iii) Rent 7,064
iv) Advertising 190,048
v) Rates 7,838
vi) Insurance 3,213
vii) Office salaries 101,776
viii) Light and heat 7,873
ix) Bank interest 7,070
x) Preference dividends (redeemable) 20,000
xi) Salesmen salaries 64,237
xii) Increase in provision for bad debts 4,000
xiii) Depreciation on - new office block 2,600
- office equipment 11,00
- motor vehicles 30,000
xiv) General administration expense ______ 63,011 _____
373,298 244,489 27,070
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FINANCIAL ACCOUNTING III
 92 Lesson Two

Workings for classification by nature

4. Changes in finished goods and W .I. P

Finished goods Work in progress TOTAL

£ £ £
Closing inventory 95,478 47,190 142,668
Opening inventory (250,000) (126,000) (376,000)
Increase (decrease) (154,522) (78,810) (233,332)

An increase is treated as a saving while a decrease is an expense .

5. Depreciation

Plant and machinery 109,500

New office block 2,600
Office equipment 11,000
Motor vehicles 30,000
153,100

6. Employee benefits

Manufacturing wages 501,400

Factory manger salary 20,000
Director salaries 40,114
Office salaries 101,776
Salesman salaries 64,237
727,527

7. Other expenses

Transport 85,013
Rent 42,384
Advertising 190,048
Rates 47,031
Insurance 19,276
Ling and heat 47,241
Plant maintenance 30,102
Factor power 30,014
Provision for bad debts 4,000
Bank interest 7,070
General administration 63,011
558,120

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 93

8. Property, Plant and Equipment

Cost Depreciation to date Net Book value

Office block 170,000 2,600 167,400
Plant and machinery 730,000 334,000 396,000
Office equipment 110,000 35,500 74,500
Motor vehicles 200,000 110,000 90,000
727,900

9. Prepayments and Accruals

Prepayments Accruals
Rates 3,140 Light and heat 1,214
Insurance 840 Rent 2,321
____ Dividend on redeemable preference shares 10,000
3,980 13,535

10. Retained profits

Balance c/d 42,475

Profit for the period 253,492
295,967

Example 2

IAS 12: INCOME TAX

IAS 12 deals with two main types of taxes:-

i) Corporation tax
ii) Deferred tax

i) Corporation Tax
This is the tax payable by companies on their trading activities of a given financial period. The
standard doesn‘t give the guidelines on how this tax should be computed because the corporation
tax is based on the rules and procedures of a country with regards to tax matters.

However, once this tax has been computed then the standard gives the guidelines on how it
should be treated in the financial statements.

IAS 12 requires that income tax should be shown as a separate item on the face of the income
statement and described as ―Income tax expense‖. If part of this amount remains unpaid, then it
should be shown as part of current liabilities in statement of financial position and described as
―Current tax‖.

In practice, it may be difficult for a company to know exactly how much tax should be paid in
relation to a given financial period. Therefore, many companies use an estimate for the purpose
of completion of the accounts.

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FINANCIAL ACCOUNTING III
 94 Lesson Two

In the subsequent financial period, the amount actually payable would be confirmed with the tax
authorities and the firm may be required to pay either more than or less than what was actually
provided for.

The ‗the more than‘ or ‗less than‘ tax is called on under or over provision of previous years tax.

IAS 12 requires that under or provision of previous year‘s tax should be adjusted for in the period
in which it arises and thus the company shouldn‘t adjust its previous year‘s financial statements.

An underprovision of previous years tax will thus be added to the current years income tax
expense and over provision of previous years tax will be deducted from the current years income
tax expense and eventually the net amount shown as the income tax expense in the income
statement.

Example:

During the year ended31/12/2003, A Ltd. had estimated the corporation tax for the year to be
£100,000. The amount was still outstanding as at 31/12/03. During the year ended 2004, on 30 th
June the actual amount payable was agreed with the tax authorities and eventually paid.
Meanwhile during the year 2004, the company paid additional investment taxes of £80,000. As at
the end of the year the company the company estimated that he payable for year 2004 will be
£120,000.

Required:
Compute the income tax expense and the statement of financial position liability for year 2004
assuming that; A

a) The actual tax paid for year 2003 was £90,000

b) The actual tax paid for year 2003 was £110,000.

a) Tax for 2003 (£90,000) – Over provision of previous years tax

Profit and loss change in 2004

Current years tax estimate 120,000
Less overprovision of previous years tax (100 – 90) ‗000‘ (10,000)
Income tax expense 110,000

Statement of financial position liability

Current years tax estimate 120,000
Less installment taxes paid (80,000)
Current tax 40,000

b) Tax for 2003 (£110,000) – Under provision of previous years tax

Profit and loss change in 2004

Current years tax estimate 120,000
Add: underprovision of previous years tax (100 – 110) 10,000
Income tax expense 130,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 95

ii) Deferred tax

A company may enter into transactions in the current financial period that may result in the firm
either paying or saving some tax in the future. The tax that may be paid or saved in the future is
called deferred tax that may be paid in the future is called deferred tax liability whereas tax that
may be saved in the future is called deferred tax asset.

Previously accountants used to compute deferred tax using the income statement approach.
Under this approach, the difference between profit before tax and taxable profits was simply
referred to as a difference. This difference was classified into permanent and temporary timing
differences.

Permanent differences related to those items that are adjusted for tax in the current year and
will never be adjusted for tax in the future E.g. Donations to political parties.

Temporary/timing differences relate to those items that are adjusted in the current period and
are again adjusted in subsequent financial periods for tax purposes. E.g. investment income
accrued in profits before tax will be deducted in the current period for tax purpose but will be
added back in subsequent financial periods when investment income is received.

All temporary differences therefore result to deferred tax

However, currently the computation of deferred tax is based on the statement of financial
position approach whereby temporary differences are given as the difference between the carrying
amount of an asset or liability (book value) and its tax base.

The carrying amount is the accounting value or book value of an asset or liability. The tax base
is the value attributable to asset or liability for tax purpose.

Example;
A firm bought an item of plant at a total amount of £50,000. During the first year, the firm
provided for depreciation of 10,000. The item of plant has a capital allowance of`£15,000 for the
first year.

Re. Compute the carrying amount of the asset, the tax base and hence the temporary difference.

Carrying amount cost – depreciation

=50,000-10,000 =40,000

Tax base cost – capital allowance

=50,000-15,000 =35,000

Temporary differences carrying amount – tax base

=40,000-35,000 =£5,000

There are two main types of temporary differences;

i) Taxable temporary difference

If the carrying amount is more than the tax base then it means that this difference is taxable and
the firm will end up paying some tax in the future. Therefore all taxable temporary differences
lead to deferred tax liability.

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FINANCIAL ACCOUNTING III
 96 Lesson Two

ii) Deductible temporary differences

If the tax box is more than the carrying amount, then the firm will end up saving some tax in the
future because the amounts due from the tax authorities will be deducted from the future taxes.
Therefore, all deductible temporary differences will lead to deferred tax assets.

Accounting treatment of deferred tax

The objective of accounting for deferred tax is to ensure that the profits for the period d onto
fluctuate due to temporary differences. To achieve this objective, an account called deferred tax
account is prepared upon which adjustments are made at the end of every financial period.

The approach is normally to compute the temporary differences. Thereafter we apply the
corporation tax rate on the temporary difference to get the balance carried down in the deferred
tax account. The balance carried down is compared with the balance brought down and the
difference being the balancing figure in the deferred tax account represents a transfer to or from
the profit and loss or income statement.

The transfer to or from the profit and loss is not debited or credited directly in the income
statement but adjustments are made on the income tax expense whose net amount will now
appear in the income statement.

The final figure for income tax expense that will appear in the income statement will be arrived as
follows:-

£
Current year estimated corporation tax x
Add/(less) under cover provision of previous years tax x/(x)
Add/(Less) transfer to (from) deferred tax account x/(x)
Income tax expense xx

In the statement of financial position, deferred tax liability will be shown under NON-
CURRENT LIABILTIES. Whereas a deferred tax asset will be shown under NON-CURRENT
ASSETS.

Example
A Ltd., bought an item of plant at a cost of £100,000 in year 2000. The estimated useful life of
the plant was 5 years and depreciation is on a straight line basis with no residual value. The
company makes profits before tax of £200,000 and the corporation tax rate is 30%. The item of
plant has the following:

Year 1 2 3 4 5
Rate 30% 25% 20% 15% 10%

Required: (for each of the five years)

i) Tax liability (corporation)

ii) Carrying amount, tax base, taxable temporary difference of the plant and the balance carried
down on deferred tax account.

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 97

iii) The deferred tax account

iv) Final accounts extracts (Profit and loss + statement of financial position)
Assume that the corporation tax liability is unpaid by the year end.

Corporation tax liability

2000 2001 2002 2003 2004

£ £ £ £ £
Profit before tax 200,000 200,000 200,000 200,000 200,000
Add back depreciation 20,000 20,000 20,000 20,000 20,000
220,000 220,000 220,000 220,000 220,000
Less capital allowances (30,000) (25,000) (20,000) (15,000) (10,000)
Taxable profits 190,000 195,000 200,000 205,000 210,000
Taxable liability (30%) (57,000) (56,500) (60,000) (61,500) (63,000)
133,000 136,500 140,000 143,5000 147,000

Carrying amount, tax base, and taxable temp diff.

2000 2001 2002 2003 2004

£ ‗000‘ £ ‗000‘ £ ‗000‘ £ ‗000‘ £ ‗000‘
Carrying amount: Cost 100 100 100 100 100
Accumulated depreciation 20 40 60 80 100
80 60 40 20 -
Tax box: Cost 100 100 100 100 100
Accumulated capital all (30) (55) (75) (90) (100)
70 45 25 10 -
Taxable temp. difference 10 15 15 10 -
Bal c/d on deferred tax a/c (30%) 3 45 45 3 -

Deferred Tax Account

£ ‗000‘ £ ‗000‘
31/12/00 Bal c/d 3 31/12/00 P & L (bal. fig) 3
31/12/01 Bal c/d 4.5 1/1/01 Bal b/d 3
31/12/01 P & L (bal. fig) 1.5
4.5 4.5
31/12/02 Bal c/d 4.5 1/1/02 Bal b/d 4.5
31/12/03 P & L (Bal. fig) 4.5 1/1/03 Bal b/d 4.5
31/12/03 Bal c/d 1.5
3
4.5 4.5
3 1/1/04 Bal b/d 3

Final accounts extracts

Income statement

2000 2001 2002 2003 2004

£ ‗000‘ £ ‗000‘ £ ‗000‘ £ ‗000‘ £ ‗000‘
Profit before tax 200 200 200 200 200
Income tax 60 60 60 60 60

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FINANCIAL ACCOUNTING III
 98 Lesson Two

Profit for the period 140 140 140 140 140

Workings: Income tax expense

Current year estimated corporation tax

liability 57 58.5 60 61.5 63
Add/(less) transfer to/(from) deferred tax
a/c 3 1.5 - (1.5) (3)
60 60.0 60 60 60

Statement of financial position

NON-CURRENT LIABILITIES
Deferred tax 3 4.5 4.5 3 -
CURRENT LIABILITIES
Current tax 57 58.5 60 61.5 63

IAS 8: ACCOUNTING POLICIES CHANGES IN A ACCOUNTING ESTIMATES AND

ERRORS

The objective of IAS 8 is to recommend the accounting statement of accounting policies changes inn
accounting statements and errors.

Accounting policies
Accounting policies are the specific assumptions, bases, principles and practices that are adopted by
firms in preparing financial statements. The standard requires that companies follow the policies
consistently from one financial period to the next.

A company should be guided by accounting standards or the current practices in choosing and
applying accounting policies. The standard allows firms to change their accounting policies when;

i) There is new standard

ii) The change is required by the law
iii) The new change will result in a fair presentation of the financial performance and position.

When a company changes its policies, then the change should be accounted for respectively i.e. the
previously reported financial statements should be adjusted/restated to reflect the new policy for
comparison purposes.

Example:

A Ltd., has decided to change its policy of writing off borrowing costs to capitalizing the same. As at
31st December, 2003, the company had written off borrowing costs amounting to £200,000. During
the year ended 31/12/04. The company reported profit for the period of £450,000 but after charging
borrowing costs of £50,000. As at 31/12/03 the retained profits were £1,500,000. Other transactions
were:-

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 99

 Transfer from revaluation reserve on sale of PPE - £40,000

 Transfer from retained profits to general reserve - £50,000
 Interim dividends paid - £200,000

Required: Prepare the statement of changes in equity extract for the year-ended 81/12/04

Retained profits
£
Balance as at 1.1.2004 1,500,000
Change in accounting policy 200,000
Balance as restated 1,700,000
Transfer from revaluation reserve on sale of PPE 40,000
Profit for the period (450,000 + 50,000) 500,00
Transfer to general reserve (50,000)
Interim dividends paid (200,000)
Balance as at 31/12/2004 1,990,000

Changes in accounting estimates

In preparing financial statements, it may be difficult to arrive at exact values for certain items to be
presented in the financial statements and thus estimates are normally used.

Examples of estimates: Depreciation, provision for doubtful debts and other provisions in relation to
contingent liabilities e.g. pending court cases (suits)

These estimates are based on the available information as at the time of preparing financial
statements.

However, in subsequent financial periods, changes may be required on these estimates because of new
information becoming available. IAS 8 requires that a change in accounting estimate should be
accounted for in the period in which the change arises and where relevant, in other subsequent
financial period. E.g. an increase or decrease in provision for doubtful debts will be adjusted for in
the current years income statement whereas depreciation will not only be adjusted for in the current
year but also in the subsequent financial periods. i.e. the remaining Net Book Value of the assets will
be depreciated over the remaining useful life starting with the current financial period.

Example:
B Ltd., bought an item of plant at a total cost of £100,000. The estimated useful life commencing
from 1st January 2000 was 10 years. At the start of the 4 th year it was discovered that the actual
estimated useful life of the plant was 8 years and not 10 years.

Required: Compute the depreciation charge for each of the eight years on the plant.

Initial depreciation = 100,000

10
=£10,000 each for 3 years

Net Book Value at beginning of year 4

= 10,000 x 3 years = 30,000
= 100,000 – 30,000 = 70,000

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FINANCIAL ACCOUNTING III
 100 Lesson Two

depreciation for rest of the 5 years

= 70,000
5
=£ 14,000

Errors

An error is an error discovered in the current financial period but it relates to one or more previous
financial periods. Such errors arise due to mathematical mistakes, misapplication of accounting
policies, oversights and fraud.

The statement requires that if such an error is material i.e. the previously reported financial statements
were materially misstated or misrepresented, then, the opening balances of the current financial period
must be restated and if practical, the previous financial statements should be restated.
Therefore an error requires retrospective application.

Example:
ABC Ltd., reported the following transactions during the year ended 31/12/2004

Retained profits b/d £100,000

Transfer from revaluation reserve £20,000
Transfer to general reserve £15,000
Profit for the period £60,000
Interim dividends paid £20,000

After the above balances were extracted, new information came to light that the opening inventory
was overstated by £10,000 due to double counting of some stock items.

Required: Prepare the statement change in equity extract for the year ended 31 st December 2004.

Retained profits £
Balance as at 1.1.04 100,000
Error (10,000)
Balance restated 90,000
Transfer from revolutions reserve 20,000
Profit for the period (60,000 + 10,000) 70,000
Transfer to general reserve (15,000)
Interim dividends paid (20,000)
Balance as at 31.12.04 145,000

Example 3
The authorized share capital of Shirika Jipya Limited consists of 75,000 redeemable preference shares
of Sh.10 each and 1,500,000 ordinary share of Sh.25 each. The former are to be redeemed during
2005.
The trial balance of Shirika Jipya Limited as at 30 June 2000 was as follows:

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 Preparation of published Financial Statements 101

Sh. ‗000‘ Sh. ‗000‘

Ordinary Share capital (shares fully paid) 15,375
6% redeemable preference share capital 750
Share premium account 3,150
Income statement (1 July 1999) 21,600
10% convertible loan stock 8,000
Deferred tax 1,080
Inventories (1 July 1999) 25,073
Trade receivable 34,979
Trade payables 25,425
Provision for doubtful debts 90
Wages and salaries payable 473
Value added tax payable 681
Interim dividend paid 430
Freehold land, at cost 848
Building at cost 5,100
Plant at cost 30,750
Provision for depreciation on building 398
Provision for depreciation on plant 12,059
Long-term investment quoted 3,525
Interest paid 450
Purchases 141,450
Preferred dividend paid 32
Profit on sale of plant 173
Bad debts 23
Sales 179,100
Dividend received from investments (gross) 300
Installment tax and withholding tax paid 738
Wages and salaries 24,450
Bank 806
268,654 268,654

Additional information:
1. The 10% convertible loan stock is secured against the plant.
2. (i.) During the year fixed assets were purchased as follows
Buildings Sh.750,000 and plant Sh.4,050,000.
(ii). Plant with an original cost of Sh.1,500,000.
3. Depreciation is to be charged as to buildings Sh.53,000 and plant Sh.690,000.
4. The quoted investments had a market value at 30 June 2000 of Sh.6,750,000.
5. The wages and salaries figure includes the following:
Directors Salaries 122,00
General Manager 33,000
Company Secretary 23,000

6. The firm had signed a contract for Sh.23,243,000 being the lower of cost and net realisable value.
7. Sh.75,000 needs to be transferred from the deferred tax account.
8. The stock as at 30 June 2000 was Sh.23,243,000 being the lower cost and net realisable value.
9. The following provisions need to be made:

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FINANCIAL ACCOUNTING III
 102 Lesson Two

(i). Audit fees of Sh. 53,000

(ii). A final dividend on ordinary shares of Sh.35 per share. This had been proposed
before the year end.
(iii) The provision of doubtful debts is to be adjusted to Sh.120,000.
(iv). Corporate tax of the year‘s profit is estimated at Sh. 4,290,000. Last year‘s tax was
Overestimated by Sh.15, 000: this figure had been netted off against the installment and with-
holding tax paid.

10. After payment of the preference dividend in March 2000, the company decided to redeem these
shares and this was done in June 2000. No entries have been made in the books in respect of the
same. The shares were redeemed at a premium of 5% and this is to be written –off in the share
premium account.

Required:
(a) An Income Statement (using the cost of sales method: do not attempt to classify expenses
according to their functions). (8 marks)

(b) A statement of Changes in Equity for the year ended 30 June 2000. (8 marks)

(c) Statement of financial positionas at that date in a form suitable for publication and conforming (as
far as the information permits) with the requirements of the Companies Act and International
Accounting Standards. (9 marks)
(Total: 25 marks)
Solution
Shirika Jipya
Income statement for the yaer ended 30 June 2000
Sh.000 Sh.000
Turnover 179,100
Cost of sales (W1) (143,023)
Gross profit 35,077
Other operating income: Profit on disposal 173
Investment income 300 473
Expenses 35,550
Other expenses (W) 24556
Finance cost 832 (25,388)
Profit before tax 10,162
Income tax expense (4,200)
Profit for the period 5,962

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 Preparation of published Financial Statements 103

Shirika jipya
Statement of changes in equity for the year ended 30 june 2000

Ordinary Share Capital Investment Retained

share Premium redemption revaluation Profits Total
capital reserve Sh.‘000‘
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Bal as at 1.7.99 15,375 3,150 - 21,600 40,125
- -__ -__ -__ -__
15,375 3,150 - 21,600 40,125
Gain on inv. - - - - -
revaluation - 3225 - -3225
- - - - -
- - - - -
- - - - -
Purchase of shares - (37.5) - - (37.5)
Transfer to CRR - - 750 (750) -
Profit for year - - - 5,962 5,962
Dividends:
Interim (W4) - - - (430) (430)
-__ -__ -__ -__

15,375 3,112.5 750 3225 26362 48844.5

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FINANCIAL ACCOUNTING III
 104 Lesson Two

Shirika Jipya
Statement of financial position as at 30 June 2000
Sh.000 Sh.000

NON CURRENT ASSETS

23,498
Plant, property and equipment (Note 4)
6750
Investments
30248

CURRENT ASSETS
23,243
Inventory
34,859
Receivables (W6)
18.5 58,120.5
Bank (W7)
88368.5
FINANCED BY
37,500
Authorised share capital 750
1.5m ordinary shares @ Sh.29 38,250
75,000 preference shares @ Sh.10

ISSUED AND PAID UP

15,375
Ordinary share capital
750
Capital redemption reserve
3,112.5
Share premium
3,225 7,087.5
26,382
Investment revaluation
48,844.5
Retained profits
Shareholders funds 8,000
1,005 9,005
Non Current Liabilities
Loan stock 25,425
Deferred tax 1,557
4,537
Current liabilities 30,519
Creditors 88368.5
Accruals (W8)
Accrued tax (W9)

Notes to the Financial Statements

1. The above financial statements have been prepared under the historical basis of
accounting which is modified to accommodate revaluation of certain assets.They are
in compliance with the applicable IFRSs and the Company‘s Act..

2. The profit for the period has been arrived at after charging:
Sh.000
Directors fee 122
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 Preparation of published Financial Statements 105

Depreciation 743
Auditors remuneration 53
Staff costs 24328

3. The tax expense for the year is arrived at by applying the corporate rate of tax in
Kenya of 30% to the adjusted profit for the year.

4. Property, plant and Equipment

Land Buildings Plant Total

Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Cost/valuation
Bal b/d 848 28,200 4,350 33,398
Additions - 4,050 750 4,800
Disposal - (1,500) - (1,500)
Bal c/d 848 30,750 5,10 46,698
Depreciation
Bal b/d - 13,214 398 13,612
Eliminated and disposed - (1,155) - (1,155)
Charge for year - 690 53 743
Bal c/d = 12,749 451 13,200
NBV c/a 848 18,001 4,649 23,498
NBV b/d 848 14,986 3,952 19,786

5. The 10% loan stock is secured against the plant.

6. The firm has signed a contract of Sh.8.775m for the construction of a warehouse for storage
of goods.
Workings

1.
Cost of sales 25,073
Opening stock 141,450
Purchases 166,523
Closing stock (23,243)
143,280
Add:Depreciation on:
 Buildings
53
 Plant
690
144023

Finance cost
2. Debenture interest (10% x 8,000) 800
Paid 450
Accrued 350
800
Add: Preference share dividend paid 32
832

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FINANCIAL ACCOUNTING III
 106 Lesson Two

3.
Other expenses 30
Increased provision (bad debts) 53
Audit fee 24,450
Wages and salaries 23
Bad debts 24556
4. Interim dividends
Ordinary share capital 430
Preference share capital 32
462
5 Income tax expense
Current years estimate 4,290
Less previous years overprovison (15)
Transfer from deferred tax (75)
4,200
Note: Under IAS 32 redeemable preference shares are treated as a non current liability. Therefore any
dividends paid thereon are finance costs and it will not appear as aprt of shareholders funds.

Sh.000
5.  15,375  21,525
Final dividends  35x 
 25 
Preference share capital (6% x 750 – 32) 13
21,538

6. Receivables = (34,979 – 120) 34,859

7. Bank: As per TB 806

Paid for redemption (787.5)
18.5

8. Accruals
Wages 473
VAT 681
Interest 350
Audit fee 53
1,557
9. Accrued tax
Estimated for year 4,290
Overestimated (15)
Paid (738)
3,537

Deferred Tax A/c

Sh.000
Sh.000
Profit & Loss 75
C/d 1,005 Bal b/d 1,080
1,080 1,080

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 Preparation of published Financial Statements 107

Example Four
Viatu Ltd, which manufactures footwear, makes up its accounts to 31 March each year. The company
has an authorised share capital of Sh. 600,000,000 divided into 15,000,000 6.5% preference shares of
Sh. 20 each and 30,000,000 ordinary shares of Sh. 10 each. The following trial balance was extracted as
at 31 March 2002.

Trial balance as at March 2002

Sh000 Sh000
Cost of Sales 699,992
Motor vehicle expenses 59,684
Selling and distribution costs 78,840
Depreciation of motor vehicles – for the year 12,580
Wages and salaries 95,834
Administration expenses 11,492
Audit fees 1,400
Sales 1,191,864
Discounts received 812
Investment income – trade investments 1,072
- others 1,608
Preference dividends paid 13,000
Debenture interest 1,600
Corporation tax paid – instalment 8,615
Compensation to director for loss of office 8,500
Depreciation of fixtures for the year) 1,040
8% debentures 20,000
Cash in hand 3,000
Ordinary share capital issued and paid-up) 200,000
Bank balance 11,745
Preference share capital issued and paid-up) 200,000
Inventory 31 March 2002) 204,132
Debtors/creditors 336,440 102,000
Deferred tax 3,000
Motor vehicles net book value) 24,800
Provision for doubtful debts 14,400
Fixtures and fittings net book value) 11,300
Income statement 1 April 2001) 110,848
General reserves 60,000
Share premium 40,000
Freehold land and building cost) 270,000
Investments – trade market value Sh.35,000,000) 30,000
Others market value Sh.62,000,000) 61,610
_______ _______
1,945,604 1,945,604

Additional information:
1. Wages and salaries include salary paid to Managing Director of Sh. 30,000,000 and salary paid to
Sales Director of Sh. 25,000,000.
2. Provision is due to be made for directors‘ fees Sh. 150,000,000.
3. Provision for doubtful debts is to be adjusted to Sh. 16,822,000.
4. Timing differences of Sh. 4,000,000 are expected to reverse in the near future.
5. The directors recommended an ordinary dividend of Sh.1.35 per share.

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FINANCIAL ACCOUNTING III
 108 Lesson Two

6. Corporation tax for the year is Sh.11; 820,000.The corporation tax rate is 30%on adjusted profit.
7. Land and buildings were professionally valued at Sh.300,000,000 at the year end. The directors
wish to incorporate the valued amount in the financial statements.
8. Information about other fixed asset is as follows:

Motor Fixtures &

vehicles fittings
Sh
Sh
Cost (including additions during the year) 51,200,000 20,800,000
Additions during the year 2,240,000 1,600,000
Cost of assets disposed of during the year (No entry made yet) 2,800,000 1,455,000
Accumulated depreciation of asset disposed of during the year 2,150,000 905,000
Proceeds of asset disposed of (including in sales in the trial 715,000 500,000
balance)

Required
(a)Income statement for the year ended 31 March 2002 (13 marks)
(b)Statement of financial position as at 31 March 2002 (12 marks)

(The above two statement should be presented in the form suitable for publication in accordance with
the requirements of International Accounting Standards .IASs)
Solution
Viatu Ltd
Income statement for the year ended 31 March 2003
Sh.‘000‘ Sh.‘000‘
Turnover (W1) 1,190,694
Cost of sales (699,922)
Gross profit 490,657
Other Incomes : Discount received 812
Profit on disposal 15
Investment income 2,680 3,507
494,164
Selling and distribution expenses 176,104
Administrative expenses 245,688
Finance costs 1,600 (423,392)
Profit before tax 70,772
Income tax expense: Current 11,820
Deferred (1,800) (10,020)
Profit for the period 60,752

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 Preparation of published Financial Statements 109

Viatu Ltd
STATEMENT OF CHANGES IN EQUITY AS AT 31.03.02
Ordinary Preference Share General F.A Rev. Retained Total
share share premium reserve Reserve earnings
capital capital Sh.‘000‘
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Bal b/f 200,000 200,000 400,000 600,000 - 110,848 610,848
Prior adjustment - - - - - - -
Restated 200,000 200,000 400,000 600,000 - 110,848 610,848
Rev. gain on - - - - 30,000 - 30,000
NCA
Rev. gain on - - - - 390 - 390-
investment
Rev. gain on - - - - - - -
foreign - - - - - 60,752 60,752
Net profit: year
Dividends: - - - - -
Interim - - - - - (13,000) (13,000)
-
Bal b/d 200,000 200,000 40,000 60,000 30,390 158,600 68,8990

(b) Viatu Ltd

Statement of financial position as at 31 March 2002
Sh.‘000‘ Sh.‘000‘
Non Current Assets
Plant, property and equipment 334,900
Investments( Other ) 62000
396900
Current Assets
Inventory 204,132
Receivables (336,440 – 16,822) 319,618
Trade investments 30,000
Cash and bank (11,745 + 3,000) 14,745 568,495
965395
FINANCED BY:
Authorised share capital
15m shares 6.5% preference @ Sh.20 300,000
50m share ordinary @ Sh.10 300,000
600,000
Issued and fully paid
10m 6.5% preference shares @ Sh.20 200,000
20m Ordinary shares @ Sh.10 200,000
400,000
Reserves
Share premium 40,000
Revaluation reserve 30,390
General reserve 60,000 130,390
Retained profit 158,600 158,600
Shareholders funds 688,990
Non current liabilities
8% debentures 20,000

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FINANCIAL ACCOUNTING III
 110 Lesson Two

Deferred tax 1,200 21,200

710190
Current liabilities
Trade creditors 102,000
Tax payable (11,820 – 8,615) 3,205
Accrued directors‘ fee 150,000 255,205

TOTAL EQUITY AND LIABILITIES 965395

Workings

1. Turnover Sh.‘000‘
As per trial balance 1,191,864
Less proceeds and disposals (1,215)
1,190,649

2. Selling and distribution costs

As per TB 78,840
Motor vehicle expenses 59,864
Wages 25,000
Depreciation: Motor vehicle 12,580
176,104

3. Administrative expenses
Wages and salaries 70,834
As per TB 11,492
Audit fees 1,400
Depreciation: fixtures 1,040
Compensation of director for loss of office 8,500
Provision for doubtful debts (16,822 – 14,400) 2,422
Director‘s fee 150,000
245,688

4. Profit on assets disposed

Motor vehicles Fixtures & Fittings Total
Cost 2,800 1,455 4,255
Acc. Dep. 2,150 905 3,055
NBV 650 550 1,200
Proceeds 715 500 1,215
Profit & Loss 6,500

DEFERRED TAX A/C

Sh.‘000‘ Sh.‘000‘
Profit U Loss 1,800
Bal c/d (30% x 4,000) 1,200 Bal b/d 3,000
3,000 3,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 111

Notes to the accounts

Note 1 Accounting policies

These financial statements have been prepared under the historical cost basis of accounting, which is
modified to accommodate the revaluation of certain properties and in accordance with the applicable
IFRSs.

Property plant and equipment is shown at cost or revalued amount less the total accumultaed
depreciation which is based on the estimated useful life of the assets.

Inventory has been stated at the lower of cost and net relisable value.

Note 2 Profit before tax

The profit before tax has been arrived at after charging the following expenses

Sh.‘000‘
Directors fee 205,000
Compensation to director for loss of office 8,500
Depreciation 13,650
Auditors fee 1,400
Staff costs 40,834

Note 3 Taxation
Corporation tax is based on the adjusted profits for tax purpose at a corporation tax rate of 30%

Note 4 Propety plant and equipment

Freehold land & Motor Fixtures &

COST/VALUATION Buildings vehicles Fittings Total
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Bal as at 01.04.01 270,000 48,960 19,200 338,160
Additions - 2,240 1,600 3,840
Disposals - (2,800) (1,455) (4,255)
Revaluations 30,000 - - 30,000
Bal as at 31.03.02 300,000 48,400 19,345 367,745
Accumulated Depreciation
Bal as at 01.04.01 - 13,820 8,460 22,280
Eliminated on disposal - (2,150) (905) (3,055)
Charge for the year - 12,580 1,040 13,650
Bal as at 31.03.02 - 24,250 8,595 32,845
NBV as at 31.03.02 300,000 24,150 10,750 315,880
NBV as at 01.04.01 270,000 35,140 10,740 315,880

Note 5 Dividends
During the year the company paid a dividend of sh.1.30 on the preference shares outstanding.
The directors are now proposing a dividend of sh.1.35 per s share on the number of ordinary
shares outstanding at the end of the year.

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FINANCIAL ACCOUNTING III
 112 Lesson Two

REINFORCEMENT QUESTIONS
QUESTION ONE
Athi River Cement (ARC) Ltd. is a company quoted on the Nairobi Stock Exchange. It makes up its
accounts to 31 March each year. The balance of the company as at 31 March 2003 is as follows:

Sh. Million Sh. Million

Administrative expenses 99
Borrowings 103
Buildings: Valuation at 1 April 1998 180
Accumulated depreciation 30
Capital work in progress 74
Cash and bank balances 5
Cost of sales 601
Compensating tax payable 8
Deferred income taxes 151
Deferred expenditure 15
Distribution costs 109
Finance leases payable 7
Finance costs 27
Finance income 2
Inventories 186
Other operating expenses 3
Other operating income 4
Plant and machinery: Cost 907
Accumulated depreciation 283
Prepaid operating lease rental: Cost 80
Amortisation of prepaid operating lease rental 20
Revaluation reserve 110
Share capital 450
Share premium 188
Taxation 17
Turnover (net of VAT) 884
Trade and other payables 160
Trade and other receivables 194
Revenue reserve 95
Unclaimed dividends _____ 2
2,497 2,497

Additional information

1. Borrowings comprise:
Bank overdraft (interest are payable in the year 20%) Sh.million
Bank loan, repayable 31 March 2005 (interest rate 13% fixed) 53
50
2. Buildings: Historical cost 103
Depreciation charge for the year included in cost of sales 60
6

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 113

ARC‘s accounting policy in relation to the difference between depreciation based on the
revalued amount of buildings (Sh.6 million) and depreciation based on the buildings‘
historical cost (Sh.2 million) is to treat it as revaluation surplus realized as the buildings are
used. This transfer for the year has not yet been made.

The buildings had been revalued by Roy and Samika, Registered Valuers and Estate
Agents, on an open market basis.

Accumulated depreciation on historical cost of buildings as at 31 March 2003 was Sh.20

million

No impairment losses have occurred in the life of the company

3. Capital work in progress relates to ongoing construction of a new kin.

4. The compensating tax payable was in respect of the previous year‘s dividend paid in the
year.
The directors have proposed that a dividend of 10% be paid for the year ended 31 March
2003. No entry has been made in the financial statements to reflect this. Proposed
dividends are accounted for as a separate component of equity until they have been
ratified at a general meeting.

5. Deferred expenditure represents development costs relating to production of new

products that are written off over four years. Expenditure of Sh.20 million was incurred
early in the year to 31 March 2003. The amortisation charge for the year was Sh.5 million.

6. The tax expense for the year is as follows: Sh. Million

Current taxation based on adjusted profit at 30% -
Deferred tax expense 17
17
Ignore deferred tax on the revaluation surplus

7. Finance lease payable comprise: Minimum Present value

lease of minimum
payments lease payments
Sh. Million Sh. Million
Payable within one year 3 5
Payable later than one year but not later than five years 8 5
11 7
8. Finance costs comprise: Sh. Million
Interest on bank loan 9
Interest on bank overdraft 16
Interest on finance leases 2
27
9. Finance income: Sh. Million
Interest received on bank deposits 2
10. Inventories comprise: Sh. Million
Raw materials 48
Work in progress 29
Finished goods 51
Stores and spares 58
186

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FINANCIAL ACCOUNTING III
 114 Lesson Two

11. The depreciation charge for the year on the plant and machinery was Sh.52 million and
the amortisation charge of the prepaid operating lease rental was Sh.2 million
All depreciation and amortisation charges are included in cost of sales

12. Other expenses included in the various functional expenses or cost of sales are:
Sh. Million Sh. Million
Directors‘ emoluments: Fees 2
Other emoluments 12 14
Other staff costs: Wages and salaries 81
Social security cost (NSSF) 2
Termination benefits 3 86
Auditors‘ remuneration 2
Loss on disposal of motor vehicles 3
105
The average number of staff employed by the company during the year was 603.

13. The authorized share capital of the company is made up of 90 million ordinary shares of
Sh.5 each.

Required:

Prepare the Income Statement and the Statement of Changes in Equity for the year ended 31 March
2003 and the Statement of financial position as at 31 March 2003. ARC Limited prepares its
Statement of financial position showing Total Assets and Total Equity and Liabilities. Any notes
necessary to ensure that the Financial Statements are prepared in accordance with Internation
Financial Reporting Standards should be added, but using only the information included above. Do
not compute the Earnings Per Share for the year.
QUESTION TWO
Maina and Ojara have been in partnership for a number of years sharing profits in the ratio 3:2.
Because of the present difficult economic situation in the country, it has been agreed that in the
period ended 30 April 2000, no salaries will be paid to the partners and no drawings will be made
either. Interest has been credited to the partners in respect of their capital accounts. They decided to
turn the partnership into a company on 30 April 2000, with its accounts being made up to 30 April
each year. They decided that they would not open a separate set of accounts on 30 April 2000, but
would continue to record the transactions of the business in the partnership books.

The trial balance extracted by the accountant, after he had computed the profit for the period ended
30 April 2000 and the year ended 30 April 20001, was as follows

Sh. ‗000‘ Sh. ‗000‘

Capital accounts at 1 November 1999: Maina 1,350
Ojara 750
Net profit before tax: period to 30 April 2000 495
Operating profit before interest and tax: year to 30 April 2001 1,680
210,000 ordinary shares of Sh. 10 each, fully paid up 2,100
20% debentures 450
Stock and work-in progress 1,140
Trade receivables 1,515
Cash at Bank and in hand 405
Interim dividend paid on 28 February 2001 300
Trade payables 1,530

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 115

Purchase consideration for company 2,850

Land and buildings 900
Plant and machinery 900
Vehicles 540
Depreciation: Land and buildings 30
Depreciation: Plant and machinery 90
Depreciation: Vehicles 135
Loss on revaluation of net assets as at 30 April 60 _____
8,610 8,610

Additional information:

1. The fair values of the identifiable assets and liabilities of the partnership at 30 April 200 were:

Sh. ‗000‘
Land and buildings 900
Plant and machinery 900
Vehicles 540
Stock 480
Trade receivables 1,470
Cash at Bank and in hand 750
Trade payables (2,505)
2,535

These fair values recorded in the books on 30 April and were the basis used for computing the purchase
consideration payables to the partners. Depreciation for the year ended 30 April 2001 has been provided for
based on these figures.

2. The purchase consideration of Sh. 2,858,000 was satisfied by the issue of 210,000 ordinary shares of Sh. 10
each, Sh. 450,000 20% debentures and the balance in cash. The ordinary shares and the debentures were
divided between the partners in their profit sharing ratio. Maina paid the dissolution expenses of the
partnership out of his personal bank account in the amount of Sh. 90,000.
3. Interest on the debentures for the year ended 30 April 2001 has not been paid and has not accrued for
either.
4. The company, which is called Maoja Limited, will pay a final dividend of Sh. 1 per shares on the profit
made in the year. This had been decided at a meeting of the board of directors held on 30 April 2001.
5. Income tax at the rate of 30% on the adjusted profit for the year needs to be provided for in the amount of
SH. 470,000. No installment tax has been paid since the year under consideration is the first year in which
the company operated.
6. Maoja Ltd. has a policy of amortising goodwill over five years on a straight line basis. In the year to 3o April
2001, turnover was Sh. 10,080,000, cost of sales was Sh. 6,720,000, distribution costs were Sh. 1,092,000
and administrative expenses were Sh. 588,000. Included in these expenses items were Directors‘
Remuneration of Sh. 60,000, staff costs of Sh. 402,000 (including contributions to a defined contribution
plan of Sh. 21,000) included in administrative expenses, and depreciation included in distribution costs.
Amortisation of goodwill should be included in administrative expenses

Required:
(a). Prepare the Realisation and Capital Accounts of Maina and Ojaro to record the dissolution of the
partnership. (7 marks)
(b). Prepare for Maoja Limited the income statement for the year ended 30 April 2001 and the statement of
financial position at that date in conformity with Kenya Companies Act and the International Accounting
Standards. Do not prepare the statement of changes in equity – deal with dividends proposed and paid in
the income statement. Ignore deferred tax. (13 marks)

CHECK YOUR ANSWERS WITH THOSE GIVEN IN THE LESSON 9 OF THE

STUDY PACK
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FINANCIAL ACCOUNTING III
 116 Lesson Two

COMPREHENSIVE ASSIGNMENT NO. 1

TO BE SUBMITTED AFTER LESSON 2
To be carried out under examination conditions and sent to the Distance Learning
Administrator for marking by the University.

TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS

QUESTION ONE
Lock Stock and Barrel have been in partnership and contractors for many years. Owing to adverse
trading conditions it has been decided to dissolve the partnership. Profits are shared as to lock 40%,
Stock 30% and Barrel 30%. Thee partnership deed also provides that in the event of a partner being
unable to pay off a debit balance, the remaining partners will treat this as a trading loss.

The partnership statement of financial position as at 1 January 2004 was as follows:

Cost Depreciation NBV

Non current assets £ £ £
Freehold land and buildings 20,000 3,000 17,000
Plant and equipment 150,000 82,000 68,000
Motor vehicles 36,000 23,000 13,000
206,000 108,000 98,000
Current assets
Inventory of land & buildings 75,000
Houses in the course of construction 115,000
Inventory of materials 23,000
Debtors fro completed houses 62,000
275,000
Current liabilities
Trade payables 77,000
Deposits and progress payments 82,000
Bank overdraft 132,000 (291,500) (16,500)
81,500

Partners capital accounts

Lock 52,000
Stock 26,000
Barrel 2,500
81,500

During the six months from 1 January 2004 to the date of dissolution, the following transactions have
taken place:
£
Purchase of raw materials 20,250
Materials for houses in the course of construction 33,750
Payment for wages and subcontractors on building sites 78,000
Payments to trade payables for materials 45,000
Sales of completed houses 280,000
Cash received from customers for houses 225,000
Payments for various general expenses 12,500
Cash withdrawn by partners

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 117

Lock 6,000
Stock 5,000
Barrel 4,000

All deposits and progress payments have been used for completed transactions.
Depreciation is normally provided for each year at £600 on the freehold yard and buildings, at 10%
on cost for plant and equipment and 25% on cost for motor vehicles.
The partners decide to dissolve the partnership on 1 July 2004 and wish to take out the maximum
cash possible, as items are sold. At this date, there are no houses in the course of construction and
one third of the stock of land had been used for building.
It is agreed that Barrel is insolvent and cannot bring in any money in the partnership. The partners
take over the partnership cars at an agreed figure of £2,000 each. All other vehicles were sold on 20
July 2004 for £6,200. At the same date, inventory of raw materials were sold for £7,000 and the stock
of land realised £72,500. On 30 September 2004 the debtors paid in full and all the plant and
equipment was sold for £50,000.
The freehold yard and buildings realised 100,000 on 1 November on which date all remaining cash
was distributed.

Required:

a) Prepare a partnership income statement for the six months to 1 July 2004, statement of
financial positionas at 1 July 2004 and the partners‘ capital accounts for the same period (8
marks).
b) Show computations of the amounts distributable to the partners. (8 marks).
c) Prepare a realisation account and the capital accounts of the partners to the final distribution.
(4 marks).
QUESTION TWO
Grant and Herd are in partnership sharing profits and losses in the ratio 3 to 2. The following
information relates to the year to 31 December 19-0;

Dr. Cr.
£000 £000
Capital accounts (at 1 January 19-0):
Grant 300
Herd 100
Cash at Bank 5
Accruals 25
Prepayments 18
Drawings during the year:
Grant (all at 30th June 19-0) 40
Herd (all at 31 March 19-0) 40
Non current assets: at cost 300
Accumulated depreciation (at 31 December 19-0) 100
Herd –salary 10
Net profit (for the year to 31 December 19-0) 60
Inventory at cost (at 31 December 19-0) 90
Trade payables 141
Trade receivables 223 ______
£ 726 £ 726

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FINANCIAL ACCOUNTING III
 118 Lesson Two

Additional information

1. The partnership agreement allows for Herd to be paid a salary of £ 20,000 per annum,
and for the interest of 5% per annum to be paid on the partner‘s capital account balances
as 1 January in Each year, Interest at a rate of 10% per annum is charged on the partners
drawings.

2. The partners decide to dissolve the partnership as at 31 December 19-0, and the business
was then sold to Valley Limited. The purchase consideration was to be £400,000 1 Shares
in Valley at a premium of 25 per share. The shares were to be issued to the partners on
31 December 19-0, and they were to be shared between then in their profit sharing ratio.

The sale agreement allowed Grant to take over one of the business car‘s at an agreed
valuation of £10,000. Apart from the car and the cash at bank balances, the company
took over all the other partnership assets and liabilities at their book values as at 31
December 19-0.

3. Matters relating to the appropriate of profit for the year to 31 December 19-0 are to be
dealt with the partners capital accounts, including any arrears of salary owing to herd.

Required:

Write up the following accounts for the year to 31 December 19-0:

i. The profit and loss appropriate account;

ii) Grant and Herd‘s capital accounts;

and

iii) The realization account;

Prepare valley‘s statement of financial position as at 1 January 19-1 immediately after the
acquisition of the partnership assuming that not no further transactions have taken place
in the meantime.
QUESTION THREE
Drake and Stone carried on business in partnership under the firm name Drakestones and made up
their accounts annually to 31 December. The relevant provisions in a partnership agreement were:

a) Profits and losses should be shared in the proportion Drake three-fifths and Stone
two fifths;
b) Interest should be allowed on capital accounts at 5% per annum but no interest
should be allowed or charged on current accounts;
c) On the retirement or admission of a partner.

i) If the change takes place during any accounting year, such partner‘s share of
profits or losses for the period up to retirement or from admission should be
arrived at by apportionment on a time basis except where otherwise agreed;

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 119

ii) No account for goodwill should be raised in the firm‘s books, any necessary
adjustments as between continuing partners and retiring or incoming
partners in respect of goodwill being made by transfers between the
respective capital accounts,
iii) Any balance due to an outgoing partner should carry interest at 4 % per
annum from the date of his retirement to the date of payment.

By mutual agreement Stone retired from the partnership on 30 June 19x1, and on the
following day an employee, Major, was admitted as a partner. It was agreed that the terms of
the existing partnership agreement should apply in all respects except that, as from date,
profits or losses should be shared in the proportion, Drake two-thirds and Major one-third.

A trial balance extracted from the books on 31 December 19x1 was as follows:

Dr. Cr.
£ £
Purchases 36,200
Inventory-1 January 19x1 6,400
Wages 8,800
Salaries 2,800
Receivables 5,800
Capital accounts-1January 19x1
5,000
Drake
Stone 3,000
Current accounts-1 January 19x1
Drake 600
Stone 405
Sales 64,500
Drawings:
Drake 1,200
Stone 500
Major 400
Balance at Bank 7,205
Trade expenses 640
Furniture and fittings-1 January 19x1 at cost 2,400
Furniture and fittings-provision for
Depreciation to 1 January 19x1 620
Payables 4,600
Rent and rates 920
Plant and machinery-1 January 19x1 at cost 6,200
Plant and machinery-provision for
Depreciation to 1 January 19X1 3400
Office expenses 1,370
Bad debts 120
Repairs 760
Heating and lighting 410
82,125 82,125

No account has been taken in the books of a payment of £8,000 made on 1 July 19x1 to
Stone by major, representing Major contribution of capital regarded as a payment to Stone on

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FINANCIAL ACCOUNTING III
 120 Lesson Two

account of the balance due to the latter on his retirement. The balance due to Stone after
taking into account this payment remained unpaid at 31 December 19x1.

It was agreed that:

1) The inventory at 31 December 19x1 should be valued at £8,100.

2) The whole of the charge of £140 of the charge were specifically attributable to the period
to 30 June 19x1.

3) The sum of £600 included in the total of salaries and paid to major prior to his being
admitted as a partner should be entirely against the profits for the half year.
4) Plant and machinery should be depreciated at the rate of 105 per annum on cost, and
fixtures and fittings at 5% per annum on cost;
5) At 31 December 19x1, wages accrued amounted to £120 and rates paid in advance to
£40.
6) The firm‘s goodwill should be valued at June 19x1 at £21,000 but should not be retained
in the accounts.

You are required to:

a. Prepare the trading and profit loss account of the firm for the year to 31 December 19x1,
and the statement of financial position as on that date , and
b. Prepare partners capital accounts and current account (in columnar form) covering the
year 19x1
QUESTION FOUR
The following list of account balances relate to Larcher, a public listed company, at 30 September
2003.

$‘000‘ $‘000‘
Equity shares of $1 each 100,000
11% Loan Note 30,000
Retained profit as at 1 October 2002 23,440
Property, plant and equipment at cost 216,740
Depreciation of PPE as at 1 October 2002 50,740
Trade receivables 25,500
Trade payables 8,390
Lease rental 800
Sales 247,450
Cost of sales 165,050
Distribution cost 13,400
Administration expenses 12,300
Income tax paid 400
Interim dividends 3,300
Loan interest paid 1,650
Inventories as at 30 September 2003 16,240
Cash at bank 4,640
460,020 460,020

The following notes are relevant.

(a) Non current assets.

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 121

Property plant and equipment and its accumulated depreciation, is made up of the following
assets.

Cost$‘000‘ Dep $‘000‘

Land 12,000 Nil
Buildings 80,000 16,000
Plant 124,740 34,740

All of Larcher‘s land and buildings were revalued at open market value on 1 October 2002 at
$120 million in total. This was made up of $20 million attributed to the land and $100 million
to the buildings. The buildings‘ original estimated life of 50 years (with a nil residual value)
has not changed. From the date of the revaluation there were 40 years of life remaining. The
directors wish to include the revalued amounts in the financial statements for the year to 30
September 2003. Plant is depreciated at 15% of the reduced balance.

(b) Lease rentals.

A lease rental of $800,000 was paid on 30 September 2003. It is the first of five annual
payments in arrears for the rental of an item of equipment that has cash purchase price of $3
million. The auditors have advised that this is a finance lease and have computed the implicit
interest rate as 10% per annum.

(c) Income tax.

A provision for income tax for the year ended 30 September 2003 of 9 million is required.
Income tax is paid 6 months after the company‘s year end. A provision for income tax of $6.8
million made for the year ended 30 September 2002 was settled on 31 March 2003 for $7.2
million. A transfer of $1.5 million is to be transferred to the deferred tax account.

(d) Sale or return basis.

Included in the trade receivables is an amount of $7.65 million relating to sales made on a sale
or return basis. The customer was meant to confirm acceptance but had not done so by the
end of the year. Meanwhile the initial sales price had been marked down by 15% to encourage
the customer to buy the goods. The company makes on average a profit of 20% on cost in
relation to sales.

(e) The closing inventory given in the list of balances now seems to be incorrect because the
stock take carried out on 30 September 2003 was not reliable. One week after the year end
another stock take was carried out and this time the inventory was recorded at $18 million.
During the same week the firm made sales of $2.1 million at normal selling price and
Purchases of $3.75 million.
(f) On 1 January 2002, Larcher agreed to act as a selling agent for an overseas company,
Brandberg. The terms of the agency are that Larcher receives a commission of 10% on all
sales made on behalf of Brandberg. Thisis achieved by Larcher remitting 90% of the cash
received from Brandberg‘s customers one month after Larcher has collected it. Larcher has
included in its sales revenue $7·2 million of sales on behalf of Brandberg of which there is
one month‘s outstanding balances of $1·2 million included in Larcher‘s accounts receivable.
The cash remitted to Brandberg during the year of $5·4 million (i.e. 90% of $6 million) in
accordance with the terms of the agency, has been treated as the cost of the agency sales.

Required:

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FINANCIAL ACCOUNTING III
 122 Lesson Two

Prepare an income statement, statement of changes in equity and statement of financial

positionfor the company according to the International Financial Reporting Standards for
published purpose. (20 marks).

QUESTION FIVE
The following trial balance is prepared by Powis plc, plastics manufacturers on 31 May 2005 which is
the end of the company‘s accounting period:

Powis plc
Trial balance as at 31 May 2005
Share capital: £ £
Authorized and issued 300,000 ordinary shares of £1 each, fully paid 300,000
100,000 8.4% cumulative preference shares of £1 each, fully paid 100,000
Capital redemption reserve 50,000
Share premium account 100,000
General reserve 50,000
Retained profits – 31 May 2004 238,500
Goodwill 205,000
Accumulated impairment – goodwill- 31 May 2005 39,500
Patents and trade marks 80,000
Accumulated amortization – patents and trade marks 30,000
– 31 May 2005
Freehold land and building at cost 250,000
Leasehold property at cost 75,000
Amortization of leasehold property – 31 May 2004 15,000
Factory, plant and machinery at cost 150,000
Accumulated depreciation – plant and machinery 68,500
– 31 May 2004
Fixtures and fittings 50,000
Accumulated depreciation – fixtures and fittings – 15,750
31 May 2004
Motor vehicles at cost 75,000
Accumulated depreciation – motor vehicles – 31 May 2004 25,000
10% Loan stock (2008-2009) 100,000
Accounts receivables and payables 177,630 97,500
Bank overdraft 51,250
Inventory – raw materials at cost – 31 May 2004 108,400
Purchases – raw materials 750,600
Carriage inwards – raw materials 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Cash 5,120
Work-in-progress – 31 May 2004 32,750
Sales 1,526,750
Administration expenses 158,100
Selling and distribution expenses 116,800
Other expenses 54,100
Provisions for doubtful debts – 31 May 2005 5,750
Inventory – finished goods – 31 May 2004 184,500 ________
2,858,500 2,858,500

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STRATHMORE UNIVERSITY● STUDY PACK
 Preparation of published Financial Statements 123

Additional information

£ £
1. Inventory at 31 May 2005 was:
Raw materials 112,600
Finished goods 275,350
Work-in-progress 37,800

2. Depreciation for the year to be charged as follows:

Plant and machinery 8% on cost - charged to production
Fixtures and fittings 10% on cost - charged to
administration
Motor vehicles 20% on reducing value - selling and distribution
3. Manufacturing overheads include:

Works Director‘s salary 10,000

4. Administration expenses include:

Executive director‘s salaries (three at £8,000 and 35,000
one at £11,000)
Non-executive chairman‘s fee 2,500

5. Selling expenses include:

Sales director‘s salary 13,000

6. Other expenses include:

Auditor‘s fees 10,000
Auditors‘ expenses 500
Taxation service fees 1,250
Solicitor‘s fees for purchase of the freehold property 5,000
Acquired 31 May 2005

7. Corporation tax at 30% on the profits of the year is estimated at £40,000 and is due for
payment on 28 February 2006.
8. The directors recommend that a dividend of 3.5 pence per share be paid on the
ordinary share capital. No ordinary dividend was paid for the year ended 31 May 2005.
9. The leasehold land and buildings are held on a 50-year lease, acquired ten years ago.
10. Impairment and amortization has been charged on goodwill and intangible assets
respectively (goodwill £14,000 and patents £4,000) and included under the relevant
expense heading in the trial balance.

Required
From the information given above and using the classification of expenses by nature, prepare the
published accounts for the year ended 31 May 2005.
(20 marks)

Do not prepare a statement of changes in equity and the notes to the accounts.

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FINANCIAL ACCOUNTING III
 124 Lesson Two

END OF COMPREHENSIVE ASSIGNMENT No.1

NOW SEND YOUR ANSWERS TO DISTANCE LEARNING ADMINSTRATOR FOR
MARKING.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 125

LESSON THREE

BRANCHES

OBJECTIVES
At the end of the lesson you should be able to:

 Deal with the accounting system whereby branch transactions are recorded in the Head office
books;
 Deal with the maintenance of current accounts between the head office and branches where
each branch maintains its own records, and the preparation of the overall Income statement
and Statement of financial position for the enterprise as a whole;
 Account for transactions between a head office and a branch situated in a foreign country,
and translate the foreign currency financial statements of a branch into the reporting currency
of the Head Office in order to prepare the overall Income statement and Statement of
financial position of the enterprise as a whole.

CONTENTS
 Read the study text below on:

a. System one: The head office maintains all accounts (selling agency branches);
b. System two: Each branch maintains full accounting records (autonomous branches);
c. Foreign branches.

 Attempt reinforcing questions at the end of the lesson and compare them with solutions
given in Lesson 9.

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FINANCIAL ACCOUNTING III
 126 Branches

INTRODUCTION:
Accounting has two main objectives:

(i) To assist control over the assets and liabilities, and the income and expenditure of the enterprise;
and
(ii) To ascertain the profit or loss of the enterprise, the main sources of income and expenditure
contributing to this profit or loss and the assets and liabilities that represent the profit or loss.

If the owners of an enterprise want it to earn more profit, they must increase the volume of turnover.
As turnover increases, the enterprise must expand physically; as it expands, it will create departments,
which deal with different lines of sales or services; there is a limit to the physical expansion at a single
site – and the market there is also limited. Hence, enterprises set up branches, so that expansion can
be continued. The need then arises to control the assets, liabilities, income and expenditure of the
different departments and/or branches.

There are two main ways by which this can be achieved:

(i) All the accounting records are maintained at the head office; or
(ii) Each branch or department maintains its own accounting system.

There can be combinations of both systems; for example, each branch could maintain its own
accounting system for income and expenditure, stock, debtors, cash and creditors, but fixed assets at
branches, long-term investments made by and loans granted to the enterprise as a whole are reflected
in the accounting system maintained by the head office.

We shall consider these accounting systems, and, in addition, we shall consider how accounts
maintained by a foreign branch are translated into the currency of the head office.

1.1 SYSTEM ONE - THE HEAD OFFICE MAINTAINS ALL THE ACCOUNTS
This system is suitable for an enterprise that has small branches (possibly in another area of the town
or city where the Head Office –HO – is situated), which sell goods supplied by the HO. On the sale
of goods, cash is received which should be banked intact into the local branch of a bank; the bank can
be instructed to credit the Head Office account, which is maintained at a different branch of the same
bank. Cash expenditure by a branch is normally funded by an imp rest provided by the HO,
replenished at regular intervals by a cheque for the actual amount of expenditure incurred. Where
credit sales are permitted at a branch, each invoice raised at the branch will be made out in the
triplicate; one copy is given to the customer as the invoice; the second copy is sent (as part of a batch
of invoices) to the HO; the third is retained by the branch for reference. All goods should be
purchased through a central buying department at the HO. Goods are issued to branches on the basis
of requisitions received from branch managers. Of course it should be realized, that with the advent
of computers the amount of paperwork may be substantially reduced and procedures not exactly as
described.

The branch manager should be required to forward to HO at weekly, fortnightly or monthly intervals,
returns giving particulars of goods received from and returned to HO, cash and credit sales, cash
received from debtors, expenses, cash banked and stock and cash in hand at the end of the period.
From these, the HO will maintain accounts for the branch in the HO books.

In order to provide a check that branch managers and staff deal properly with goods and cash passing
through their hands, goods are normally charged to branches at the actual prices at which branches
sell them. Consider the following set of figures relating to a branch:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 127

20X2 Shs‘000
January 1: Goods in hand at the branch, valued at selling price 3,000
January 31: Goods sent from the Ho to the branch, valued at selling price 3,460
January 31: Goods sold to customers for cash in the month of January 3,280

What would be the value of closing stock at the branch at 31st January 20X2, valued at selling price?
It would be:

Shs‘000
Opening stock (at selling price) 3,000
Add goods received (at selling price) 3,460
Total goods available 9at selling price) 6,460
Deduct goods sold (at selling price) 3,280
Closing stock (at selling price) 3,180

In the above example, it was assumed that there was no wastage of goods, no breakages, and no
pilfering by customers, and that all sales were made at the predetermined selling price. A check can be
made by staff from the HO, E.G from the internal audit department, to ensure that the stock of Shs
3,180,000 is really present at 31 st 20X2. Usually an allowance will be made for wastage and breakages,
e.g. if an allowance of 1% of goods sent to a Brach is given as a ―normal loss‖, a closing stock figure
of Shs 3.18m – Shs 34,600 = Shs 3,145,400 would be accepted; if the stock level is less than this, an
investigation as to why this is the case would be made.

1.2 In the HO books, the following accounts are kept in respect of each branch:

a) Branch Stock Account

b) Branch Mark-up (or Adjustment) Account
c) Goods Sent To Branch Account
d) Branch Total Debtors Account (if the branch is permitted to sell goods on credit) and
e) Branch Expense Accounts

a) Branch Stock Account

i. It sis maintained at estimated selling price (invoice price).
ii. It controls branch stocks.
iii. The balance should represent the selling price of branch stock in hand.
iv. Any difference between physical stock and the balance on the account must be investigated
(unless this difference is a normal loss)

b) Branch Mark-up Account

i. The opening balance represents the provision for unrealized profit on stock brought forward.
ii. This account records anticipated profits on goods sent to branch.
iii. The balance carried forward, representing unrealized profit on closing stock, is deducted from
the branch stock account balance in the statement of financial position thus reducing stock to
cost.
iv. The gross profit of the branch will be the balancing figure in the account.

c) Goods Sent To Branch Account

i. The amount on this account at the year-end represents the cost of goods sent to branch.

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FINANCIAL ACCOUNTING III
 128 Branches

ii. This figure is credited to the HO Trading account to reduce goods available for sale by head
office (or if the head office is not a selling organization, the stocks held on behalf of the
branches at the year end).
iii. This account has neither an opening nor a closing balance.

d) Branch Total Debtors Account – This is used to control branch debtors.

e) Income statement – The expenses incurred by each branch (posted to separate branch
expense accounts) are charged against the branch gross profit to give the net profit or loss of the
ranch. These profit and loss accounts are normally prepared in a columnar format, so that the
income statement for the enterprise as a whole can be arrived at. As s the gross profit is shown in
the mark up account, it is not necessary to prepare the trading account unless the examiner
specifically requires this. In practice, however, the trading account is required so that the total
turnover of the enterprise can be obtained.

f) Statement of financial position – This is not normally required by the examiner under this
system. However, if it is required, stock is shown at cost, which is arrived at by deducting the
balance carried down on the mark up account from that on branch stock account.

Sundry Matters
a. The accounting system is also appropriate for departmental accounts.
b. The branch stock account is a practical means of controlling stock at the branch. Supervisors can
quickly ascertain the selling price of stock at a branch and compare this with the balance shown in
the head office books. Such spot checks will bring to light:

i. Normal differences e.g. wastage, evaporation, minor miscalculation of selling price, or

errors in stock taking;
ii. Abnormal differences e.g. goods or cash stolen.

c. This method prevents branch staff from knowing the cost of goods being sold and preserves
secrecy with regard to profits.
d. Ascertaining the percentage or fraction to deduct from invoice price may cause some students
difficulty. No doubt it is appreciated that the percentage to be deducted from the selling price is
not the same as that which is added to cost, e.g. If 33 1/3% is added to cost to arrive at invoice
price then 25% must be deducted from selling price to get back to cost.

Mark up is defined as the rate of gross profit to cost of sales:

Mark up = Gross Profit

Cost of sales

Margin is defined as the rate of gross profit to sales:

Margin = Gross profit

Sales

Calculations of markup and margin are necessary to compute the profit loading on:

 Closing stock at the branch

 Returns from branch to head office

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 129

Examination questions may provide information on either the markup or the margin. If one is
provided, it may be necessary to compute the other.

Let us assume: X = Gross Profit

Y = Sales

Therefore: Margin = Gross Profit = X

Sales Y

However:
Sales – Costs = Gross Profit

Or:
Costs = Sales – Gross Profit

Which is stated as:

Costs = Y–X

And since:
Mark up = Gross Profit
Costs

This is stated as:

Mark up = X
Y–X

In summary, if: Margin = P/Q

Then the related Markup shall be P/(Q – P)

Using similar arguments, it can be established tat if the Markup is give by P/Q,

Then the related margin shall be P/(Q+P)

For example, B Ltd marks up its goods by 2/11 of the cost. It the sales are Sh 202,800, what is the
gross profit?
In conclusion, let us assume C Ltd earns a gross profit of 2/17 of its selling price. It the cost of sales
in a particular month was Sh 4,819,500, what were the sales and gross profit?

Gross Profit = 2/15 X 4,819,500 = 642,600

Sales = (4,819,500 + 642,600) = 5,462,100

Sales = (17/2 X 642,600) = 5,462,100

Sales = 17/15 X (4,819,500) = 5,462,100

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FINANCIAL ACCOUNTING III
 130 Branches

1.4 Double entry

Transactions Debit Credit
Cost of goods sent to branch Branch stock account Goods sent to branch
account
Mark-up on goods sent to Branch stock account Branch mark up
branch account
Cost of goods returned by Goods sent to branch Branch stock account
branch to head office account
Mark-up on goods returned to Branch mark-up account Branch stock account
head office
Cash sales Cash account Branch stock account

Credit sales Branch debtors account Branch stock account

Returns from credit customers Branch stock account Branch debtors

account
Discounts allowed to credit Branch profit and loss Branch debtors
customers account account
Bad debts written off Branch profit and loss Branch debtors
account account
Amount of cash lost from Branch profit and loss Branch stock account
branch account (or branch cash
account)
Cost of stock lost from branch Branch profit and loss Branch stock account
account
Mark-up on stock lost from Branch mark-up account Branch stock account
branch
Amount of normal stock loss Branch mark-up account Branch stock account
of branch
Balance on branch mark-up Branch mark-up account Branch profit and loss
account being gross profit of account
branch
Balance on goods sent to Goods sent to branch HO trading account
branch account being cost of account
goods sent for period

Illustration 1
A limited set up a branch in Buruburu, Nairobi, on 1 st January 2002 to expand its volume of business.
The accounts for the branch are maintained in the HO Ledger. Goods sent to the branch are
invoiced to the branch at selling price, which is HO cost plus 33 1/3% of O cost.

By 31st December 2002, goods with a selling price of Shs 4m had been sent to the branch; goods with
a selling price of Shs 200,000 were unsuitable for sale in this branch and were returned to the head
office. In the year cash sales amounted to Shs. 2,800,000 and credit sales amounted to Shs 600,000
and closing stock on 31 December 2002 was (at selling price) Shs 400,000.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 131

The Head Office and branch expenses ere Shs 2,200,000 and Shs 810,000 for the year to 31
December 2002 respectively. For simplicity, these expenses have not been analyzed into their
constituent components; they are posted in their total amounts in a columnar Expense Account.

BRANCH STOCK ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 GSTB 3,000 Dec 31 Goods sent to branch 150
Dec 31 Branch Mark up 1,000 Dec 31 Branch mark-up 50
Dec 31 Cash book 2,800
Dec 31 Branch debtors 600
____ Dec 31 Balance c/d 400
4,000 4,000
2003
Jan 1 Balance b/d 400

BRANCH ADJUSTMENT (Mark up) ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 Branch stock a/c 50 Dec 31 Branch stock a/c 1,000
Dec 31 Branch P & L 850
Dec 31 Balance c/d 100 ____
1,000 1,000
2003
Jan 1 Balance b/d 1,000

GOODS SENT TO BRANCH ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 Branch stock a/c 150 Dec 31 Branch stock 3,000
Dec 31 HO trading a/c 2,850 ____
3,000 3,000

EXPENSE ACCOUNTS
2002 Shs 000 Shs 000 2002 Shs 000
HO Branch Dec 31 HO Branch

Dec 31 Cash book/creditors 2,200 810 Dec 31 P&L a/cs 2,200 810

Let us see how the figures relating to this branch would now be combined with a set of figures for the
HO to give an overall trading and Profit and Loss Account. The overall or combined sales figure
would be shown in the statutory accounts of A Limited. We will assume that the following
information relates to the head office:

Shs 000
Opening stock at HO 1,000
Closing stock at HO 550
Purchases made by HO 10,500
Sales made by HO 10,800

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FINANCIAL ACCOUNTING III
 132 Branches

TRADING & PROFIT & LOSS ACCOUNT FOR THE YEAR ENDED 31ST DECEMBER
2002
Head office Branch Combined
Shs 000 Shs 000 Shs 000
Sales 10,800 3,400 14,200
Opening stock 1,000 NIL 1,000
Purchases/goods from HO 10,500 2,850 10,500
11,500 2,850 11,500
(2,850)
Closing stock 8,650
Cost of sales (550) (300) (850)
Gross profit (8,100) (2,550) (10,650)
Expenses 2,700 850 3,550
Net profit 2,200 810 3,010
Branch 500 40 540
Combined 40
540

Even though the stocks and purchases in the branch are not accurate, let us assume that this is so until
autonomous branches have been studied.

The branch sales, opening stock, goods from HO and closing stock figures are all memorandum
figures i.e. these figures are extracted from the accounts in the ledger but they do not arise as a result
of the double entry process.

In 2003, the following transactions occurred: we shall now call the Buru Buru branch of A Limited
branch 1 (one) to distinguish it from branch 2, branch 3, etc.

Shs 000
Goods sent to branch 1, at invoice price 6,000
Goods returned to HO from branch 1 at invoice price 180
Cash sales 4,800
Credit sales 1,020
Returns to branch 1 debtors 60
Returns to the HO by branch debtors 80
Goods sent to branch 2 from branch 1 (at selling price) 96
Goods sent to branch 1 from branch 3 (at selling price) 76
Branch 1 expenses for the year 1,100

We shall consider four different scenarios at 31 st December 2003. In situation (a) when stock was
counted on 31st December 2003, the value of the physical stock on hand valued at selling price agreed
wit the balance in the stock account.

In situation (b) when stock was counted on 31 December 2003, the value of physical stock on hand
valued at selling price was Shs 360,000. After investigation, it was found that stock at selling value of
Sh 80,000 had been stolen in the year.

In situation (c) again the closing stock was discovered to be short by Sh 80,000 (at selling price). In
this case, it was established that cash was stolen on its way to the bank.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 133

In situation (d), the closing stock was short by Shs 80,000 (at selling price). This figure is an
acceptable normal loss amount due to evaporation, spilling, etc).

BRANCH 1 STOCK ACCOUNT

a b, c, & d
2003 Shs Shs 000 2003 Shs Shs Shs Shs
000 000 000 000 000
Jan 1 Bal b/d 400 400 Dec 31 Sundry a/c 180 180 180 180
Dec 31 Sundry a/c 6,000 6,000 CB 4,800 4,800 4,800 4,800
Branch 1
Dec 31 Debtors Dec 31 Branch 1 a/c
a/c 60 60 1,020 1,020 1,020 1,020
Dec 31 Branch 3 Branch 2
Stock a/c 76 76 Dec 31 Stock a/c 96 96 96 96
Branch 1
Dec 31 mark up a/c
- 20 - 80
Branch 1
Dec 31 P & L a/c - 60 80 -
Dec 31 Bal c/d 440 360 360 360
6,536 6,536 6,536 6,536 6,536 6,536
2004
Jan 1 Bal b/d 440 360

BRANCH I MARK UP ACCOUNT

a b c d a b,c,d
2003 Shs Shs Shs Shs Shs Shs
000 000 000 000 000 000
Dec
31
Branch 1 stock a/c 45 45 45 45 Jan 1 Bal b/f 100 100
Branch 1 debtors a/c 20 20 20 20 Dec 31 Branch 1 stock a/c 1,500 1,500
Branch 2 markup a/c 24 24 24 24 Branch 3 markup ac 19 19
Branch 1 stock a/c - 20 - 80
Branch 1 P&L 1,42 1,420 1,440 1,360
0
Bal c/d 110 90 90 90 ____ ____
1,61 1,619 1,619 1,619 1,619 1,619
9
2004
Jan 1 Bal b/d 440

GOODS SENT TO BRANCH ACCOUNT

2003 Shs 2003 Shs 000
000
Dec 31 Branch 1 stock a/c 135 Dec 31 Branch 1 stock a/c 4,500
Branch 1 debtors a/c 60 Dec 31 Goods sent to branch 3 a/c 57
Goods sent to branch 2 a/c 72
HO trading a/c 4,290 ____
4,557 4,557
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FINANCIAL ACCOUNTING III
 134 Branches

COMPUTATION OF SALES
In situations (a), (b) and (d), Branch 1 sales for the year are arrived at as follows;

Shs‘000 Shs‘000 Shs‘000

Cash sales 4,800
Credit sales 1,020
Deduct returns to: branch 60
HO 80 140 880
Net sales 5,680

In situations (c ), Branch 1 sales for the year are arrived at as follows;

Shs‘000
Cash sales as above 4,800
Add: cash collected but stolen before being banked 80
Total cash sales 4,880
Net credit sales, as above 880
Net sales 5,760

In d below it can be said that a normal loss is not reported separately in the Trading and Profit and
Loss Account; since it is ―normal‘, it is included as part of cost of sales and reduces the gross
accordingl

Branch 1 Trading & Income statement For The Year Ended 31 December 2003
(a) (b) (c ) (d)
No loss Stock loss Cash loss Normal loss
Shs ‗000‘ Shs ‗000‘ Sh ‗000‘ Sh ‗000‘
Sales MEMO FIG 5,680 5,680 5,760 5,680
Opening stock MEMO FIG 300 300 300 300
Goods received from HO MEMO FIG 4,290 4,290 4,290 4,290
4,590 4,590 4,590 4,590
Goods Stolen MEMO FIG (60)
4,530
Closing stock MEMO FIG (330) (270) (270) (270)
Cost of sales 4,260 4,260 4,320 4,320
Gross profit DOUBLE
ENTRY FIG
1,420 1,420 1,440 1,360
Expenses (1,100) (1,100) (1,100) (1,100)
Goods or cash stolen ___- (60) (80) __-
Net profit 320 260 260 260

1.5 GOODS AT BRANCH MARKED DOWN, OR MARKED UP BY AN ADDITIONAL

AMOUNT
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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 135

If goods at the branch are not selling well, branch could be authorized by the Head office to mark-
down the goods. Conversely, if the goods are selling much better than expected, or if replacement
goods will cost more, the selling price could be marked up. These mark-downs and mark-ups are
credited or debited into the branch stock account and debited or credited into the branch mark-up
account respectively.

Special care needs to be exercised in valuing closing stock.

Illustration 2
E Limited sent goods to its branch in Thika invoiced at selling price, which was cost plus 505 of cost.
On 1st July 20X2, the opening stock in Thika was Shs 3 million at selling price. Goods at selling price
of SHS 16.5 million were received by Thika in the year ended 30 th June 20X3.

On 28th February 20X3, goods valued at selling price of Shs 6 million were marked-up by a further
40% of cost price. 75% of these goods were sold in the year ended 30 th June 20X3. The remaining
25% were held in stock at 30th June 20X3. Sales for the year ended 30 th June 20X3 amounted to Shs
16.8 million. Write up the Branch Stock and the Branch Mark-up accounts.

Branch Stock A/C

20X2 Shs 20X3 Shs 000
000
Jul 1 Balance b/f 3,000 Jun 30 Cashbook/debtors 16,800
20X3
June 30 Sundry a/c 16,500
Feb 28 Branch Markup a/c 1,600 Jun 30 Balance c/d 4,300
21,100 21,100
20X3
Jul 1 Balance b/d 4,300

Branch Mark Up A/C

20X3 Shs 20X2 Shs 000
000
Jun 30 Branch profit and loss a/c 6,400 July 1 Bal b/f 1,000
20X3
Jun 30 Bal c/d 1,700 Jun 30 Branch stock a/c 5,500
_____ Feb 28 Branch stock 1,600
8,100 8,100
20X3
July 1 Balance b/d 1,700

Workings
a.
Sales Selling price Gross profit Cost of sales
Sh ‗000‘ Sh ‗000‘ Sh ‗000‘
Total sales 16,800 6,400 10,400
Marked up goods (75% X Shs 7.6m) 5,700 2,700 3,000
Normal sales 11,100 3,700 7,400

b.

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FINANCIAL ACCOUNTING III
 136 Branches

Closing stock
Total 4,300 1,700 2,600
Marked up goods 1,900 900 1,000
Normal sales 2,400 800 1,600

It can be seen that if goods are sold at a price in excess of the normal selling price, an additional profit
is earned. Goods may be sold at a price in excess of the normal selling price without authority from
the HO; if this occurs, the credit side of the branch stock account exceeds the debit side by the
amount of the additional profits.

2 SYSTEM TWO – ―AUTONOMOUS BRANCHES‖

2.1 Legal Aspects

There is no law relating to branch accounts but examination problems under this heading are frequently
linked to either partnership or company account problems. Answering such problems will therefore
requires knowledge of branch accounting as well as the legal matters appropriate to partnership or
company accounting.

2.2 Accounts required and their purpose

a. Branch Current Account (Head Office Books)

 Records all transactions branch and head office;
 The balance represents the investment made by head office in the branch.

b. Head office Current Account (Branch Books)

 Records all transactions between branch and head office;
 The balance represents the branch‘s capital;
 Income statement balance must be transfeeed to this account at the end of the period.

[Tutorial note: The branch current account in the head office books and the head office current
account in branch books must be reconciled before preparation of final accounts.]

c. Final accounts
i. Examination questions – two types of problems arise in examinations:

Either (a) transfers between head office and branch are made at cost;
Or
(b) Transfers between head office and branch are made at ―wholesale‖ price
which will include a small element of profit. In such cases the examiner
frequently requires the final columnar accounts to show in the branch
column, goods from head office and stocks at invoiced price, but not reduce
these the head office cost in the combined column.

ii. Trading Account – head office column records transactions from the point of view of the
head office. It show all purchase made by the head office, sales to customers and transfers to
the branch at ―wholesale‖ price.
iii. Trading Account – branch column records transactions from the point of view of the branch.
It shows goods received from head office at ―wholesale‖ price and local purchases at cost,
and stocks of goods from head office valued at ―wholesale‖ price (i.e. includes an element of

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 137

unrealized profit from the point of view of the business as a whole) and stocks of local
purchases valued at cost.

iv. Trading Account – combined column records transaction from the point of view of the
business as a whole, profits between head office and branch being eliminated – gross profit
figures will not cross-cast to the combined gross profit.
v. Income statement – provisions for unrealized profits on closing stock held by the branch an
on goods in transit are entered in the head office column. Net profit figures will cross cast to
the combined net profit.
vi. Statement of financial position – current accounts will appear in the head office and the
branch columns but not in the combined column;
vii. The provision for unrealized profit on branch stock and goods in transit will appear under
current liabilities in the head office column but will be deducted from the stock figures in the
combined column.
viii. The ‗combined‘ column in the income statement and in the statement of financial position are
derived from the head office figures and the branch figures; normally the head office figures
and the branch figures should be prepared first and the combined columns are then prepared
from the individual columns.

2.3 Sundry Matters

a. Current accounts balances must always be equal and opposite.

b. The head office current account in the branch books should always have a credit balance.
c. The branch current account in the head office books should always have a debit balance.
d. Goods in transit and cash in transit must always be adjusted in the head office books
(regardless of the direction in which they are in transit)
e. The final entry to close the current account will be the transfer of branch profit to head
office.

2.4 Double Entry

IN HEAD OFFICE BOOKS
Transactions Debit Credit
Invoice value of goods sent to Branch current account Goods sent to branch account
branch (may be cost or
―wholesale‖ price)
Cash received from branch Cash account Branch current account
Expenses of branch paid by Branch current account Cash account or expense
head office (if any) creditors account
Profit of branch transferred Branch current account Profit and loss account
into head office books
Provision for unrealized profit Profit and loss account Provision for unrealized profit
where goods are invoiced to account
branch at cost plus a mark up
i. Adjustment for goods and cash in transit are always made on the credit side of the branch
current account. The accounts will have equal and opposite balances once adjustments are
made.
ii. The balance on the current account is in fact represented by the branch fixed and current assets
less liabilities (i.e. the head office has provided the branch with its capital).

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FINANCIAL ACCOUNTING III
 138 Branches

IN BRANCH BOOKS
Transactions Debit Credit
Invoice value of goods received Goods received from head Head office current account
by branch (will not be the same office account
as goods sent by head office if
there are goods in transit)
Cash sent to head office (will Head office current account Cash account
not be the same as cash
received by head office if there
is cash in transit)
Expenses paid by head office Relevant expense account Head office current account
on behalf of branch
Profit of branch transferred Profit and loss account Head office current
into head office books

Pro-formstatement of financial positionfor a head office and autonomous branch:

Head office Branch Combined
ASSETS Sh Sh Sh Sh Sh Sh
Non – Current assets
Property plant and equipment X X X
Financial assets: investment in branch X
Less unearned profit (X)
X _-_ _-_
X X X
Current assets
Stocks in warehouses X X X
Stocks in transit X
Less unearned profit (UP) (X)
X - X
Debtors X X X
Cash at bank X X X
Cash in hand X X X
Cash in transit X - X
X X X
XX XX XX
EQUITY AND LIABILITIES
Capital and Reserves
Head office current account X
Ordinary share capital X X
P & L Reserve X X
X X
Non-current liabilities
Bank loan X X

Current liabilities
Creditors X X X
Accruals X X X
X X X
XX XX XX

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 139

Pro-formincome statement for a head office and autonomous branch

Head office Branch Combined
Sh Sh Sh Sh Sh Sh
Sales X X X
Goods sent to branch X _-_ _-_
X X X
Cost of sales:
Opening stock X X X
Purchases X - X
Goods from head office _-_ X _-_
X X X
Less closing stock (X) (X) (X)
(X) (X) (X)
Gross profit X X X
Sundry expenses X X X
Increase in UP X _-_ _-_
(X) (X) (X)
Net profit XX XX XX

Tackling the question

It is recommended that you reconcile the balances on the current accounts before working on the
final accounts, which are most probably what the exam question will require. The positioning of
current account balances in trial balances will be seen as follows:

Trial balance (extracts)

Head office Branch
X X
Head office current account X
Branch current account X
X X
X X
X __ X __
XX XX XX XX

It is highly unlikely that the balances will be equal and opposite. The difference arises due to items in
transit. What was sent out by the head office and recorded by them has not been fully received by the
branch and reported. The difference may also arise when a branch sends items to the head office but
the head office has not received everything dispatched by the branch. Therefore, each party has
reported different values for transactions with each other, the difference being items in transit.
Reconciliation of these accounts merely requires reporting items in transit in the branch current
account in the books of the head office.

Illustration 3
The balances on the current accounts of a head office and branch were Ksh 698,000, before the
transactions listed below:

Kshs
Goods sent to branch by head office 1,727,000
Remittances received by head office from branch 892,000
Goods received by branch from head office 1,620,000
Remittances sent to head office by branch 944,000

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FINANCIAL ACCOUNTING III
 140 Branches

Branch profit for the period 594,000

Goods in transit from head office to branch 107,000
Cash in transit from branch to head office 52,000

Books of head office:

Branch Current A/C
Sh Sh
Bal b/d 698,000 Cash book 892,000
GSTB 1,727,000 Bal c/d *1,533,000
2,425,000 2,425,000
Bal b/d 1,533,000 Goods in transit 107,000
Branch profit 594,000 Cash in transit 52,000
________ Bal c/d 1,968,000
2,127,000 2,127,000

* Entry that is usually found in the trial balance of the Head Office.

Goods sent to branch

Sh Sh
Branch current a/c 1,727,000

Goods in transit
Sh Sh
Branch current a/c 107,000

Cash in transit
Sh Sh
Branch current a/c 52,000

Books of the branch:

Head office current account
Sh Sh
Cash book 944,000 Bal b/d 698,000
Bal c/d* 1,374,000 1,620,000
2,318,000 2,318,000
Bal b/d 1,374,000
Bal c/d 1,968,000 Branch profit 594,000
1,968,000 1,968,000

* Entry that is usually found in the trial balance of the branch.

Goods from head office

Sh Sh
H.O current a/c 1,620,000

Before commencing on final accounts, it is important to understand that each entity is deemed to be
totally independent and standing alone in order to generate the financial statements as per the
proforma statements seen earlier. This will be illustrate further:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 141

Illustration 4
E Ltd sets up a branch in Nyeri on 1 July 2001. Goods are sent to branch at an invoice price which is
10% above cost. Sales attained during the financial year to 30 th June 2002 were Sh 15m and sh 9m at
the head office and branch respectively; goods sent to the branch had an invoice price of Sh 7.15m.
Purchases by the head office totaled Sh 18m. What is the profit that the head office can claim to have
made?

If the head office were to stand alone, it can claim two sets of sales:
Sales to public Goods sent to branch
(deemed to be ‗sales‘ to
branch)
% Sh‘000 % Sh‘000
Cost 100 10,000 100 6,500
Profit 50 5,000 10 650
Selling price 150 15,000 110 7,150

Sales to public and goods sent to branch (currency columns only) can be combined to generate:

Cost 16,500
Profit 5,650
Selling Price 22,150

If the branch were to stand alone, it must consider its cost to be the value at which ―goods were
‗purchased‘ from the head office. This of course is the price at which the head office ‗sold‘ the goods
to the branch (110% of original cost to head office)

% Sh‘000
Cost 110 6,600
Profit 40 2,400
Selling Price 150 9,000

All this information could be set out in the pro-forma layouts seen earlier as follows:

Head office Branch Combined

Sh Sh Sh Sh Sh Sh
Sales 15,000 9,000 X
Goods sent to branch 7,150 ___- _-
22,150 9,000 X
Cost of sales: opening stock - - -
Purchases 18,000 - X
GFHO - 7,150 _-
18,000 7,150 X
Closing stock (1,500) (550) (X)
(16,500) (6,600) (X)
Gross profit 5,650 2,400 X

Tutorial note: Study the formats provided earlier in the chapter, then turn back to the income
statement above. Try to understand how each item fits in . Remember, each item has a specific
position where it belongs in the pro-forma layouts.

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FINANCIAL ACCOUNTING III
 142 Branches

After arriving at a subtotal of opening stock, goods from head office and purchases, the following
steps were applied:

i. Slot in the gross profits based on the calculations made before commencement on the income
statements (sh 5,650 in column 1 and Sh 2,400 in column 2)
ii. Above this slot in / compute the cost of sales (Sh 16,500 in column 1 and Sh 6,600 in column
2)
iii. The difference between the subtotal referred to above and the cost of sales will be the closing
stock.

End of tutorial note.

The figures to appear in the combined income statement are based on the following diagram:

(3)
18,000 HO Br
(1) 7,150
(2) (2)

15,000 9,000
 An arrow pointing into a box refers to purchases by the organization represented by the box
 An arrow leading out of the box refers to sales made by the organization represented by the
box
 The outside box refers to the combined entity.
 When the head office purchased and received goods costing sh 18,000, the combined entity also
purchased and received goods costing Sh 18,000. Thus the purchases reported by the head
office (column 1) will usually be the purchases reported by the combined entity (column 3). The
only exception would be if the branch also had external purchases.
 If the head office and branch made sales of Sh 15,000 and Sh 9,000 respectively, the
combined entity will have made sales of Sh 24,000 (Sh 15,000 + Sh 9,000)
 The sales of Sh 7,150 made by the head office (which is deemed to be a purchase by the
branch) cannot be claimed to be a sale or purchase by the combined entity.
 The combined closing stock should be shown at original cost to the combined entity. This
means that the combined closing stock is made up of two components, all at original cost:

(i) Closing stock at the head office at an original cost of Sh 1,500;

(ii) Closing stock at the branch. This had cost the branch Sh 550 (as can be seen in the income
statements), but had an original cost of Sh 500 (550 x 100/110) when received by the head
office on behalf of the combined entity.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 143

Complete trading accounts will be as follows:

Head office Branch Combined
Sh Sh Sh Sh Sh Sh
Sales 15,000 9,000 24,000
Goods sent to branch 7,150 ___- ____-
22,150 9,000 24,000
Cost of sales:
 Opening stock - - -
 Purchases 18,000 - 18,000
 Goods from head office ____- 7,150 ____-
18,000 7,150 18,000
Less closing stock (1,500) (550) (2,000)
(16,500) (6,600) (16,000)
Gross profit 5,650 2,400 8,000
It can be seen that the combination of head office gross profit and branch gross profit do not give the
combined gross profit. This is because, from a combined entity perspective, the profit made by the
head office is deemed to be overstated. This is illustrated further below:

70
50
HO Br 100

If the head office buys an item for Kshs.50, transfers it to the branch at Kshs.70, and the branch sells
it off for Kshs.100, the head office made a profit of Kshs.20 (Kshs.70 - Kshs.50) and the branch
made a profit of Kshs.30 (Kshs.100 - Kshs.70). This agrees with the combined profit of Kshs.50
(sales Kshs.100 – costs Kshs.50).

However, consider the following:

70
50
HO Br

The head office buys an item for Kshs.50 and transfers it to the branch at Kshs.70. However the
branch is unable to sell it and quotes it as closing stock for Kshs.70. The head office has reported a
profit of Kshs.20; the branch reported no profit. The diagram clearly shows that the combined entity
has no profit. At this point, a new concept comes to light:

The head office cannot claim to make any profit by just moving its stock to its branch – where the
branch has not sold off the goods but is keeping them as closing stock.

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FINANCIAL ACCOUNTING III
 144 Branches

The overstated profit reported by the head office needs to be eliminated. It is known as unrealized
profit. In this example it is exactly equal to the overstatement in closing stock in the branch (difference
between ‗cost‘ to branch and original cost). The elimination of excess profit in the head office is
accomplished by showing an expense for the head office only.

Illustration 5
A and B are partners in a business. A runs a head office in Mombasa and B runs a branch in Malindi.
Separate books are maintained for the head office and the branch. Profits and loses are shared
equally. The trial balances as at 30 th June 2002 were as follows:

Head Office Branch

Sh Sh Sh Sh
Property plant and equipment (NBV) 760,000 308,000
Stocks at 1 July 2001:
- Head office at cost 560,000
- Branch at transfer price 340,000
Goods sent to branch/from head office 1,430,800 1,398,800
Debtors 348,960 78,080
Sales 3,880,400 2,388,000
Bank and cash 612,280 115,360
Purchases 3,918,000
Remittances 2,247,600 2,257,200
General expenses 680,000 400,000
Branch current a/c/ Head office current a/c 2,530,640 2,498,640
Creditors 324,680 10,800
Capital at 1 July 2001 (held equally) 1,492,400
Provision for unearned profit ________ 34,000 _______ _______
9,409,880 9,409,880 4,897,440 4,897,440

Notes:
a) Mombasa invoices goods to Malindi at cost plus one ninth
b) At 30th June 2002:

 Stocks at head office at cost Sh 508,000

 Stocks at the branch at transfer price Sh 192,000
 Stocks in transit at transfer price Sh 32,000
 Cash in transit to head office Sh 9,600

Required:
a) Prepare an incomes statement for the year ended 30 th June 2002 and statement of financial
positionas at that date, separately for

 The head office

 The branch
 The combined entity

b) Post and balance both current accounts.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 145

Tutorial note: As usual, it would be a better option to start with the current accounts as per the
standardized procedure. It may not be possible to complete them, but items in transit may be posted
to ensure that they have equal and opposite balances.

Branch current a/c

Sh Sh
Bal b/d 2,530,640 Remittance 2,247,600
Goods in transit 32,000
Cash in transit 9,600

Head office current a/c

Sh Sh
Remittance 2,257,200 Bal b/d 2,498,640

We know that the remittances had not been posted to the current accounts as yet because they are still
hanging in the trial balance.

A and B
Income statement for the year ended 30 th June 2002
Head office Branch Combined
Sh Sh Sh Sh Sh Sh
Sales 3,880,400 2,388,000 6,268,400
Goods sent to branch 1,430,800 _______- _______-
5,311,200 2,388,000 6,268,400
Cost of sales:
 Opening stock 560,000 340,000 866,000
 Purchases 3,918,000 - 3,918,000
 GFHO ______- 1,398,800 -___
4,478,000 1,738,800 4,784,000
Closing stock (508,000) (192,000) (709,600)
(3,970,000) (1,546,800) (4,074,400)
Gross profit 1,341,200 841,200 2,194,000
Decrease in provision for UP 11,600 - -
1,352,800 841,200 2,194,000
General expenses (680,000) (40,000) (1,080,000)
Net profit 672,800 441,200 1,114,000
Profit share: A 557,000
B 557,000
1,114,000

The current accounts can now be properly completed:

Head office current account

Sh Sh
Remittance 2,257,200 Bal b/d 2,498,640
Bal c/d 682,640 Branch profit 441,200
2,939,840 2,939,840
Bal b/d 682,640

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FINANCIAL ACCOUNTING III
 146 Branches

Branch current a/c

Sh Sh
Bal b/d 2,530,640 Remittance 2,247,600
Branch profit 441,200 Goods in transit 32,000
Cash in transit 9,600
________ Bal c/d 682,640
2,971,840 2,971,840
Bal b/d 682,640

A and B
Statement of financial position as at 30th June 2002
Head office Branch Combined
Sh Sh Sh Sh Sh Sh
ASSETS
Non-Current Assets
Property plant & equipment 760,000 308,000 1,068,000
Financial assets
 Investment in branch 682,640
 Less unearned profit (19,200)
663,440
1,423,440 308,000 1,068,000
Current Assets
Stocks in warehouses 508,000 192,000 680,800
Stocks in transit 32,000
Less unearned profit (3,200)
28,800 28,800
Debtors 348,960 78,080 427,040
Bank and cash in hand 612,280 115,360 727,640
Cash in transit 9,600 _____- 9,600
1,507,640 385,440 1,873,880
2,931,080 693,440 2,941,880
EQUITY AND
LIABILITIES
Head office current a/c 682,640
Capitals: A 1,303,200 1,303,200
B 1,303,200 1,303,200
2,606,400 2,606,400
Current liabilities
Creditors 324,680 10,800 335,480
2,931,080 693,440 2,941,880

Tutorial notes and workings:

Sh Sh
P & L (3) 11,600 Bal b/d (1) 34,000
Bal c/d (2) 22,400 _____
34,000 34,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 147

The provision for unearned profit can now be described as a provision similar to provision for bad
debts and provision for discounts allowed. When the amount of asset to be shown in the statement
of financial position is overstated, it may be reduced by means of a relevant provision. This is what
the provision for bad debts does to the overall value of debtors in the statement of financial position.

In this case the values of stocks that have been dispatched to the branch are above cost; i.e. values of
stocks that have been dispatched to the branch are above cost, i.e. overstated, as can be seen in the
computation for closing stocks:

Sh Sh
Stocks at head office 508,000
Stocks at branch at invoice price 192,000
Less unearned profit (19,200)
172,800
Stocks in warehouses (seen in statement of financial position) 680,800
Stocks in transit at invoice price 32,000
Less unearned profit (3,200)
28,800
Total stocks (seen in income statement) 709,600

The overstatement of stocks at the branch is reduced form the

investment in branch (statement of financial position) Sh 19,200

The overstatement of stock in transit is reduced from the item

itself (in the statement of financial position) Sh 3,200
_______
Item (2) in the provision for unearned profit account Sh 22,400

Item (3) which is the increase or decrease in provision will finally be transferred to the income
statement. It is the balancing figure n the provision account.

FOREING BRANCHES:

The head office my set up a branch in a foreign country. IAS 21 requires that the results of that
foreign branch to be translated into the local currency for the purpose of preparing the financial
statements for the whole business.

There are two main ways of translating the results of the branch ;

The functional currency method. (formerly temporal method)

Under this method, the branch is considered to be an extension of the head office and this is reflected
by the trading arrangement between the head office and branch.

In most cases the head office will send goods to the branch and the branch will remit the proceeds on
sale of these goods to the head office. Any exchange gain or loss arising from translating the results
of the branch is treated as profit and loss item reported as an income or an expense.

Presentation method (formerly closing rate or net investment method)

Under this method, the branch operates with a lot of degree of autonomy from the head office. This
position is reflected by the fact that there are fewer transactions taking place between the head office
and the branch.

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FINANCIAL ACCOUNTING III
 148 Branches

Any exchange gain or loss arising from translating the results of branch should be transferred to the
foreign exchange reserve.

NOTE: the functional currency method is normally used because in most cases the branch is an
extension of the head office and the presentation method should only be used if the examiner requires
so.

The following should be the exchange rates to be used in translating the balances of the branch under
each of the respective methods.

REF: Historical rate : Rate when transaction took place (e.g. rate when asset was acquired)
Closing rate : Rate on statement of financial position date (end of financial period)
Average rate : Average rate of or the financial period.
Actual rate : Actual rate on date of conversion of cash from the branch.
Specific rate : Rate agreed by head office and branch for goods transferred from head

Balance Functional currency Presentation

Method Method

Profit and loss items

Sales Average Average
Opening inventory Historical Average
Purchases Average Average
Goods transferred from head office Average/specific Average/specifi
c
Closing inventory – local purchases Historical Average
Goods from head office Average/specific Average/specifi
c
Depreciation Historical Average
Office expenses Average average

Statement of financial position items

Property, plant and equipment Historical Closing
Inventory – from local purchases Historical Closing
From head office Specific Specific
Receivables Closing Closing
Cash – at bank Closing Closing
- in transit Actual Actual
Payables Closing Closing
Head office current account – no translation but we take branch current account and deduct GIT
and CIT

The following steps should be followed in preparing the final accounts where we have a foreign
branch.

1. Update the trial balance of the branch that is given in the foreign currency with the following
items:
a) closing inventory DR Statement of financial position
CR profit and loss.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 149

b) Accrued or prepaid expenses. Accrual : DR. profit and loss (expense)

CR statement of financial position (liability)

Prepayment : DR. Statement of financial position (Asset)

CR Profit and loss (expense, income)

c) Depreciation: DR. Profit and loss (expense)

CR Statement of financial position (provision)

2 Translate the updated trial balance of the branch using the exchange rates given and depending
on the method of translation.
Once the trial balance has been translated into the local currency, the debit side may not be the
same as a credit side and balancing figure is the exchange gain or loss.
If the debit side is more than the credit side, then difference is an exchange gain and if the
credit side is more than the debit side then the difference is an exchange loss.

3 Prepare the final accounts of the branch in the normal way using the trial balance of the head
And the translated trial balance of the branch.

- Care should be taken on the treatment of the exchange gain or loss. The following points
should be applicable.

a) If the functional currency method is being used, then any exchange gain or loss will appear in
the column of the branch and the combined business in the profit and loss accounts. An
exchange gain will appear as other incomes under gross profit and exchange loss and expense in
the profit and loss account.

b) If the presentation method is being used, then the exchange gain or loss will be taken to a
foreign exchange reserve which will appear as part of capital and reserves in the statement of
financial position
of the branch and the combined business or added to the head office current account.

EXAMPLE
K Ltd established a branch in Arusha Tanzania on 1.1.X2, when Kshs 1 = TShs 15. PPE costing Kshs
800,000 were purchased on that day. In addition, cash of Shs 500,000 was sent to Arusha on 1.1.X2,
together with goods which had cost K Ltd Shs 1m. The Arusha branch sells HO goods and also
goods purchased in Tanzania.

Arusha Branch Trial balance as at 31.12.X2

Dr: TSH‘000 Cr: TSH‘000
PPE 12,000
Sales 48,000
Goods from head office 15,000
Purchases in Tanzania 15,000
Expenses 18,000
Receivables and Payables 2,000 1,000
Cash at bank 2,000
Remittances to Kenya 19,500
Head office current account _____ 34,500
83,500 83,500

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FINANCIAL ACCOUNTING III
 150 Branches

Additional information:
1) Inventory at 31 December 20X2 was valued at Tsh 6 million, being goods from HO.
2) Depreciation is to be charged at 10% on the cost of fixed assets.
3) Accrued expenses amounted to Tsh 1.5 million.
4) Prepaid expenses amounted to Tsh 1.8 million.
5) There was no closing inventory of goods purchased in Tanzania.
6) The remittance was made on 1 Oct 2002 and translated into Ksh 1,650,000.
7) Exchange rates during the year were:

31 Dec X2: Ksh 1 = Tsh 10

1 Oct X2: Ksh 1 = Tsh 11.82 (Approx)
Average for the year = Ksh 1 = Tsh 12

Required:
Income statements for the year to 31 December X2 and statement of financial positions as at that date
in

i. Tanzanian shillings
ii. Kenya shillings:
 Using the functional currency method of translation;
 Using the presentation method of translation.

[Tutorial note: All the relevant information in the notes to the trial balance will first be included in
the trial balance. The adjusted trial balance can then be translated.]

Translation of Arusha branch trial balance (functional currency method)

Original trial Rate Translated trial
balance balance
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
PPE 12,000 1/15 800
Sales 48,000 1/12 4,000
Goods from head office 15,000 1/15 1,000
Purchases in Tanzania 15,000 1/12 1,250
Expenses 17,700 1/12 1,475
Receivables & Payables 2,000 1,000 1/10 200 100
Cash at bank 2,000 1/10 200
Remittances to Kenya 19,500 ACT 1,650
Head office current a/c 34,500 ACT 2,300
Closing inventory (for statement of 6,000 1/15 400
financial position)
Closing inventory (for trading a/c) 6,000 1/15 400
Depreciation expense (P&L ) 1,200 1/15 80
Provision for depreciation (statement of 1,200 1/15 80
financial position)
Accrued expenses (statement of financial 1,500 1/10 150
position)
Prepaid expenses (statement of financial 1,800 1/10 180
position)
92,200 92,200 8,105 7,030

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 151

Exchange gain 205

7,235 7,235

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FINANCIAL ACCOUNTING III
 152 Branches

Translation of Arusha branch trial balance ((Presentation method)

Translated trial
Original trial balance Rate balance
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
PPE 12,000 1/10 1,200
Sales 48,000 1/12 4,000
Goods from head office 15,000 1/12 1,250
Purchases in Tanzania 15,000 1/12 1,250
Expenses 17,700 1/12 1,475
Receivables and Payables 2,000 1,000 1/10 200 100
Cash at bank 2,000 1/10 200
Remittances to Kenya 19,500 ACT 1,650
Head office current a/c 34,500 ACT 2,300
Closing inventory (for statement of 6,000 1/10 600
financial position0
Closing inventory (for trading a/c) 6,000 1/12 500
Depreciation expense (P&L ) 1,200 1/12 100
Provision for depreciation (statement of 1,200 1/10 120
financial position)
Accrued expenses (statement of financial 1,500 1/10 150
position)
Prepaid expenses (statement of financial 1,800 _____ 1/10 180 _____
position)
92,200 92,200 8,105 7,170
Exchange gain ____ _935
8,105 8,105

Arusha Branch
Income statement for the year to 31 December X2 (functional currency method)
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
Sales 48,000 4,000
Cost of sales:
 Goods from head office 15,000 1,000
 Purchases 15,000 1,250
30,000 2,250
Less closing inventory (6,000) (400)
(24,000) (1,850)
Gross profit 24,000 2,150
Exchange gain - 205
24,000 2,355
Expenses
General expenses 17,700 1,475
Depreciation 1,200 80
(18,900) (1,555)
Net profit 5,100 800

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 153

Arusha Branch
Income statement for the year to 31 December X2 (Presentation method)
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
Sales 48,000 4,000
Cost of sales:
 Goods from head office 15,000 1,250
 Purchases 15,000 1,250
30,000 2,500
Less closing inventory (6,000) (500)
(24,000) (2,000)
Gross profit 24,000 2,000
Expenses
General expenses 17,700 1,475
Depreciation 1,200 100
(18,900) (1,575)
Net profit 5,100 425

Arusha Branch
Statement of financial position as at 31 December X2 (Functional method)
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
ASSETS
Non-current assets
Property plant and equipment 10,800 720
Current Assets
Inventory s 6,000 400
Receivables 2,000 200
Prepayments 1,800 180
Bank 2,000 200
11,800 980
22,600 1,700
CAPITAL AND LIABILITIES
Head office current a/c 20,100 1,450
Current liabilities
Payables 1,000 100
Accruals 1,500 150
2,500 250
22,600 1,700

Head Office Current A/C (In Branch Books): Functional currency method
Tsh‘000 Ksh‘000 Tsh‘000 Ksh‘000
GFHO 15,000 1,000
Fixed Assets 12,000 800
Bal c/d 34,500 2,300 Cash 7,500 500
34,500 2,300 34,500 2,300
Remittance 19,500 1,650 Bal b/d 34,500 2,300
Bal c/d 20,100 1,450 Branch profit 5,100 800
39,600 3,100 39,600 3,100

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FINANCIAL ACCOUNTING III
 154 Branches

Arusha Branch
Statement of financial position as at 31 December X2 (Presentation method)
Tsh‘000 Tsh‘000 Ksh‘000 Ksh‘000
ASSETS
Non-current assets
Property plant and equipment 10,800 1,080
Current Assets
Inventory 6,000 600
Receivables 2,000 200
Prepayments 1,800 180
Bank 2,000 200
11,800 1,180
22,600 2,260
EQUITY AND LIABILITIES
Head office current a/c 20,100 2,010
Current liabilities
Payables 1,000 100
Accruals 1,500 150
2,500 250
22,600 2,260

Head Office Current A/C (in branch books):

Tsh‘000 Ksh‘000 Tsh‘000 Ksh‘000
GFHO 15,000 1,000
PPE 12,000 800
Bal c/d 34,500 2,300 Cash 7,500 500
34,500 2,300 34,500 2,300
Remittance 19,500 1,650 Bal b/d 34,500 2,300
Branch profit 5,100 425
Bal c/d 20,100 2,010 Exchange gain - 935
39,600 3,660 39,600 3,660

Example
On April 2001, Dolly Manufacturers Ltd opened a branch in Zumala, a foreign country whose
currency is the zuma (zm),to sell an assortment of dolls.The branch manager was authorised to
purchase local dolls for resale, but it was expected that the major proportion of the sales would be the
dolls supplied by the head office in Kenya.
On 31 March 2002, the trial balance of the head office and branch were as follows;

Trial balance as at 31 March 2002

Head Office Branch
Ksh Ksh Ksh Ksh
Share capital 50,000,000
Reserves 20,000,000
Profit and loss a/c 12,000,000
Premises at cost 45,000,000
Fixtures and fittings 16,000,000 94,500,000
Provision for dep. fixtures & fittings 6,400,000
Stock 1 April 2001 14,050,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 155

Debtors 17,550,000 35,100,000

Creditors 4,500,000 12,336,000
Bank balance 9,200,000 27,084,000
Cash in hand 980,000 8,598,000
Sales 101,090,000 277,233,000
Purchases 65,630,000 48,807,000
Goods sent to branch 13,520,000
Goods received from head office 156,500,000
Branch current account 15,900,000
Head office current account 129,350,000
Branch stock adjustment account 3,380,000
Administration expenses 19,250,000 28,514,600
Distribution expenses 7,330,000 ________ 19,815,400 _________
210,890,000 210,890,000 418,919,000 418,919,000

Additional information
1. Stock on hand as at 31 Macr 2002 was;

Stock on hand as at 31 March 2002 was

Head office Ksh.28,500,000
Branch;
From head office Zm.12,000,000
From local purchases Zm.9,775,000

2. Goods were invoiced by head office to branch at cost plus 23%. The branch sold the goods at
invoiced price plus 50%. Goods sent to branch from head office were converted at affixed rate
of 10 Zumas to 1 Ksh.
3. On 31 March 2002,goods in transit from head office to branch were at an invoiced value of
Ksh.1,250,000
4. A remittance of Zm 5,800,000 from branch to head office was in transit 0n 31 march 2002.The
remittance was converted at Zm.12.5 to Ksh.1
5. The fixtures and fittings were acquired when the exchange rate was Zm 10.5 to Ksh.1 on 1 July
2001.
6. Depreciation of the head office and branch fixtures and fittings is to be provided at the rare of
10% per annum on cost. A full year‘s depreciation should be provided branch fixtures and
fittinds.
7. The branch manager was to be allowed a commission of 2% on the sales of dolls supplied by
the head office.
8. Rates of exchange at other dates were;
9.
Zumus Ksh.
1 June 2001 10 to 1
31 March 2002 12 to 1
Average for the year 11 to 1
Date of purchase of closing stock 11.5 to 1
Required

(a). Trading, income statement in columar form for the head office, the branch and the combined
business for the year ended 31 March 2002. (12 marks)
(b). Statement of financial position of the office, branch and the combined business as at 31 March
2002 (8 marks)

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FINANCIAL ACCOUNTING III
 156 Branches

(Use the temporal method to translate branch balances into Kenya shillings)

Solution

Dolly Manufacturers
Trading, Profit and Loss account for the year ended 31 March 2002
HEAD OFFICE BRANCH COMBINED
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Sh. ‗000‘
Sales to customers 101,090 25,203 126,293
Goods sent branch 16,900 - -
117,990 25,203 126,293
Cost of sales
Opening inventory 14,050 - 14,050
Purchases 65,630 4,437 70,067
Goods from head office - 15,650 -
79,680 20,087 84,117
Closing inventory – in hand (28,500) (2,050) (30,310)
- in transit - 51,180 - 18,037 (1,000) (52,807)
66,810 7,166 73,486
GROSS PROFIT
Expenses
Provision for unrealized profit
- inventory at branch 240 - -
- goods in transit 250 - -
Administration expenses 19,250 2,592 21,842
Distribution costs 7,330 1,801 9,131
Depreciation on furniture 1,600 900 2,500
Managers commission - 394 394
Foreign exchange loss - (28,670) 1,005 (6,692) 1,005 (34,872)
NET PROFIT 38,140 474 38,614

Books of Head office

Branch current account
Sh. ‗000‘ Sh. ‗000‘
Balance b/d 15,900 Goodwill in transit 1,250
Branch profit 474 Cash in transit 464
_____ Balance c/d 14,660
16,374 16,374

Head office current account

Sh. ‗000‘ Sh. ‗000‘
Balance c/d 14,660 Balance b/d 14,186
_____ Profit - branch 474
14,660 14,660

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 157

Dolly manufacturers
Statement of financial position as at 31 March 2002
HEAD OFFICE COMBINED
BRANCH
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
NON-CURRENT ASSETS
Premises 45,000 - 45,000
Fixtures and fittings 16,000 9,000 8,100 25,000
Depreciation on furniture (8,000) 8,000 (900) (8,900) 16,100
Branch current account 14,660 - - -
Less U.P at branch (240) 14,420 - 8,100 - -
67,420 61,100

CURRENT ASSETS
Inventory – in hand 28,500 2,050 30,310
- in transit 1,000 - 1,000
Receivables 17,750 2,925 20,475
Cash at bank 9,200 2,257 11,457
In transit 464 - 464
980 57,694 717 7,949 1,697 65,403
In hand 125,114 16,049 126,503

Ordinary share capital 50,000 - 50,000

Reserves 20,000 - 20,000
Retained profits 50,614 - 50,614
Head office current a/c - 14,660 -
Shareholders funds 120,614 14,660 120,614

CURRENT LIABILITIES
Payables 4,500 1,028 5,528
Manages commission - 4,500 361 1,389 361 5,889
125,114 16,049 126,503

Workings:

Managers commission In z ‗000‘

Goods from head office 156,500
Less closing inventory (12,000)
Cost of sales for goods from head office 144,500
Add mark-up at 50% 72,250
Sales for goods from head office 216,750
Commission at 2% 4,335

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FINANCIAL ACCOUNTING III
 158 Branches

Workings functional method

Z ‗000‘ Z ‗000‘ E rate Ksh. ‗000 Ksh. ‗000‘

Fixtures and fittings – cost 94,500 X 9,000
1/10.5(H.R)
Receivables 35,100 X 1/12 (C.R) 2,925
Payables 12,336 X 1/12 (C.R) 1,028
Bank 27,084 X 1/12 (C.R) 2,257
Cash in hand 8,598 X 1/12 (C.R) 717
Sales 277,233 X 1/11 (A.R) 25,203
Purchases 48,807 X 1/11 (A.R) 4,437
Goods from head office 156,500 X 1/10 (S.R) 15,650
Head office current a/c 129,350 Branch C/A 14,186
–G.I.T-C.I.T
Administration expenses 28,515 X 1/11 (A.R) 2,592
Distribution expenses 19,815 X 1/11 (A.R) 1,801
Closing inventory - B/s from 12,000 X 1/10 (S.R) 1,200
Head office
Local purchase 9,775 X 1/11.5 850
(H.R)
Profit & loss from head office 12,000 X 1/10 (S.R) 1,200
Local purchase 9,775 X 1/11.5 850
(H.R)
Depreciation Profit & loss 9,450 X 1/10.5 900
(expense) (H.R)
B/s –(provision for 9,450 X 1/10.5 900
depreciation) (H.R)
Managers commission - 4,335 X 1/11 (C.R) 394
profit & loss (expense)
B/s (accrual 4,335 X 1/12 (C.R) 361
Exchange loss (bal figure) - - 1,005 _____
454,479 454,479 43,728 43,728

Z ‗000‘ Z ‗000‘ E rate Ksh. ‗000 Ksh. ‗000‘

Fixtures and fittings – cost 94,500 X 9,000
1/10.5(C.R)
Receivables 35,100 X 1/12 (C.R) 2,925
Payables 12,336 X 1/12 (C.R) 1,028
Bank 27,084 X 1/12 (C.R) 2,257
Cash in hand 8,598 X 1/12 (C.R) 717
Sales 277,233 X 1/11 (A.R) 25,203
Purchases 48,807 X 1/11 (A.R) 4,437
Goods from head office 156,500 X 1/10 (S.R) 15,650
Head office current a/c 129,350 Branch C/A 14,186
–G.I.T-C.I.T
Administration expenses 28,515 X 1/11 (A.R) 2,592
Distribution expenses 19,815 X 1/11 (A.R) 1,801
Closing inventory - B/s from 12,000 X 1/10 (S.R) 1,200
Head office

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 159

Local purchase 9,775 X 1/12 (C.R) 850

Profit & loss from head office 12,000 X 1/10 (S.R) 1,200
Local purchase 9,775 X 1/11 (A.R) 889
Depreciation Profit & loss 9,450 X 1/11 (A.R) 900
(expense)
B/s –(provision for 9,450 X 1/12 (C.R) 788
depreciation)
Managers commission - 4,335 X 1/11 (A.R) 394
profit & loss (expense)
B/s (accrual 4,335 X 1/12 (C.R) 361
Exchange loss (bal figure) - - 2,133 _____
43,655 43,655

Under presentation method, the final accounts will be prepared the same way as before. However, the
exchange loss of sh.2,133 will appear as a negative reserve in the statement of financial position of the
branch and the combined business.

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FINANCIAL ACCOUNTING III
 160 Branches

REINFORCEMENT QUESTIONS
QUESTION ONE
B LTD, whose head office is in Mombasa, operates a branch at Malindi. All goods are purchased by
head office and invoiced to and sold by the branch at cost plus 33 1/3%. Other than a sales ledger kept
in Malindi, all transactions are recorded in the books in Mombasa. The following particulars are given
of the transactions at the branch during the year ended 30th June 20X7.

Shs
Stock on hand, 1st July 20X6 at invoice price 308,000
Debtors on 1st July 20X6 276,220
Stock on hand, 30th June 20X7 at invoice price 276,360
Goods sent from Mombasa during the year at invoice price 1,736,000
Credit sales 1,470,000
Cash sales 168,000
Returns to head office at invoice price 70,000
Invoice value of goods stolen 42,000
Bad debts written off 10,360
Cash from debtors 1,568,000
Normal loss at invoice price due to wastage 7,000
Cash discount allowed to debtors 29,960

Any further loss should be treated as a loss of cash.

You are required to write up the Branch Stock Account, the Branch Mark-up Account and Branch
Total Debtors Account for the year ended 30th June 20X7 as they would appear in the head office
books.
(Total: 15 marks)
QUESTION TWO
DLimited has a head office in Nairobi and a branch in Bungoma. The following information has
been extracted from the head office books of account as at 31 st March 20X6.

Information relating to the branch

Balances Opening Closing
Shs‘000 Shs‘000
Branch bank account (positive balance) 30 120
Branch debtors 660 810
Branch stock (at transfer price) 750 900
Transactions during the year Shs‘000
Bad debts written off 150
Branch general expenses (paid from bank branch account) 420
Cash received from credit customers and banked 3,900
Cash sale banked 1,200
Cash transferred from branch to head office bank account 4,590
Credit sales 4,370
Discounts allowed to credit customers 90
Goods returned by credit customers 80
Goods returned from branch (at transfer price from head office) 300
Goods sent to branch (at transfer price from head office) 6,000
INFORMATION RELATING TO HEAD OFFICE

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 161

Balances
Opening Closing
Shs‘000 Shs‘000
Stock 1,800 2,200
Transaction during the year Shs‘000
Bad debts written off 240
Cash sales 15,000
Credit sales 20,000
Discounts allowed to credit customer 290
General expenses 4,100
Goods returned by credit customers 400
Purchases 27,800

Additional information:
1. Most of the accounting records relating to the branch are kept by the head office in tis own books
of account.
2. All purchases are made by the head office, and goods are invoiced to the branch at selling price,
that is, at cost plus 50%.

Required:
a. Write up the following ledger accounts for the year to 31 st March 20X6, being careful to bring
down any balances as at that date:

1. Branch stock account;

2. Goods sent to branch account;
3. Branch stock adjustment account;
4. Branch debtors account; and
5. Branch bank account.

b. Compile D Limited‘s Income statement for the year to 31st March 20X6 showing the turnover,
gross profit and net profit for the head office, the branch and the enterprise as a whole.
c. Examine briefly the merits and demerits of D Limited‘s method of branch bookkeeping including
comments on the significance of the ‗balance figure‘ in the branch stock account.

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FINANCIAL ACCOUNTING III
 162 Branches

QUESTION THREE

The following balances were extracted from the books of K Limited which has a head office in
Nairobi and a branch in Nakuru.

NAIROBI NAKURU
(Head office) (BRANCH)
Dr Cr Dr Cr
Shs 000 Shs 000 Shs 000 Shs 000
Issued share capital 700,000
(35,000 ordinary shares of Shs 20 each)
Unclaimed commission 5,000
Profit and loss account 150,000
General reserve 100,000
Current accounts (1st June, 20X1) 124,000 124,000
Goods from Nairobi to Nakuru (at cost) 350,000 350,000
Purchases 1,050,000 660,000
Sales 1,360,000 860,000
Stock (1st June 20X1) 260,000 90,000
Remittances from Nakuru 550,000 600,000
Sundry debtors and creditors 170,000 47,000 6,000 48,000
Furniture and fittings 280,000 50,000
Rent and rates 10,000 14,000
Salaries and wages 130,000 80,000
Staff commission paid 8,000 6,000
Water and electricity 28,000 15,000
Advertising 13,000 2,000
Sundry expenses 18,000 5,000
Motor vehicles 155,000 35,000
Cash at bank 216,000 _______ _______ 174,500
2,912,000 2,912,000 1,563,000 1,563,000

The following information is also available:

i. The staff of K Limited are entitled to a commission equal to 12% of the net profit before
charging directors‘ fees, provision for doubtful debts and such commission.
ii. Depreciate furniture and fittings at 12 ½% per annum and motor vehicles at 25% per annum
iii. Provide a dividend of 20 % on the issued capital.
iv. Directors‘ fees payable by the head office amounted to Shs 35,000.
v. Make a provision for doubtful debts of 5% on the sundry debtors.
vi. Transfer Shs 40,000 to the general reserve.
vii. The branch purchases include goods transferred from head office
viii. Closing stock, Nairobi Head office – Shs 320,000, Nakuru branch – Shs 85,000.

Required:
Prepare the Trading and Profit and Loss Accounts in columnar form, the Appropriation Account, for
the year ended 31st May, 20X2 and the statement of financial position as at that date, for the Head
office, the Branch and the overall company.
(Total: 25 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 163

QUESTION FOUR
Maina commenced business on 1st January 20X9 at a head office and at one branch. Purchases were
made exclusively by head office where all goods were processed before sale. There was no loss nor
wastage in the processing. Only processed goods received from head office were handled by the
branch and these were charged thereto at processed cost plus 10%. All sales whether by head office
or the branch were at a uniform gross profit of 25% on the processed cost.

The following trial balances as on 31st December 20X9 were extracted from the books before
adjusting for any of the matters referred to below:

Head office Branch

Shs 000 Shs 000 Shs 000 Shs 000
Maina – capital 15,500
Drawings 2,750
Purchases 98,475
Cost of processing 2,525
Sales 64,000 41,000
Goods sent to/received by branch 46,200 44,000
Selling and general expenses 9,450 1,060
Debtors/creditors 15,480 30,070 5,680 540
Head office/branch
Current account 19,490 13,075
Balance at bank 7,600 3,875
155,770 155,770 54,615 54,615

You ascertain that:

1. Goods charged by head office to the branch in December 20X9, at Shs. 2.2m were not received
or recorded by the branch until January 20X0, and a remittance of shs 4.215m from the branch
to head office in December 20X9 was not received or recorded at head office until January
20X0. Any necessary adjustments in respect of these items are to be made in the head office
accounts.
2. Stock taking at the branch disclosed a shortage of goods of a selling value of Shs 1m. There
was no shortage or surplus at head office.
3. The cost of the stock of unprocessed goods at head office on 31st December 20X9 was Shs 5m.

For the purpose of the separate trading account of the head office, stocks are valued at cost. In the
case of the separate account of the branch, stocks are to be valued at the price charged by head office.
Any necessary adjustments are to be made in the head office profit and loss account.

You are required to prepare in columnar form for:

i. The head office ii. The branch and iii. The business as a whole:

a. Trading and Profit and loss accounts for the year ended 31st December 20X9 and,
b. Statement of financial positions as on that date. (Ignore taxation)
(Total: 24 marks)

QUESTION FIVE

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FINANCIAL ACCOUNTING III
 164 Branches

Antiquarius Ltd is a company which deals in antiques. The Company is based in London and operates
in the UK, but also has a profitable outlet in San Francisco, California, which is managed by one of
the directors on his frequent trips to the States. Separate records are kept of the outlet‘s transactions b
the American staff.

The following trial balances were extracted from the books of Antiquarius Ltd at 31 December 2003

London San Francisco

£ £ $ $
Share capital 20,000
Retained Profits as at1 January 2003 20,200
Lease hold premises 15,000 40,000
Amortization of lease 7,000 8,000
Delivery vans, at cost 12,000 10,000
Provision for dep‘n on delivery vans 6,000 5,000
Opening inventory, at cost 8,620 12,460
Accounts receivable 3,869 6,293
San Francisco current account 22,600
London current account 44,400
Sales 78,318 116,308
Transfers to San Francisco 21,600
Purchases 70,066 21,800
Transfers form London 38,620
Administration expenses 2,386 3142
Salaries and wages 17,420 23,500
Selling and delivery costs 5,485 8,940
Provision for unrealized profit 500
Cash at bank 6,923 13,879
Accounts payable ______ _10,751 ______ __4,926
164,369 164,369 178,634 178,634

You are given the following additional information:

(a) Transfers of goods from London to San Francisco are made at cost plus 20%.
(b) The average rate of exchange during the year was $1.80 to the £. The rates of exchange at 1
January 2003 and 31 December 2003 were $2.00 and $1.60 to the £ respectively.
(c) Inventory of antiques on hand at 31 December 2003 were:

London £ 12,470
San Francisco (including $9,180 of goods sent $15,240
from London when the rate of exchange was
$1.70)
(d) Salaries and wages for London include director‘s emoluments of £8,000 of which £3,200 is to
be charged to the US outlet at the rate of exchange of $1.60 to the £1.
(e) Administration expenses accrued but not yet taken into account amount to:
London £800
San Francisco $760
(f) When the leasehold premises and delivery vans were acquired in San Francisco the rate of
exchange was $2.20 to the £.
(g) Depreciation is to be provided for the year on the vans at 25% of cost, and the leases are to
be amortized by equal amounts written off over the periods of the leases, which are:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Three 165

London 15 years
San Francisco 10 years
(h) On 31 December 2003 London office had shipped a regency bureau to San Francisco at a
value of £900. Although they recorded as a transfer in the London books no entry was made
in the books in San Francisco until it was received on 20 January 2004.

You are required to prepare for the year ended 31 December 2003

(a) The trial balance of the San Francisco outlet, converted at ‗historic rate‘, after making the year end
adjustments, and indicating clearly the rates of the conversion used.
(3 marks)
(b) The income statement of London, San Francisco and the combined business in columnar form.
(10 marks)
(c) The statement of financial position of the combined business (7 marks)
(Total: 20 marks)

END OF REINFORCING QUESTIONS

NOW CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY
PACK

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FINANCIAL ACCOUNTING III
 166 Group Accounts

LESSON FOUR

GROUP ACCOUNTS

OBJECTIVES
After studying this lesson you should:

 Understand why group accounts are prepared;

 Know the Companies Act and the international Accounting Standards requirements in relation
to the preparation of group accounts;
 Know how to prepare the consolidated Statement of financial position of a group of
companies,
 Know how to prepare the consolidated Income statement of a group of companies,
 Know how to prepare the consolidated cash flow stament and the treatment of Associate
cpmpanies in group accounts.

CONTENTS
 Read the Study Text below.
 Attempt the reinforcing questions at the end of the Lesson.
 Compare your solutions with those given in Lesson 9.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 167

4.1 INTRODUCTION:

A company can have investments in other companies in the form of : ordinary shares, preference shares
and loan stock. The investment in ordinary shares leads to ownership and therefore requires further
consideration. The investment in the ordinary shares can be summarized diagrammatically as follows;

> 50% O.S.C

A

50% O .S. C
B

THE FIRM
<50% but>=20% O.S.C

<20% O. S. C
D

NOTE;

1. Company A is referred to as a subsidiary company and is accounted as per the requirements of

1AS 27 ― subsidiary company and separate financial statements.‖

2. Company B is a jointly controlled entity and is accounted for according to the requirements of
1AS 31 ―joint ventures‖.

3. Company C is an Associate company and is accounted for as per requirements of 1AS/28

―Associate companies‖.

4. Company D is a pure investment accounted for as per requirements of 1AS 32 and 39 ―financial
instruments.
Jointly controlled entities and pure investments are beyond scope.

SUBSIDIARY COMPANIES (1AS 27)

A subsidiary company is a company in which the investing company (also called holding or parent
company) controls the financial and operating policies of the subsidiary company.

In most cases, control is evidenced (but not limited) to owning more than 50% of the ordinary share
capital of the subsidiary company. Control may also be exercised in the following ways;

i) The holding company owing more than 50% or the voting rights in the company or subsidiary
company.

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FINANCIAL ACCOUNTING III
 168 Group Accounts

ii) The holding company being able to appoint majority of the directors in the board of directors.
iii) The holding company carrying out favourable transactions with the subsidiary e.g. sale and
purchase of goods at a price below the market value.

The substance of the relationship between holding company and subsidiary company is the effectively,
the holding company controlls the subsidiary company. This means that the holding company
controll the assets of the subsidiary company and is liable to the debts of the subsidiary company.

1AS 27 therefore requires that the holding a company should include the financial results of the
subsidiary company in its own financial statements. The process involves adding the assets, liabilities
and incomes and expenses of the subsidiary company to those of the holding company while
excluding inter-company transactions and balances. This process is called consolidation and the
combined financial statements are called Group accounts or consolidated accounts.

1AS 27/IAS 1 require the holding company to present the following in its published financial
statements.

i) A consolidated income statements

ii) A consolidated statement of changes in equity
iii) A consolidated statement of financial position
iv) A consolidated cash flow accounts
v) Group notes to the accounts.

1AS 27 also requires the holding company to present its own financial statements separately ie
excluding the subsidiary company.

1 CONSOLIDATED STATEMENT OF FINANCIAL POSITION

The consolidated statement of financial position involves adding assets and liabilities of the
subsidiary to those of the holding company while excluding inter-company balances. The
following points need to be considered in preparing the consolidate statement of financial
positions.

i) Good will on consolidation

Good will on consolidation arises when the purchase consideration paid by the holding company
is different from the value of the net assets acquired in the subsidiary company.

If purchase consideration is more than net assets acquired, then the difference is positive goodwill
and if purchase considered is less than net assets acquired, then the difference is negative
goodwill.

Goodwill will thus be computed in the following two ways;

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 169

Method 1

£ £
Cost of investment in subsidiary xx
less:
Ordinary share capital of subsidiary x
Capital reserves or date of acquisition x
Revenue reserves (retained profits) on date of acquisition x
Shareholders funds on date of acquisition xx
Holding company shares acquired (x)
GOODWILL POSITIVE/NEGATIVE xx

Method 2

£
Cost of investment in subsidiary xx
Less: share of net assets acquired (on date of acquisition) (x)
xx/(xx)

NOTE : Total assets less total liabilities i.e. net assets is the same as shareholders funds. The most
common approach used in computing goodwill is by preparing an account called cost of
control whereby the cost of investment is posted on the debit side and the holding company
share of the ordinary share capital, capital reserves and revenue reserves on the date of
acquisition in the subsidiary company are posted on the credit side. The balancing figure in
that account is goodwill.

ii) Minority interest (MI)

When the holding company owns less than 100% of the ordinary share capital of the subsidiary
company then the other balance is held by minority interest. Therefore if the holding company
owns 80% of the ordinary share capital of the subsidiary then the minority interest owns 20%.
The minority interest (M.I) should be shown separately in the consolidated statement of financial
position but as part of shareholders funds and the figure to appear in the statement of financial
position will be made up of the following.

-Minority interest share of the ordinary share capital in subsidiary on statement of financial
position date
-Minority interest share of capital reserves in subsidiary company on statement of financial
position date
-Minority interest share of revenue (retained profits) in subsidiary company on statement of
financial position date.

Alternatively, the total due to the minority interest can be prepared by opening the Minority Interest
account whereby the Minority interests share of the osc, capital reserves and retained profits in
subsidiary company is posted to the credit side.

iii)Group retained profits

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FINANCIAL ACCOUNTING III
 170 Group Accounts

Retained profits ideally should be the amounts that can be distributed as dividends. Therefore, in
arriving at group retained profits, careful attention should be paid to the profits of the subsidiary
company. all the profits of the holding company can be distributed or are distributable.

However, the subsidiaries profits belong to both the holding company and the minority interest.
Thus the share that belongs to the minority interest will be transferred to the Minority interest‘s
account.

The remaining profits that belong to the holding company should be split between pre-acquisition
profits and post acquisition profits.

The pre acquisition profits are the profits in the subsidiary company on the dare of acquisition
and are thus used in computing goodwill.

The post acquisition profits relate to the period after acquisition and can thus be distributed or
can be paid out to the shareholders of the holding company. They should thus form part of the
group retained profits.

In summary, the group-retained profits is made up of: -

£
Holding company‘s retained profits x
Add: Holding company‘s share of post acquisition retained profits In subsidiary company x
xx

iv) Preference share capital in subsidiary (irredeemable)

Investment in preference shares does not lead to ownership and therefore, if the holding
company owns part of the preference share capital in subsidiary company then, the percentage
will not be the basis of consolidation.

However, the asset of investment in preference shares and the percentage of preference shares
acquired will still be used to compute goodwill arising on consolidation.

The other statement of financial position is due to the minority interest and will thus be included
as part of total due to minority interest or posted to credit side of minority interest account.

vi) Loan stock in subsidiary

The holding company may also invest in the loan stock of the subsidiary company or part of the
loan stock of the subsidiary company. The cost of the loan stock to the holding company will
not be used to compute goodwill but instead should cancel out with the liability appearing in the
subsidiary company such that in the consolidated statement of financial position, only the loan
stock held by 3rd parties in the group will appear.

Group loan stock will thus be given as follows: -

£ £
Loan stock appearing holding company statement of financial position x

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 171

Add: Loan stock appearing in subsidiary company statement of x

financial position
Less: Loan stock of subsidiary company held b holding company (x)
Group loan stock x

Steps in preparing the consolidated statement of financial position

Step 1

Prepare the 3 important accounts i.e. - cost of control to determine goodwill

- Group retained profits
- Minority interest
Step 2
Add the assets and liabilities of the subsidiary company to those of the holding company noting the
following:

a) The investment in subsidiary company appearing in the holding company statement of financial
position will be excluded from the consolidated statement of financial position and instead we will
have goodwill on consolidation.
b) The ordinary share capital and preference share capital in consolidated statement of financial
position will only be that of the holding company. This is because the share capital of the holding
company and the subsidiary is split between the cost of control (holding companies share) and the
Minority interest.
c) The group retained profits will be the balance appearing in the group retained profits account and
group capital reserves should also be completed the same way company group retained profits.
(This means that group capital reserves will be made up of the holding company‘s capital reserves
plus holding companies share of post acquisition capital reserves in subsidiary).
d) The minority interest will be shown as part of shareholders funds in consolidated statement of
financial position but this is after getting the sub-total of the ordinary share capital, preference-
share capital, group capital reserves and group retained profits.

Example:

H Ltd owned S Ltd since the date of incorporation of S Ltd. The statement of financial positions of the two
companies
as at 31 December 20X2 is as follows.

H Ltd S Ltd
Non Current assets £ £ £ £
Tangible - PPE 35,000.00 45,000.00
Investment in S Ltd 45,000.00
80,000.00 45,000.00
Current assets
Inventory 16,000.00 12,000.00
Accounts receivables 8,000.00 9,000.00
Cash at bank 1,000.00 25,000.00 - 21,000.00
TOTAL ASSETS 105,000.00 66,000.00

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FINANCIAL ACCOUNTING III
 172 Group Accounts

Share Capital 70,000.00 40,000.00

Retained profits 11,000.00 19,000.00
81,000.00 59,000.00

Non Current
Liabilities
10% Loan Stock 10,000.00 -

Current Liabilities
Bank Overdraft - 3,000.00
Accounts Payable 14,000.00 14,000.00 4,000.00 7,000.00
105,000.00 66,000.00

Required;
Prepare the consolidated statement of financial position of H Ltd and S Ltd as at 31 December 20X2

Solution

Consolidate Statement of financial position of H and S Ltd.. As at 31 December 20x2

NON-CURRENT ASSETS £ £
Property, plant and equipment (35+45) 80,000
Goodwill 5,000
85,000

CURRENT ASSETS
Inventory (16+12) 28,000
Accounts receivable(8+9) 17,000
Cash at bank 1,000 46,000
TOTAL ASSETS 131,000
Ordinary share capital 70,000
Retained profits 30,000
100,000

NON-CURRENT LIABILITIES
10% Loan stock 10,000

CURRENT LIABILITIES
Bank overdraft 3,000
Accounts payables 18,000 21,000
TOTAL EQUITY AND LIABILITIES 131,000

WORKINGS

NOTE:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 173

H owns S Ltd. since date of incorporation thus:

It owns 100% of S Ltd.. (No minority interest)

There are no pre-acquisition profits (all the profits of share capital are distributable)

Cost of control
£ £
Investment in S 45,000 OSC (40,000 x 100%) 40,000
_____ Goodwill (balance figure) 5,000
45,000 45,000

Group retained profits

£ £
Balance c/d 30,000 H Ltd.. 11,000
_____ S Ltd.. 19,000
30,000 30,000

Example
Set out below are the draft statement of financial positions of H Ltd and it's subsidiary S Ltd as at 31
December 20X2.

H Ltd S Ltd
Non Current assets £ £ £ £
Tangible - PPE 50,000.00 40,000.00
Inv. S Ltd OSC 12,000.00
PSC 10,000.00
Loan
Stock 5,000.00 27,000.00
77,000.00 40,000.00
Current assets
Inventory 12,000.00 10,000.00
Accounts receivables 8,000.00 4,000.00
Cash at bank 3,000.00 23,000.00 2,000.00 16,000.00
TOTAL ASSETS 100,000.00 56,000.00

Share Capital OSC 50,000.00 30,000.00

PSC 10,000.00 12,000.00
Retained profits 20,000.00 4,000.00
80,000.00 46,000.00

Non Current Liabilities

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FINANCIAL ACCOUNTING III
 174 Group Accounts

10% Loan Stock 10,000.00 6,000.00

Current Liabilities
Accounts Payable 10,000.00 4,000.00
100,000.00 56,000.00

Additional information:
H Ltd acquired 60 % of the Ordinary Share capital of S Ltd when the retained profits
Amounted to £1,000, 40% of the Preference Share Capital and part of the 10% loan
Stock.

Required :
Prepare the consolidated statement of financial position of H Ltd and it's Subsidiary S Ltd as at 31
December 20X2

Solution

H Ltd.. And its subsidiary

NON-CURRENT ASSETS £ £
Tangible PPE 90,000
Goodwill (1,400)
88,600

CURRENT ASSETS
Inventory 22,000
Accounts receivables 12,000
Cash at bank 5,000 39,000
127,600

Ordinary share capital 50,000

Preference share capital 10,00
Retained profits 21,800
81,800
Minority interest 20,800
Shareholders funds 102,600

NON-CURRENT LIABILITIES
10% loan stock 11,000

CURRENT LIABILITIES
Accounts payables 14,000
127,600
Workings:

Group retained profits

£ £

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 175

C.O.C – P & L at Acquisition 600 H. Ltd.. 20,000

Minority interest in S 1,600 S Ltd.. 4,000
Balance c/d 21,800 _____
24,000 24,000

Group Loan Stock

£ £
Investment S – Loan 500 H Ltd.. 10,000
Balance c/d 11,000 S. Ltd. 6,000
21,000 21,000

Cost of control
£ £
Investment in S – O.S.C 12,000 O.S.C (60% x 30,000) 18,000
P.S.C 10,000 P.S.C (40% x 12,000) 4,800
Goodwill 14,000 P & L (60% x 1,000) 600
23,400 23,400

Minority interest
£ £
Balance c/d 20,800 O.S.C (40% x 130,000) 12,000
P. S. C (60% x 12,000) 7,200
_____ P & L (40% x 4,000) 1,600
20,800 20,800

Group retained profits is made up of:-

£
H. Ltd. 20,000
H. Ltd.. Share of post acquisition profits in S (60% x (4,000 – 1,000) 1,800
21,800

Example
H Ltd Acquired S Ltd a few years ago when the Capital and Retained profits stood at £5,000 and
£6,000 respectively.

The following statement of financial positions relate to the two companies as at 30 June 20X3.

H Ltd S Ltd
Non Current assets £ £ £ £
Tangible - PPE 50,000.00 40,000.00
20,000 Ordinary shares in S Ltd 30,000.00

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FINANCIAL ACCOUNTING III
 176 Group Accounts

80,000.00 40,000.00
Current assets
Inventory 3,000.00 8,000.00
Accounts receivables 20,000.00 17,000.00
Cash at bank 2,000.00 25,000.00 - 25,000.00
TOTAL ASSETS 105,000.00 65,000.00

Ordinary Shares of £1 each 45,000.00 25,000.00

Capital Reserves 12,000.00 5,000.00
Retained profits 30,000.00 23,000.00
87,000.00 53,000.00

Current Liabilities

Accounts Payable 18,000.00 12,000.00

105,000.00 65,000.00

Required :
Prepare the consolidated statement of financial position of H Ltd and it's Subsidiary S Ltd as at 30 June 20X3

Solution

H Ltd. And Its Subsidiary

Consolidated Statement of financial position as at 20 June 20x3
£ £
NON-CURRENT ASSETS
Tangible – PPE 90,000
Goodwill 1,200
91,200

CURRENT ASSETS
Inventory 11,000
Receivables 37,000
Cash at bank 2,000 50,000
141,200

Ordinary share capital 45,000

Capital reserves 12,000
Retained profits 43,600
100,600
Minority interest 10,600
Shareholders funds 111,200

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 177

CURRENT LIABILITIES
Payables 30,000
141,200

Group retained profits

£ £
P & L at acquisition 4,800 H. Ltd. 30,000
Minority interest 4,600 S. Ltd. 23,000
Balance c/d 43,600
53,000 53,000

Group capital reserves

£ £
C.O.C capital reserves at acquisition 4,000 H. Ltd. 12,000
M I ‗s share of P&L in S 1,000 S. Ltd. 5,000
Balance c/d 12,000 _____
17,000 17,000

Remember that the holding company has bought 20,000 shares out of the 25,000 shares that the
subsidiary company has issued. Therefore the percentage acquired is 80%.

Cost of control
£ £
Investment in S 30,000 O.S.C (80% x 25,000) 20,000
Capital (80% x 5,000) 4,000
P & L (80% x 600) 4,800
_____ Goodwill 1,200
30,000 30,000

Minority interest
£ £
Balance c/d 10,600 O.S.C (20% x 25,000) 5,000
P. S. C (20% x 5,000) 1,000
_____ P & L (20% x 23,000) 4,600
10,600 10,600

INTRA COMPANY ADJUSTMENTS

In preparing the consolidated statement of financial position, the following items may require
adjustments:.

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FINANCIAL ACCOUNTING III
 178 Group Accounts

1 Goodwill
2 Unrealized profit on closing inventory
3 Unrealized profit on PPE
4 Inter company balances
5 Proposed dividends by subsidiary
6 Fair value of subsidiaries net assets on date of acquisition

1 GOODWILL
Previously under IAS 22 on Business combinations, goodwill on consolidation used to be
amortized over an estimated period of years. However, IFRS 3 (still on business combinations)
prohibits the amortization Goodwill and instead requires;

a) Positive goodwill to be carried in the accounts at cost and incase the management feels there‘s
been a loss of value (impairment), then it should be charged as an expense.

For the consolidated statement of financial position, the relevant entry is ;

DR. Group retained profits
CR. Cost of control (with the impairment)

b) Negative goodwill should be reported as income immediately.

Relevant entries are;;
DR. Cost of control
CR. Group profit and loss/retained profits (with the full negative goodwill)

2 UNREALIZED PROFIT ON CLOSING INVENTORY

Where one company has bought goods from another company in the group and part of these
goods are included in the closing inventory, then the selling company is reporting an unrealized
profit.

An entry is thus required to reverse the unrealized profit and the overstatement in closing
inventory.

The following situation will apply;

a) If the holding company made the sale,

DR. Group retained profits
CR. Group closing inventory
(with the full unrealized profits).

b) If Subsidiary company made the sale:

DR. Group retained profits (with holding company share of UP)
DR. Minority Interest (With minority Interest share of U.P)
CR. Group closing inventory (with the full UP)

NOTE:

Where the subsidiary is company makes the sale, its profits are overstated with the
unrealized profit and the subsidiary‘s profit belong to both holding company and minority

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 179

interest. Therefore the reversal of the unrealized profit in the situation will also affect the
Minority interest.

3 Unrealized profit on Property, Plant and Equipment

Where one company sells an item of PPE to the other company in the group then, this will
lead to two main problems.

a) The selling company will report on unrealized profit because the item of PPE is still used
within the group. Whereas the PPE of the buying company will be overstated by the
unrealized profit.

An entry is thus required to reverse the unrealized profit and the overstatement. Relevant
entries

i) If the holding company made the sale

DR. Group retained profits
CR. Group PPE
(With the full unrealized profit)

ii) If the subsidiary company made the sale,

DR. Group retained profits (with holding company‘s share of unrealized profit)
DR Minority interest (With unrealized profit)
CR. Group PPE (With the full unrealized profit)

b) The buying company will charge excess depreciation due to the inflated price of PPE
(excess depreciation is the difference between charged to date based on the actual cost of
PPE)

This means, that the profits of the buying company are understated and PPE is also
understated due to the excess depreciation.

An entry is thus required to write back the depreciation and also the reserve the
understatement of the PPE. The following entries are relevant:

If the holding company made the sale and thus the subsidiary company is charging the
excess depreciation.

DR Group PPE (With the full excess depreciation)

CR. Group retained profits (with holding company share of excess depreciation)
CR M2 (With the minority‘s share of excess depreciation)

If subsidiary company made the sale and thus holding company is charging the excess
depreciation,

DR Group PPE
CR Group retained profits
(With the full excess depreciation)

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FINANCIAL ACCOUNTING III
 180 Group Accounts

4 Inter Company balances

One of the companies may appear as receivable (debtor) or payable (creditor) in the other company‘s
books. Just like in accounting four branches, such inter-company balances should be excluded from
the consolidated statement of financial position.

The following situations may therefore apply:

a) If the inter-company balances are directly opposite and equal ie a receivable in one companies
books is the same as the payable in the other company books and these amounts are included in
the receivables and payables of the group.
DR. Group accounts payables
CR. Group accounts receivable
(with the full amount due from one company to the other)
If the amounts due from one to the other are shown as separate amounts referred to as current
accounts then the amounts or balances are simply ignored and not included in the consolidated
statement of financial position.

b) If the inter-company balances are directly opposite but not equal then the first step will be;
To make them equal by adjusting the holding companys balances.
The following items will lead to differences in the inter-company balances

i) Cash in transit
Where one company may have sent cash which is yet to be received by the other company as at
the end of the financial period and thus irrespective of the company sending the cash, the following
entry will be made;
DR. Group cash at bank
CR. Group accounts receivable/payables.

ii) Goods in transit

Whereby one company has sent goods that are yet to be received by the other company as at the
end of the financial period and in most cases it is assumed that the goods are sent at an inflated price
and thus there is an unrealized profit thereof.
The relevant entry will be
DR. Group inventory (with the cost of the goods)
DR. Group retained profit (with holding company share of unrealized profit)
DR. M.J (with M.J‘s share of unrealized profit if it is subsidiary company sending goods)
CR Group account receivables /payables.

iii) Administration expenses

The holding company may have charged the subsidiary company with its share of administration
expenses but this amount is yet to be accrued or accounted for by the subsidiary…
The relevant entry will be;
DR. Group retained profits (with holding company share of admin expenses)
DR. M.I (with M.I share of admin expenses)
CR. Group accounts receivable/payable.

NOTE

The credit entry in group account receivable or payables means that if the subsidiary company is a
receivable in the holding company‘s books, then the credit entry will be made in the group account
receivables.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 181

However, if subsidiary company is a payable, then the credit entry will be made in the group account
payables.

If the holding company accounts are showing a separate current account for the subsidiary, then the
credit entry will be made in this current account.

Once adjustments have been made of the above items, the inter-company balances should agree and
the entry to make them cancel out will be passed and the position in situation (a) above will apply.

4 Proposed dividends by subsidiary company

If the subsidiary company has proposed some dividends appearing under current liabilities then the
dividends are payable to the holding company and minority interest.

The share that belongs to the Minority Interest will remain as a current liability and will be added to
the proposed dividends of the holding company to form the group proposed dividends.

However, the share that belongs to the holding company is a form of inter-company balance and
should thus be excluded from the consolidated statement of financial position.

The following entries are relevant;

a) If the holding company has accrued its share of proposed dividends.
DR. Group proposed dividends
CR. Group receivables ( includes dividends receivable)
b) If the holding company has not accrued for the share of its proposed dividends
DR. Group proposed dividends
CR. Group retained profits.

5 Fair value adjustment

IFRS 3 requires that goodwill on consolidation should be based on the fair values of the net assets of
the subsidiary company on the date of acquisition.

This means that the subsidiary company should revalue its assets on the date of acquisition.But
unfortunately no revaluation may have been done. For the purpose of consolidation, it is important to
determine what should have been the revaluation gain or loss if an asset is revalued. In most cases we
revalue non current assets such as Property, plan nd equipment, intangible assets and long term
investments. If there is a revaluation gain on any of the assets then the following entry will be made:

a) To record the revaluation gain

DR. Group PPE/intangible assets/Longterm investments (with the full revaluation gain)
CR. Cost of control (with holding company share of revaluation gain)
CR. M.I (with M.I‘s share of the revaluation gain)

For assets that are meant to be depreciated or amortized, (PPE and Intangibles), the total
depreciation or amortization that should be charged to date should be estimated and
provided for .

b) Compute the additional depreciation that should have been provided to date had the subsidiaries
assets been revalued and record the amount as follows;
DR. Group retained profits (with holding company share of additional depreciation)
DR. M.I (with M.I‘s share of additional depreciation)

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FINANCIAL ACCOUNTING III
 182 Group Accounts

CR. Group PPE/Intangible assets (with the full additional depreciation)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 183

Example

The following statement of financial positions relate to H Ltd and S Ltd as at 31 December 20X2.

H Ltd S Ltd
Non Current assets £ £ £ £
Tangible Land 100,000.00 50,000.00
Buildings 150,000.00 80,000.00
Plant 80,000.00 50,000.00
330,000.00 180,000.00
Investment in S Ltd 100,000.00

Current assets
Inventory 60,000.00 40,000.00
Accounts receivables 80,000.00 50,000.00
Cash at bank 25,000.00 165,000.00 90,000.00
TOTAL ASSETS 595,000.00 270,000.00

Ordinary Shares of £1 each 200,000.00 100,000.00

Capital Reserves 100,000.00 40,000.00
Retained profits 90,000.00 50,000.00
390,000.00 190,000.00

Non Current liabilities

10% Loan Stock 100,000.00 20,000.00

Current Liabilities
Bank Overdraft - 10,000.00
Accounts payables 80,000.00 30,000.00
Proposed dividends 25,000.00 105,000.00 20,000.00 60,000.00
595,000.00 270,000.00

Additional information
I) H ltd acquired the investment in S Ltd on 1 Jan 20X0 as follows:
£
60% Ordinary shares 90,000.00
Loan Stock 10,000.00
100,000.00

ii) On the date of acquisition the capital reserves of S ltd amounted to £10,000 and retained
profits amounted to £5,000. On the same date the fair values of land and buildings were
£10,000 and £20,000 respectively above the carrying amounts. Although no depreciation

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FINANCIAL ACCOUNTING III
 184 Group Accounts

is provided on land , buildings are depreciated at 5% p.a. on cost.

iii) Included in the inventory of H Ltd are goods purchased from S Ltd at a selling price of
£15,000 to S Ltd. S ltd reported a profit of 50% on cost.
iv) Included in the plant of S Ltd is plant bought from H Ltd on 01.01.20X1 at a price of
£20,000. H Ltd reported a profit of a third on cost. The group provides depreciation
on 30% on reducing balance.
v) H Ltd has not yet accounted for it's share of proposed dividends in s Ltd.
vi) Included in the accounts payable of H Ltd is an amount of £25,000 due to S Ltd. This
amount stood at £28,000 in the books of S Ltd. The difference was
due to the following items:
- Cash sent by H Ltd to S Ltd of £1,000.
- -Goods sent to H Ltd by S Ltd but not
yet received by H Ltd. Selling price to
H Ltd was £1,200.
- Administration fees of £800 charged by
H Ltd to S Ltd but not yet recorded by
S Ltd.
vii) Assume that goodwill on consolidation has been impired by 40%.

Required:
Prepare the consolidated statement of financial position of H Ltd and it's subsidiary as at 31.12.20X2.

Solution

H Ltd.. And its Subsidiary

Consolidated Statement of financial position as at 31/12/200
£ £
NON-CURRENT ASSETS
Property, plant and Equipment 534,550
Goodwill 1,200
535,750

CURRENT ASSETS
Inventory 95,800
Receivables 102,000
Cash at bank 26,000 223,800
TOTAL ASSETS 759,550
Ordinary share capital 200,000
Capital reserves 118,000
Retained profits 118,210
436,210
Minority interest 85,340
Shareholders funds 521,550

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 185

NON-CURRENT LIABILITIES
10% Loan stock
110,000

CURRENT LIABILITIES
Payables 85,000
Bank overdraft 10,000
Proposed dividends 33,000 128,000
759,550

Workings

Group PPE
H Ltd. 330,000 Dep. On fair value (5% x
20,000 x 3 yrs)
S Ltd. 150,000 P & L (60% x 3,000) 1,800
Fair value adjust M.I (40% x 3,000) 1,200
C.O.C (60% x 30,000) 18,000 UP on PPE (H made sale)
M I (40% X 30,000) 12,000 P & L (1/3/1,1/3 x 20,000) 5,000
Excess depreciation Balance c/d 534,550
P & L (0.6 x 2,550) 1,530
M. P (0.4 x 2,550) 1,020
542,550 534,550

Cash at bank
£ £
H Ltd.. 25,000 Balance c/d 26,000
Payables CIT 1,000 _____
26,000 26,000

Group capital reserves

£ £
C.O.C at acquisition 6,000 H Ltd.. 100,000
Minority interest share 16,000 S Ltd.d 40,000
Balance c/d 118,000 ______
140,000 140,000

Group inventory
H Ltd. 60,000 UP on closing stock (S made Sale)

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FINANCIAL ACCOUNTING III
 186 Group Accounts

S Ltd. 40,000 P & L (60% x 50/150 x 15,000) 3,000

Payables UP (GIT) 800 M I (40% x 50/150 x 150,000) 2,000
______ Balance c/d 95,800
100,800 100,800

Group inventory
£ £
Receivables 28,000 H Ltd.. 80,000
S Ltd. 30,000
Cash at bank – CIT 1,000
Goods in transit
Inventory (100/150 x 1,200) 800
P & L (60 x 150/150 x 1,200) 240
M.I (40% x 50/150 x 1,200) 160
Administration expenses
Balance c/d 85,000 P & L (60% x 800) 480
______ Minority Interest (40% x 800) 320
113,000 113,000

Group receivables
£ £
H Ltd. 80,000 Payables 28,000
S Ltd. 50,000 Balance c/d 102,000
130,000 130,000

Group Loan Stock

£ £
Cost of investment in S 10,000 100,000
Balance c/d 110,000 20,000
120,000 120,000

Group proposed dividends

£ £
P & L (60% x 20,000) 12,000 H Ltd.. 25,000
Balance c/d 33,000 S Ltd.. 20,000
45,000 45,000

Cost of control
£ £
Cost of investment in S 90,000 O.S.C (60% x 100,000) 60,000
Capital reserve (60% x 10,000) 6,000
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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 187

P & L (60% x 5,000) 3,000

PPE fair value adj. 18,000
Goodwill balance figure
P & L impaired 1,800
_____ Balance – statement of financial 1,200
position
90,000 90,000

Minority interest
£ £
PPE – fair value depreciation 1,200 O.S.C (40% x 100,000) 40,000
Inventory – UP 2,000 Capital reserve (40% x 40,000) 16,000
Payables UP GIT 160 P & L (40% x 50,000) 20,000
Payables administration 320 PPE fair value adj. 12,000
PPE Excess depreciation 1,020

Balance c/d 85,340 _____

89,020 89,020

Group retained profits

£ £
COC (P & L at acquisition 3,000 H Ltd.. 90,000
Minority interest share 20,000 S Ltd.. 50,000
PPE fair value depreciation 1,800 PPE excess depreciation 1,530
Investment Unrealized profit 3,000 Proposed dividends 12,000
PPE – Unrealized profit 5,000
Payables UP (GIT) 240 Balance c/d 118,210
480
Payables – administration
COC GN impaired 1,800 ______
153,530 153,530

Ensure that you have mastered the intra group adjustments because all consolidation questions must
have one or several of these adjustments. We shall deal with further examples as we proceed on.

OTHER ASPECTS OF THE CONSOLIDATED STATEMENT OF FINANCIAL

POSITION

The consolidated statement of financial position may require a special approach under the following
situations;
i) Pre-acquisition losses in subsidiary company on date of acquisition.
ii) Acquisition during the financial period (particularly during the financial period;
iii) Group structures

i) Pre-acquisition losses in subsidiary company on date of acquisition

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FINANCIAL ACCOUNTING III
 188 Group Accounts

If the subsidiary company has a loss on the date of acquisition i.e. a debit balance in the retained
profits (profit and loss) account, then in computing good will, the entry to cost of control of profit
and loss on acquisition will be reversed as follows.

DR. Cost of control

CR. Group retained profits
(With the holding company‘s share of the loss)

ii) Acquisition during the financial period

The holding company may acquire the subsidiary company partway through the financial period
such that as at the statement of financial position date, the subsidiary company has been held for
a period of less than 12 months.

The consolidation procedure does not change because we are dealing with the assets and the
liabilities of the two companies as at a certain date..

However, the following two points need to be considered;

a) Computation of retained profits acquisition

As the holding company has acquired the subsidiary company while trading is taking place, then it
may be difficult to determine retained profits as acquisition, unless financial amounts of subsidiary
company are prepared.

Therefore, to simplify the computations of retained profits on acquisition, we normally assume

that the retained profits for the year of the subsidiary company accrue evenly and they can be split
between the pre-acquisition and post acquisition based on the months.

Thereafter, the retained profits on acquisition are given as follows;

Retained profits on acquisition = Retained profits b/d + Re-acquisition retained profits
for the year.

Example;
Assume that H Ltd.. Acquired 80% of S Ltd.. On 1st April, 2003. The retained profits of
the subsidiary company b/d amounted to £ 120,000 and the c/d amounted to £150,000.

REQ. Compute the retained profits on date of acquisition and the amount to be
transferred to the cost of control if the financial year end is 31/12/03

Retained profits for the year ; Bal c/d – Bal b/d

150,000 – 120,000
=30,000

Pre-acquisition profits ; 1st Jan 03 – 31st March 03 = ¼ X30,000 = 7500

Retained profits on acquisition = bal b/d + pre-acquisition

= 120,000 + 7500
= £127,000
iii) To cost of control
= 80% x 127,000
= £102,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 189

b) Pre-acquisition dividends

Pre-acquisition dividend is dividend paid by the subsidiary company out of pre-acquisition profit or it
is the dividend that is received or receivable by the holding company from the subsidiary company
that relates the period before acquisition.

Thus if the holding company has owned the subsidiary company for a period of less than 12 months
and the holding company receives some share of dividends paid from the subsidiary company then
the holding company will receive some pre-acquisition dividends.

The computation of pre-acquisition dividend is also simplified because we normally assume that the
total dividends of the subsidiary (paid and proposed) accrue evenly and they can be split between pre-
acquisition and post acquisition.

Thereafter, pre-acquisition dividend to costs of control is given company;

£
Holding co. share of dividends in subsidiary company
( received + receivable) made up of:
i) Holding company‘s share of interim dividends received x
ii) Holding company‘s share of proposed dividends receivable x
x
Less: holding company‘s share of post acquisition dividends in subsidiary (x)
Pre-acquisition dividends to cost control x

Example

H Ltd.. Acquired 80% of S Ltd. during the year ended 31/12/04. S Ltd. paid an interim dividend of
40,000 on 30th September and as at 31/12/04 has proposed a dividend of 60,000.

Required
Compute the pre-acquisition dividend to cost of control assuming that H Ltd. acquired S Ltd. on the
following dates;

i) 1st July, 2004, ii) 1st October, 2004 – H did not receive share of interim dividend.

1/7/2004 1/10/2004
£ £
Total dividends : Paid 40,000 40,000
Proposed 60,000 60,000
100,000 100,000

Post acquisition dividends (6/12 x 100,000) 50,000 25,000

Pre-acquisition dividend to
cost of control
Holding company share of
dividend: Interim receive (80/100 x 40,000) 32,000
Interim proposed (80/100x 60,000) 48,000 48,000
80,000 48,000
Less: Holding company

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FINANCIAL ACCOUNTING III
 190 Group Accounts

share of post acquisition of

dividends (80/100 x 50,000) 40,000 (20,000)
40,000 28,000

NOTE:
Pre-acquisition dividends may also arise in the following situations;

i) Where the holding company acquires the subsidiary company‘s shares cum-dividend and thus
dividends eventually received will all be pre-acquisition.
ii) If the subsidiary company makes post-acquisition losses, and pays out dividends then this
dividends are assumed share come out of the pre-acquisition profits and are thus pre-
acquisitioned.

For example; If we assume that S Ltd.. was acquired on 1 st January 2001 and S Ltd.. had a credit
balance in the Profit and loss of £10,000. Then in year 2001 the company makes a post acquisition
loss of £2,000 but decides to pay dividends anyway, all these dividend is assumed to be paid out pre-
acqusitioned profits of £10,000.

Example July 2000

The following is a summary of the balances in the records of Kwa Limited and its subsidiary
Jomvu Limited as at 31 March 2000.
Kwa Ltd Jomvu Ltd

Sh.'000' Sh.' 000'

Property, plant and equipment at cost 250,000 220,000
7,500,000 ordinary shares in Jomvu Ltd. at cost 165,000
6,000.000 preference shares in Jomvu Ltd. at cost 60,000
Sh.5,000.000 6% debentures of Jomvu Ltd. 5,000
Current assets 1455000 143,400
625000 363400
Authorised and issued capital, fully paid: Ordinary 300,000 100,000
shares of Sh.10 each
7% non-cumulative preference shares of Sh.10 each 80,000
General reserves 50,000 40,000
Profit and loss account 98,500 44,400
Provision for depreciation 60,000 30,000
6% debentures 20,000
Proposed dividends: 30,000 10,000
On preference shares
ordinary shares 5,600
Debenture interest accrued 1,200
Trade payables 87,000 32 200
625500 363,400

You ascertain the following:

1.Kwa Limited acquired the shares of Jomvu Limited, cum dividend on 31 March 1999.
2. The general reserve of Jomvu Limited was the same on 31 March 1999 as on 31 March 2000.
The balance on the income statement of Jomvu Limited is made up as follows:

Sh.'000'

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 191

Balance on 31 March 1999 28,000 Net Profit for the

period ended 31 March 2000 32,000
60,000
Less: proposed dividends 15 600
44 400
3. The stock in trade of Jomvu Limited on 31 March 2000 included Sh.6 million in respect of
goods purchased from Kwa Limited. These goods had been sold by Kwa Limited to Jornvu
Limited at such a price as to give Kwa Limited a profit of 20% on the invoice price.
4 The balance on the income statement of Jomvu Limited on 31 March 1999, is after providing for
preference dividend of Sh.5,600,000 and a proposed ordinary dividend of Sh.5,000,000, both
of which were subsequently paid and credited to the income statement of Kwa Limited.
5. No entries have been made in the books of Kwa Limited in respect of the debenture interest
due from, or the proposed dividends of Jomvu Limited for the year ended 31 March 2000.
6. On 31 March 2000, the authorised and issued ordinary share capital of Jomvu Limited had been
increased by Sh.20 million by capitalizing part of the general reserve and issuing 2 million
Sh.10 shares to the existing shareholders in proportion to their existing holdings. The
transaction has not yet been reflected in the books of Kwa Limited or Jomvu Limited.
7. Group policy is to amortise goodwill on consolidation over 5 years using the straight-line
method. (Assume
goodwill has been impaired at 50%)

Required

The consolidated statement of financial position of Kwa Limited and its subsidiary company Jomvu Limited
as at 31 March 2000.
(20 marks)

Note: in this question, the subsidiary company was acquired at the start of the year. At that time the
subsidiary company had proposed dividends which the holding company received in the current year.
The illustration is important to show how to treat the preacquisition dividends and further inter
company adjustments.

Kwa Ltd. and its subsidiary

Consolidated statement of financial position as at 31 March 2000
Sh. Mill Sh. Mill
NON-CURRENT ASSETS
Property, plant and Equipment 380
Goodwill 24.84
404.84
CURRET ASSETS
Current assets 287.7
TOTAL ASSETS 692.54
Ordinary share capital 300
Preference share capital -
General reserves 50
Retained profits 107.44
457.44
Minority interest 66.1
Shareholders funds 523.54

NON-CURENT ASSETS
6% debentures 15

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FINANCIAL ACCOUNTING III
 192 Group Accounts

CURRENT ASSETS
Payables (87 + 32.2) 119.2
Accrued interest on debenture 0.9
Proposed dividends 33.9 154
692.54

Working

Cost of control
Sh. ‗M‘
Sh. ‗M‘
Cost of investment OSC 165 O.S.C (75% x 120,000) 90
PSC 60 PSC (75% x 80,000) 60
GR (75% x 20) 15
P&L (75% x 28) 21
P & L Pre-acquired dividend
OSC + PSC 7.95
GW – P&L (impaired) 6.21
Balance c/d 24.84
225 225

Group Retained profits

Sh. ‗M‘
Sh. ‗M‘
C.O.C P& L at acquisition 21 K 98.5
MR (P&L) (25% x 44.4) 11.1 J Ltd. 44.4
Pre-acquisition dividend .proposed dividends
OSC (75% x 5) 3.75 O.S.C (75% x 10) 7.5
PSC (75% x 5.6) 4.2 PSC (75% x 5.6) 4.2
C.A (.UProfit) (20% x 6) 1.2 Accrued interest
C.O.C GW (impairment) 6.21 Share of K (5/20 x 1.2) 0.3
107.44 ____
154.9 154.9

Group Current Assets

Sh. ‗M‘
Sh. ‗M‘
Balance b/d – K 145.5 P & L – U.P.C.S (20%x6m) 1.2
J 143.4 Balance c/d 287.7
288.9 288.9

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 193

Group Proposed dividends

Sh. ‗M‘
Sh. ‗M‘
P & L - OSC (75% x 10) 7.5 J. Ltd. 30
PSC (75% x 5.6) 4.2 K Ltd. – OSC 10
Balance c/d 33.9 PSC 5.6
45.6 45.6
Minority Interest
Sh. ‗M‘
Sh. ‗M‘
Balance c/d 66.1 O.S.C (25% x 120) 30
PSC (25% x 80) 20
GR (25% x 20) 5
___ P & L (25% x 44.4) 11.1
66.1 66.1

Group Accrued Interest

Sh. ‗M‘
Sh. ‗M‘
P & L share 5/20 x 1.2) 0.3 J Ltd. 1.2
Balance c/d 0.9 __
1.2 1.2

NOTE: (From additional inform no.6)

The bonus share has been funded using the pre-acquisition reserves and thus it is should not affect
the computation of goodwill because in making entries to the cost of control, we could have used the
increased share capital of sh.120 million and reduced the General Reserve to sh.20 million or have it
remain at OSC – sh.100m and General Reserve sh.40M.

However, if subsidiary company makes a bonus issue out of post-acquisition reserves e.g. from
retained profits, then we will still need to get the share capital and reserves of subsidiary on date of
acquisition an use these value to compute goodwill.
The remaining share capital that has been increased by way of bonus issue will be split between
holding company and Minority interest. Then, the amount that belongs to holding company will be
shown as any other part of capital reserves or separately in consolidated statement of financial
position.

The share that belongs to minority interest will be transferred to minority account.

3 GROUP STRUCTURES
A group structure is the relationship between the holding company and its subsidiaries. There are
normally four main types of group structures (apart from the holding company and one subsidiary) i.e.

i) Holding company with more than one subsidiary company,

ii) Holding company with a subsidiary company that has a subsidiary company (Sub-subsidiary),
iii) Holding company with direct investment in sub-subsidiary company,

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FINANCIAL ACCOUNTING III
 194 Group Accounts

iv) Multiple group structures

a) Holding company with more than one subsidiary company

Under this type of structure, the holding company controls more than one company. For example H
ltd may Own 80% of S1, 75% of S2 and 60% of S3.

The consolidated statement of financial position will remain as before because it involves adding the
assets and liabilities of all subsidiaries to those of the holding company while excluding inter-company
balances.
However, separate cost of controls will need to be prepared for each subsidiary company because the
dates of acquisition may be different and the goodwill impaired also.
In the consolidated statement of financial position, the remaining goodwill can be shown as one
figure.

b) Holding company with a subsidiary and a sub-subsidiary

Where the subsidiary company has another subsidiary company, then that subsidiary is referred to as a
sub-subsidiary company of the holding company. This can be shown as follows:

80% O.S.C

S Direct Minority interest (20%)

75% OSC

Direct Minority interest (100 – 75) = 25%

SS
Indirect minority interest (20% x 75% = 15%)
Total Minority interest /40%)

The preparation of the consolidated statement of financial position again remains the same as before
because the process involves adding the assets and liabilities of the subsidiary and sub subsidiary to
those of the holding company.

However, the following points are important:

i) The first approach is to determine the effective shareholding by the holding company and
Minority Interest in the sub-subsidiary company.
For the holding company the effective shareholding is given as:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 195

80% x 75% = 60%

and the minority interest will be computed in 2 stages: - i.e.

Direct minority interest (100% - 75%) = 25%

TOTAL Minority interest = 40%
Indirect minority interest (20% x 75%) = 15%

ii) Care should be taken when computing goodwill. The following approach will normally be used:

If the holding company acquired the subsidiary company after the subsidiary company has
acquired the subsidiary company, the goodwill can be computed as a combined figure and the
profit and loss and capital reserves on acquisition of the subsidiary company will be on the same
date the holding company acquired subsidiary company.

2001 2002 2003

H

80%

P & L reserves on acquisition

75%

P & L reserves on acquisition

(Goodwill as 1 combined figure)

If the holding company acquires the subsidiary company and thereafter the subsidiary company
acquires the sub-subsidiary company then goodwill should be computed in two stages i.e. At the
point when the holding company acquired subsidiary company and on the date when the group
acquired the sub-subsidiary company.

2001 2002 2003

H

80%

P & L reserves on
Acquisition
75%

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FINANCIAL ACCOUNTING III
 196 Group Accounts

P & L reserves on acquisition

(Separate figure for goodwill)

NOTE:
Goodwill is still computed using a single cost of control for both situations only that the first part of
the cost of control deals with the subsidiary and second part deals with the sub-subsidiary.
The investment in sub-subsidiary appearing in the statement of financial position of the subsidiary
belongs to the holding company (80%) and the direct minority interest in S (20%).

The holding company‘s share is debited to the cost of control and the minority interest is also debited
in minority interest account.

iii) Care should be taken when dealing with the proposed dividends in the sub-subsidiary company.
This is because these dividends will belong to the subsidiary company at 75% and the direct minority
interest in the sub-subsidiary company 25%.
The share that belongs to the direct minority interest will remain in group proposed dividend as a
current liability while the share that belongs to the subsidiary company will be dealt with as follows:

DR Group proposed dividends (75%)

CR Group retained profits (With holding company share 80% x 75%)
CR Minority interest (With minority interest share 20% x 75%)

Example
The draft Statement of financial positions of UNA Limited, KMN Limited and LLE Limited are as
follows: UNA Limited and KMN Limited are both listed on the Nairobi Stock Exchange.
Statement of financial positions as at 30
September 1996
UNA Ltd. KMN Ltd. LLE Ltd.
Sh.Million Sh.Million Sh.Million

684 430 330

PPE (Net Book Value)
Investments
At cost: Shares in KMN Ltd. 600
At a valuation:
Shares in LLE Ltd. 360

Current Assets:
Stocks 484 320 270
Debtors 180 150 90
Cash at bank _ 80 40
664 550 400

Current Liabilities:
Bank overdraft 60 -
Creditors 170 120 90
Taxation 60 50 40
Proposed dividends (Gross) 100 100 50
390 270 180

Net Current Assets 274 280 220

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 197

1 558 1.070' 550

Financed by:
Sh. 10 Ordinary shares 500 500 250
10% Preference shares 80
Revaluation reserve 30
Profit and loss account 1,058 460 300
1,558 1,070 550

Notes:
1. UNA Ltd. purchased 60 % of the ordinary share capital and 30 % of the preference share capital
of KMN Ltd. on 1 October 1992, when the balances on the Profit and Loss Accounts of
UNA Ltd., KMN Ltd. and LLE Ltd. were Sh.899 million, Sh.360 million and Sh. 150
million respectively.
2. KMN Ltd. had purchased 70% of the ordinary share capital of LLE Ltd. on 1 October 1991 for
Sh.330 million when the balance on the Profit and Loss Accounts of UNA Ltd., KMN Ltd.
and LLE Ltd. were Sh.856 million, Sh.330 million and Sh. 130 million respectively. The
investment was revalued upwards by Sh.30 million on 30 September 1995. The directors of
KMN Ltd. had decided to revalue the investment at Sh.378 million at 30 September 1996, but
this has not yet been reflected in the books.
3. KMN Ltd. makes sales to both UNA Ltd. and LLE Ltd. at normal selling price (cost plus a
mark-up of 33'/3%). At 30 September 1996, items purchased by UNA Ltd. and LLE Ltd. from
KMN Ltd. remaining unsold had cost Sh.24 million and Sh. 16 million respectively. Group
policy on unrealised intra-group profits is in line with current international practice i.e.
unrealised profits are eliminated in full from the book value of assets, and from the interests
held by the group and the minority interest in respective proportion to their holdings in the
company which had made the profit.
4, UNA Ltd. and KMN Ltd. have not yet accounted for the dividends receivable.
5. Intra-group balances are included in debtors and creditors as follows:

UNA Ltd.: Creditors LLE Ltd. Sh. 18 million

Debtors KMN Ltd Sh.8 million
KMN Ltd.: Creditors LLE Ltd. Sh.6 million
LLE Ltd.: Debtors UNA Ltd. Sh.18 million
. KMN Ltd Sh.6 million
6. KMN Ltd. had made out a cheque for Sh.10.4 million on 30 September 1996; this cheque
was received by UNA Ltd. on 30 October 1996 and had not been included in UNA Ltd.'s
statement of financial position. This Sh.10.4 million includes the preference dividend due to
UNA Limited.
7. Assume that goodwill on consolidation has been impaired at 80%.

Required:
Consolidated Statement of financial position of UNA Ltd. and its subsidiaries as at 30 September 1996,
complying, so far as the
information will allow, with the accounting requirements of the IFRS. (25 marks)

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FINANCIAL ACCOUNTING III
 198 Group Accounts

Solution

UNA Ltd. And its subsidiaries

Consolidated Statement of financial position as at 30th September 1996
Sh Mill Sh. Mill
NON-CURRENT ASSETS
Property, plant and equipment 1,444
Goodwill 18
1,462

CURRENT ASSETS
Inventory 1,064
Receivables 388
Cash at bank 120 1,572
TOTAL ASSETS 3,034

EQUITY AND LIABILITIES

Ordinary share capital 500
RESERVES
Retained earnings 1,186.4
1,686.4
Minority interest 637
Shareholders funds 2,23.4

CURRENT LIABILITIES
Bank overdraft 496
Payables 356
Current tax 155
Proposed dividends 150 710
TOTAL EQUITY AND LIABILITIES 3,034

Minority Interest
Sh.Mill Sh.Mill
Investment in LLE KMN OSC (40%X 500) 200
40% x 330) 132 PSC (70% x 80) 56
Unrealised profit on closing Pel (40% x 460) 184
stock ( 40% x 10m) 4 LLE OSC (58% x 250) 145
Bal c/d 637 Pel (58% x 300) 174
Proposed dividend (share in LLE)
40%x70%x50 14
773 773
=== ===

Group Receivables
Sh.Mill Sh.Mill
UNA 180 Bank overdraft – CIT 8
KMN 150 Payables due to LLE 18
LLE 90 Due to LLE 6
Bal c/d 388
420 420
=== ===

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 199

Cost on control
Sh.Mill Sh.Mill
Investment in KMN 600 KMN OSC (60%x500) 300
PSC (30%x80) 24
Pel (60%x360) 216
LLE OSC (42%x250) 105
Pel (42%x150) 63
Goodwill-balancing figure
Impaired – Pel 72
___ Bal c/d – b/s 18
798 798

Retained Profits
Sh.Mill Sh.Mill
C.O.C Pel at acquisition 216 UNA 1058
(60%x500) KMN 460
M.I share in KMN 184 LLE 300
C.O.C Pel at acquisition-LLE 63 Group proposed did – share of
KMN 60
(60%x100)
M.I share in LLE 174 Share of UML(60%x70%x50) 21
C.O.C –impaired Goodwill 72 Bank overdraft CIT –pref div 2.4
Group inv. Unrealized profit on
closing stock 6
Bal c/d 1186.4 _____
1901.4 1901.4

Group payables
Sh.Mill Sh.Mill
Receivable due from UNA 18 UNA 170
Due from KMN 6 KMN 120
Bal c/d 356 ULA 90
380 380

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FINANCIAL ACCOUNTING III
 200 Group Accounts

Group Inventory
Sh.Mill Sh.Mill
UNA 484 Unrealised profit on closing stock- 6
Pel
KMN 320 Unrealised profit on closing stock
- MI 4
LLE 270 Bal c/d 1064
1074 1074

Group Proposed Dividends

Sh.Mill Sh.Mill
Pel (60%x100) 60 UNA 100
Pel – share of UML 21 KMN 100
MI – share of UML 14 LLE 50
Bal c/d 155 ___
250 250

Bank overdraft
Sh.Mill Sh.Mill
CIT-receivables 8 UNA 60
Pel (pref div – 10%x80x30%) 2.4
Bal c/d 49.6 __
60 60

UNA

60% O.S.C
30% P.S.C

KMN
Direct M.I: O.S.C 40%
P.S.C 70%

Direct MI (100-70) = 30%

LLE Indirect MI (40%x70%) = 28%
58%
Effective shareholding of Holding
co = 60%x70% = 42%

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 201

30.9.91 30.9.92 30.9.93 30.9.94 30.9.95 30.9.96

Holding co

UNA
Subsidiary
60% OSC
30% PSC
KMN

Sub-subsidirary
LLE 70% OSC

- Goodwill will be computed as a single figure. Pel on acquisition (30.09.92) = KMN = 360M and
LLE = 150M

NOTE:
1. For the purpose of computing goodwill, the investment in the subsidiary and the subsidiary
should not be revalued and thus any revaluation carried out should be revealed first before
consolidation is done.
2. Even thought the effective control of the holding co. may be less than 50% in the sub-
subsidiary co. the sub-subsidiary co is the considered to be under the control of the holding
company and thus should be consolidated the normal way. This is because the holding
company has indirect control in the sub-subsidiary company

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FINANCIAL ACCOUNTING III
 202 Group Accounts

NOTE;

1) For the purpose of computing goodwill, the investment in the subsidiary of the sub-subsidiary
should not be revalued and thus any revaluation carried out should be reversed first before
consolidation is done.
2) Even though the effective control of the holding company may be less than 50% on the
subsidiary company sub-subsidiary company is considered to be under the control of the holding
company and thus should be consolidated the normal way. This is because the holding company
has an indirect control in the sub-subsidiary company.

c) Holding company with a direct shareholding in sub-subsidiary company

Under this type of structure, both the holding and subsidiary company have some shareholding in the
sub-subsidiary company. The consolidation process will also remain the same as the second type of
structure only that this time care should be taken in dealing with the following items.

1) The effective shareholding of the holding company will now be both direct and indirect. E.g.
Assume the following structure.

80% OSC

20% OSC
S MI: DR 20%

60% OSC

MI: DR 20%
SS

MI: INDIRECT 12%

The same approach will be used as that of the previous structure. The following additional points
need to be considered:

II) On the debit side of the cost of control, the investment in subsidiary and sub-subsidiary will
appear as follows;

On the section of the subsidiary, we will have the cost of investment in subsidiary appearing in
holding company‘s statement of financial position.
On the section dealing with the sub-subsidiary, we will have the cost of investment in sub-subsidiary
appearing in the holding company‘s books or statement of financial position and the holding

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 203

company‘s share of investment in sub-subsidiary company appearing in the subsidiary‘s statement of

financial position or books.

iii) The proposed dividends in sub-subsidiary company may also require a different accounting
entry and this is because the holding company will now receive its share.
Two entries may thus be necessary and these are;

DR. Group proposed dividends (with holding company‘s direct share in proposed dividend of ss)
CR. Group retained profits
DR Group proposed dividends (with subsidiary company share of the proposed dividends in sub-
subsidiary)
CR. Group retained profits (with holding company‘s indirect share for proposed dividends in
sub-subsidiary)
CR. M.I (with Minority interest‘s indirect share of proposed dividends in subsidiary)

Example
Rain Ltd., Storm Ltd. and Thunder Ltd. are in the business of manufacturing tents. Their statement of
financial positions as at 30 September 2003 were as below:

Rain Ltd. Storm Ltd. Thunder Ltd.

Sh. Sh. Sh. Sh. Sh. Sh.
―000‖ ―000‖ ―000‖ ―000‖ ―000‖ ―000‖
Non-current assets:
Non-current assets
(net of depreciation) 14,000 6,300 1,700
Shares in subsidiaries 5,000 1,900 -
19,000 8,200 1,700

Current assets:
Inventory 2,000 1,200 1,600
Trade payables 4,800 2,000 800
Cash 2,700 1,400 1,100
9,500 4,600 3,500
Current liabilities:
Trade payables ( 5,000 ) ( 2,600 ) ( 1,800 )
Net current assets 4,500 2,000 1,700

23,500 10,200 3,400

Financed by:
Authorised and issued
Share capital:
Ordinary shares of Sh.100 15,000 5,000 2,000

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FINANCIAL ACCOUNTING III
 204 Group Accounts

10% preference shares of Sh. 100

each fully paid - 3,000 -

General reserve 6,000 3,000 1,000

Retained Profits 2,500 ( 800 ) 400
23,500 10,200 3,400

Additional information:

1. Rain Ltd. purchased 30,000 ordinary shares in Storm Ltd. on 1 October 2001 for Sh. 3,400,000
and 5,000 preference shares on 1 October 2002 for Sh. 600,000. On 1 October 2002, Rain Ltd.
purchased 5,000 ordinary shares in Thunder Ltd. for Sh. 1,000,000. Storm Ltd. purchased 11,000
ordinary shares in Thunder Ltd. for Sh. 1,900,000 on the same date.

2. Balances are as given below:

Profit and loss account

Storm Ltd. 1 October 2001 Sh. 500,000 (debit).
1 October 2002 Sh. 600,000 (debit).
Thunder Ltd. 1 October 2002 Sh. 300,000 (debit).

General reserve
Storm Ltd. 1 October 2001 Sh. 1,000,000
1 October 2002 Sh. 2,000,000
Thunder Ltd. 1 October 2002 -

3. The following inter-company balance are included in the balances of trade debtors and trade
creditors:

Receivables Rain Ltd. Sh. 600,000 due from Thunder Ltd.

Thunder Ltd. Sh. 300,000 due from Rain Ltd.
Sh. 200,000 due from Thunder Ltd.

4. On 30 September 2003, thunder Ltd. remitted Sh.200,00 to Rain Ltd. which was not received
until 3 October. There were no other inter-company balances.
5. Rain Ltd. sold goods to Storm Ltd. for Sh.800,000. The goods had originally cost Rain Ltd.
Sh.600,000. Storm Ltd. still had Sh.200,000 worth of these goods (at invoiced price) in stock as at
30 September, 2003.

Required:
Prepare the consolidated statement of financial position of Rain Ltd. and its subsidiaries as at 30
September 2003.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 205

Solution:

Rain Ltd and its subsidiaries

Consolidated Statement of financial position as at 30 September 2003
Sh.‘000‘ Sh.‘000‘
Non Current Assets
PPE 22,000
Goodwill (W2) 1,006
23,006
Current Assets
Inventory (2 + 1.2 + 1.6 – 0.05) 4,750
Receivables(W6) 6,500
Cash (2.7 + 1.4 + 1.14 + 0.2) 5,400
16650
39656
EQUITY AND LIABILITIES
Share capital 15,000
Sh.100 ordinary shares fully paid 7,780
General reserve (W5) 2,328
Retained Profits (W4) (300 + 2,028) 25,108
6,048
Minority interest (W3) 31,156

8500
Current liabilities:

Payables
TOTAL EQUITY AND LIABILITIES 39,656

Workings

1. Determination of group ownership structure

Storm Ltd Thunder Ltd
Ordinary Preference Ordinary
Rain Ltd: 1/6 25%
Direct 60% 33%
Indirect (60% x 55%) 58%

Minority Interest 40% 5/6 42%

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FINANCIAL ACCOUNTING III
 206 Group Accounts

2. Cost of Control
Sh.‘000‘ Sh.‘000‘
Investment in Storm: Share of Storm equity
Ordinary 3,400 Ordinary share capital (60% x 5000) 3,400
Preference 600 General reserves (60% x 1000) 600
Share of retained losses Preference share capital (i/6x3,000) 500
(60% x 500) 300 Goodwill I 200
4,300 4,300
Investment in Thunder Share of Thunder equity
(60% x 1,900) by Storm 1,140 Ordinary share capital (58%x2,000) 1,160
Rain spent in Thunder 1,000 Profit b/f (58% x 300) 174
____ Goodwill II 806
6,440 6,440

Total goodwill on consolidation = 806 + 200 = 1,006

3. Minority Interest
Sh.‘000‘ Sh.‘000‘
Cost of shares in Thunder Storm Ltd: Equity
(40% x 1900) 760 Ordinary share capital (40% x 5000) 2,000
Storm Ltd Profit & Loss Preference share capital (5/6 x 3000) 2,500
40% x 800) 320 General reserve (40% x 3000) 1,200
Consolidated statement of 6,048 Thunder Ltd: Equity
financial position Ordinary share capital (42% x 2000) 840
Preference share capital -
General reserve (42% x 1000) 420
Thunder Ltd Profit & Loss
_____ (42% x 400) 158
7,128 7,128

4. Group retained Earnings A/c

Sh.‘000‘ Sh.‘000‘
Rain Ltd Bal b/d: Rain 2,500
UPCs (200/800 x 200) 50 Cost of control a/c
Bal b/f 800 (60% x 500) 300
Thunder ltd: Minority Interest A/c
Cost of control a/c (40% x 800) 320
25% x 300 75 Bal b/d: Thunder 400
33% x 300 99 174
Minority interest
(42% x 400) 168
Consolidated statement of 2,328 ____
financial position
3,520 3,520

5. Consolidated General reserve

Sh.‘000‘ Sh.‘000‘
Storm Ltd: COC (60% x 1000) 600 Bal b/f
MI (40% x 3000) 1,200 Rain 6,000
Thunder: MI (42% x 1,000) 420 Storm 3,000
Consolidated statement of 7,780 Thunder 1,000
financial position
10,000 10,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 207

6. Group Receivables A/c

Sh.‘000‘ Sh.‘000‘
Rain Ltd 4,800 Cash in transit (Thunder) 200
Storm Ltd 2,000 Group creditors: T – R 400
Thunder Ltd 800 R–S 300
T–S 200
____ To consolidated statement of 6,500
financial position
7,600 7,600

7. Group Payables A/c

Sh.‘000‘ Sh.‘000‘
Group debtors 900 Rain Ltd 5,000
To consolidated statement of 8,500 Storm Ltd 2,600
financial position ____ Thunder Ltd 1,800
9,400 9,400

CONSOLIDATED INCOME STATEMENT AND CONSOLIDATED STATEMENT OF

CHANGES IN EQUITY.

The consolidated income statement follows similar principles as those of the consolidated statement
of financial position. This is because the procedure involves adding the transactions of the subsidiary
company to those of the holding company while excluding inter company transactions and making the
necessary inter-group adjustments for items like unrealized profits on inventory.

The consolidated statement of changes in equity only reports transactions that tare attributable to the
holding company. Therefore, it deals with the holding company‘s retained profits plus the holding
company‘s share of post acquisition retained profits in subsidiary company.
The formats are given as follows;

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FINANCIAL ACCOUNTING III
 208 Group Accounts

H Ltd and its Subsidiary

Consolidated income statement for the year ended 31 December

£ £

Revenue X

Cost of Sales (x)

Gross Profit x

Other incomes x

Distirbution costs (X)

Administration expenses (X)

Other expenses (X)

Finance costs (x) (x)

Profit before tax X

Income tax expense (x)

Profit for the period x

Profit attributable to Holding company x

Profit attributable to Minority Interest x

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 209

Consolidated statement of changes in equity (only the retained profits section)

£ £
Balance as at 1.1 .2004 X
Profit attributable to the holding company X
X
Dividends: Interim Paid X
Final Proposed X (x)
Balance as at 31.12.2004 (the group retained profits to the statement of X
financial position)

If we are not preparing the published consolidated income statement and the consolidated statement
of changes in equity then the two reports can be combined and the income statement can be modified
as follows from profit before tax:

£ £
Profit before tax x
Income tax expense (x)
Profit after tax x
Profit attributable to minority interest (x)
Profit attributable to holding company x
Less: Interim dividend paid x
Final proposed dividend x (x)
Retained profits for the year x
Retained profits b/d x
Retained profits c/d x

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FINANCIAL ACCOUNTING III
210 Group Accounts

NOTE
The figures in the consolidated income statement can be deterimed as follows:

Reve COS OI AE/ FC TAX

nue OE
£ £ £ £ £ £
Figures appearing in the income statement of Holding Co. x x x x x X
Figures appearing in the income statement of Subsidiary Co. x x x x x X
Total Before adjustments x x x x x X
Less:
- Intercompany sales of goods (deducted at selling price) (x) (x) - - - -
- Intercompany sales of PPE ( deduct selling price from revenue) (x) - - - - -
( deduct cost of the PPE from COS) - (x) - - - -
- Excess annual depreciation due inter company sale of PPE (x)
-Intercompany incomes (e.g. dividends & interest from subsidiary) (x)
-Intercompany interest paid (e.g. from subsidiary to Holding co.) (x)
- Unrealized prfit from opening inventory (x)
Add:
-Unrealsied profit on closing inventory X
-Addiditonal annual depreciation /amortization due to Fair value adjustment x
-Impairement of goodwill (charge for the year) _ _ _ x _ _
Final figures to appear in the consolidated income statement x x x x x x

Don‘t worry about the adjustments that need to be made as it will be difficult to get a question that has alll these adjustments at once. But they are the
probable adjustments that you will come across.

Intercompany sales of goods and PPE should be excluded from the consolidated income statement as these tracsactions do not involve third parties.
Try to recal the treatment of goods sent to the branch and goods received from the head office. These items do not apper in the combined trading
profit and loss account. The same approach is used here.

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 211

For intercompany sales of goods, we normally deduct the figures at the selling price because what is a selling price to
one company is a purchase price to the other company. For sale of property, plant and equipment we should deduct the
selling price from revenue and the cost from cost of sales. This is because the selling company may be dealing with the
PPE and as such it has included both selling price in its Revenue and the cost of the PPE in the Cost of Sales. However
if the selling company has only reported a profit on sale and included in other incomes, then we deduct this from the
groups other incomes.

Adjustments for unrealised profit on opening and closing inventory are also important. We normally deduct the
unrealised profit on opening inventory from the cost of sales because the cost of sales of one of the company is
overstated (this is because the opening inventory is overstated and hence the cost of sales). For unrelalsied profit on
closing inventory we add to cost of sales as the closing inventory is overstated and this lead to an understatement of the
cost of sales.

MINORITY INTEREST

The minority interest ideally is entitled to the profit after tax in minority interest. However due to consolidation, the
profits of the subsidiary company should be adjusted first before getting their share. Care should also be taken
especially if the subsidiary company has issued preference share capital and the minority interst owns part of this.

The computation will therefore be carried out as follows:

£ £
Subsidiary company‘s profit after tax X
Add:
Annual excess depreciation charged by subsidiary co X
Unrealised profit on opening inventory if subsidiary co. had made the sale x X
x
Less
Annual additional depreciation on Fair value adjustment X
Unrealised profit on closing inventory if subsidiary co. made the sale X
Unraelsied profit on PPE if subsiadiary company made the sale X (x)
Adjusted profit after tax in subsidiary X
Less Preference dividend (x)
Profit attributable to ordinary share holders in subsidiary company X
Total due to Minority interest:
- MI‘s share of preference dividend X
- MI‘ s share of profit attributable to ordinary shareholders X
X

DIVIDENDS

The dividends that appear in the consolidated statement of change in equity are for the holding company only. This is
because the dividends of the subsidiary belong to the holding company and minority interest. By consolidating the
subsidiary company, the holding company has taken its share of the dividends in subsidiary and the M.I has taken its
share which is included in the minority interest‘s share of profit after tax in subsidiary company.

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FINANCIAL ACCOUNTING III
212 Group Accounts

RETAINED PROFITS BROUGHT FORWARD

If we recall from the consolidated statement of financial position, the group-retained profits should be made up of the
holding companies retained profit plus the holding companie‘s share of subsidiary companies post acquisition retained
profits. The same case applies to computing the retained profits brought forward of the group. The group-retained
profits brought forward should be made up of the holding companies retained profit brought forward plus the holding
companie‘s share of subsidiary companies post acquisition retained profits brought forward.

But we have to make adjustments to the holding companies retained profits brought forward and the subsiairy
company‘s profits before we get the holding companies sher. The adjustments are for transactions that took place
previously that affect the profits of these two companies.

The holding companies retained profits brought forward will therefore be adjusted as follows:

£ £
Holding companies retained profit brought forward X
Add: Excess depreciation charged by holding company up to start of the year X
x
Less : Unraelised profit on opening inventory if holding company had made the sale x
Goodwill impaired to date (up to the start of the yaer) x
Unrealised profit on sale of PPE in previous years if holding co. made the sale x (x)
Holding companies retained profit b/f adjusted for conslidation x

The subsidiaries profits brought forward will be adjusted as follows before the holding company takes its share:
£ £
Subsidiary companies retained profit brought forward X
Add: Excess depreciation charged by subsidiary company up to start of the year X
x
Less : Unraelised profit on opening inventory if subsidiary company had made the sale x
Depreciation on Fair value adjustment that should have been charged to date x
Unrealised profit on sale of PPE in previous years if holding co. made the sale x (x)
Subsidiary company‘s retained profit b/f x

Example
H Ltd acquired 75% of the ordinary shares of S Ltd since S Ltd was incorporated. The
Summarized income statement for the two companies for the year ending 31 December

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 213

20X2 is as follows:

H Ltd S Ltd
£ £
Sales revenue 75,000.00 38,000.00
Cost of sales (30,000.00) (20,000.00)
Gross profit 45,000.00 18,000.00
Operating expenses (14,000.00) (8,000.00)
Profit before tax 31,000.00 10,000.00
Taxation (10,000.00) (2,000.00)
Profit after tax 21,000.00 8,000.00
Retained profit b/f 87,000.00 17,000.00
Retained profit c/f 108,000.00 25,000.00

Required:
Prepare the consolidated income statement for the year ended 31 December 20X2.

H Ltd. And Its Subsidiary

Consolidated Income Statement for year ended 31/12/2002
£ ‗000‘ £ ‗000‘
Revenue(75+38) 113
Cost of sales(30+20) (50)
Gross profit 63
Operating expenses(14+8) 22
Profit before tax 41
Income tax expense(10+2) (12)
Profit after tax 29
Profit attributable to minority interest (2)
Profit attributable to holding company 27
Retained profits b/f 99.75
Retained profit b/f 126.75

Example
The share capital of S Ltd is made up of the following items:
£
10,000 6% 1 preference shares 10,000.00
10,000 1 ordinary shares 10,000.00
20,000.00

On 1 January 20X0,H ltd acquired 3,000 preference shares and 7,500 ordinary shares
when the retained profits of S ltd amounted to £4,000. The cost of investment at the date
of acquisition was £15,000. Goodwill arising on consolidation is amortized over a period
of 5 years.
The following income statements relate to the two companies for the year ended 31 December

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FINANCIAL ACCOUNTING III
214 Group Accounts

20X1.
H Ltd S Ltd
£ £
Sales 200,000.00 98,000.00
Cost of Sales (90,000.00) (40,000.00)
Gross Profit 110,000.00 58,000.00
Operating expenses (35,000.00) (19,000.00)
Profit before tax 75,000.00 39,000.00
Taxation (23,000.00) (18,000.00)
Profit after tax 52,000.00 21,000.00
Dividends Preference - (600.00)
Ordinary (14,000.00) (2,000.00)
Retained profits for the year 38,000.00 18,400.00
Retained profits b/f 79,000.00 23,000.00
Retained profits c/f 117,000.00 41,400.00

Additional information.
1) During the year ended 31.12.20X1 H Ltd sold an item of plant to S Ltd. The plant cost
H Ltd £15,000 and H Ltd reported a profit of £5,000 on the sale.This transaction is included
in the sales and cost of sales of H Ltd. It is the policy of the group to charge depreciation
of 20% on cost for plant.
2) During the year S Ltd sold some goods amounting to £20,000 (cost to S Ltd). S Ltd reported
profit of 20% on cost. Half of these goods are still in the
inventory of H Ltd.
3) H Ltd has not yet accounted for it's share of the proposed dividends in S Ltd.

Required:
Prepare the consolidated income statement for the year ended 31 December 20X1.

H Ltd. And Its subsidiary

Consolidated income statement for year ended 31/12/20x1
£ ‗000‘ £ ‗000‘
Sales 254
Cost of sales (92)
Gross profit 162
Operating expenses (54.3)
Profit before tax 107.7
Income tax expense (41)
Profit after tax 66.7
Profit attributable to minority interest (5.27)
Profit attributable to holding company 61.43
Less: dividends (14)
Retained profits for the year 49.43
Retained profits b/d 92.95
Retained profits c/d 140.38

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 215

Workings:
(i) Items to income statement

Revenue COS Expenses Tax

£ ‗000‘ £ ‗000‘ £ ‗000‘ £ ‗000‘
H Ltd 200 90 35 23
S Ltd 98 40 19 18
298 130 54 41
Less Intercompany sales : PPE (20) (15)
Goods (24) (20)
Excess depreciation (1)
Add: Unraelsied profit on closing inventory 2
Goodwill impaired 0.3
To consolidated income statement 254 92 54.3 41

(iii) Minority Interest

£ ‗000‘
Subsidiary company‘s profit after tax 21
Add:
Annual excess depreciation charged by S Ltd 1
22
Less
Unrealised profit on closing inventory S Ltd made the sale (2)
Adjusted profit after tax in subsidiary 20
Less Preference dividend (0.6)
Profit attributable to ordinary share holders in S Ltd 19.4
Total due to Minority interest:
- MI‘s share of preference dividend (70% X 0.6) 0.42
- MI‘ s share of profit attributable to ordinary shareholders (25% X 19.4) 4.85
5.27

(iv) Retained profit b/f

£ ‗000‘ £ ‗000‘
Holding company‘s retined profit b/d 79
Less: Goodwill impaired in previous year (0.3)
78.7
Add: Share in S Ltd
Retained profit b/f in S Ltd 23
Less pre acquisition profits (4)
Post acquisition profits 19
Share of H Ltd (75% X 19) 14.25
92.95

ACQUISITION OF A SUBSIDIARY COMPANY DURING THE YEAR.

When the holding company acquires a subsidiary company portray during the financial period, then the approach to
preparing the consolidated income statement will change slightly. This is because IAS 27 requires that the subsidiary
company should be consolidated from the date of acquisition.

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FINANCIAL ACCOUNTING III
216 Group Accounts

This means that the results of the subsidiary company should be assumed to accrue evenly over the year and thus they
can be split between pre-acquisition and post-acquisition period.

Thereafter the post-acquisition results are consolidated the normal way, paying attention to the following items.

i) The sales, cost of sales, expenses and tax of the subsidiary company that relate to the post-acquisition period will be
added to those of the holding company while making adjustments for inter-company items that have arisen or that
relate to the post-acquisition period.
e.g.; Inter-company sales should relate to the post acquisition period, goodwill impaired should be pro-rated and
same case applies for additional depreciation on fair value adjustments.

ii) The computation of the minority interest will remain as before only that this time we will take the post acquisition
profits after tax of the subsidiary company.

NOTE: In the adjustments, there will be no unrealised profit on opening inventory on opening inventory.

iii) The group retained profits b/f will only be for the holding company. this is simply because the retained profits
b/f of subsidiary company are all pre-acquisition.

NOTE: In computing goodwill, do not forget pre-acquisition dividend..

Example;

H Ltd acquired 60% of the ordinary share capital of S Ltd on 1.4.20X2.The income
statements of the two companies for the year ended 31.12.20X2 are as follows:

H Ltd S Ltd
£ £
Turnover 170,000.00 80,000.00
Cost of Sales (65,000.00) (36,000.00)
Gross profit 105,000.00 44,000.00
Operating expenses (43,000.00) (12,000.00)
Profit before tax 62,000.00 32,000.00
Taxation (23,000.00) (8,000.00)
Profit after tax 39,000.00 24,000.00
Dividends proposed (12,000.00) (6,000.00)
Retained profits for the year 27,000.00 18,000.00
Retained profits b/f 81,000.00 40,000.00
Retained profits c/f 108,000.00 58,000.00

H Ltd has not accounted for it's share of proposed dividends in S Ltd. The profits of
S Ltd accrued evenly through out the period.

Required:
Prepare the consolidated income statement for the year ended 31.12.20X2.

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 217

Solution

H Ltd. and Its Subsidiary

Consolidated income statement for the year 31/12 20x2

£
Revenue 230,000
Cost of sales (92,000)
GROSS PROFIT 138,000
Operating expenses (52,000)
Profit before tax 86,000
Income tax expense (29,000)
Profit after tax 57,000
Profit attributable to Minority interest (7,200)
Profit attributable to holding company 49,800
Less: dividends (only for H) (12,000)
Retained profits for the year 37,800
Retained profits b/f (only for H) 81,000
Retained profits c/d 118,800

Example(June 1997 Q1)

Mtito Limited purchased 80% of the ordinary shares of Andei Limited on 1 May 1996. On 30 September 1996, the
trial balances of the two companies were as follows:
Mtito Ltd. Andei Ltd.
Sh. 1000 Sh. 1000'
Cash at bank ' 11,500
Debtors 62,300 51,600
Dividend: Interim paid 4,500 3,000
Expenses (including depreciation of fixed assets) 184,700 123,600
Freehold land and buildings (net book value) 25,500 18,900
Investment in Andei Limited 94,260
Motor vehicles (net book value) 6,700 4,900
Purchases 375,400 335,200
Plant and machinery (net book value) 28,900 21,600
Stock 22,100 17,600
Taxation: instalment tax paid 9,100 6 380
813460 594280

Bank overdraft (secured on land andbuildings) 6,700

Creditors 38,200 17,100
Sales 586,600 480,000
Share capital: Authorised, issued
and fully paid Ordinary shares of 60,000 20,000
Sh. 10
Profit and loss account 121960 77,180
813460 594280

Additional information:

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FINANCIAL ACCOUNTING III
218 Group Accounts

1 Closing stock was Sh.24,200,000 in Mtito and Sh.19,200,000 in Andei.

2. The turnover and expenses in Andei accrued evenly over the year; the rate of gross profit was constant
throughout the year.
3. Mtito paid its interim dividend on 15 May 1996; Andei paid its interim dividend on 31 March 1996. Mtito
has not yet accounted for any dividend receivable from Andei.
4. Between 1 May 1996 and 30 September 1996, Mtito sold goods to Andei. These goods had cost Mtito Sh.30
million. Mtito earned a gross profit of 37.5% on the selling price of these goods. At 30 September 1996, one
sixth of these goods were included in the stock of Andei. Included in the debtors figure for Mtito was
Sh.7,200,000 from Andei: Mtito's account in Andei's books agreed with this figure.
5. The self assessment tax returns of Mtito and Andei show the corporation tax charge for the year at Sh.
10,020,000 and Sh.7,980,000 respectively; both companies have paid instalment tax on the preceding year basis.
6. The directors have proposed that Mtito should pay a final dividend of Sh.6 million and Andei Sh.3
million.
7. Mtito's accounting policy with regard to goodwill is to carry it as an asset and amortise it over 60 months, on
a straight line basis. Mtito removes the whole amount of any unrealised profit on closing stock from the
stock and from the company which made the profit, in the latter case adjusting the minority interest, if
appropriate. Mtito incorporates the results of operations of Andei as from the date of acquisition, and carries
any dividends to minority interests as a current liability.

Required:
A consolidated income statement for the year ended 30 September 1996 (including reconciliations of the retained
profit for the year and carried forward) and a consolidated statement of financial position as at 30 September 1996.
(25 marks)

Solution

Note: This is a challenging question due to the fact that you have to prepare consolidated final accounts from the trial
balances. The first step as part of your workings will be to prepare the draft income statements for both the holding
company and the subsdiary company.

Mtito and its Subsidiary

Consolidated income statement for the year 30/9/1996
Sh. ‗000‘ Sh. ‗000
Revenue 738,600
Cost of sale 467,300
GROSS PROFIT 271,300
Expenses (237,200)
Profit before tax 34,100
Income tax expense (13,345)
Profit after tax 20,755
Profit attr. to minority interest (20%X5/12X 14,820) (1,235)
Profit attributable to holding company 19,520
Less dividends : Interim paid 4,500
Fund proposed 6,000 (10,500)
Retained profit for year 9,020
Retained profit for b/d 121,960
Retained profit for c/d 130,980

Statement of retained profits

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 219

B/d For the year C/d

Sh . ‗000‘ Sh. ‗000‘ Sh. ‗000‘
H Ltd. Profits 121,960 6,080 128,040
Share in Andei Ltd. - 2,940 2,940
Group 121,960 9,020 130,980

Workings for H Ltd.

As per the accounts 121,960 8,080 130,040
Add: dividends receivable from A 2,400 2,400
Less: Pre-acquisition dividends to C.O.C (400) (400)
Less: UP on closing inventory (3,000) (3,000)
Goods impaired ______ (1,000) (1,000)
121,960 6.080 128,040

Workings for share in Andei

As per the accounts 77,180 8,820 86,000
Less: pre-acquisition profits (77,180) (5,145) (82,235)
Pre-acquisition retained profits - 3,675 3,675
Share of Mtito @ 80% - 2,940 2,940

Mtito and its Subsidiary

Consolidated Statement of financial position as at 30/9/1996
Sh. ‗000‘
Sh. ‗000‘

NON-CURRENT ASSETS
Freehold land and buildings 44,400
Plant and machinery 50,500
Motor vehicles 11,600
Goodwill 11,000
117,500

CURRENT ASSETS
Inventory (total less unrealized profit) 40,400
Debtors (total less intercompany balance) 106,700
Cash at bank 11,500 158,600
276,100

Ordinary share capital 60,000

Retained profits c/d 130,980
190,980
Minority interest (20%X (20,000+86,000)) 21,200
Shareholders funds 212,180

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FINANCIAL ACCOUNTING III
220 Group Accounts

CURRENT LIABILITIES
Bank overdraft 6,700
Creditors (total less intercompany balance) 48,100
Current tax liability 2,520
Proposed dividends (6000 + (20%X3,000)) 6,600 63,920
276,100

Workings:

1. Draft income statements

MTITO ANDEI
Sh. ‗000‘ Sh. ‗000‘
Sales 586,600 480,000
Cost of sales (373,300) (333,600)
GROSS PROFIT 213,300 146,400
Expenses (184,700) (123,600)
Profit before tax 28,600 22,800
Income tax expense (10,020) ( 7,980)
Profit after tax 18,580 14,820
Dividends interim paid (4,500) (3,000)
Final proposed (6,000) (3,000)
Retained profit for year 8,080 8,820
Retained profit b/d 121,960 77,180
Retained profit c/d 130,040 86,000

2 Items in the income statement (figures in sh000)

Revenue COS Expenses Tax

Mtito Ltd 586,000 373,300 184,700 10,020
Andei Ltd (Only for five months) 200,000 139,000 51,500 3,325
Total before adjustments 786,000 512,300 236,200 13,345
Less: Intercompany sale of goods (48,000) (48,000)
Add: Unrealised profit on closing inventory (1/6X 18m) 3,000
Add: Goodwill impaired 1000
To Consolidated income statement 738,600 467,300 237,200 13,345

Goodwill impaired
Note: we assume that goodwill has been impaired at the rate of 8.3333% i.e 5 out sixt months

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 221

Cost of control account

Sh. ‗000‘
Sh. ‗000‘
Investment in A 94,260 OSC (80% x 20,000) 16,000
P & L (80% x 82,325) 65,860
Pre-acquisition dividend 400
Goodwill impairment 1,000
_____ Balance c/d ( b/s) 11,000
94,260 94,260

Profits on date of acquisition:

Retained profits for the year in subsidiary: 8,820

Pre-acquisition profits ; 1st May 1996 – 30st September 1996 = 7/12 X8,820 = 5,145

Retained profits on acquisition = bal b/d + pre-acquisition

= 77,180 + 5,145
= sh82,325,000

Pre acquisition dividends sh000

Total dividends by A : Paid 3,000
Proposed 3,000
6,000

Post acquisition dividends (5/12 x 6,000) 2,500

Pre-acquisition dividend to
cost of control
Holding company share of
dividend: Interim receive (did not receive) 0
Interim proposed (80/100x 3,000) 2,400
2,400
Less: Holding company
share of post acquisition of
dividends (80/100 x 2,500) 2,000
400

Circumstances under which a subsidiary company can be excluded from consolidation

Consolidated financial statements shall include all subsidiaries of the parent

A parent need not present consolidated financial statements if and only if;
(a) The parent is itself a wholly owned subsidiary, or is a partially-owned subsidiary of another entity and its
other owners, including those not otherwise entitled to vote, have been informed about, and do not object
to, the parent not presenting consolidated financial statements.
(b) The parent‘s debt or equity instruments are not traded in a public market (a domestic or foreign stock
exchange or an over-the-counter market, including local and regional markets).
(c) The parent did not file, nor is it in the process of filling, its financial statements with securities commission
or other regulatory organization for the purpose of issuing any class of instruments in a public market.

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FINANCIAL ACCOUNTING III
222 Group Accounts

(d) The ultimate or any intermediate parent of the parent produces consolidated financial statements available
for public use that comply with international financial reporting standards.

Note:
 The standard does not require consolidation of a subsidiary acquired when there is evidence that the control is
intended to be temporary. However there must be evidence that the subsidiary is acquired with the intention
to dispose of it within twelve months and that management is actively seeking a buyer. When a subsidiary
previously excluded from consolidated is not disposed of within twelve months it must be consolidated as
from the date of acquisition unless narrowly specified circumstances apply.
 An entity is not permitted to exclude from consolidated an entity it continues to control simply because that
entity is operating under severe long-term restrictions that significantly impair its ability to transfer funds to the
parent. Control must be lost for exclusion to occur.
 A subsidiary is not excluded from consolidated simply because the investor is a venture capital organization,
mutual fund, unit trust or similar entity.
 A subsidiary is not excluded from consolidated because its business activities are dissimilar from those of the
other entities within the group. Relevant information is provided by consolidating such subsidiaries and
disclosing additional information in the consolidated financial statements about the different business activities
of subsidiaries. For example, the disclosure required by IAS 14 (segment reporting) help to explain the
significance of different business activities within the group.

Some of the reasons for exclusion are given under the companies Act but are now prohibited by the standard.

ASSOCIATE COMPANIES (IAS 28)

An associate company is a company in which the investing company owns more than 20% but less than 50% of the
voting rights. This means that the investing company does not control or own the associate company but has a
participating influence in the financial and operating activities of the associate company.

The participating influence arises because the investing company virtue of its significant voting rights can be able to
appoint one or two directors in the board of directors of the associate company. These directors will take part in the
decision making process.

As the investing company doesn‘t control the associate company, associate company are therefore NOT consolidated.
However, due to the participating influence, they cannot be treated as mere investments and thus IAS 28 requires the
use of equity method of accounting.

In summary, the equity method of accounting requires that the investment in associate company should initially be
carried in the accounts at cost and thereafter the amount increased with the investing company‘s share of post-
acquisition retained profits in the associate company.

In preparing the final accounts the following approach will be used;

INCOME STATEMENT

a) Ignore the sales, cost of sales and the expenses of the associate company. However, premium or goodwill arising
on acquisition of associate company should be computed the normal way as that of the subsidiary company incase
of any impairment, then it should be included in the investing company‘s expenses..
b) The investing company should report its share of profit before tax in associate company as part of other incomes
and its hare of tax in associate company as part of its income tax expense.
Alternatively, the investing company can show its share of profit after tax in associate company as other incomes..

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 223

c) Just like in subsidiary companies the retained profits b/d of the investing company will be made up of the investing
company‘s retained profits b/d of the associate company.
Adjustments for previously impaired goodwill or premium should be made at this stage.

STATEMENT OF FINANCIAL POSITION

In the statement of financial position, the assets and liabilities of the associate company will be ignored but instead the
investment in associate company will be shown as part of the non-current assets. The amount to appear in the
statement of financial position can be computed in the following two ways;

£
Cost of investment in associate company x
Add; Investing company share of post-acquisition retained profits in associate company x
x
Less: Premium (goodwill) in associate company impaired to date (x)
x

NOTE

The premium or goodwill in associate company is used in computing investment in associate company that appears in
the statement of financial position and should therefore not be shown as a separate item in the investing company‘s
statement of financial position.

That means that if the investing company has a subsidiary company, it is only the goodwill of the subsidiary company
that should appear in the consolidated statement of financial position.

INTER-COMPANY TRANSACTIONS AND BALANCES

As the associate company is not consolidated, care should be taken when there are trading transactions and inter-
company balances between the investing company and associate company.
The following general approaches should apply;

a) Inter-company sales of inventory and PPE should be ignored and not adjusted for.

b) Incase of unrealized profit on PPE, opening and closing inventories and excess depreciation, then the
investing company‘s share of these items is not deducted from the group retained profits and also from the
investment in associate company appearing in the statement of financial position.
If the sale took place in the current year, then the Unrealised profit on PPE and on closing inventory and excess
depreciation are deducted from the investing company share of profit before tax in associate company.

However, if the sale took place in previous financial periods, then the UP on PPE, UP on opening inventory and
excess depreciation are deducted from the group retained profits b/d.

NOTE ; The accounting treatment is the same irrespective of the company that made the sale.

c) In the case of inter-company balances, the amount due to or from the associate company will still appear in the
final statement of financial position as they are not supposed to be cancelled out.

However you may present the amounts due to or from associate company as a separate item from the other
receivables or payables.

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FINANCIAL ACCOUNTING III
224 Group Accounts

For example.
In the consolidated statement of financial position, the final statement of financial position of the investing
company, below the receivables will have; due from associate company which is made up o the balance due from
associate company as a debtor plus the investing company share of the proposed dividends in the associate
company.
Example (June 1999)

Amua Limited purchased 80% of the ordinary share capital of Sawana Limited on 31 January 1999 for Sh.496 million
and 20% of the ordinary share capital of Ukwala Limited on 31 July 1998 for Sh.56 million. Profits in all companies are
deemed to accrue evenly over the year.
The draft accounts for the three companies are shown below:

Statement of financial position as at 30 April 1999 Profit and loss accounts for the year ended 30 April
1999
Amua Sawana Ukwala Amua Sawana Ukwala
Ltd Ltd Ltd Ltd Ltd Ltd
Sh Sh Sh. Sh Sh Sh.
.million .million million .million .million Million
Fixed assets (NBV) 414 280 220 Sales 2,346 2,400 1,400
Investments 552 - - Cost of sales (1,564) (1,620) (840)
966 280 220 Gross profit 782 780 560
Current assets Distribution costs (310) (400) (200)
Stock 180 210 70 Admin expenses (240) (200) (180)
Debtors 240 140 56 Profit from operations 232 180 180
Bank 28 12 21 Interest on debentures (42) - -
448 362 147 Profit before tax 190 180 180
Current Liabilities Taxation (72) (40) (20)
Creditors 189 109 45 Profit after tax 118 140 160
Tax 7 3 2 Dividends proposed 63 40 40
Proposed dividends 63 40 40 Retained profits
259 152 87 For the year 55 100 120
Net current assets 189 210 60 Brought forward 120 190 (40)
1,155 490 280 Carried forward 175 290 80

Share capital ordinary

Shares of Sh.10 each 700 200 200
Retained earnings 175 290 80
Shareholders‘ Funds 875 490 280
15% Debentures 280
1,155

Additional information
1. Amua Limited has not yet accounted for dividends receivable from either its subsidiary or its associated company.

2. Assume that goodwill and premium has been impaired at the rate of 20% per annum.. The fair value of the
identifiable net assets in the subsidiary, at the time Amua Ltd. acquired its shareholding, are equal to book values.
Amua Limited carries dividends due to minority interests as a current liability.

Required:

The consolidated income statement (which should be in accordance with the International Accounting Standard No. 1,
showing expenses by function on the face of the profit and loss account) for the year ended 30 April 1999, and the
Consolidated statement of financial position as at that date.

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 225

Do not produce a statement of changes in equity for the year: the retained profit brought forward and carried forward
should be included instead in the profit and loss account. Account for the associated company in accordance with the
equity method as laid down in IAS 28.

Solution

Amua Ltd. And to be subsidiary

Consolidated income statement for the year ended 30 April 1999.
Sh. Million Sh. Million
Revenue (2346 + 2400 x 3/12) 2946
Cost of sales (1564 + 3/12 x 1620) (1969)
GROSS PROFIT 977
Other incomes
Share of profit before tax in Ukwala (20% x 180) x 9/12 27
Expenses 1,004
Distribution costs (310 + 3/12 x 400) 410
Administration cost (240 + 3/12 x 200 + 7.4) 297.4
Finance costs 42 (749.4)
Profit before tax 254.6
Income tax expense [72 + (3/12 x 40) + (20% x 20 x 9/12)] (85)
Profit after tax for the period 169.6
Attributable to Holding company 162.6
Minority interest (20% x 3/12 x 140) 7
169.6

Consolidated statement of changes in equity (extract)

Sh million (retained profits)

Balance as at 1 May 1998 120
Profit for the period 162.6
282.6
Dividends proposed (of holding (63)
company)
Balance as at 30 April 1999 219.6

Workings: Sh. M
Goodwill/Premium impaired
Goodwill impaired in Sakana 5
Premium impaired in Ukwala 2.4
7.4

Cost of control account - S

Sh. M
Sh. M
Investment in S 496 OSC (80% x 200) 160
P & L (80% x 265) 212
Pre-acquisition dividend (80% x 9/12 x 40) 24
Goodwill
Impaired P&L (20 x 100 x 3/12 5
___ Balance c/d b/s 95

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FINANCIAL ACCOUNTING III
226 Group Accounts

496 496

Cost of control account - U

Sh. M
Sh. M
Interest in U 56 OSC (20% x 200) 40
P 7 L (20% x 10) 2 Pre-acquisition dividend (20% x 3/12 x 40) 212
premium 24
Impaired P&L (20% x 16 x 9/12
__ Balance c/d (Statement of financial 5
position)
58 496

Amua Ltd. And Its Subsidiaries

Consolidated Statement of financial position as at 30 April 1999
Sh. Million Sh. Million
NON-CURRENT ASSETS
Property, plant and equipment 694
Goodwill 95
Investment in associate company 69.6
858.6

CURRENT ASSETS
Inventory 390
Debtors 380
Due from associate (20% x 40) dividend due 8
Bank 40 818
1,676.6

Ordinary share capital 700

Retained earnings 219.6
919.6
Minority interest 98
Shareholders funds 1,017.6

NON-CURRENT LIABILITIES
Debentures (15%) 280

CURRENT LIABILITIES
Creditors 298
Current tax liability 10
Proposed dividends 71 379

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 227

1,676.6

Investment in associate company

Sh. M

Cost of investment I associate 56

Less: Pre-acquisition dividends (2)
54

Add: Share of post-acquisition profits in U 18

72
Less: Premium amortized to date (2.4)
69.6
Sh.m
Share of net assets/shareholders funds n U 56
Add: Premium unimpaired 13.6
69.6

Statement for retained profits (not part of published accounts)

B/f For the years C/d

Sh. M Sh.M Sh. M
Amua Ltd. 120 61.6 181.6
Share in Sawana - 20 20
Share in Ukwala - 18 18
120 99.6 219.6
Working in Amua Ltd.
As per the account 120 55 175
Add: dividends receivable - 32 32
Less: Pre-acquisition to S (24) (24)
Dividend receivable U 8 8
Less: Pre-acquisition (2) (2)
Less: Goodwill impaired in S (5) (5)
U ___ (2.4) (24)
120 61.1 181.6
Working for share in S
As per the account 190 100 290
Less: Pre-acquisition 190 (75) (265)
- 25 25
Share of annual @80% - 20 20

Working for share in U

As per the account (40) 120 80
Less: pre-acquisition 40 (30) 10
- 90 90
Share of A @ 20% - 18 18

If we are to prepare the consolidated statement of financial position with an associate company then, the group retained
profits account will be shown as follows:

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FINANCIAL ACCOUNTING III
228 Group Accounts

Group profit and loss account

Sh. M Sh. M
C.O.C P & L at acquisition 212 Amua Ltd. (P & L) 175
Minority interest in S (20% x 290) 58 Sawana Ltd. ( P & L) 290
Impairment GW 5 Share of post-acquisition in U (20% x 90) 18
Premium 2.4 Post-acquisition dividend S 8
U 6

Balance c/d 219.6

___ ___
497 497

CONSOLIDATED CASHFLOW STATEMENTS (IAS 7)

The basic cash flow statement has been covered under Financial Accounting II. The following introduction will serve as
a quick reminder.

A Cashflow statement is a simple report that explains the various sources of cash and how the business puts this cash
into use. The objective of IAS 7 is to recommend the format in which the cashflow statement should be presented and
where the various sources of cash and payments should be classified.

The cash received and payments made should be classified into main categories which are:-

1. Cashflows from operating activities: operating activities are the principle revenue generating activities of the
business and examples of such cashflows include:

i) Cash received from customers

ii) Cash paid to suppliers of goods and services
iii) Cash paid to employees

2. Cashflows from investing activities: involving activities involve the acquisition and disposal of non-current
assets such as; property, plant and equipment, intangible assets, and long-term investments.

Examples of such cashflows include:

i) Proceeds on sale of non-current assets e.g. PPE and

ii) Cash used on acquisition of non-current assets e.g. PPE
iii) Investment income received (not accrued)

3. Cashflows from financing activities; Financing activities are those activities that will lead to either an increase or
decrease in shareholders funds and long-term liabilities.

Examples of such cashflows include;

i) Proceeds on issue of shares

ii) Repayment of loans e.g. loan stock or debentures

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 229

iii) Capital repayment on finance lease

iv) Dividends paid

IAS 7 recommends that the cashflow statement can be prepared using two methods:-

I) Direct method
Whereby, cash from operations is determined by getting the differences between cash received from customers and
cash paid to suppliers of goods an services and employees.

II) Indirect method

The cash from operations is determined by making adjustments to the profit before tax for the following items.

b) Non-cash income and expenses e.g. depreciation, amortization, loss or profit on disposal of PPE
c) Incorrectly classified items e.g. investment income and interest charged
d) Working capital changes.

In addition to the above items, the following points need to be noted about preparation of consolidated cashflow
statements.

i) Goodwill impaired for the year is a non-cash expense that should be added back to the group profit before the tax.

ii) Where the group has investments in associate company then dividends received from associate should be reported
as a separate item under investing activities. The dividend to be reported can be determined as follows.

Investment in associate account

£ £
Balance b/d x Share of tax in associate company
Share of profit before tax in associate company Dividends balance figure x
Balance c/d x
x x

The dividends paid to minority interest should also be disclosed separately from those of the holding company and
classified under financing activities

Dividends paid to minority interest may be determined as follows:

Minority interest account

£ £
Dividends balance figure x Balance b/d
Balance c/d x Share of profits in subsidiary x

x x

Example (December 2002)

The voice of the Nation Limited is a Nairobi based media company. Its Consolidated Income Statement for the year
ended 30 April 2003, and its Consolidated Statement of financial positions as at 30 April 2002 and 2003 are as follows:

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FINANCIAL ACCOUNTING III
230 Group Accounts

Consolidated Income Consolidated 2003 2002

Statement for the year Statement of Sh.milli Sh.million
ended 30 April 2003 financial position on
as at 30 April
Sh.million Non-current assets:
Sales 3,325
Cost of sales (1,935) Property, plant and equip.
Gross profit 1,390 (Cost or Valuation) 2,297 2,134
Distribution costs (225) Accumulated (931) (733)
Administrative expenses (790) Depreciation 1,366 1,401
Operating profit 375 Intangible asset: Goodwill 126 126
Finance costs: Int expense (8) Amortisation (30) (17)
Share of results of associate 50 96 109
Profit before tax 417 Investment in associate 263 246
Tax: Group companies (110) 1,725 1,756
Share of associate (15) (125) Current assets:
Profit before minority interest 292 Inventories 276 178
Minority interest (28) Receivables and 607 623
Profit after tax 264 prepayments 93 71
Cash and cash equivalents 976 872
Current Liabilities:
Payables and accrued 615 484
expenses 22 16
Additional information: Current tax 8 133
1. The holding company, the subsidiary and Borrowings: bank overdraft 645 645
the associate had all paid dividends during 331 331
the year. Net current assets 2,056 1,940
A class of assets in the subsidiary had been Capital and reserves:
revalued during the year. Depreciation of Share capital 500 500
Sh.20 million had been written back on the Revaluation reserve 260 133
revaluation. The transfer to the revaluation Retained earnings 839 725
surplus account in the subsidiary was Shareholders‘ funds 1,599 1,413
Sh.120 million. The minority interest owns Minority interest 240 204
40% of the share capital of the subsidiary. Non-current liabilities:
Borrowings: commercial 110 200
Property, plant and equipment which had paper 107 123
cost Sh.100 million and on which Deferred tax 217 323
accumulated depreciation stood at Sh.47 2,056 1,940
million at 30 April 2002 was sold for Sh.70
million in the year.

The group classifies interest paid as an

operating cash flow, there were no accruals
at the beginning or at the end of the year in
respect of this item. It classifies dividends
received as an investing activity and any
dividends paid as an investing activity. The
bank overdraft is classified as a component
of each and cash equivalent.

Required:

Prepare the Consolidated Cash flow Statement for the year ended 30 April 2003 for the group using the indirect
method. (20 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 231

Solution

Voice of Nations Ltd.

Consolidated cashflow statement for the year ended 30 April 2003
Sh m Sh. m

Cashflows from operating activities

Group profits before tax 417

Adjustments – cash items

Depreciation 265
Amortization of goodwill 13
Profit on disposal of PPE (70 – (100 – 47) (17)
Interest expense 8
Share of results in associate company (50)
636

Changes in making capital

Increase in inventory (98)
Decrease in debtors and prepayment 16
Increase in payables 131
Cash from operations 685
Less interest paid (8)
Tax paid (120)
Net cash received from operating activities 557

Cashflows from investing activities

Cash proceeds on sale of PPE 70
Acquisition of PPE (163)
Dividends from associate company 18
Net cash used in investing activities (75)

Cash flows from financing activities

Dividends paid – Group (150)
Minority interest (40)
Repayment of commercial paper (90)
Net cash used in financing activities (280)
Net cash used in financing activities 202
Net increase in cash and cash equivalents b/d (117)
Cash and cash equivalents c/d 85

NOTE: Cash and cash equivalents

B/d sh m C/d Sh. M
Cash and cash equivalents 71 93
Bank overdraft (188) (8)
Short term investments - -
(117) 85

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FINANCIAL ACCOUNTING III
232 Group Accounts

Workings

1. Depreciation

Depreciation account
Sh m Sh m
PPE – Revaluation 20 Disposal 100
Disposal 47 Profit and loss 265
Balance c/d 931
998 998

2. Tax

Tax account
Sh m Sh m
Balance c/d 120 Balance b/d – def 123
Balance c/d – def 107 Current tax 16
Current 22 Profit and loss 110
249 249

3. Acquisition of PPE

PPE cost account

Sh m
Sh m
Balance b/d 2,134 Disposal 100
Revaluation reserve - gain 120 Depreciation on revaluation 20
Cash book 163
Balance c/d 2,297
2,417 2,417

4. Dividends from associate company

PPE cost account

Sh m
Sh m
Balance b/d 246 Share of tax 15
Share of PBT 50 Dividends 18

Balance c/d 263

296 296

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 233

5. Dividends paid

Group retained profits

Sh m
Sh m
Dividend balance figure 150 Balance b/d 725
Balance c/d 839 Profit after tax & MI 264
989 989

6. Minority interest account

Sh m
Sh m
Dividend balance figure 40 Balance b/d 204
Balance c/d 240 Revenue reserve 48
Profit after tax 28
280 280

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FINANCIAL ACCOUNTING III
234 Group Accounts

REINFORCEMT QUESTIONS
QUESTION ONE

Loita Limited purchased 60% of the ordinary shares of Leserin Limited on 1 January 1999. On 30 September 1999, the
trial balances of the two companies were as follows.

Loita Ltd. Leserin ltd.

Sh. ‗000‘ Sh. ‗000‘
Profit and loss account 64,950 31,800
Sales 642,500 372,000
Share capital 100,000 40,000
Trade and other payables 31,800 18,100
Dividend receivable 12,000 -
20% debenture stock 50,000 -
901,250 461,900

Administrative expenses 94,550 36,400

Cash at bank 6,830 8,200
Distribution cost 112,350 64,600
Dividends paid 20,000 20,000
Installment tax paid 28,100 22,900
Interest paid 10,000 -
Investment in subsidiary (at cost) 62,080 -
Land and buildings (net book value) 60,200 38,100
Inventories 51,250 28,240
Motor vehicles (net book value) 11,270 4,400
Purchases 320,650 187,500
Plant and machinery (net book value) 70,450 20,300
Trade and other receivables 53,520 31,260
901,250 461,900

Additional information:

1. The authorised chare capital of both companies had been fully issued and paid up in Sh.10 ordinary shares.
2. The turnover and the expenses in Leserin Limited accrued evenly over the year, and the mar-up on the cost of
goods sold was constant throughout the year at 100%. Between 1 January 1999 and 30 September 1999. Leserin
limited made sales to Loita Limited of Sh.68 million, earning the usual gross profit. Loita limited did not have any
of these goods in hand at 30 September 1999, but owed Leserin Limited Sh.6 million. According to Leserin‘s books
Loita Limited owed Sh.9 million but a cheques for Sh.3 million, posted on 28 September 1999 by Loita Limited was
not received by Leserin Limited until 8 October 1999.
3. Both companies paid their interim dividends on 15 April 1999. The directors of Loita Limited have proposed a
final dividend of 40% and have required Leserin Limited to propose a final dividend of 50%. These have not yet
been accounted for but the directors have instructed you to debit these into income statement (not in the statement
of changes in equity and carry the proposed dividends as current liabilities. Dividends proposed payable to minority
interests should also be carried as current liabilities.
4. The current tax charge for the year was Sh. 31 million and Sh.25 million for Loita Limited and Leserin Limited
respectively. Deffered tax is to be ignored.

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 235

5. Closing inventories at cost to each company was Sh.51,300,000 for Loita and Sh.29,740,000 for Leserin Limited.
6. Goodwill on consolidation should be carried as an asset and amortised on the straight line basis over 5 years, with
the appropriate proportion being amortised for a period of less than one year. The results of operations of the
subsidiary should be incorporated into the consolidated income statement with effect from the date of acquisition.

Any unrealised profit on intra-group sales of assets is removed from the group assets and from the company which
made the profit, in the latter case adjusting the minority interest, if appropriate. The goodwill amortisation charge
should appear as a separate expense in the profit and loss account.

Required:

The consolidated income statement for the year ended 30 September 1999 and the consolidated statement of financial
position as at that date in accordance with International Accounting Standards and the Kenya Companies Act.
(Total: 25 marks)

QUESTION TWO
The figures that relate to the Profit and Loss Accounts and to the Statement of Charges in Equity for Addis Limited and as
subsidiaries Bunyala Limited and Chania Limited for the year ended 30 November 2000 are as follows:

Addis Ltd. Bunyala Ltd. Chania Ltd.

Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Sales revenue 84,000 66,000 48,000
Inventory 1 December 1999 (3,824) (3,757) (2,822)
Inventory 30 November 2000 4,286 4,124 2,452
Purchases (50,862) (49,862) (38,430)
Distribution cost (13,440) (8,050) (9,600)
Administrative expenses (8,400) (3,950) (6,400)
Taxation: Current (2,140) (1,050) -
Deferred (1,420) (300) 2,040
Dividends
Preference: Interim paid 31 May 2000 - (450) -
Final paid 30 November 2000 - (450) -
Ordinary: Interim paid 31 August 2000 (3,000) (500) -
Final proposed 30 November 2000 (4,500) (750) (150)
Dividends received 580 - -
Retained profit: 1 December 1999 18,300 12,600 9,200
Issued and paid-up share capital:
Preference share capital Nil 9,000 Nil
Ordinary share capital 15,000 10,000 3,.000

Additional information:

1. Addis Limited acquired 180,000 10% preference shares of Sh.20 each and 800,000 ordinary shares of Sh.10 each on 1
December 1996 when the balance on the income statement of Bunyala Limited was Sh.8,100,000. Goodwill of
Sh.2,500,000 had arisen on the purchase of these shares. Addis Limited is amortizing this goodwill over 5 years on the
straight line basis.
2. Addis Limited acquired 180,000 ordinary shares of Sh.10 each in Chania Limited on 1 March 2000: the purchase
price of these shares was to be fixed once the results for the year ended 30 November 2000 to maintain its trustee
status.
3. Bunyala Limited makes sales to Addis Limited at its nominal selling price. In the year ended 30 November 2000,
Bunyala Limited‘s sales to Addis Limoted amounted to Sh.9,300,000. Stock purchased from Bunyala Limited and

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FINANCIAL ACCOUNTING III
236 Group Accounts

held by Addis Limited at cost amounted to Sh.540,000 and Sh.720,000 on 30 November 1999 and 30 November
2000 respectively.
4. Addis Limited sold an item of plant to Bunyala Limited on 1 December 1998 for Sh.2,400,000. Addis Limited had
marked up its cost by 20%. Bunyala Limited is depreciating this item of plant to nil residual value on the straight
line basis over 10 years with the charge appearing as part of cost of sales.
5. There has been no intra-group trade between Chania Limited and other two companies.
6. Group policy in relation to unrealised profit on intra-group sales is of assets os to remove the whole of the
unrealised profit from the asset and from the company which made the profit on the sale of the asset adjusting the
minority interest‘s share of this profit as appropriate. The amortization of goodwill is classified as an administrative
expense and deemed to be a charge against the profit of the holding company.

Required:

The consolidated Income Statement and the portion of the Consolidated Statement of Charges in Equity that relates to
accumulated profit, giving the details required by International Accounting Standard and the Kenya Companies Act,
including reconciliation of the group retained profit for the year and carried forward.
(Total: 20 marks)
QUESTION THREE
The statement of financial positions of AC Limited, BEM Limited and CET Limited as at 31 May 2000 were as follows:

BEM Ltd. CET Lld.

AC Ltd. Sh. ‗000‘ Sh. ‗000‘
Sh. ‗000‘
Fixed assets 68,700 36,200 31,900
Investments in subsidiaries:
BEM Ltd. (Book value) 75,000
CET Ltd. (cost) 40,000
Current assets: Debtors 21,200 8,700 6,900
Cash - 27,100 16,200
164,900 112,000 55,000
Share capital:
Authorized issued and fully paid
Ordinary shares of Sh.10 100,000 30,000 10,000
Profit and loss account 11,000 54,000 28,000
Shareholders‘ funds 111,100 84,000 38,000
12% loan stock 30,000 20,000 10,000
141,100 104,000 48,000
Current liabilities:
Bank overdraft (secured) 9,300 - -
Creditors 12,700 6,500 5,800
Taxation 1,800 1,500 1,200
23,800 8,000 7,000
164,900 112,000 55,000

Additional information:

1. BEM Limited purchased 800,000 ordinary shares in CET Limited on 1 June 1999 for Sh.36 million and Sh.5 million
nominal of the 12% loan stock of CET Limited on the same day for Sh.4 million. CET Limited paid an interim
dividend of Sh.5 million on 9 January 2000. The directors have proposed a final dividend of the same amount but
this dividend has not been included in the statement of financial position above. The balance on the income
statement of CET Limited was Sh.30 million at 1 June 1999. Interest on the 12% loan stock has always been paid
up to date.

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 237

2. AC Ltd. Purchased 2,250,000 ordinary shares in BEM Ltd. On 1 June 1998 for Sh.70 million. The balance on the
income statement of BEM Ltd. On that date was Sh.50 million. On the same day AC Limited purchased Sh.10
million nominal of the 12% loan stock in BEM Limited for Sh.8 million. BEM Limited made a profit after tax of
Sh.16 million in the year ended 31 May 2000. BEM Ltd. paid a single dividend of Sh.20 million for the year ended
31 May 1999, which AC Ltd. accounted for appropriately. BEM Ltd. paid an interim dividend of Sh.10 million on
11 February 2000 which AC Ltd. credited to its profit and loss account. A final proposed dividend of Sh.15 million
has not yet been reflected in the statement of financial position of BEM Limited above.

When BEM Limited received the dividend from CET Limited on 10 January 2000, BEM Limited credited its profit
and loss account: the dividend is included in the Sh.18 million reported by BEM Limited. BEM limited has always
paid interest on the 12% loan stock up to date.
3. Goodwill is carried at cost and amortized at 20% per annum on the straight-line basis.
4. The directors of AC limited ask to provide a final dividend of Sh.10 million.

Required:

The consolidated statement of financial position of AC Limited and its subsidiaries as at 31 May 2000.
Note: Proposed dividends should be shown as current liabilities. (Total: 20 marks)

QUESTION FOUR
On 1 April 2001 Mega Ltd .acquired 4,500,000 ordinary shares of Ksh.20 par value in Lenga Ltd at a cost of Ksh.152,
000, 000.Further, on 1 July 2001 Mega Ltd acquired 15,000,000 ordinary shares of Ksh 20 par value in Tera Ltd at a
cost of Ksh.716, 600,000.Directors were appointed to the boards of both companies by Mega Ltd so as to take an
active part in their management. Given below is the information extracted from the books of the companies as at 31
March 2002.

Statement of financial position as

at 31 March 2002
Mega Lenga Tera
Sh. Sh. Sh.
‗000‘ ‗000‘ ‗000‘
Freehold property at cost 720,000 0 200,000
Plant and machinery at cost 1,375,000 450,000 350,000
Inventory 380,000 218,000 360,600
Receivables 374,800, 185,000 125,000
Amount due from Mega Ltd - - 48,000
Investments 868000 - -
Bank balances _______- 9,000 40,000
3,717,800 862,000 1,123,600

Share capital 1,000,000 300,000 400,000

Share premium 200,000 24,000 -
Capital reserve 300,000 - 56,000
Retained profit (as at 31 March 2002) 786000 218,000 288,000
2,286,000 542,000 744,000

Payables 590,000 110,000 152,000

Amount due to Tera Ltd. 36,000 - -
Accumulated depreciation –plant and machinery 521,800 120,000 124,600
Current tax 190,000 90,000 103,000

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FINANCIAL ACCOUNTING III
238 Group Accounts

Bank balance 94,000 - _______-

3,717,800 862,000 1,123,600

Additional informationis given as follows

1. Profit for the year ended 31 March 2002 after tax and before dividends were as follows;

Sh
Mega Ltd 252,000,000
Lenga Ltd 102,000,000
Tena Ltd 128,000,000

These profits are included in the retained profits.

2. No interim dividends were paid in the year but final proposed dividends are as follows;

Mega Ltd 20%

Lenga Ltd 10%
Tera Ltd 10%

3. Profits accrued uniformly throughout the year

4. Included in the inventory of Mega Ltd. were goods purchased from Tera Ltd. at Sh.40, 000,000.Tera had made
profits of 25% on cost of the goods.
5. A Remittance of Sh 12,000,000 from Mega ltd to Tera Ltd at the end of financial year was received in April 2002.
6. On1 April 2001 plant and machinery of Lenga Ltd was revalued upwards by Sh 240,000,000 and the revaluation was
not incorporated in the books .Plant and machinery is depreciated at the rate of 10% per annum based on cost.
7. Goodwill or premium on consolidation is has been impaired at 20%.

Required
Consolidated statement of financial position of Mega Ltd and its subsidiary as at 31 March 2002 (20 marks)

QUESTION FIVE

The following are the group accounts of Empire Limited and its subsidiary Expansion Ltd. and its associate Broader
Ltd.

Consolidated income statement for the year ended 30 June 1998

Sh.
Group profit before and extra ordinary items 10,950,000
Group taxation 2,250,000
Group profit after tax 8,700,000
Provision for deferred tax 2,700,000
6,000,000
Deduct minority interest 300,000
5,700,000
Extra ordinary items (gains) 150,000
5,850,000
Less ordinary shares dividends 4,650,000
Retained profit for the year 1,200,000

Consolidated statement of financial position as at 30 June

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Four 239

1998 1997
Sh. ‗000‘ Sh. ‗000‘
Goodwill 41,250 41,250
Fixed assets 50,850 45,600
Associate (Net assets) 5,850 5,400
Investments 22,350 37,350
Current assets 120,300 129,600
Stocks 49,950 39,450
Debtors 29,850 26,700
Cash at bank 1,200 900
81,000 67,050

Current liabilities:
Creditors 33,000 31,650
Dividends 4,650 4,200
37,650 35,850
Net current assets 43,350 31,200
163,650 160,800

Financed by:
Issued share capital 26,400 25,500
Reserves 64,350 73,350
Minority interest 1,500 1,200
Loan capital 38,550 45,750
Short term borrowing 25,050 9,150
Taxation: Deferred tax account 6,600 3,900
Income tax liability 1,200 1,950
163,650 160,800

The following additional information is provided:

1. Depreciation charge for the year was Sh.3,600

Sh. 3. Additions of fixed assets during the

2. Retained profits by: Subsidiary 150,000 year Sh.11,550,000
Parent 600,000 4. Deposals of fixed assets during the
Associate 450,00 year Sh.2,700,000
1,200,000 Required:
A cash flow statement for the year ended
30 June 1998
(20 marks)

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FINANCIAL ACCOUNTING III
 240 Group Accounts

3. Reserves Share Investment Undistribute

Premium Revaluation d Profits
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Total
Sh. ‗000‘
1 May 1997 - 29,550 43,800 73,350
Investment revaluation - (11,700) - (11,700)
Surplus - 900 900
Retained profits for the year - 1,200 1,200
Premium received 600 - - 600
600 18,750 45,000 64,350

4. Additions of fixed assets during the year Sh.11,550,000

5. Disposals of fixed assets during the year Sh.2,700,000

Required:

A cash flow statement for the year ended 30 June 1998 (Total: 20 marks)

CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY PACK

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 241

COMPREHENSIVE ASSIGNMENT NO. 2

TO BE SUBMITTED AFTER LESSON 4
To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by
the University.

TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS

QUESTION ONE

Sir Charles' is a fashionable men's clothing store with a Head Office in Mombasa and branches all over Kenya.
Books are not maintained in the branches: data is sent by Kenpack Services Ltd. from the branches to a head office
computer in Mombasa. A computer program has been developed by Sir Charles' to write up the traditional accounts
of each branch in the usual way. The following data relates to the Kisumu branch. All prices quoted are selling
prices.
Sh‘ 000'

1 July 2003 Opening stock (at Head Office cost plus 50% on cost: goods with
a normal selling price of Sh.600,000 had with the authority of the Head
Office been marked down by 15%). 6,210

Transactions to
30 June 2004 Goods received by branch from Head Office (at cost plus 50%) 71,040

Goods returned to Head Office (including one fifth of the opening

stock of marked down goods) 1,470
Cash sales (these include the remainder of the opening stock of
marked down goods and one half of goods received in the year at a
selling price of Sh.720,000 marked down by 50% to clear them - the
other half is included in closing stock at the year end) - to general public 38,592
Credit sales (to other retailers) 27,990
Retailer customer returned goods to Kisumu branch 186
Goods received from Kisii branch during the year 246
Goods sent to Kitale branch during the year 321
Retailer customer returned goods to Head Office in Mombasa 522
Cash stolen in transit to the bank on 21 June 2004 129
Goods stolen on the night of 9 March 2005 420
The stock-take carried out on 1 July 2004 confirmed that the book value of closing stock was correct. Kisumu
branch expenses amounted to Sh. 19,200,000.

Required:
To test the correctness of the computer program, the chief accountant asks you to write up the Kisumu branch stock
account and the Kisumu branch mark-up account, and a memorandum income statement for the year ended 30 June
2004 (15 marks)

QUESTION TWO
Traders Limited operates two branches one in the head office in Nairobi and the other in Busia. Purchases of stock are
made exclusively by the head office branch which does some modification to the stocks before they are sold. Goods are
sent to the Busia branch at modified cost plus 10% and all sales by both Busia branch and head office branch are made
at a gross profit of 25% on the modified goods.

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FINANCIAL ACCOUNTING III
242 Group Accounts

The trial balances as at 30 June 2002 before taking account of the under mentioned adjustments were:
Nairobi Branch Busia branch
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Capital 1,550
Purchases 9,847.5
Cost of modification 252
Drawings by the owner 275
Sales 6,400 4,100
Goods sent/received by branch 4,620 4,400
Selling and general expenses 945 106
Debtors/Creditors 1,548 3,007 568 54
Branch and head office current accounts 1,949 1,307.5
Bank balances 760 ______ 387.5 ______
15,577 15,577 5,461.5 5,461.5

Additional information:

1. Goods worth Sh.220,000 sent to Busia branch in June 2002 were not received ir recorded by the branch until July 2002
while a remittance of Sh.421,500 from the Busia branch to the head office in June 2002 was not received or recorded at
head office until August 2002. Any adjustmenta in respect of these items are to be made in the head office accounts

2. There was a shortage in stocks of selling value of Sh.100,000 at the Busia Branch. There was no shortage of surplus
at the head office.

3. Unmodified goods costing Sh.500,000 were at the Nairobi branch as at 30 June 2002.

4. There was no loss or wastage in the process of modification of stocks by the head office. The branch handles only
goods received from the head office.

Required:

Prepare in columnar form for the Nairobi branch, Busia branch and the combined business.

(a) The income statement for the year ended 30 June 2002 (12 marks)
(b) The statement of financial positions as at 30 June 2002. (8 marks)
(Total: 20 marks).

QUESTION THREE

Amini Ltd. is a manufacturing business with the head office in Nairobi Kenya, and a branch in Kampala, Uganda. The
branch carries out the final assembly of the goods before selling them. The trial balances for both the head office and
the branch in their respective currencies as at 31 October were as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 243

Head office Branch

Sh. ―000‖ Sh. ―000‖ Ush. Ush. ―000‖
―000‖
Freehold building at cost 28,000 126,000
Debtors and creditors 17,800 19,000 72,000 3,120
Sales 208,000 864,000
Shares capital 80,000
Goods sent to branch 70,000
Head office/branch account 120,200 1,008,520
Cost of sales – branch 720,000
Provision for deciation on machinery 3,000 113,400
Head office cost of sales (including goods sent 118,000
to branch)
Administration costs 30,400 36,000
Stock – 31 October 2003 57,800 23,040
Income statement – 1 November 2002 4,000
Machinery at cost 12,000 252,000
Remittances 56,000 544,000
Bank balance 9,200 158,400
Selling and distribution costs 46,600 ______ 57,600 ________
440,000 440,000 1,989,040 1,989,040

Additional information:
1. The cost of sales figure includes a depreciation charge of 10% per annum on the cost of machinery.
2. A provision of Kshs. 600,000 for unrealized profit in the branch stock is to be made.
3. The branch remitted Ushs. 32,000,000 on 30 October 2003 which was not received by the head office until 3
November 2003. The amount realized was Kshs. 3,980,000.
4. During September 2003, a customer of the branch paid the head office for goods supplied by the branch. The
amount due from him was Ushs. 640,000 which realized Kshs. 72,000. It has been correctly dealt with by the
head office but not yet entered in the branch accounts.
5. Commission, which is payable to the branch Manager, is to be provided at 5% of the net profits of the branch
after charging such commission.
6. The relevant exchange rates were as follows:
Ks T Ush
hs. o s.
On 1 November 2002 1 10
On 31 October 2003 1 8
Average rate for the year ended 31 October 2003 1 9
On date of purchase of freehold building and machinery 1 7
Required:
(a) Branch trial balance (after the necessary adjustments) in Kenya shillings. (6 marks)

(b) Income statement for the head office, the branch and the combined business for the year ended 31 October
2003. (6 marks)

(c) Combined statement of financial position as at 31 October 2003. (8 marks)

(Ignore the effects of taxation). (Total: 20 marks)

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FINANCIAL ACCOUNTING III
244 Group Accounts

QUESTION FOUR

On 1 January 2003, H Ltd., a manufacturer of clay products, made the following investments
 Acquired 60% of the ordinary shares of S Ltd. for Sh.80,000,000.
 Acquired 40% of the preference shares of S Ltd. for Sh.25,000,000
 Acquired 30% of the ordinary shares of A Ltd. for Sh. 55,000,000.
H Ltd. is represented in the board of directors of A Ltd. by two directors.
The draft accounts of H Ltd., S Ltd. and A Ltd. for the year ended 31 December 2003 were as follows:

Draft profit and loss accounts as at

December 2003
H Ltd. S Ltd. A Ltd.
Sh. ―000‖ Sh. ―000‖
Turnover 600,000 400,000 350,000
Profit before tax 200,000 180,000 100,000
Taxation (60,000) (45,000) (30,000)
Profit after tax 140,000 135,000 70,000
Less proposed dividends: -
Preference - (30,000)
Ordinary (60,000) (60,000) (40,000)
Retained profits 80,000 45,000 30,000
Balance brought forward 40,000 60,000 50,000
Balance carried forward 120,000 105,000 80,000

Draft profit and loss accounts as at

December 2003
H Ltd. S Ltd. A Ltd.
Sh. ―000‖ Sh. ―000‖
Assets:
Non-current assets 375,000 195,000 135,000
Current assets:
Stocks 90,000 85,000 60,000
Debtors 80,000 65,000 40,000
Cash at bank 75,000 50,000 45,000
245,000 200,000 145,000
Total assets 620,000 395,000 280,000
Equity and liabilities:
Equity:
Authorized and fully paid:
3,000,000 ordinary shares of Sh. 100 par value 300,000
1,000,000 ordinary shares of Sh. 100 par value 100,000 100,000
500,000 Preference shares of Sh. 100 par value
50,000
Income statement balance 120,000 105,000 80,000
420,000 255,000 180,000
Liabilities
Current liabilities:
Creditors 80,000 35,000 30,000
Proposed dividends 60,000 60,000 40,000
Taxation 60,000 45,000 30,000
200,000 140,000 100,000
Total equity and liabilities 620,000 395,000 280,000
Additional information:

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STRATHMORE UNIVERSITY● STUDY PACK
Lesson Four 245

1. Non-current assets of H Ltd. include the cost of investments in S Ltd. and A Ltd.
2. H Ltd. has not accounted for dividends receivable from S Ltd. and A Ltd. H Ltd. accounts for dividends due to
minority interests as a current liability.
3. The assets in A Ltd. are to be revalued upwards by Sh. 60,000,000 to arrive at their values.
4. Included in the stocks of S Ltd. were goods purchased from H Ltd. for Sh.5,000,000. H Ltd. had marked up the
goods by 25% of their cost.
5. On 15 January 2003, S Ltd. made a bonus issue of 2 shares for every 5 held.

Required:
(a) Consolidated income statement and statement of retained earnings, of H Ltd., its subsidiary and associated
company, for the year ended 31 December 2003. (10 marks)

(b) Consolidated statement of financial position, of H Ltd., its subsidiary and associated company, as at 31 December
2003.
(15 marks)
(Total: 25 marks)
QUESTION FIVE

On 1 April 2001 Mega Ltd .acquired 4,500,000 ordinary shares of Ksh.20 par value in Lenga Ltd at a cost of Ksh.152,
000, 000.Further, on 1 July 2001 Mega Ltd acquired 15,000,000 ordinary shares of Ksh 20 par value in Tera Ltd at a
cost of Ksh.716, 600,000.Directors were appointed to the boards of both companies by Mega Ltd so as to take an
active part in their management. Given below is the information extracted from the books of the companies as at 31
March 2002.

Statement of financial position as

at 31 March 2002
Mega Lenga Tera
Sh. Sh. Sh.
‗000‘ ‗000‘ ‗000‘
Freehold property at cost 720,000 0 200,000
Plant and machinery at cost 1,375,000 450,000 350,000
Stock 380,000 218,000 360,600
Debtors 374,800, 185,000 125,000
Amount due from Mega Ltd - - 48,000
Investments 868000 - -
Bank balances _______- 9,000 40,000
3,717,800 862,000 1,123,600

Share capital 1,000,000 300,000 400,000

Share premium 200,000 24,000 -
Capital reserve 300,000 - 56,000
Retained profit (as at 31 March 2002) 786000 218,000 288,000
2,286,000 542,000 744,000

Creditors 590,000 110,000 152,000

Amount due to Tera Ltd. 36,000 - -
Accumulated depreciation –plant and machinery 521,800 120,000 124,600
Taxation 190,000 90,000 103,000
Bank balance 94,000 - _______-
3,717,800 862,000 1,123,600

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FINANCIAL ACCOUNTING III
246 Group Accounts

Additional informationis given as follows

8. Profit for the year ended 31 March 2002 after tax and before dividends were as follows;

Sh
Mega Ltd 252,000,000
Lenga Ltd 102,000,000
Tena Ltd 128,000,000

These profits are included in the retained profits.

9. No interim dividends were paid in the year but final proposed dividends are as follows;

Mega Ltd 20%

Lenga Ltd 10%
Tera Ltd 10%

10. Profits accrued uniformly throughout the year

11. Included in the stock of Mega Ltd. were goods purchased from Tera Ltd. at Sh.40, 000,000.Tera had made profits
of 25% on cost of the goods.
12. A Remittance of Sh 12,000,000 from Mega ltd to Tera Ltd at the end of financial year was received in April 2002.
13. On1 April 2001 plant and machinery of Lenga Ltd was revalued upwards by Sh 240,000,000 and the revaluation was
not incorporated in the books .Plant and machinery is depreciated at the rate of 10% per annum based on cost.
14. Goodwill or premium on consolidation is amortized on a straight line basis over five years.

Required
Consolidated statement of financial position of Mega Ltd and its subsidiary as at 31 March 2002 (20 marks)

END OF COMPREHENSIVE ASSIGNMENT No.2

NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 247

LESSON FIVE

BANKRUPTCY AND LIQUIDATION

OBJECTIVES
At the end of this lesson, you should:

 Know the law relating to the bankruptcy of individuals and partnerships;

 Know the law relating to the receivership of companies;
 Know the law relating to the liquidation of companies;
 Know how to prepare the statements of affairs and the deficiency or surplus account for an
individual, a partnership and a company undergoing a creditors' voluntary liquidation or a
compulsory liquidation;
 Know how to prepare a statement of assets and liabilities of a company undergoing a members;
voluntary liquidation;
 Know how to prepare the accounts of a trustee in bankruptcy, of a liquidator and a receiver of
company.

CONTENTS

 Read the study text below.

 Attempt reinforcing questions at the end of the lesson.
 Compare your solutions with those given in Lesson 9.

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FINANCIAL ACCOUNTING III
 248 Bankruptcy and Liquidation

5.1 DEFINITION OF BANKRUPTCY

FORWARD NOTE:
Bankruptcy is another key area of accounting 3. The issues addressed here deal with the properties of
an individual (a sole trader or partner in a partnership) when they become bankrupt. There is a lot of
legal issues and most of these are addressed under the Bankruptcy Act. Please go through the notes
patiently but emphasise more on the final accounts i.e. the statement of affairs and the deficiency
account.

A bankrupt is a person against whom an adjudication order has been made by the court primarily on
the grounds of his insolvency. Any person (other than a body corporate) can be made bankrupt
(including in certain cases, infants and persons of unsound mind) who:

(a) Has incurred liquidated debts of Shs 1,000 or more; and

(b) Has committed an act of bankruptcy within the three months preceding presentation of the
petition; and
(c) At the time the petition was presented was domiciled or within a year before, was ordinarily
resident in Kenya or carrying on business in Kenya personally or by an agent or as a member of
a firm.

5.2 ACTS OF BANKRUPTCY

The following are the acts of bankruptcy on which a petition may be founded:

(a) Assignment of property to trustee: whereby one gives up all his property to be managed by a
trustee
Provided that:

i. The assignment is of substantially the whole of the debtor's property, and

ii. It is for the benefit of the creditors generally.

Such an assignment will normally be void unless registered as a deed of arrangement.

(b) Fraudulent conveyance: the debtor unfairly transfers his property to one creditor, so that the
other creditors have no assets to attach their claims on.
i.e. a transfer of any property to any person which gives one creditor an unfair advantage, or
which tends to defeat or delay creditors.
(c) Fraudulent preference
Where the preference constitutes a conveyance or transfer of property, or a charge thereon,
(d) Absenting
i.e. departing or remaining out of Kenya, or departing from his dwelling-house, or otherwise
absenting himself, or 'keeping house', with the intention of defeating or delaying his creditors.
(e) Execution against goods
This is committed when the bailiff has taken possession of goods and either sold them or
retained them for 21 days.
(f) Petition by debtor
A bankruptcy petition by the debtor against himself, or a formal declaration of his inability to pay
his debts filed with the court, operates as an act of bankruptcy.
(g) Non-compliance with bankruptcy notice
A bankruptcy notice may be issued by a judgement creditor in respect of a final judgment or
order for any amount provided that execution has not been stayed or already levied: failure by
the debtor to pay the amount of the judgment within seven days of service of the notice
constitutes an act of bankruptcy, unless the debtor applies to have it set aside on the grounds of
set off, etc.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 249

(h) Notice of suspension of payment of debts

This may be in any form provided it shows a clear intention to suspend payment.

5.3 THE PETITION

(a) Petition by debtor

If the debtor presents his own petition, a receiving order is made at once without a court hearing
and an adjudication order may also be made at once.
(b) Petition by creditor
Any creditor including an assignee of a debt, may petition, provided:

i. The debt due to him amounts to at least Shs 1,000;

ii. The debt is certain and is for a liquidated sum;
iii. The petition is based on an act of bankruptcy committed within the previous three
months.
iv. The debtor is domiciled in Kenya, or within the previous year has ordinarily
resided or carried on business in Kenya.

A creditor whose debt is less than Shs 1,000 may petition jointly with other, if the
aggregate of the debts is Shs 1,000 or more A secured creditor may only petition in respect
of the balance unsecured unless he agrees to surrender his security.

(c) Presentation and hearing

The petition is presented to the court and must be served on the debtor at least eight days
before the hearing. If the debtor wishes to oppose it he must give notice of that fact and the
reasons for his opposition at least three days before the hearing. The court may dismiss the
petition if the creditor fails to prove

i. The debt
ii. Service of the petition on the debtor
iii. The act of bankruptcy relied on or
iv. If satisfied that the debtor can pay his debts, or for other sufficient cause.

Otherwise it may stay the proceedings on such terms as it thinks fit, or make a receiving order
against the debtor.

(d) Protection of debtor‘s property

At any time after presentation of the petition, the court may appoint the official receiver
(O R) to be interim receiver of the property and the O R may himself appoint a special
manager. The court may also stay any action or other legal process against the debtor.

(e) The official receiver

The Official Receiver is an officer of the court appointed by, and under the supervision of, the
Minister. His duties are to investigate the debtor's conduct and report thereon to the court, to act
as receiver of the debtors property, summon and preside at the first meeting of creditors,
advertise requisite matters in the Kenya Gazette and elsewhere, and act as trustee pending
appointment of a trustee by the creditors and during any vacancy, and in small bankruptcies. He
may appoint a special manager to carry on the debtor's business until a trustee is appointed.

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5.4 RECEIVING ORDER

(a) Effect of receiving order
The consequences of the making of the receiving order are:

i. The debtor retains ownership, but loses possession and control of his property;
ii. The official receiver becomes receiver of the debtor's property;
iii. No legal proceedings may be brought in respect of provable debts except by leave
of the court;
iv. Transactions subsequently entered into by the debtor are prima facie invalid;
v. The receiving order must be advertised in the kenya gazette;

(b) Rescission of receiving order:

The order may be rescinded by the court if:

i. The court has sanctioned a composition or scheme of arrangement;

ii. The debts have been paid in full; or
iii. The court otherwise considers that the order ought not to have been made.
(c) Statement of affairs
Within fourteen days of the receiving order '(or before, but not more than three days before, the
date of the debtor's own petition) the debtor must submit to the Official Receiver a statement of
his affairs verified by affidavit, showing:

1. Particulars of his assets, debts and liabilities;

2. The names, residences and occupations of his creditors;
3. The securities (if any) held by them, and the dates they were given; and
4. Such further or other information as may be prescribed or as the official receiver may require

(d) First Meeting of creditors

The Official Receiver must convene this meeting within 60 days of the receiving order, unless the
court extends the time, by giving notice to each creditor mentioned in the statement of affairs and
by six days' notice in the Gazette. He must send with the notice a summary of the statement of
affairs, his own comments thereon, a form of proof, and details of any scheme proposed by the
debtor. The debtor must be given three days' notice of the meeting.
The purpose of the meeting is to decide whether to accept a scheme of arrangement (if any) or to
have the debtor adjudged bankrupt, and in the latter case to appoint a trustee and a committee of
inspection.

(e) Public examination

This is fixed by the court, on the application of the Official Receiver, as soon as is convenient after
the time for submission of the debtor's statement of affairs Notice must be given to the debtor and
the creditors and advertised in the Kenya Gazette and a local paper.
The debtor must attend, and must answer on oath all questions properly put to him about his
affairs, even if the answers are incriminating.
If the debtor fails to attend or refuses to answer such questions, the examination may be adjourned
sine die (indefinitely), and the debtor adjudged bankrupt forthwith.

5.5 COMPOSITIONS AND SCHEMES OF ARRANGEMENT

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The debtor may lodge a written proposal with the Official Receiver for a composition or other
arrangement of his affairs within four days of submitting his statement of affairs, or such
further time as the Official Receiver may allow. The procedure thereon is as follows:

(a) The Official Receiver must summon a meeting of creditors before the conclusion of the
public examination, sending a copy of the proposal to each of them with his report
thereon;
(b) The proposal must be approved by a majority in number and three fourths in value of all
creditors who have proved;
(c) If the proposal is accepted by the creditors, it must be approved by the court, three days'
notice of hearing being given to each creditor; the hearing cannot take place until after the
conclusion of the examination;
(d) The court cannot approve the proposal until it is heard the Official Receiver's report on
the debtor's conduct and any objections of the creditors: the court should approve the
proposal if satisfied that the statutory requirement have been complied with, and it is in
the interests of creditors generally and not contrary to public policy;
(e) The court must refuse to approve it if:

i. The terms are unreasonable or not for the benefit of the creditors generally, or
ii. Any of the facts that would disentitle a bankrupt to an immediate unconditional
discharge from bankruptcy are proved unless provision is made of at least Shs 25
per Shs 100 on all provable unsecured debts, or
iii. Provision is not made for the prior payment of preferential debts;

(f) If approved by the court, the scheme is binding in respect of all provable debts, except
those from which the debtor would not be released on discharge (see paragraph 6.7(a)
below);

(g) The scheme may be annulled if:

i. The debtor defaults in payment, or

ii. It cannot proceed without injustice or undue delay to the creditors or the debtor,
or
iii. The court's consent was obtained by fraud.

In practice, such proposals are rare; of a debtor wishes to put forward a scheme, he will normally
do so before bankruptcy proceedings are begun.

5.6 ADJUDICATION OF DEBTOR

1. Adjudication order
The court may adjudge the debtor bankrupt on the application of the O.R. or any creditor in the
following cases:

a. If the creditors so resolve at their first meeting, or pass no resolution, or do not meet at all;
i. If a composition or scheme is not approved within 14 days after the conclusion of the
public examination, or such further time as the court may allow;
ii. If the debtor applies to be made bankrupt;
iii. If there is no quorum at the first meeting of the creditors;
iv. If the debtor has absconded or does not intend to propose a composition or scheme;
v. If the public examination is adjourned sine die;

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vi. If the debtor fails without reasonable cause to submit his statement of affairs;
vii. If a composition or scheme is annulled by the court.

2. Consequences of adjudication
The consequences of the making of the adjudication order are:

1. The order must be advertised in the gazette and a local paper;

2. The ownership of the debtor's property vests in the trustee in bankruptcy;
3. The debtor must not obtain credit for shs 100 or more without informing the creditor that he is
an undischarged bankrupt; credits under shs 100 can be added together to make this offence r v.
Hartley (1972);
4. The debtor must not engage in any trade or business under a different name without disclosing
the name under which he was adjudicated;
5. The debtor cannot act as a company director or take part in the management of a company
except by leave of the court;
6. The debtor cannot act as a receiver or manager of the property of a company unless appointed
by the court;
7. The debtor cannot be appointed or act as a justice of peace or be elected to or hold the office of
mayor or member of local authority council, school committee or road board: this
disqualification operates for five years after discharge unless he obtains a certificate of misfortune
or the bankruptcy is annulled.

3. Annulment of order
The order may be annulled if

a. In the opinion of the court the debtor ought not to have been adjudicated bankrupt;
b. All the debts have been paid in full; or
c. A composition or scheme is accepted by the creditors and approved by the court.

As to (b) voluntary release of a debt is not equivalent to payment; a disputed debt is considered as paid
in full if the debtor enters into a bond to pay it if the dispute is settled in favour of the creditor and a
debt due to an untraceable or unidentifiable creditor by payment of the debt into court. The court may
refuse an annulment, although the debts have been paid in full, or the O.R. reports that the bankrupt
has committed bankruptcy offenses.
An annulment must be advertised in the Kenya Gazette, and releases the debtor from the disabilities of
bankruptcy, but does not invalidate payments or other acts properly made by the Official Receiver or
the trustee. The property of the debtor vests in such person as the court directs, or otherwise reverts to
the debtor.

5.7 DISCHARGE OF BANKRUPT

1. Application of discharge
Application may be made at any time after adjudication, but cannot be heard until the conclusion of the
public examination. Notice of the hearing must be given in the Kenya Gazette, and 14 days' notice
given to every creditor. The Official Receiver must report to the court on the bankrupt's conduct, and
the bankrupt is entitled to a copy of this report at least seven days before the hearing.
The court may -

1. Grant an absolute and immediate discharge;

2. Refuse the application; or
3. Grant a suspended or conditional discharge;

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4. In particular, the court may only grant a discharge suspended for a definite period or until at least
Shs 50 per Shs 100 has been paid to all creditors, or a conditional discharge subject to judgement
being entered against the bankrupt for all or part of the unpaid balance of provable debts, if
either -

(a) The bankrupt has been convicted of a bankruptcy offence, or

(b) Any of the "facts" set out on s.29 (3) have been proved against him; such "facts" include -
assets less than Shs 50 per Shs 100 of unsecured liabilities; failing to keep proper books of
account; knowingly trading when insolvent; gambling; extravagant living or neglect of
business; frivolous litigation; previous bankruptcy, composition or scheme; fraud or
fraudulent breach of trust.

2. Effect of discharge
An order of discharge releases the bankrupt from all disabilities imposed by the bankruptcy (except
those which apply for a fixed period after discharge - see paragraph. 6.6 (b) (g), and from all provable
debts except:

i. Debts due to the government for breach of a revenue statute, or on recognizance, unless the
Treasury gives written consent to his release;
ii. Debts incurred by fraud or fraudulent breach of trust;
iii. Liability under a judgment for seduction, or under an affiliation order, or as a correspondent in a
divorce action, unless the court otherwise orders.

The order does not release him from liability to prosecution for bankruptcy offenses.

3. Revocation of discharge
The court may revoke or vary the order of discharge in the event of the debtor's failure to assist as
required in supplying information or in the realisation of the estate.
5.8 THE TRUSTEE IN BANKRUPTCY
a. Appointment of trustee
The trustee is appointed:
I .By the creditors by ordinary resolution, or
ii. By the committee of inspection, if so resolved by the creditors, or
iii. By the court if a trustee is not otherwise appointed within four weeks of the adjudication
or within seven days of rejection of a composition or scheme.

A vacancy is filled in the same way, the court having power to appoint if the vacancy is not filled within
three weeks. A trustee appointed by the court may be replaced by a new trustee appointed by the
creditors or committee of inspection.
b. Court objections
The court may object to a trustee appointed by the creditors or committee of inspection on any
of the following grounds:

i. Appointment not made in good faith by a majority in value of creditors voting;

ii. Person appointed not fit to act as trustee;
iii. Trustee‘s relationship with bankrupt or a creditor makes it difficult for him to act
impartially;
iv. Misconduct or failure to render accounts or deal properly with unclaimed moneys, in a
previous trusteeship.

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Certificate of appointment
If the court has no objection to the trustee, and the trustee gives security of the nature and
amount required, the court will certify that his appointment has been duly made, and the
appointment takes effect from that date. The trustee must advertise his appointment in the
Kenya Gazette and in a local paper.

5.9 COMMITTEE OF INSPECTION

i. Appointment
A committee of inspection may be appointed by the creditors at their first or any subsequent
meeting to supervise the trustee.
ii. Membership
The committee consists of between three and five members, who must be creditors whose
proofs have been admitted, or the holders of general proxies of powers of attorney from them; a
person may be appointed before, but cannot act until, these conditions are satisfied. Membership
may be terminated by:

1. Written resignation to the trustee;

2. Bankruptcy of member or arrangement with his creditor;
3. Failure to attend five consecutive meetings; or
4. Removal by creditors.
5. Vacancies are filled by the creditors.

iii. Meetings
Meetings must be held at least once a month and may be called by the trustee or any member; a
majority of members constitutes a quorum.
iv. Fiduciary position of members
A member is not entitled to payment for his services or to enter into any transaction in relation
to the bankrupt's estate, except with the sanction of the court.

5.10 RIGHTS AND DUTIES OF TRUSTEE

8. Powers of trustee
1. Of his own initiative, he may:

1. Sell and transfer any part of the bankrupt's property;

2. Gives receipts for money received;
3. Take all necessary steps to recover debts due to the bankrupt;
4. Exercise any powers vested in him under the bankruptcy act (cap.53)
5. Bar an entail; and
6. Do all necessary or expedient acts in his official name.

2. With permission of the committee of inspection or the court, he may:

1. Carry on the business of the bankrupt;

2. Bring and defend legal proceedings relating to the bankrupt's property;
3. Employ a solicitor or other agent;
4. Sell property in consideration of a future payment;

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5. Mortgage or pledge any part of the property;

6. Refer disputes to arbitration and compromise claims;
7. Distribute property in specie among creditors;
8. Appoint the bankrupt to manage his property or carry on his trade for the benefit of the
creditors; and
9. Pay such allowances as he thinks fit to the bankrupt for the support of himself and of his
family.

9. (b) Right of indemnity

If the Official Receiver or trustee has seized or disposed of any property in the possession
of the debtor, without notice or claim relating thereto, he is not personally liable to any
person having a claim against that property, unless the court is of opinion that he has
been negligent.

10. (c) Renumeration of trustee

This is fixed by ordinary resolution of the creditors, or by the committee of inspection. It
takes the form of a commission payable partly on the amount realised by him less sums
paid to secured creditors, and partly on the amount distributed as dividend. The court
may fix the amount at the request of one-fourth in number or value of the creditors or of
the bankrupt, if satisfied that the agreed amount is too large. If the trustee receives any
other payment he loses all right to remuneration.

11. (d) Accounts of trustees

The trustee must keep proper books of account, which may be inspected by the creditors
at any time. The cash book must be audited by the committee of inspection at least once
every three months, and the trading account examined and certified by them at least once
a month. The accounts must be submitted for audit by the Official Receiver every six
months and when the estate has been fully realised and distributed, one copy of the
audited accounts is retained by the Official Receiver and another filed with the court. The
trustee must also submit to the Official Receiver a progress report at least once a year.

12. (e) Trustee's bank account

The trustee must pay all money received into the Bankruptcy Estates Account at the
prescribed bank if he retains sums exceeding Shs 1,000 for more than ten days, he is
liable to pay 20% per annum interest on the amount, loses his rights to remuneration,
may be removed from office, and is liable to pay any expenses incurred through his
being advantageous to the creditors of the committee of inspection, or the trustee
satisfies the court that there are good reasons for doing so. The trustee cannot draw
cheques on the Bankruptcy Estates Account; only the Official Receiver can do so.

5.11 RESOLUTIONS OF CREDITORS

Normally, decisions at meetings of creditors are taken by ordinary resolution, viz., a resolution passed
by a simple majority in value of creditors present, personally or by proxy, and voting on the resolution.

A special resolution, viz., a resolution passed by a simple majority in number and three-fourths in
value of the creditors present and voting, is required:

(a) To appoint a trustee other than the Official Receiver in a small bankruptcy;
(b) To make an allowance to the bankrupt in a form other than money;

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FINANCIAL ACCOUNTING III
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(c) To require the Official Receiver to remove a special manager.

5.12 TERMINATION OF OFFICE OF TRUSTEE
The trustee may vacate office in the following ways:

1. (a) Resignation
He may resign at a meeting of creditors and with their consent.
2. (b) Removal
He may be removed either by the creditors by ordinary resolution, or by the court, if:

i. He is guilty of misconduct or failure to perform his statutory duties;

ii. The trusteeship is being needlessly protracted;
iii. He is incapable of performing his duties;
iv. He is unable to act impartially; or
v. He has been removed from office in another bankruptcy for misconduct.

3. (c) Receiving order

He automatically vacates office if a receiving order is made against him..

4. (d) Release
He may be released by the court when the administration of the estate is complete, or he has
resigned or been removed.
Upon release he is discharged from liability in respect of any act or default as trustee, unless his
release was obtained by fraud or concealment of material facts.
The release must be gazetted and the trustee must deliver to the O.R. all books and papers in his
possession.

5.13 DIVISIBLE PROPERTY

The property of the bankrupt divisible among creditors includes:

(a) Property belonging to the bankrupt at the commencement of the bankruptcy;

(b) Property acquired by him before his discharge ("after - acquired property"); and
(c) In certain cases, property owned by, or in the hands of, third parties.

The 'property' of a bankrupt includes property held under a joint tenancy (Re Rushton, 1972)

5.14 DEBTOR'S PROPERTY AT COMMENCEMENT OF BANKRUPTCY

i. Doctrine of "relation back"
The trustee's title to the debtor's property is deemed to relate back to the commencement of the bankruptcy,
i.e., the time the act of bankruptcy was committed on which the receiving order was made or, if the
bankrupt committed more than one act of bankruptcy, the time of the first such act committed within
the three months preceding presentation of the petition.
All property belonging to the bankrupt at the commencement of the bankruptcy is divisible among
creditors, with the following exceptions:

ii. Protected transactions

These fall into three categories:

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a. Under Section 50:

i. Payments by the bankrupt to creditors;
ii. Payments or deliveries to the bankrupt;
iii. Conveyances or assignments by the bankrupt for value; provided that:
iv. Other contracts, dealings or transactions by or with the bankrupt for value;

Provided that:

(1) The transaction took place before the date of receiving order, and
(2) The other party did not notice of an available act of bankruptcy.

b. Under Section 51:

Any payment or delivery to the bankrupt or his assignee,

i. Before the date of the receiving order,

ii. Without notice of presentation of the petition, and
iii. Either pursuant to the ordinary course of business or otherwise bona—fide.

This includes payments made to a third party "on the request, order or direction of the bankrupt"
(Re Dalton)
c. Payment or transfer of money or property of the bankrupt by a person in possession of it to
some other person, after the date, but before the gazetting, of the receiving order, provided
that the transferor had no notice of the receiving order.
Such a transaction is not completely protected - but no claim can be made against the transferor
unless it is "not reasonably practicable" for the trustee to recover it from the transferee.

iii. Completed executions

A judgement creditor cannot retain the "benefit" of an execution or attachment, unless he has
completed it-

i. Before the date of the receiving order, and

ii. Without notice of the presentation of a petition or the commission of an available act of
bankruptcy,
but he can retain any money received by him before that date (Re Andrew).
If the judgement exceeds Shs 400 the bailiff must retain the proceeds of sale for 14 days, and us
hand over the proceeds to O.R. or trustee, of notice of a petition is served on him during that
time; and the same applies if, before sale, notice is served on him that a receiving order has been
made.
The court has a discretion to set aside these rights in favour of the creditor if it thinks fit.

iv. Trust Property

Property held by the bankrupt on trust for any other person does not pass to his trustee.

v. Excepted articles
The trustee cannot claim the tools of the bankrupt's trade or necessary wearing apparel and bedding of
the bankrupt and his family to a total value not exceeding Shs 500.

vi. Determinable interests

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The trustee cannot claim property in which the bankrupt's interest is determinable upon bankruptcy,
except property settled by the bankrupt on himself on these terms.

vii. Personal rights of action

Rights of action relating to the bankrupt's property pass to the trustee, but those affecting his person,
e.g. for assault or libel, do not.

viii. Contracts of personal service

Contracts involving the personal skill of the bankrupt do not pass to the trustee: other contracts do
unless disclaimed.

5.15 AFTER-ACQUIRED PROPERTY

All property acquired by the bankrupt between the commencement of bankruptcy and his discharge
passes to the trustee, except as stated above and below.

(a) Rule in Cohen v Mitchel

Property acquired by the bankrupt after adjudication may be validly transferred by him to a third party
taking in good faith and for value, before the trustee has intervened to claim the property; the bankrupt
must then account to the trustee of the consideration received.
Payments to or by a banker are deemed to be for value for this purpose, but a banker who discovers
that a customer is an undischarged bankrupt must not make payments out of his account without
informing the trustee of its existence and seeking his instructions.

(b) Salary and other income

The bankrupt's income from whatever source, passes to the trustee, unless otherwise provided by
statute as, e.g. in the case of certain pensions.In respect of personal earnings, however the bankrupt is
entitled to keep sufficient for the maintenance of himself and his family.The trustee can apply to the
court for any periodical payments due to the bankrupt to be paid directly to himself.

(c) Subsequent bankruptcies

If an undischarged bankrupt is adjudicated for a second or further time, property acquired by him after
the first adjudication vests in the trustee in the subsequent bankruptcy, unless it had been distributed at
the time the subsequent petition was presented.

A trustee having notice of a subsequent petition must retain after-acquired property in his possession
for transfer of the trustee in the subsequent bankruptcy, and may prove for its value in that bankruptcy.

5.16 PROPERTY IN BANKRUPT'S REPUTED OWNERSHIP

The trustee may claim property owned by third parties which is in the bankrupt's possession at the
commencement of the bankruptcy if:

1. The property consists of goods or business debts;

2. In the sole possession, order or disposition of the bankrupt at the commencement of the
bankruptcy;
3. For use in his trade or business;
4. With the consent of the true owner;

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5. In such circumstances that the debtor was the 'reputed owner' of the goods.

The trustee's claim may be defeated by evidence of a trade custom of possession of such goods without
ownership; in view of the prevalence of hire purchase and similar agreements, this clause now seems to
have little practical importance.

5.17 PROPERTY TRANSFERRED BEFORE BANKRUPTCY

(a) Voluntary settlements
The trustee can claim all property settled by the bankrupt on other persons within two years preceding
the bankruptcy unless made:

a. Before and in consideration of marriage; or

b. In favour or a person taking in good faith and for value; or
c. For his wife or children in respect of property accruing to him in right of his wife.

The trustee may further claim property settled within ten years of bankruptcy, unless it is proved:

a. That at the time of making the settlement, the bankrupt could pay all his debts without the aid of
the settled property, and
b. All interest of the bankrupt in the property passed at the time the settlement was made.

(b) Agreements to settle property

The trustee is not bound by such an agreement if it remains executory. If property has already been
settled, the trustee can recover it unless it is proved:

i. That the settlement was made more than two years before the bankruptcy, or
ii. That, at the date of the settlement the bankrupt was able to pay all his debts without the aid of the
settled property, or
iii. The agreement related to property expected to accrue to the bankrupt on the death of a named
person and was made within three months of its coming into his possession.

(c) Fraudulent preferences

The trustee can set aside any transaction effected within the six months preceding the presentation of
the petition in circumstances such as to make it a fraudulent preference, i.e., a voluntary transaction by
an insolvent person in favour of a creditor, or his trustee, with the dominant intention of giving the
creditor or a surety, a preference over the other creditors.

(d) Fraudulent conveyances

The trustee may set aside a transfer of property made by the bankrupt before the commencement of
bankruptcy with the intention of defrauding creditors, unless the transferee took the property for good
or valuable consideration, in good faith and without notice of that intent.
The trustee cannot recover property in any of the above cases which has been further transferred to a
person taking in good faith and for value.

Assignments of book debts

The trustee can set aside an assignment of existing or future book debts, whether absolute or by way of
charge, unless the assignment was registered as an absolute bill of sale, except in the case of debts-

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i. Due at the time of the assignment from specified debtors; or

ii. Growing due under specified contracts; or
iii. Included in a bona fide transfer of a business for value; or
iv. Included in an assignment of assets for the benefit of creditors generally.

5.18 DISCLAIMER OF ONEROUS PROPERTY

1. Effect of disclaimer
The trustee may disclaim onerous property consisting of:

i. Land burdened with onerous covenants;

ii. Stocks and shares;
iii. Unprofitable contracts, or
iv. Other property which is not readily saleable by reason of the liabilities attaching thereto;

and thereupon all the rights, interests and liabilities of the bankrupt and of the trustee in relation to the
property are determined as from the date of disclaimer.

2. Time for disclaimer

The trustee may disclaim in writing at any time within twelve months of his appointment, or of
becoming aware of the property, or such extended period as the court may allow.

This right is lost if a person interested in the property applies in writing for him to decide whether he
will disclaim or not; in this case the trustee must give notice of disclaimer within 28 days of receiving
the application, unless the court extends the time:

The court's consent is not required to the disclaimer except in the case of certain leases.

3. Disclaimer of leases
In principle where the bankrupt is a lessee the lease cannot be disclaimed without leave of the court; but
such leave is not required in the following cases.

1. If the property is not sublet or mortgaged and

i. Its real value is less that Shs 400 p.a.; or

ii. The estate is being administered summarily, or
iii. The trustee serves notice of his intention to disclaim on the lessor and the lessor does not
within seven days require the matter to be brought to court;

2. If the property is sublet or mortgaged and the trustee serves all parties with notice of his intent to
disclaim and no party within 14 days requires the matter to be brought to court.

4. Rights arising on disclaimer

Any person interested in property disclaimed may apply to the court for an order vesting the property
in himself; but the court will not make a vesting order in respect of a lease unless the lease is taken
subject to the same liabilities and obligations as bound the bankrupt.

Any person injured by the disclaimer may prove in the bankruptcy to the extent of his loss.

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5.19 PROVABLE DEBTS

All debts and liabilities present or future, certain or contingent, are provable in bankruptcy, except:

(a) Claims for unliquidated damages in tort;

(b) Debts incurred after the creditor had notice of an available act of bankruptcy;
(c) Debts incapable of being fairly estimated;
(d) Debts incurred after the date of the receiving order;
(e) Debts void or unenforceable under the ordinary law of contract;
(f) Maintenance payable by a husband to his wife.

Non-provable debts, if otherwise enforceable, are unaffected by the bankruptcy and can be
enforced after discharge.
In the case of contingent debts e.g. possible liability as an indorser of a bill of exchange, the
trustee must estimate the value of the contingent liability. If the creditor is aggrieved he may
appeal to the court which may itself value the liability. If, in the opinion of the court, the liability
cannot be fairly estimated the debt will not be provable.
(g) Guarantees
The creditor or a surety (but not both) may prove in the bankruptcy of the principal debtor; a
surety may prove in the bankruptcy of a co-surety; and a creditor may prove in the bankruptcy of
a surety.

(h) Bills of exchange

The holder may prove in the bankruptcy of all prior parties, unless the bill was made for his
accommodation.

(i) Annuities
An annuitant may prove for the estimated value of the annuity; if he dies before the proof is
accepted, the amount becomes certain and the proof must be amended; if he dies after
declaration of a dividend, the payment on the estimate cannot be disturbed, even though it
exceeds the amount actually due.
(j) Periodical payments
Rent and other payments falling due at stated periods may be apportioned and proof from
the person entitled to payment may be lodged for the proportionate part accruing due at
the date of the receiving order.

(k) Interest
Interest may be claimed-up to the date of the receiving order - if it is payable:

i. By agreement;
ii. By statute;
iii. If the debt was created in writing and due at a certain time at 6% p.a. from due
date; or
iv. Otherwise, after written demand for payment giving notice that interest is claimed,
at 6% p.a. from date of demand.

Interest over 6% p.a. is a deferred debt, although except in the case of a moneylender, the
trustee can admit proof for the full amount.
Statutory interest is payable in all debts at 6% p.a. from the date of the receiving order, if
there is a surplus after payment of all debts in full.
Sums paid to the creditor before the receiving order must be apportioned between
principal and interest.

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5.20 MUTUAL DEALINGS

A right of set-off is allowed where there have been -

(a) Mutual credits, debts or other dealings resulting in pecuniary liabilities,

(b) Between the debtor and a creditor in the same right,
(c) Prior to the date of the receiving order,
(d) Without notice of an available act of bankruptcy.

An account is taken as at the date of the order, and the balance paid or claimed by the creditor.
Persons with mutual dealings cannot contract out of the right of set-off given by s.36 ibid though it may
be possible for them to agree that their dealings shall not be regarded as mutual. National
Westminster Bank Ltd. v Halesowen Presswork and Assemblies Ltd. (1972).

5.21 SECURED CREDITORS

A secured creditor may:
(a) Rely on his security and not prove at all.
(b) Surrender his security and prove for the full amount of the debt.
(c) Realise his security (if he has a power of sale) and prove for the balance; or
(d) Estimate the value of his security and prove for the balance.
He must disclose the security in his proof or surrender it to the trustee unless the court grants relief. If
the creditor estimates his security

i. If proof used for voting purposes trustee may within 28 days require him to give up security on
payment of its estimated value plus 20% or amount at which revalued by creditor;
ii. If valued for dividend purposes trustee may redeem it at any time by paying its assessed value or
if dissatisfied with valuation require security to be sold;
iii. He may by writing, require trustee to redeem security or have it realised, and if trustee does not
do so within six months property vests absolutely in creditor;
iv. He may amend valuation and proof at any time unless he has called upon trustee to redeem it;
v. He may realise security and amend his proof accordingly.

5.22 LANDLORD'S RIGHT OF DISTRESS

The Landlord's right to distrain for arrears of rent is not lost on the tenant's bankruptcy, but

(a) Distress can only be levied after commencement of bankruptcy for up to six month's rent due
prior to adjudication and is not available for rent payable after date of distress;
(b) If distress is levied within three months preceding date of receiving order, proceeds are subject to
a first charge in favour of preferential creditors; if the landlord suffers loss as a result he acquires
the same rights of priority as the preferential creditors who are paid;
(c) He can distrain for rent due after adjudication if trustee remains in possession and does not
disclaim lease; if tenant's goods have been seized in execution of a judgment, landlord can claim
up to one year's arrears out of proceeds, or six months' arrears if claim made after
commencement of bankruptcy.

Unless the landlord has distrained he has no priority over the creditors.

5.23 PROOF OF DEBTS

The following rules apply as to the proving of debts:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 263

(a) A creditor has no right to vote or receive dividends until his debt is proved to the satisfaction of
the trustee;
(b) Proofs should be made by affidavit as soon as possible after the receiving order - but may be
accepted at any time before the final dividend;
(c) Proofs may be made provisionally accepted for voting at the first meeting of creditors;
(d) The trustee (but not the O.R.) must deal with a proof within 28 days of receipt; if the proof is
rejected the creditor may appeal to the court within 21 days;
(e) The trustee must satisfy himself that there is a real debt; he is not bound by any judgement or
estoppel against the debtor;
(f) The trustee may apply to the court to expunge or reduce a debt wrongfully admitted;
(g) The trustee must each month file with the court all proofs admitted or rejected in the previous
month and on declaring a dividend he must send to the court a list of proofs so filed;
(h) Proof on a contingent debt may be admitted for dividend purposes but not for voting while the
contingency remains;
(i) Double proof is not allowed in the same bankruptcy for the same debt but proof may be
lodged against two separate estates for the same debt.

5.24 ORDER OF PAYMENTS

The bankrupts estate must be distributed in the following order.

1. Cost and charges

Costs and charges properly incurred in administering the estate must be paid in priority to all debts
and in the proper sequence.

2. Pre preferential debts

These are:
(a) Proper funeral and testamentary expenses of a deceased insolvent;
(b) Premiums paid by apprentices or articled clerks;
(c) Property of a friendly society of which the bankrupt is an officer; and
(d) Expenses properly incurred by a trustee of a deed of arrangement.

If funds are insufficient to pay these in full, they abate rateably.

3. Preferential debts
These include:

(a) Local rates and amounts deducted as P.A.Y.E by a bankrupt employer from employees'
pay accruing due during the twelve months preceding the receiving order;
(b) Up to one year's arrears of any other assessed taxes;
(c) Wages and salary due to employees for work done during the four months preceding the
receiving order up to Shs 4,000 per employee;
(d) Rents due to the Government not more than five years in arrear;
(e) Employer‘s national social security fund contributions due during the previous twelve
months.
(f) Amounts due for compensation under the Workmen's Compensation Act. If funds are
insufficient to pay these in full, they abate rateably.

4. Unsecured debts
These rank equally after payment of preferential debts in full.

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FINANCIAL ACCOUNTING III
 264 Bankruptcy and Liquidation

5. Deferred debts
These include:

(a) Accrued interest in excess of 6% per annum, due to an unsecured creditor;(paid in priority
to other deferred creditors).
(b) Salary or wages due to or money or other property lent by a relative by consanguinity or
affinity i.e. a grandparent, parent, uncle or aunt, brother or sister or cousin, child (including
adopted child) or nephew or niece, grandchild or any person married to any one of these;
or a husband or wife.
(c) Loans to a person for business purposes at a rate of interest varying with profits;
b) and c) rank equally — proof cannot be admitted for any purpose until all other debts
are paid in full.
(d) Statutory interest at 6% per annum; and
(e) Claims arising under a settlement set aside by the trustee.

6. Surplus
Any surplus remaining after payment of all debts and other liabilities in full must be returned to the
bankrupt.

5.25 DIVIDENDS
Dividends must be declared and paid in accordance with the following rules:

(a) The first dividend must be declared and paid within four months of the first meeting of the
creditors, unless postponed with the consent of the committee of inspection;
(b) Subsequent dividends must be declared and paid at intervals of not more than six months;
(c) The trustee must give not more than two month's notice of intention to declare a dividend to
every creditor mentioned in the statement of affairs who has not proved his debt, requiring proof
to be lodged not later than a date at least 14 days from the date of the notice; he must admit or
reject all proofs within 14 days of the date specified; appeal against rejection must be commenced
within seven days; the trustee must have the notice gazetted;
(d) After declaring a dividend, details thereof must be sent to every creditor who has proved and
must be gazetted;
(e) The trustee must make provision for creditors who have not had time to submit proofs, or to
establish disputed claims, and for the expenses of administration;
(f) A creditor who has not proved before declaration of a dividend may be paid if the trustee has
any money still in his hands, and may participate in future dividends;
(g) If a dividend is paid on a future debt, a rebate of interest at 6% per annum from the date of the
dividend to the date for payment of the debt must be deducted;
(h) A final dividend may be declared when all the bankrupt's property has been realised, or so much
of it as can be realised without needlessly protracting the trusteeship; notice must be given to
persons who have notified, but have not established, their claims, requiring them to do so within
the time specified in the notice;
(i) Unclaimed dividends remaining in the hands of the trustee for six months must be paid into the
Bankruptcy Estates Account; the receipt of the Official Receiver discharges the trustee in respect
thereof, any claimant must apply to the Official Receiver for payment.

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 Lesson Five 265

5.26 SMALL BANKRUPTCIES

The court may order the estate of a debtor to be administered summarily, if the debtor's assets are not
likely to exceed Shs 12,000 in value. This is known as a "small bankruptcy" or "summary case".

A small bankruptcy differs from an ordinary bankruptcy in the following respects:

1. The Official Receiver acts as trustees;

2. There is no committee of inspection — the court gives all necessary consents;
3. The proceedings need not be advertised in a local paper;
4. The court may adjudge the debtor bankrupt forthwith if no composition or scheme is proposed;
5. The first meeting of creditors may be held at the same time as the public examination or at any
other given time fixed by the Official Receive.;
6. Notice of subsequent meetings need not be sent to creditors whose claims do not exceed Shs 40;
7. A single dividend is paid, if possible, within six months of the first meeting of creditors;
8. Simpler accounts are required;
9. Costs, other than a solicitors', need not be taxed, unless required by the O.R.;
10. The court's consent is not required to disclaim leases not sublet or mortgaged.

5.27 DEEDS OF ARRANGEMENT (D of A)

1. Nature of a D of A
To avoid the expense and delay involved in a bankruptcy, a debtor in trouble may make a private
arrangement with the creditors to accept payment of a smaller sum of money in full discharge of their
debts before a bankruptcy petition has been presented. In contrast to compositions and schemes of
arrangement (see paragraph 6.5 above) the arrangement will be outside the bankruptcy law. Such
arrangements will bind only those creditors who assent to the arrangement and the debtor will not be
released from the claims of the others,

Whereas under a composition or scheme or arrangement the debtor is released from all claims except
those from which he would not be released by his discharge from bankruptcy.
These arrangements will usually come within the ambit of the Deeds of Arrangement Act. The
D.A.A. defines a D of A as any instrument, whether under seal or not, made for the benefit of creditors
generally, or made by an insolvent debtor for the benefit of three or more creditors. It may be:—

(a) An assignment of property

(b) A deed of composition
(c) A deed of inspectorship for carrying on or winding up a business
(d) A letter of license authorising a debtor or any other person to carry on or dispose of a business
with a view to the payment of debts
(e) Any agreement for the carrying on or winding up a debtor's business with a view to the payment
of his debt (DAA s.3).

2. Registration of a D of A and assent of creditors

A D of A will be void unless it is registered with the Registrar within 7 clear days after first execution
and is properly stamped (DAA s.4).

Within 21 days after registration a deed for the benefit of creditors generally must be assented to by a
majority in number and value of the creditors concerned. This assent can be given by the creditor
signing the D of A or by signing a separate deed of assent. Further, the trustee appointed by the deed
must file a statement that the necessary majority of creditors has assented to the deed. This declaration
must be filed within 28 days after the D of A itself was registered (DAA s.5).

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FINANCIAL ACCOUNTING III
 266 Bankruptcy and Liquidation

3. Effect of bankruptcy
A D of A made for the benefit of creditors generally will be an act of bankruptcy and therefore a
bankruptcy petition may be presented against the debtor within 3 months of its execution by a creditor
who has not assented to the D of A (but if such creditor has been served by the trustee under the D of
A with a notice of the execution of the D of A the time is reduced to 1 month). The trustee should
therefore not act under the D of A for 3 months after its execution unless all creditors have assented to
it because if the debtor becomes bankrupt the D of A will be void and the doctrine of relation back will
apply, the trustee having to account to the trustee in bankruptcy for all dealings with the debtor's
property; however all expenses properly incurred by the trustee of the D of A in the performance of his
duties must be paid to him by the trustee in bankruptcy as a first charge on the estate (DAA s.23).
Normally if a D of A is void the trustee under the D of A must account for dealings with the debtor's
property even if a bankruptcy petition is presented after the lapse of 3 months from the D of A. But,
in the latter event, if the D of A is void by reason only that

(a) The requisite assents from the creditors have not been obtained or
(b) In the case of a D of A for the benefit of three or more creditors, by reason only that the debtor
was insolvent at the time of the execution of the D of A and that the D of A was not registered
in accordance with the DAA and the trustee did not know and had no reason to suspect that it
was void, the trustee is not liable to account for dealings with the debtor's property which would
have been proper had the deed been valid (DAA s.21).

4. Appointment of trustee
The trustee is nominated by the parties to the deed and, his appointment is made and his remuneration
fixed by the deed. In the event of his death, resignation or incapacity, the parties may appoint a new
trustee who must immediately notify the registrar of his appointment. If the parties to the deed cannot
agree upon a new trustee, or wish to remove an existing trustee, the court may appoint a new trustee
under The Trustee Act, s.42.

5. Trustee's security
Within 7 days from the filing of the declaration of assent by the requisite creditors, the trustee of a D of
A for the benefit of creditors generally must give security to the local bankruptcy registrar in a sum
equal to the estimated assets available for distribution among the unsecured creditors. This security can
be dispensed with, however, by a majority in number and value of the creditors (DAA s.13).

6. Trustee's accounts and audit

A Trustee under a D of A must account annually to the Official Receiver and every 6 months to all
assenting creditors. A majority in number and in value of creditors can demand an audit during the
administration or within 12 months from the rendering of the final accounts to the O.R.

7. Trustee's duties in administering the D of A

(a) To carry out the trusts of the D of A and to distribute the property assigned to him in accordance with the
provisions of the D of A.
(b) To pay all creditors equally unless the D of A gives priority to those debts which would be preferential in
bankruptcy (as it usually will)?

Note that since the B.A does not apply to the D of A, rules such as those relating to disclaimer of onerous
property, reputed ownership and voidable settlements are inapplicable.

8. Discharge of trustee
The trustee is automatically discharged as soon as he has carried out his duties under the D of A — he does not
have to obtain a formal release.

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 Lesson Five 267

5.28 BANKRUPTCY ACCOUNTS FOR INDIVIDUALS AND PARTNERSHIPS

These include a statement of affairs and deficiency account.

A statement of affairs takes the following form:
INDIVIDUAL
STATEMENT OF AFFAIRS AS AT
(DATE), DATE OF RECEIVING ORDER
Gross Liabilities as stated & Expected to Assets as stated & Estimated to
Liabilities estimated by debtor rank estimated by debtor produce
Sh ‗000‘ Sh ‗000‘ Sh ‗000‘ Sh ‗000‘
x Unsecured creditors x Cash at bank x
x Creditors fully secured x Cash in hand x
Less value of security (x) Stock-in-trade x
Surplus to contra x Machinery x
x Creditors partly secured x Trade fixtures x
Less value of security (x) Furniture x

x Life policies x
x Liabilities on bills x Stocks, shares and
discounted other investments
x Contingent and other x Bank debts: Good x
liabilities
x Preferential creditors : Doubtful x
deducted per contra x : Bad x
x
Estimated to produce x
Bills of exchange x
Estimated to produce x
Surplus from secured
Creditors
per contra x
x
Deduct preferential (x)
Creditors per contra x

Deficiency as per
Deficiency a/c x
xx xx xx

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FINANCIAL ACCOUNTING III
 268 Bankruptcy and Liquidation

DEFICIENCY (SURPLUS) A/C

Sh ‗000‘ Sh ‗000‘
Excess of assets over liabilities Losses from Trading x
(One year before receiving order) x Estimated loss on realization of
Excess of private assets over Assets x
Liabilities (one year before receiving Drawings x
Order) x
Net profits from the business for the
Period under review x
Other receipts-gifts legacies etc x
Deficiency as per statement of affairs x
xx xx

Example
Njuguna Mwandawiro, carrying on a business as a trader in Likoni, Mombasa, finds himself
insolvent, and on 15 August 1997 files his petition in bankruptcy. The following balances are
extracted from the books of his business on that date:

Sh Sh
N. Mwandawiro Capital 1,200,000 Shop – land and buildings 4,000,000
Mortgage on shop (land and buildings) 3,000,000 Furniture and fittings 1,000,000
Loan – I.C.D.C. Ltd. 1,200,000 Stock of goods 575,100
Loan – Barclays Bank Ltd. 600,000 Debtors 641,300
Loan – Co-operative Bank Ltd. 200,000 N. Mwandawiro drawings 1,314,000
Loan – Paul Nkobei 100,000 Cash on hand 2,000
Loan – Mutiso Kuria 20,000
Trade creditors 1,140,000
N.H.I.F., N.S.S.F. and P.A.Y.E. 36,000
Salaries and wages payable 18,000
Bank overdraft 18,000 ________
7,532,400
7,532,400

The following information is provided:

1. The trade creditors includes Sh.30,000 owing to Mombasa Municipal Council in respect of rates
in for the current period and a small loan from Mwandawiro‘s friend Waititu for Sh. 10,000.
2. The amount owing for salaries and wages and statutory payroll deductions are for 1997.
3. There is 210,000 interest unpaid on the mortgage as at 15 August 1997, which has not been
recorded in the books.
4. The loan from I.C.D.C. Ltd. is secured by a second mortgage on the shop (land and buildings).
The unrecorded interest owing as at 15 August 1997 was Sh.96,000.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 269

5. The loan from the Co-operative Bank Ltd. was obtained when Mwandawiro pledged his wholly
owned piece of land as security. The value of the piece of land is sh.300,000. There is no interest
outstanding on his loan.
6. The interest on loan from Paul Nkobei was to vary with profits, but since the business has beeb
operating at a loss, there is no interest due.
7. There is no interest outstanding on the loan from Barclays Bank Ltd.
8. Mutiso Kuria is Mwandawiro‘s brother-in-law.
9. The value of the assets is estimated to be:

Sh.
Shop – land and buildings 4,200,000
Furniture and fittings 800,000
Stock of goods 200,000

10. Of the debtors, Sh.400,000 are thought to be good and Sh.200,000 doubtful, of which
Sh.150,000 should be collectable.
11. Mwandawiro‘s uncle died recently and he will be receiving Sh.50,000 as an inheritance.
12. Mwandawiro has no personal creditors outside the business, but he has other personal assets,
beside the piece of land, amounting to Sh.60,000, exclusive of household and personal effects.

Required:

(a) A statement of affairs for Njuguna Mwandawiro as at 15 August 1997 in good form
(15 marks)
(b) A deficiency account as at that date. (4 marks)
(c) Income statement for the period ended 15 August 1997. (3 marks)
(Total: 22 marks)

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FINANCIAL ACCOUNTING III
 270 Bankruptcy and Liquidation

Solution
NJUGUNA MWANDAWIRO

STATEMENT OF AFFAIRS AS AT 15 AUGUST 1997

GROSS LIABILITIES EXPECTED ASSETS ESTIMATED

LIABILITY TO RANK TO PRODUCE
SHS. Sh.
1,848,000 Unsecured creditors 1,848,000 Cash on hand 2,000
(W1) Stock 200,000
3,410,000 Fully secured creditors 3,410,000 Furniture 800,000
(W2) Personal assets 60,000
Less: value of security 4,500,000 Debtors – Good 400,000
Surplus below (990,000) Doubtful 200000
Surplus per contra Bad 41300
(100,000) 241300
1,296,000 Partly secured creditors Estimated to produce 150,000
(W3) Inheritance receivable 50,000
Deduct surplus from 1,296,000 Surplus from fully
above) secured creditors per
Deficiency ranking contra 100,000
unsecured (990,000)
1,762,000
84,000 Preferential creditors Preferential as per
deducted per contra 306,000 contra (84,000)
(W4)
Deficiency as per 1,678,000
84,000
deficiency account
476,400

6,658,400 2,154,400 2,154,400

WORKINGS

1. Unsecured creditors

Sh.
Barclays bank loan 600,000
Loan from Paul Nkotei 100,000
Loan from Mutiso Kuria 20,000
Trade creditors (1,140,000 – 30,000) 1,110,000
Bank overdraft 18,400
1,848,400

Assumption: Kuria is married to Mwendawiro‘s sister making him a relative by consanguinity.

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 Lesson Five 271

2. Fully secured creditors

Liabilities Security Surplus

Shop mortgage 3,210,000 4,200,000 990,000
Cooperative Bank loan 200,000 300,000 100,000
3,410,000 4,500,000 1,090,000

3. Creditors partly secured:

Liabilities Value of Deficit

Security
ICDC Loan (1,200 + 96) 1,296,000 990,000 306,000

4. Preferential creditors

Sh.
Mombasa municipal council (Note 1) 30,000
Salaries and wages payable 18,000
NHIF, NSSF & PAYE 36,000
84,000

DEFICIENCY ACCOUNT
Sh. Sh.
Excess of business assets over Estimated Loss on realization of assets:
liabilities 1,200,000 Furniture
Excess of private assets over 360,000 Stock 200,000
liabilities 1,560,000 Debtors 375,100
(641,300–400,000–150,000) 91,300
Estimated surplus: 200,000 Unrecorded expenses
On realization on land & buildings 50,000 210,000
Mortgage interest
Gift from uncle by will 96,000
ICDC loan interest
1,314,000
Drawings
Deficiency as per statement of
account 476,400 _______
2,286,400 2,286,400

The format for the statement of affairs and surplus or deficiency account of a partnership will be as
follows:

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FINANCIAL ACCOUNTING III
 272 Bankruptcy and Liquidation

STATEMENT OF AFFAIRS
Joint A B Joint A B
Estat Estat
e e
Unsecured creditors x x x Assets not specifically
Creditors fully secured x x x Pledged x x x
Less value of security (x) (x) (x) Surplus from creditors
Surplus below/contra x x x Fully secured x x

Creditors partly secured x x Preferential creditors

Less value of deducted per contra (x) (x) (x)
security/surplus b/d
(x) (x)
x x Surplus from B‘s
Preferential creditors Personal estate x
Deducted per contra x x x Deficiency as per
deficiency a/c
x x
Surplus as per surplus x
a/c
xx xx xx xx xx xx

SURPLUS/DEFICIENCY A/C
Joint Joint
Estat A B Estat A B
e e
Excess of assets over Est. loss on realization
Liabilities x x x Of assets x x x
Est. surplus on realization Loss on guarantee x
Of assets x x x Loss of partnership
Surplus from B‘s Estate x Capital x x
Deficiency as per Surplus as per
Statement of affairs x x Statement of affairs x
xx xx xx xx xx xx

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 Lesson Five 273

Example

Akili and Bidii trade in a partnership under the name of Jaribio Enterprises. One of the creditors of
the partnership presented a petition in bankruptcy against the partnership and the High Court made
out a Receiving Order on 31 October 1996.

The assets and liabilities of the joint and separate estates on that date were as follows:

Book Value Estimated Realisable

Values
Jaribio Akili Bidii Jaribio Akili
Bidii
Sh. ‗000‘ Sh. ‗000‘ Sh. '000‘ Sh.‗000‘ Sh.‗000‘ Sh.
‗000‘
Land and buildings 11,750 3,000 4,500 13,500 4,800
5,000
Plant and equipment 13,640 8,500
Furniture & household
Goods 600 850 200
420
Stock 16,300 9,700
Debtors 10,790 4,750
Partnership capital 4,000 6,000
Investments 2,000 1,000 3,350
800
Cash 200 100 300
Motor car 900 1,500 300
500
52,680 10,600 14,150

Capital accounts: A 4,000

B 6,000
Creditors 24,320 260 180
Bank overdraft 8,360
Loans secured on land
And buildings 10,000 2,500 3,000
Loans secured on cars 600 1,000
Personal surpluses 7,240 9,970
52,680 10,600 14,150

Additional information:
1. Of Jaribio‘s creditors, Sh.700, 000 are preferential.
2. Jaribio‘s bank overdraft was secured by a second mortgage on the partnership, land and
buildings and by the personal guarantee of Akili together with the deposit of his investments.
3. Akili and Bidii share profits or losses equally.

Required:
Statements of Affairs and Deficiency or Surplus Accounts for the firm and for the separate personal
estates of the partners, using the format laid down in the Bankruptcy Act and showing the legal
position in relation to the double proof.

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FINANCIAL ACCOUNTING III
274 Bankruptcy and Liquidation

Solution
Akili and Bidii

Akili and Bidii

Statement of affairs as at 31 October 1996

Joint Akili Bidii Joint Akili Bidii

Estate Estate
Sh ‗000‘ Sh.‗000‘ Sh.‗000‘ Sh. ‗000‘ Sh.‗000‘ Sh.‗000‘
Unsecured creditors 23,620 260 180 Cash 200 100 300

Creditors fully secured 10,000 2,500 3,000 Stock 9,700 - -

Less value of security 13,500 4,800 5,000 Investments - - 800
Surplus below/to contra 3,500 2,300 2,000 Plant & equip 8,500 - -
Creditors partly secured 8,360 8,960 1,000 Furniture and
Household - 200 420
Less value of security 3,500 3,650 500 Debtors 4,750
Deficiency ranking as 4,860 5,310 500 Surplus from
Unsecured fully secured creditors
Per contra - 2,300 2,000
Pref. Creditors deducted 23,150 2,600 3,520
Per contra 700 - - Surplus from B‘s
Estate 2,840 - -
25,990 2,600 3,520
Less pref. creditors
Per contra (700) (-) (-)
25,290 2,600 3,520
Surplus as per surplus a/c - 2,840 Deficiency per
___ deficiency a/c 3,190 2,970 -
28,480 5,570 3,520 28,480 5,570 3,520

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 275

Deficiency a/c
Joint Akili Bidii Joint Akili Bidii
Estate Estate
Sh. ‗000‘ Sh.‗000‘ Sh.‗000‘ Sh.‗000‘ Sh.‗000‘ Sh.‗000‘
Excess of assets 10,000 7,240 9,970 Loss on o/d guarantee 8,360
over liabilities
Loss of P.ship capital
Estimated surplus Est. loss on realisation of 4,000 6,000
on assets:
Realisation of  Motor car
assets:  Investment
Land and  Debtors - 600 1,000
buildings 1,750 1,800 500 - - 200
 Stock
- -
Investments  Plant - -
- 1,350 -  Furniture - -
Surplus from B‘s Surplus as per SOA - -
estate 2,840 - 400 430
- - 2,840
Deficiency as per
SOA 3,190 2,970 -
_____ _____ _____ _____ _____ _____
17,780 13,360 10,470 17,780 13,360 10,470

Workings for unsecured creditors:

Sh. ‗000‘ Sh. ‗000‘ Sh ‗000‘

Joint Estate Akili Bidii
Trade creditors 24,320 260 180
Less pref. Creditors _(700) (-) (-)
Unsecured creditors 23,620 260 180

Workings for fully secured creditors

Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘

Joint Estate: Liability Security Surplus
Loans (L &B) 10,000 13,500 3,500

Akili: Loans (L &B) 2,500 4,800 2,300

Bidii: Loans (L & B) 3,000 5,000 2,000

Workings for partly secured creditors

Sh.‘000‘ Sh.‘000‘ Sh.‘000‘

Joint Estate: Bank o/d 8,360 3,500 4,860

Akili: Bank o/d 8,360 3,350 5,010

: Car Loan 600 300 300
8,960 3,650 5,310

Bidii: Car Loan 1,000 500 500

6.28 RECEIVERSHIPS
APPOINTMENT OF RECEIVER
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FINANCIAL ACCOUNTING III
 276 Bankruptcy and Liquidation

If a company defaults in payment of principal or interest, or otherwise defaults in observing the

conditions contained in debentures issued, a receivership may result. . A receiver can only be appointed
where the debentures are secured by a fixed or floating charge, or both.

Where power is given in the terms of issue, the debenture holders or their trustees, if there is a trust
deed, may appoint a receiver without having to apply to the court; and where the terms of issue provide
for such an appointment, they usually provide also for the events upon the happening of which he shall
be appointed, e.g. non—payment of principal, interest in arrears.

If no power to appoint a receiver is given by the terms of issue, the trustee for the debenture holders, or
a debenture holder acting on behalf of himself and others, may ask the court to appoint a receiver.
Before such an appointment will be made it will be necessary for the applicant to show that:-

(a) Default is made in payment of principal or interest

(b) The company is being wound up, or
(c) The security is in jeopardy.

An appointment will be made under (c) where there is a serious risk that the security may be seized to
satisfy claims which do not rank in priority to those of the debenture holders, e.g., where unsecured
creditors obtain a judgement and levy execution; but mere insufficiency of the security is not itself
"jeopardy" re (New York Taxicab Co).

A body corporate may not be appointed S.345 (Companies Act 1962), nor an undischarged bankrupt,
except under an appointment by the court S.346. The official receiver may be appointed if the company
is being wound up by the court S.347.
The duties of a receiver are to get in and realise the assets subject to the charge - he has no power to
carry on the business of the company; if such a power is required, as where there is a floating charge on
the company's business or undertaking and it is desired to sell the business as a going concern, the
receiver (or some other person) may be appointed manager to carry on the business for this purpose: if
appointed by the court this will be for a limited period, usually three months.

Effects of the appointment of the receiver:

(a) Floating charges: these crystallise on the appointment of a receiver and become fixed on the
assets then in the hands of the company, which cannot be dealt with without the receiver's
consent.
(b) Directors: their powers to deal with the assets charged are suspended, but their appointments are
not terminated.
(c) Employees: if the receiver is appointed by the court, they are automatically dismissed, but may be
re-employed by him (Reid v Explosives Co.): if appointed out of court as agent of the company,
their position is not affected (re Mack Trucks Ltd 1967).

If appointed by the court, the receiver must give security as directed by the court.

The following notification must be given:

(a) The debenture holders must give notice of the appointment to the registrar within seven days for
entry in the register of charges s.103,
(b) If appointed receiver or manager of substantially the whole of the company's assets under a
floating charge, the receiver must give notice of his appointment forthwith to the company s.351
(1)(a),

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(c) Every invoice, order for goods or business letter on which the company's name appears must
state that a receiver or manager has been appointed s.349.

Where (b) above applies, the company must, within 14 days of receiving the notice (or such
longer period as the court or the receiver may allow), submit a statement of affairs to the receiver
s. 351 (1)(b), verified by affidavit or statutory declaration by a director and the secretary, and
showing.

i. Particulars of the company's assets, debts and liabilities

ii. Names, residences and occupations of creditors
iii. Securities, if any, held by them, and the dates on which they were given, and

(d) Such further or other information as may be prescribed s.352(1).

The receiver may, if necessary, require the statement to be submitted by:

(a) Past or present officers of the company

(b) Persons who have taken part in the formation of the company at any time within the previous
year
(c) Persons employed by the company within the previous year, and capable, in the opinion of the
receiver, of giving the information required
(d) Persons who are or have been within the previous year officers or employees of a company
which is or has been within that year an officer of the company s.352(2).

Within two months of receipt of the statement of affairs the receiver must send:

(a) A copy of the statement of affairs

(b) His comments thereon (if any)
(c) A summary of the statement of affairs, and
(d) A summary of his comments, to:

i. The registrar
ii. The court (if appointed by the court) - (a) and (b) only
iii. The company - (b) only, or a notice that has no comments to make, and
iv. To the debenture holders and their trustees (if any) - (c) only s.351(1) (c).

Apart from the duties imposed by law, the receiver should, upon appointment, master the terms of his
appointment and ensure the validity of the charge, and, if he is appointed manager:- open an account as
receiver and have existing balances and all moneys received paid into that account: give instructions that
no goods are to be ordered or payments made without his authority, and that all letters etc., are to
comply with s.349; make arrangements for continuing or terminating contracts of employment; take an
inventory of all the assets; check insurances; and prepare lists of the company's debtors and particulars
of the debts.

If the receiver is appointed by the court, he is an officer of the court, and no action can be brought
against him, or taken or continued by him without leave of the court; he is not the agent of either the
company or the debenture holders.

(a) Liability on contracts: he is personally liable on contracts made by him, with a right of indemnity
against the company's assets; he is not bound by existing contracts except by novation, but he
should carry out such contracts if failure to do so would damage the company's goodwill.

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FINANCIAL ACCOUNTING III
 278 Bankruptcy and Liquidation

(b) Borrowing powers: he may obtain leave of the court to borrow money on security ranking in
priority to the debentures, and may borrow without security in the ordinary course of business
without leave.

(c) Remuneration: this is fixed by the court.

If the receiver is appointed out of court, prima facie, he is the agent of the debenture holders,
but he is usually expressly appointed as agent of the company; he may apply to the court for
directions s.348 (1).

(a) Liability on contracts: he is personally liable to the same extent as if appointed by the court
and with the same right of indemnity s.348(2); if appointed as agent of the company the
debenture holders are not liable for his acts, but he may require an indemnity from them
before accepting the appointment; he ceases to be the company's agent and his authority
as manager (if any) to carry on the company's business is revoked in the event of winding
up.
(b) Borrowing powers: the same as if appointed by the court.
(c) Remuneration: this is fixed by agreement with the debenture holders, but the court may fix
it retrospectively on the application of the liquidator s.350.

If appointed in circumstances to which s.351 applies (see above) he must within two months of the end
of each year after his appointment and of ceasing to act send an abstract of his receipts and payments
during that period and the aggregate amounts of receipts and payments since his appointment to:

(a) The registrar

(b) The company, and
(c) The debenture holders and their trustees if any s.351 (2).

Otherwise, e.g. where the charge is a fixed charge only on certain assets, if appointed out of court, he
must send similar accounts every six months and on ceasing to act to the registrar s.353; and, if
appointed by the court he must file accounts with the court as often as the court may require.

If the receiver is appointed in respect of debentures secured by a floating charge, he must pay in full
those debts which would be preferential in liquidation under s.311 before paying the debenture holders
s.95. The order of payments out of the proceeds that the receiver has realised is:

(a) Cost of realisation

(b) Receiver‘s costs and remuneration
(c) Trustee‘s remuneration (if any)
(d) Plaintiff‘s cost of action (if receiver appointed by court)
(e) Preferential creditors (if applicable)
(f) Debenture holders.

If appointed by the court, the receiver is discharged by order of the court and his security released; if
appointed out of court, he is discharged by agreement with the debenture holders, and, in this case,
notice of his ceasing to act must be given to the registrar for entry in the register of charges s.103(2).

6.29 LIQUIDATION OF COMPANIES

(a) Methods of Winding Up

A company may be wound up:

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i. By the court
ii. Voluntarily, either as a members' or a creditors' winding up; or
iii. Subject to the supervision of court s.212

(b) Grounds for compulsory winding up

A company may be wound up by the court under s.219 if:

a. The company so resolves by special resolution,

b. Default is made in delivering the statutory report or holding the statutory meeting: a petition can be
presented by members only at least 14 days after the last available date for the meeting s.221: the
court may order the report to be delivered or the meeting held instead of making a winding-up
order s.222,
c. The company has not commenced business within a year of incorporation or has suspended
business for a whole year (and has no intention of carrying on or resuming business:
(Middlesbrough Assembly Rooms Co.)
d. The number of members fall below seven, or two if a private company
e. Company is unable to pay its debts: this is deemed to be so if -

1. A creditor for more than Shs 1,000 has served a written demand for payment on the
company, and payment has not been made within three weeks; or
2. Execution or other process on a judgement remains wholly or partly unsatisfied; or
3. It is otherwise proved to the satisfaction of the court that the company cannot pay its debts,
taking into account its contingent and prospective liabilities s.220.
4. The court is of opinion that it is just and equitable for the company to be wound up, e.g.,
substratum gone, (re German Date Coffee Co), deadlock in management (re Yenidje
Tobacco Co Ltd), company a "bubble" or formed for a fraudulent or illegal purpose
mismanagement or misapplication of funds by directors of a private company (Loch v John
Blackwood Ltd). The petitioner may rely on any circumstance of justice or equity which
affects him, in a capacity, in his relations with the company or with the other shareholders
(Ebrahimi v Westbourne Galleries 1972).

(c) Persons Who May Petition

A petition may be presented by any of the following:

2. A Creditor
A creditor may petition if his debt exceeds Shs 1,000 and is undisputed. The order is made as of
right, unless the majority of creditors oppose it, in which case it is for the majority to justify their
opposition unless the company is already in voluntary liquidation (re J. D. Swain Ltd).
"Creditor" includes a contingent or prospective creditor (if he gives security for costs: s.221), a
debenture holder, and an assignee of a debt.

3. A Contributory
A contributory is a person liable to contribute to the assets of the company in the event of winding
up s.213: this includes all present members (even though their shares are fully paid) and past
members who ceased to be members during the year preceding the winding up and the personal

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FINANCIAL ACCOUNTING III
 280 Bankruptcy and Liquidation

representative of a deceased member - but not the trustee in a member's bankruptcy or the holders
of share warrants.

A contributory can only petition if:

a. The number of members has fallen below the statutory minimum; or

b. His shares:

i. Were originally alloted to him, or

ii. Have been held by him in his own name for at least six of the preceding 18 months, or
iii. Have devolved on him through the death of a former holder s.221.

c. There will be assets for distribution among the members: if the company is insolvent a
contributory has no tangible interest in the winding up (Re Rica Gold Washing Co.)

4. The Official Receiver

The Office Receiver may petition if the company is already being wound up voluntarily or under
supervision and the liquidation cannot proceed with due regard to the interests of the creditors or
contributories, e.g., because of the liquidator's misconduct s.221 (2).
5. The Company
The company may petition in consequence of a special resolution passed for this purpose.
6. The Attorney General
The A.G. may petition if it appears from an inspector's report that it is expedient in the public
interest that the company concerned should be wound up (P.D.A. 1963, s.16; C.A. 1967, s.81).

(d) The Petition

The petition must be in the prescribed form and verified by affidavit, and must be advertised in the
Gazette and a local paper seven clear business days before the hearing. Any creditor or contributory is
entitled to be heard on the petition if he has previously given notice to the petitioner that he intends to
appear and that he supports or opposes the petition. The court may dismiss the petition, or adjourn it,
or make a winding-up order or make any other that it thinks fit s.222.

(e) Interim Liquidator

An application to the court for such an appointment (usually of the O.R.) may be made at any time
between presentation and hearing, especially if the assets are in jeopardy s.235: he takes control of all
the company's property and no legal proceedings can thereafter be begun or continued against the
company without leave of the court s.228. The court may also stay any action against the company
during this period on the application of the company or any creditor or contributory s.223.

(f) Effect of Winding-up Order

The consequences of a winding-up order are:

a. Any disposition of the company's property and any transfer of shares is void, unless the
court otherwise orders s.224: this provision "relates back" to the commencement of the
winding up, i.e., the date of presentation of the petition, or, if the company has previously
passed a resolution to wind up voluntarily, the date of that resolution s.226,
b. Any attachment, execution or distress against the property of the company after the
commencement of the winding up is void s.225,
c. No legal proceedings may be begun or continued against the company without leave of the
court s.228,

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STRATHMORE UNIVERSITY● STUDY PACK
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d. The O.R. becomes provisional liquidator (contrast provisional liquidator in note e above)
until a liquidator is appointed s.236, and may apply to the court for the appointment of a
special manager to carry on business of the company pending the appointment of a
liquidator s.258,
e. Every invoice, order or business letter on which the company's name appears must state that
the company is being wound up s.329,
f. The company's employees are automatically dismissed, and the director's powers are
terminated.

(g) Procedure after Winding-up Order

1. A copy of the order must be filed by the company with the registrar s.227.
2. The company must deliver a statement of affairs to the Official Receiver within 14 days of
the order, or of the appointment of a provisional liquidator s.232 (the details are the same as
in the case of a receivership: se paragraph6.28 above.
3. The Official Receiver must submit a report to the court as soon as practicable after receiving
the statement of affairs showing:

a. The amount of issued, subscribers and paid-up capital and the estimated amount of
debts and liabilities,
b. The causes of the company's failure, if any, and
c. Whether further inquiry is desirable s.233.

If he thinks fraud has been committed he may submit a further report and the court may then
order the public examination of any promoter or officer named therein s.265.

4. The first meetings of creditors and contributories are summoned by O.R.. These must be
held within one month of the order, or within six weeks if a special manager has been
appointed, by notice in the Gazette and a local paper, and seven days' notice to each creditor
and contributory, accompanied by a summary of the statement of affairs and his comments
thereon: the meetings determine whether to appoint a liquidator and a committee of
inspection and, if so, to nominate them s.236.

(h) Appointment of Liquidator

The liquidator is appointed by the court after the above meetings have been held: if the meetings
do not agree, the court must settle the issue: if no appointment is made the O.R. continues as
liquidator ss.236.
A liquidator other than the O.R. must notify his appointment to the registrar and give security to
the satisfaction of the O.R. s.237, and must advertise his appointment.
The liquidator may be removed by the court, vacancies in the office are filled by the court, and
his remuneration is fixed by the court. s.238.
Note. A body corporate cannot be appointed liquidator in any kind of winding up s.326.

(i) Committee of Inspection

Appointed by the court if so decided at the above meetings s.248, s.249. There is no prescribed
number of members, but it should be representative of both creditors and contributories. The
function of the committee is to assist and supervise the acts of the liquidator.

(j) Dissolution

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FINANCIAL ACCOUNTING III
 282 Bankruptcy and Liquidation

If the winding up continues for more than a year, the liquidator must file progress reports with
the registrar at such intervals as the court may prescribe s.333. When the winding up is complete
the liquidator may either:

(a) Apply to the court for an order dissolving the company, and file a copy of the order with
the registrar within 14 days s.269: the dissolution operates from the date of the order, but
the court may declare it void at any time within two years s.352; or
(b) Apply to the registrar to strike the company's name off the register as being defunct 5338:
the registrar will then strike off the company's name two years after the release of the
liquidator by three months' notice to the O.R. and in the Gazette.

(k) Defunct Companies

A company may be dissolved under s.338 without winding up if the registrar has reasonable
cause to believe it is defunct: The procedure is:

a. Registrar writes to company asking if it is still in operation

b. If no reply within one month, the registrar sends registered letter within next 14 days
warning that company will be struck off if no reply within one month
c. If no reply, notice to company and in Gazette that company will be struck off after three
months unless cause shown
d. Company struck off the notice to effect in Gazette: dissolution from date of notice
e. To protect members and creditors, the liability of every office and member continues as
if the company had not been dissolved, and the court can wind up the company
notwithstanding that it has been struck off: moreover on the application of any member,
creditor or of the company, the court may within ten years order restoration to the
register whereupon the company is deemed to have continued in existence as if its name
had never been struck off.

(l) Resolution For Voluntary Winding Up

A company may be put into voluntary liquidation:

i. By ordinary resolution: where any period fixed for the duration of the company has
expired or any event upon which the company is to be dissolved has happened;
ii. By special resolution: for any reason whatsoever. s.271;

The resolution must be advertised in the Kenya Gazette and in a newspaper within 14 days
s.272, and the winding up is deemed to commence from the passing of the resolution s.273.
(m) Effect of Resolution
The consequences of the resolution to wind up are:

i. The company must cease to carry on its business except so far as is necessary for the beneficial
winding up thereof s.274
ii. The corporate state and powers of the company continue until it is dissolved s.274,
iii. A transfer of shares without the liquidators's sanction and any alteration in the status of the
members is void s.275,
iv. There is no automatic stay of proceedings against the company, but the court has a discretion
to do so on the application of the liquidator or a creditor or contributory s.301
v. Invoices, letters, etc, must state that the company is being wound up s.329
vi. The directors' powers cease, unless their continuance is sanctioned by the liquidator or the
company in the case of a members' voluntary winding-up, or the creditors or the committee of
inspection in the case of a creditors' voluntary winding-up ss.278, 290,

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vii. The company's employees are automatically dismissed if the company is insolvent (Fowler v
Commercial Timber Co.); otherwise probably not.

(n) Members' Voluntary Winding Up

The company may be wound up by the members themselves without reference to the creditors, if the
company is solvent.

1. Declaration of solvency
To do this all the directors, or a majority if more than two, must make a statutory declaration of
solvency to be filed with the registrar within the 30 days preceding the resolution to wind up.
This must state that the directors have made a full inquiry into the company's affairs and have
formed the opinion that the company will be able to pay its debts in full within a period not
exceeding twelve months of the commencement of winding up, and it must embody a statement
of the company's assets and liabilities practicable date s.276.

2. Appointment of liquidator
The liquidator is appointed and his renumeration fixed by the members in general meeting s.278,
and any vacancy is filled in the same way s.279. He must advertise his appointment in the
Gazette and notify it to the registrar within 14 days s.299. The court has power, if necessary, to
appoint and remove a liquidator s.298. The liquidator has similar powers to those in compulsory
winding up, and also the power to make calls and convene meetings s.297.
3. Further meetings
If the winding up continues for more than a year, the liquidator must convene a meeting of the
company at ` the end of that and each further year, and lay before it an account of his conduct of
the winding up during the preceding year s.282.
4. Dissolution
When the winding up is complete, the liquidator must call a final meeting of the company by one
month's notice in the Gazette and in a local newspaper, and lay before it an account of the
winding up and the disposition of the company's property. He must send a copy of this account
and a return of the holding of the meeting within a week thereof to the registrar, and after a
further three months the company is automatically dissolved s.283: but the court may declare the
dissolution void within the next two years s.338.

(o) Creditors' voluntary winding up

If no declaration of solvency is filed the winding up must take place under the control of the
creditors.

1. Meeting of creditors
The company must summon a meeting of creditors for the same day or the day following
that on which the meeting of members is held to pass the resolution to wind up, by notice
to the creditors and by advertisement in the Gazette and a local newspaper. The
directors must lay before the creditors' meeting a statement of the company's affairs and a
list of creditors, and appoint one of their number as chairman s.286.
2. Appointment of liquidator
Both the members and creditors (by a majority in number and in value or the creditors
voting in person or by proxy) nominate a liquidator. The creditors' choice prevails if they
differ, but in this case the court may be asked, within seven days of the nomination, to
make the appointment s.287. If the members have nominated a liquidator and the
creditors have not met, the liquidator has power to act until his appointment is terminated
by the creditors. His remuneration is fixed by the committee of inspection or the
creditors s.289 and vacancies are filled by the creditors s.291. Sections 297-299 (see
paragraph m 1, 2 above) apply.

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FINANCIAL ACCOUNTING III
 284 Bankruptcy and Liquidation

3. Committee of inspection
Both the members and creditors may nominate up to five persons, but the creditors may
object to the members' nominees who will not then be able to act unless the court
otherwise directs s.288.
4. Further meetings and dissolution
The position is the same as in a members' winding up, except that meetings of creditors
must also be held whenever meetings of members are required ss.293, 294.

(p) Conversion of members' to creditors' winding up

If the liquidator in a members' winding up forms the opinion that the company will not be able
to pay its debts in full within the period stated in the declaration of solvency, he must forthwith
summon a meeting of creditors and lay before it a statement of the company's assets and
liabilities, and thereafter the winding up proceeds as if it were a creditors' winding up ss.281, 284.
A creditor or contributory may petition for a compulsory winding up, notwithstanding that the
company is being wound up voluntarily s.303. An application by a contributory will only be
upheld if the court is satisfied that the rights of contributories will be prejudiced by the voluntary
winding up. In the absence of special circumstances a creditor's application will fail if the other
creditors wish the voluntary winding up to continue.

(q) Winding up under supervision

Virtually obsolete, in consequence of s.303 and the power to invoke the court's assistance under
s.301. If a supervision order is made, the effect is the same as on the making of a winding-up
order (except that the O.R. does not become liquidator): the procedure is the same as in
voluntary winding up, but the court may impose restrictions on the liquidator and will require
him to submit regular reports on the conduct of the winding up: the court may appoint an
additional liquidator ss.304-308.

(r) Realisation of assets

1. Divisible property
The ownership of the company's property does not vest in the liquidator (unless the court
makes a vesting order: s.240); but he must take it under his control and apply it in
satisfaction of the debts, and distribute any surplus among the members according to their
respective rights and interests ss.239,296. The property available for this purpose is:

1. All the property of the company at the commencement of winding up.

2. Property seized in execution of a judgement which was not completed by that date
3. Property used to give a fraudulent preference to creditors s313. Any transaction made
by a company which cannot meet its debts as they fall due with a view to preferring
one creditor to another, within 6 months of the commencement of the winding up, is
void.

2. Recovery of property
The following steps may be taken to recover the company's property:

a. A private examination many be held by the court of any person thought capable of
giving information as to the company's property or affairs s.263

b. Public examination of a promoter or officer may be held on a further report by the

Official Receiver s.265: (see paragraph g,3 above)
(The above steps are only available in a compulsory liquidation).

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c. If it appears that the company has carried on business with intent to defraud creditors or
for any fraudulent purpose, the court many order any person who were knowingly parties
to the fraud to be personally liable without any limitation of liability for such debts of the
company as the court may direct s.323.
d. Misfeasance proceedings may be brought against any promoter, officer, manager or
liquidator for the recovery of money or property or the contribution of a just sum to the
company's assets s.324.

3. Disclaimer
The liquidator may disclaim onerous property consisting of:

1. Land burdened with onerous covenants;

2. Stocks and shares;
3. Unprofitable contracts, or
4. Other property which is not saleable by reason of the liabilities attaching thereto;

and thereupon all the rights, interests and liabilities of the company in relation to the property are
determined as from the date of disclaimer.

The liquidator may disclaim in writing at any time within twelve months after commencement
of the winding up, or such extended period as the court may allow.

This right is lost if a person interested in the property applies in writing for him to decide
whether he will disclaim or not; in this case the liquidator must give notice of disclaimer within
28 days of receiving the application, unless the court extends the time.

The court's consent is not required to the disclaimer except in the case of certain leases.

Any person interested in property disclaimed may apply to the court for an order vesting the
property in himself.

Any person injured by the disclaimer may prove in the liquidation to the extent of his loss.

(s) Contributories
In compulsory winding up, the court must settle a list of contributories, distinguishing between
present (A List) and past (B list) members s.252: written notice must be given by the liquidator to
every person on the list by leave of the court or committee of inspection ss.255, 268. The court
may dispense with settlement of the list of contributories if it appears that it will not be necessary
to make calls on or adjust the rights of contributories s.252.
In voluntary winding up the liquidator settles the list and normally follows the above procedure.

(t) Distribution of Assets

1. Proof of debts
If the company is insolvent, the rules in bankruptcy as to provable debts, secured creditors,
interests, mutual dealings, annuities and contingent claims apply ss. 309, 310: if the company is
solvent all claims enforceable at the commencement of winding up are provable. In compulsory
liquidation the rules in bankruptcy as to the method of proving debts apply: formal proof is not
necessary in voluntary liquidation.
2. Preferential debts
These are almost the same as in bankruptcy, with the addition that any person who has advanced
money for the payment of wages has the same priority as the person receiving payment out of the

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FINANCIAL ACCOUNTING III
 286 Bankruptcy and Liquidation

advance would otherwise have had s.311. The "relevant date" for calculating these debts is the date
of the
resolution to wind up, or the date of the winding-up order or of the appointment of a provisional
liquidator. There are no pre-preferential debts in liquidation, and the only deferred debt is interest
in excess of 6 per cent per annum.

The preferential debts in bankruptcy include the following:

a. Local rates and amounts deducted as P.A.Y.E. from employees' pay accruing due during the
twelve month preceding the commencement of the winding up;
b. Up to one year's arrears of any other assessed taxes;
c. Wages and salary due to employees (but not directors) for work done during the four months
preceding the winding-up up to Shs 4,000 per employee;
d. All government rents not more than one year in arrears;
e. Employer‘s National Social Security Fund due during the previous twelve months;
f. Any amounts, which have accrued before the winding up due to employees is respect of any
compensation under the Workmen's Compensation Act.

3. Dividends
In compulsory liquidation, the rules are the same as in bankruptcy, except that they are payable
"as and when" there are assets available. In voluntary liquidation dividends are paid without
formality at the discretion of the liquidator.

4. Unclaimed assets
Money representing unclaimed dividends or undistributed assets must, after six months, be paid
into the Companies Liquidation Account : any person who later claims the assets may apply to
the O.R. for payment, which will be made on certification by the liquidator: any property of a
dissolved company (unless held on trust for some other person) vests in the government as bona
vacantia s.340 subject to the Crown's right of disclaimer s.341. The books and papers of the
company may be disposed of as directed by the court, the members or the creditors, but the
court may order their preservation for up to five year from dissolution s.332.

6.30 Bankruptcy Accounts: The Statement of Affairs and Deficiency Account For An
Individual
i. The Statement of Affairs
The statement of affairs sets out:

(a) The various assets of the debtor, at the values they are expected to realise;
(b) The creditors, classified according to their "priority".

The balancing figure on the statement of affairs is the estimated deficiency as at the date at
which it was prepared.

For a sole trader, one statement of affairs will be prepared to include all assets and liabilities,
whether private or business.
For a partnership, a statement of affairs is prepared in respect of the partnership assets and
liabilities - called the joint estate. A separate statement is also prepared for each partner, showing
his personal assets and liabilities. Any surplus on a separate estate becomes an asset of the joint
estate and vice versa.

The pro-forma statement of affairs sets out the order in which assets are shown.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 287

The order in which liabilities are discharged is:

1. Secured creditors, out of the proceeds of their security;

2. Costs and expenses of the bankruptcy; (these are not included in the Statement of
Affairs because they have not been incurred at the date at which it is prepared);
3. Pre-preferential creditors (see paragraph 6.24 above);
4. Preferential creditors (see paragraph 6.24 above);
5. Unsecured creditors;
6. Deferred creditors (see paragraph 6.24 above);
7. Any balance to the debtor.

ii. The Deficiency Account

Purpose of deficiency account
The purpose of the deficiency account is to explain the deficit shown on the statement of affairs.
The deficiency account opens with the surplus of assets over liabilities of the bankrupt, one year before
receiving order. This figure consists of the capital account of his business plus his net private assets at
that date.
Items contributing to deficit:
The following items will be shown on the right-hand side of the deficiency account as being items
contributing to the deficit:

1. Losses during the period as per the profit and loss account;
2. Bad debts;
3. Drawings and household expenses;
4. Estimated losses on the realisation of assets:

a. Stock
b. Machinery
c. Property
d. Other assets.

Items reducing the deficit:

Items reducing the deficit would include:

(a) Profits from trading;

(b) Estimated profit on the realisation of assets.

Notes:
(a) Where an examination question fails to give you statement of financial positionat the date of the receiving
order, you should draw up a "rough" statement of financial position to provide the basis for agreeing the
deficiency shown in the statement of affairs with that in deficiency account.
(b) Preparation of the statement of affairs and the deficiency account is based on "double entry" principles.

i. Items not in the statement of financial position must have a debit and credit within the statement of
affairs and deficiency account.
ii. Where the estimated realisable value of an asset differs from its book value i.e. the value at which it
appears in the statement of financial position given or computed as in (i) above, the difference must
be reflected in the deficiency account.
a. An estimated loss is put on the right-hand side;
b. An estimated surplus is put on the left-hand side.
c. A landlord may recover by distress rent outstanding in respect of the period, not exceeding six
months, prior to adjudication (date debtor declared bankrupt). If the landlord distrains he

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FINANCIAL ACCOUNTING III
 288 Bankruptcy and Liquidation

effectively removes assets to satisfy the outstanding rent and can therefore be considered in the
same category as a secured creditor. Do NOT assume distraint unless the question clearly states
this course of action. In other cases treat the rent outstanding as an ordinary creditor.
d. Deferred creditors do not become entitled to any dividend at all until the unsecured creditors
have received payment in full; however include them in the unsecured creditors in the Statement
of Affairs and put in a note on the Statement of Affairs. If there is any surplus, the deferred
creditors will rank against it to the full extent of their debts before any return is made to the
debtor. This point is seldom relevant to examination problems.
ACCOUNTS REQUIRED
This can be summarized depending on the nature of the situation. In a receivership you may be required to
prepare a receivers receipt and payments. In the process of liquidation you have various reports. They can be
summarsed as follows:

Pro-forma Statement of Affairs of a Company in Compulsory or Creditors‘ Voluntary Liquidation

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 289

STATEMENT OF AFFAIRS AS AT…….

Assets not specifically Est. Realisable
Pledged:
Values (Sh)
Balance at bank xx
Investments xx
Trade debtors xx
Stock-in-trade xx
Fixed Assets xx
xx
Assets specifically
pledged
Est. Realisable Due to secured Deficiency Surplus to last
unsecured (sh) (sh)
Values (sh) crs (sh)
Asset 1 xx xx xx xx
Asset 2 xx xx xx xx
xx xx xx xx

Estimated Surplus from assets specifically pledged xx

ESTIMATED TOTAL ASSETS xx

Gross Liabilities
Liabilities (sh)
xx Secured creditors (Fixed charge)
xx Preferential creditors (xx)
Estimated surplus for unsecured creditors and xx
Creditors secured by a floating charge.
xx Secured creditors (Floating charge) (xx)
Estimated surplus for unsecured creditors xx
Unsecured creditors:
xx -Trade creditors xx
xx - Bank overdraft xx
xx - Contingent liabilities xx
xx - Unsecured deficiency on pledged assets xx
xx xx
Estimated deficiency as regards unsecured creditors (xx)
Issued and called up share capital (xx)
ESTIMATED DEFICIENCY AS REGARDS MEMBERS
xx

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FINANCIAL ACCOUNTING III
 290 Bankruptcy and Liquidation

Pro-Forma ―Deficiency or Surplus Account‖

DEFICIENCY OR SURPLUS ACCOUNT

Items contributing to deficiency (or reducing surplus) Shs shs

1) Excess of capital and liabilities over assets 3 years
before winding up (if any) xx
2) Dividends and bonuses declared xx
3) Net trading losses xx
4) Losses other than trading losses written off xx
5) Estimated realization losses xx
6) Other items contributing to deficiency xx
xx
Items reducing deficiency (or contributing to surplus)
7) Excess of assets over capital and liabilities 3 years
before winding up order (if any) xx
8) Net trading profits xx
9) Profits and income other than trading profits xx
10) Other items reducing deficiency or contributing surplus xx
xx
DEFICIENCY AS PER STATEMENT OF AFFAIRS xx

Tutorial Notes:

Item number 1 above would be represented by a debit balance on the P & L account.
Item number 7 above would be represented by the reserves of the company three years before
the winding up order.
Example
A compulsory winding up order was made on 30 November 2003 against Hasara Ltd. A summary of
the company‘s statement of financial position as at that date was as follows:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 291

Non-current assets: Sh. ―000‖ Sh. ―000‖ Sh. ―000‖

Goodwill
Freehold property 2,689
Plant and machinery 4,940
Shares in subsidiaries 14,620
22,249
Current assets:
Stocks 19,180
Debtors 9,040
Cash in hand 20
28,240
Current liabilities:
Bank overdraft 22,790
Creditors 20,900
Customs and excise tax 200
Accruals 399
Debenture interest due 100 (44,389) (16,149)
6,100

Financed by:
Share capital 5,000,000
ordinary shares of Sh.20
each – fully paid 10,000
400,000 ordinary shares of
Sh.20 each- Sh.12.50 paid 5,000
15,000
Revenue reserves:
Retained profits (losses) (12,900 )
Shareholders‘ funds 2,100

Non-current liability:
10% debentures 4,000
6,100
Additional information:
1. The 10% debentures are secured by a first charge on freehold property and the bank
overdraft is secured by a floating charge on the assets.
2. The accruals consisted of:

Sh. ―000‖
Directors fee, 6 months to 30 November 2003. 75
Managers salary, 2 months to 30 November 2003 80
Wages of 3 workmen, 4 weeks to 30 November 2003 18
Rates – half year to 30 November 2003 20
Taxes for the year to 30 November 2001 120
Miscellaneous expenses 86
399
3. A holder of 20,000 of the partly paid shares was bankrupt and it was anticipated that his
trustees would be in a position to pay a dividend of 25% to his unsecured creditors.

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FINANCIAL ACCOUNTING III
 292 Bankruptcy and Liquidation

4. The company‘s assets were estimated to be realized as follows:

Sh. ―000‖
Freehold property 4,480
Plant and 14,000
machinery
Stocks 18,760

5. The debtors were considered to be good except as to Sh. 520,000 of which Sh. 400,000 were
doubtful and were expected to realize Sh.110,000. The remaining Sh.120,000 were
considered bad. Goodwill was regarded as valueless.
6. Legal proceedings for breach of contract were pending against the company as at 30
November 2003. The company was considered to have a poor defence and attempts were
being made to settle the claim out of court for Sh.100,000 plus costs estimated at Sh.80,000.
No provision for this claim is included in the statement of financial position.
7. The company had incurred losses of Sh.3,040,000, Sh.3,840,000 and 6,020,000 respectively in
each of the three years ended 30 November 2003. The aggregate of the sums charged to the
profit and loss accounts during the three years in respect of depreciation, debenture interest
and directors‘ remuneration were Sh.2,380,000, Sh.600,000 and Sh.1,800,000 respectively.

Required:
(a) Statement of affairs as at 30 November 2003. (10 marks)

(b) Deficiency account as at 30 November 2003. (10 marks)

(Total: 20 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 293

Solution

HASARA LTD
STATEMENT OF AFFAIRS AS AT 30.11.2003
Sh.‘000‘
Assets not specifically pledged
Cash in hand 20
Debtors (8,510 + 110) 8,630
Stocks 18,760
Plant and machinery 14,000
Amounts receivable from calls (2,850 + 25% x 2,887.5
150) 44,297.5
Assets Specifically pledge
Estimation Due to secured Surplus carried
realizable Values Creditors to last column
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Freehold property 4,480 4,100 380 380
Estimated total assets available for preferential creditors,
Bank overdraft secured by floating charge and unsecured 44,677.5
creditors
Summary of Assets 4,480
Gross realizable value of assets specifically pledged 44,297.5
Other assets 48,775
Gross assets

Gross Liabilities
Sh.‘000‘ Liabilities
4,100 Secured creditors
398 Preferential creditors (356)
44,321.5
22,790 Bank overdraft secured by floating charge (22,790.0)
21,531.5
20,900 Unsecured creditors 20,900
201 Trade creditors 243
108 Contingent liability 108 (21,251)
48,497 Estimated Surplus as regards creditors 280.5

Issued and called up capital 800,000 shares of Sh.20 18,000

each 17,719.5
Estimated deficiency as regards members

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FINANCIAL ACCOUNTING III
 294 Bankruptcy and Liquidation

DEFICIENCY ACCOUNT
Sh.‘000‘ Sh.‘000‘
Net trading losses for the three years ended 30 th (12,900)
November 2003 after charging:
Depreciation 2,380
Debenture interest 600
Directors‘ remuneration 1,800
Estimated losses now written off:
Goodwill 2,689
Debtors 410
Stock 420
Plant and machinery 620
Legal claim 108
Calls in arrears not receivable ( 20,000 X sh.7.50 X 75%) 112.5
Freehold property 460 (4,819.5)
17,719.5

Preferential creditors
Sh 000
Customs and Excise tax 200
Managers salary ( max imum amount) 4
Wages of 3 workment ( max 3 X 4000) 12
Rates 20
Taxes 120
356

Example 2
Filisika Ltd. is insolvent and is in process of filing for relief under the provisions of the Bankruptcy
Act. The company has no cash and its statement of financial position currently shows creditors of
Sh.48 million. An additional Sh.8 million is owed in connection with various expenses but these
amounts have not yet been recorded. The company‘s assets with an indication of both book value
and anticipated net realizable value as at 30 September 1999 as follows:

Book Value Expected NRV

Sh. ‗000‘ Sh. ‗000‘
Land 80,000 75,000
Buildings 90,000 60,000
Accumulated depreciation (38,000) -
Equipment 110,000 20,000
Accumulated depreciation (61,000) -
Investments 10,000 18,000
Stocks 48,000 36,000
Debtors 31,000 9,000
Other assets 5,000 -
275,000 218,000

Additional information:

1. Filisika Ltd. has three debentures payable, each with a difference maturity date:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 295

 Debentures one due in 5 years – Sh.120 million, secured by a mortgage lien on Filisika‘s land
and buildings.
 Debenture two due in 8 years – Sh.30 million secured by Filisika‘s investments.
 Debenture three due in 10 years – Sh.35 million, unsecured.

2. Of the creditors owed by Filisika Ltd. Sh.10 million represents salaries to employees. However,
no individual is entitled to receive more than Sh.4,000. An additional Sh.3 million is included in
this liability item that is due to the Kenya Government in connection with taxes.

3. The shareholders equity balance reported by the company at the current date is Sh.42 million:
composed of ordinary share capital of Sh.140 million and a deficit of Sh.98 million.

4. If the company is liquidated, administrative expenses of approximately Sh.20 million would be

incurred.

Required:

A statement of affairs and deficiency or surplus account for Filisika Ltd. to indicate the expected
availability of funds if the company is ligidated as at 30 September 1999.

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FINANCIAL ACCOUNTING III
 296 Bankruptcy and Liquidation

Solution
FILISIKA LTD
STATEMENT OF AFFAIRS AS AT 30.09.99
Sh.‘000‘
Assets
Unpledged Assets 20,000
Equipment 3,600
Stock 9,000
Debtors -
Others 65,000

Pledged Assets
Assets NRV Liability Surplus Deficit
Land & buildings 135,000 120,000 15,000 -
Investments 18,000 30,000 - 12,000
153,000 150,000 15,000 12,000 15,000
Surplus on pledged assets 80,000

Total assets for creditors and members

Gross Assets Sh.‘000‘
Pledged 153,000
Unpledged 65,000
218,000

Gross liabilities Liabilities

150,000 Secured creditors
Preferential creditors
20,000 Administrative expenses (20,000)
10,000 Salaries to employees (10,000)
3,000 Government taxes (3,000)
47,000
Unsecured creditors
35,000 Creditors 35,000
35,000 Debentures 35,000
8,000 Accrued expenses 8,000
261,000 Deficit on secured creditors 12,000 (90,000)
Deficiency to unsecured creditors (43,000)
Ordinary share capital (140,000)
Estimated deficiency as regards to members 183,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 297

RE: FILISIKA LTD

DEFICIENCY A/C FOR THE YEAR ENDED 30.09.99
Sh.‘000‘ Sh.‘000‘
Items contributory to deficiency
Accumulated trading losses (98,000)
Omitted accrued expenses (8,000)
Administrative expenses (20,000)
(126,000)
Estimated losses on realization
Land 50,000
Equipment 29,000
Stock 12,000
Debtors 22,000
Other assets 5,000 (73,000)
(199,000)
Items reducing deficiency
Estimated surplus on realization
Buildings 8,000
Investments 8,000 16,000
Deficiency as per SOA 183,000

Pro-Forma Statement of Assets and Liabilities (For use in members‘ voluntary

liquidation)
STATEMENT OF ASSETS AND LIABILITIES
Estimated to realize or to
rank for payment
Assets Sh
Balance at bank xx
Marketable securities xx
Trade debtors xx
Stocks and work-in-progress xx
Freehold and leasehold property xx
Plant and machinery xx
xx
Liabilities
Secured on specific assets xx
Secured by a floating charge xx
Estimated costs of liquidation xx
xx
Unsecured creditors xx
Bills payable and other liabilities xx xx
ESTIMATED SURPLUS AFTER PAYING DEBTS IN FULL xx

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FINANCIAL ACCOUNTING III
 298 Bankruptcy and Liquidation

This is rarely examined and therefore no examples are available.

RECEIPTS AND PAYMENTS ACCOUNTS
This is a straight forward receipts and payments account but does not necessarily deal only with
cash since the receiver may receive stocks, shares etc in satisfaction for company assets he has
sold, and distribute these.

RECEIVER‘S RECEIPTS AND PAYMENTS ACCOUNT

Shs Shs
Bank balance taken over xx Cost of realizations xx
Sales of pledged assets xx Receiver‘s remuneration xx
Preferential creditors (where the
Secured creditors are secured
By a floating charge)* xx
Creditors secured by the pledged
Assets (Fixed charge) taken over xx
Balance transferred to liquidator xx
xx xx

LIQUIDATOR‘S RECEIPTS AND PAYMENTS ACCOUNT

Shs Shs
Balance from receiver xx Cost of liquidation xx
Sales of assets xx Liquidator‘s remuneration:
Calls on shareholders xx - % of amounts realized on sale
of assets xx
- % of distribution to unsecured
creditors and members xx
Preferential creditors (if unpaid
by receiver)* xx
Unsecured creditors xx
Preference shareholders xx
Ordinary shareholders xx
xx xx

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 299

*If the receiver was appointed by creditors secured by a floating charge, he must settle
preferential creditors before paying such secured creditors.

If the receiver was appointed by creditors secured by a fixed charge, he will directly settle the
creditors who appointed him – and therefore preferential creditors must be paid by the liquidator
(if liquidation is to take place).

The receivers‘ and liquidators receipt and payments can be presented in vertical formats.
Example
(a) List and explain briefly the powers of liquidator (5 marks)

(b) Hasara Ltd makes its accounts each year 31 October and has been trading at a loss. On 31
October 2002, a resolution for a voluntary liquidation was passed. The statement of
financial position as at that date was as follows.

Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘

Non Current assets 11,000

Freehold property 2,750
Plant and machinery 13,750

8,750
Current assets: 13,375
Stock 125
Debtors 22,250
Cash
3,750
Current liabilities: 11,250
Bank overdraft 500 (15,500) 6,750
Creditors 20,500
Interest payable (5% debentures)

Paid up capital:
10,000 10% cumulative preference shares of Sh.500 each fully paid 5,000
25,000 Ordinary shares of Sh.500 each fully paid 12,500
10,000 Ordinary shares of Sh.500 each. Sh.250 paid. 2,500
20,000
Revenue reserves: profit and loss account (9,500)
Non Current liabilities: 10,000
5% debentures 20,500

Additional information:
1. The debentures are secured by a floating charge on the asset and undertaking of the
company.
2. The bank overdraft is secured by a fixed charge on the company‘s freehold property.

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FINANCIAL ACCOUNTING III
 300 Bankruptcy and Liquidation

3. The preference shares carry a right to a fixed cumulative dividend of 10% per annum up to
the date of liquidation and a repayment of Sh.500 per share in priority to all other classes of
shares. No dividend has been paid on the preference shares for two years.
4. The creditors include:
Sh.
‗000‘
Directors fees for one year 1,000
Rates for six months to 31 October 2002 125
Manager‘s salary for October 2002
Wages for 15 employees
Pay As You Earn (PAYE)

5. The assets realized the following amounts:

Freehold property 12,500
Plant and machinery 2,000
Stock 6,250
Debtors 12,250

6. The expenses of liquidation amount to Sh.125,000 and the liquidator‘s remuneration was
fixed at Sh.500,000.

Required:

The liquidator‘s statement of account showing in order of priority, the payments made and the
computation of any calls to be made.

Solution
(a) Powers of a liquidator

Under section 241 of the Companies Act the liquidator has some powers some of which are
exercisable with the consent of the court or a committee of inspection while others are
exercisable without consent.

Powers exercisable with consent

 To blame or defend any action or other legal proceedings in the name and on behalf
of the company.
 To carry on the business of the company in so far as may be necessary for beneficial
winding up.
 To appoint an advocate to assist in the performance of his duties
 To pay any class of creditors in full
 To make any compromises or arrangement with creditors
 To compromise all calls, liabilities to calls depts. And other liabilities.

Powers exercisable without consent

 To sell any movable or immovable properties of the company

 To execute deeds and other documents in the name of the company and on its
behalf
 To prove rank and claim in the bankruptcy or insolvency of a contributory

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 301

 To draw, accept or endorse any of exchange, a promissory note in the name of a

company.
 Raise money on the security of the company‘s assets
 Appoint an agent to do business which he can not do himself
 Do all such other things as are necessary for the winding up of a company and
distributing its assets.

(b) Hasara Ltd

Liquidators Statement of Account
Sh. Sh.
Cost & charges (W2) 625
Sales of pledged assets Preferential creditors (W1) 504
Freehold property 12,500 Floating charge – Debentures 10,000
Bank overdraft (3,750) - Interest 500
10,500
Sale of unpledged assets Unsecured creditors (11,250 – 10,746
Plant and machinery 2,000 540)
Stock 6,250 Preferential share holders: 5,000
Debtors 12,250 Capital 1,000
Cash 125 Dividend 6,000
Calls made (150 x 10,000) (W3) 1,500 (10% x 5000 x 2) 2,500
Ordinary shareholders (25,000 x
100)
30,875 30,875

WORKINGS
1. Preferential creditors:
Rates 6 months to 31.10.02 125
Managers salary (max) 4
129
Wages for 15 employees 50
PAYE 325
504

2. Cost & charges: 125

Liquidation expenses 500
Liquidator‘s remuneration 625

3. Determination of calls (if any) 1,000

Calls available 2,500
Notional calls (250 x 10,000) 3,500
35
No. of shares (25 + 10) 3,500 = 100
Notional distribution 35
Calls made 250 – 100 = 150

Example 2
Nagala supermarket Ltd. deals in imported goods which are paid for in foreign exchange. Following
the recent depreciation of the Kenyan shilling the company has incurred exchange losses on trade

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FINANCIAL ACCOUNTING III
 302 Bankruptcy and Liquidation

debtors and its business has become generally uncompetitive and consequently forcing the company
into a voluntary liquidation on 1 November 1997:

As at 1 November 1997:
1. The company had a bank loan of Sh.625,000 which was secured on furniture and fittings. The
furniture and fittings realised Sh.1,000,000.
2. Assets not specifically pledged realised Sh.4,250,000.
3. Liquidation expenses amounted to Sh.187,500.
4. Salaries payable to messengers for the last three months amounted to Sh.22,500, Sh.60,000 was
four months salary payable to clerks.
5. Unsecured trade creditors were Sh.1,092,500.
6. The share capital comprised of 10,000 8% preference shares of Sh.100 each and 25,000 ordinary
shares of Sh.100 each.
7. Calls in arrears were: Sh.25 on 10,000 ordinary shares
: Sh.40 on 8,000 ordinary shares
: Sh.50 on 7,000 ordinary shares
Required:
The liquidator‘s statement of receipts and payments with the appropriate support schedule (15 marks)

Solution
RE: Nagala Supermarket Ltd
Liquidators statement of receipts and payments

Shs. Shs.
Proceeds from sale of furniture Expenses of liquidation 187,500
And fittings 1,000,000
Repayment of bank loan (625,000) Preferential creditors paid
Salaries to messengers 22,500
Proceeds from sale of assets Salaries to clerks 60,000
Not specifically pledged 4,250,000

Unsecured creditors Paid

Trade creditors 1,092,500
Share capital repaid
Preference shareholders 1,000,000
Ordinary shareholders 1,580,000
2,580,000
Dividend to ord shareholders 682,500
4,625,000 4,625,000

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 303

Schedule of repayments to shareholders

Issued Paid up Calls in Gross Net Surplus

Div
S capital S capital Arrears Rep. Rep
Per Sha
Shs Shs Shs Shs Shs Shs
Shs.
8% pref.S cap 1,000,000 1,000,000 1,000,000 1,000,000 -
-
10000 Ord Sh 1,000,000 750,000 250,000 1,000,000 750,000 323,972
32.40
8000 Ord Sh 800,000 480,000 320,000 800,000 480,000 207,342
25.90
7000 Ord. Sh 700,000 350,000 350,000 700,000 350,000 151,186
21.60
3,500,000 2,580,000 920,000 3,500,000 2,580,000 682,500
N/A

Available cash 3,262,500

Total repayments 4,182,500

Tutorial notes:
1) Since the total repayments Sh4182500) is in excess of the issued share capital sh3500000) the
issued share capital may be returned in full to the shareholders, less of course, any calls
expected from them. This meant a return to shareholders of Shs2580000. The surplus of
Sh682500 Sh3262500 – Sh2580000) is given only to the ordinary shareholders as a dividend.
2) It is assumed that all the messengers and clerks are owed a maximum of Sh4000 per person
per month.
3) It is also assumed that the preference dividends are paid up to date and the company‘s
articles of association are based on Table A i.e dividends payable to shareholders is based on
paid up share capital and not issued share capital.

OSC 1st lot): 750000/1580000 X 682500 = 323972

OSC 2nd lot): 480000/1580000 X 682500 = 207342
OSC 3rd lot): 350000/1580000 X 682500 = 151185

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FINANCIAL ACCOUNTING III
 304 Bankruptcy and Liquidation

REINFORCING QUESTIONS
QUESTION ONE
Chege, a trader, filed his own petition in bankruptcy. The statement of financial position of his business
as on
30th June 20X1, the date of the Receiving Order, showed:
Net
Realisable
Value
Kshs Kshs Kshs
000‘ 000‘ 000‘

Capital Account as on
1st July 2000 600 Freehold shop building 1,200 1,400
Add: Profit for year to 10,000 shares of Shs 100
30th June 20X1 200 each at cost in Ivory 1,000 20
Ventures Ltd
800

Deduct: drawings in year

30th June 20X1 180 Stock 400 300
620 Trade Debtors 450 350
Trade Creditors Balance at Bank 50 50
(including Shs.50,000
Preferential in 1,680
bankruptcy)
Loan, secured on
freehold shop building 800
3,100 3,100
Chege's personal assets, not included above, comprised of a motor car valued at Shs. 20,000, a current
account with his bank of Shs.40,000 and a gold watch valued at Shs.50,000. His personal liabilities
outside the business were Shs.6,000 due to his butcher and Shs.10,000 for unsuccessful horse-racing
forecasts due to his bookmaker.
The value of personal assets and liabilities had remained unchanged since 1st July 20X0.
In 20V9 (i.e. 12 years previously), Chege had made a voluntary settlement of Shs.200,000 in favour of
his invalid sister, Mary.
You are required to prepare, as on 30th June 20X1:

(a) A Statement of Affairs, and

(b) A Deficiency Account. (15 Marks)

QUESTION TWO
Wanja and Juma, who trade in partnership, find themselves unable to meet their obligations
and instruct you to prepare a Statement of Affairs for submission to a meeting of creditors.
You are able to ascertain the following particulars from the books as at 1st November 20X1:

Shs ‗000
Unsecured creditors 1,200
Loan from Kuria 100
Creditors partly secured 230
Estimated value of security 200

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 305

Preferential claims 14
Stock-in-Trade (at cost) 100
Cash in Bank 35
Cash in Hand 12
Fixtures 100
Debtors Good 140
Debtors Bad 40
Debtors Doubtful 50

There was an excess of assets over liabilities at 1st January 20X8, of Shs.216,000, but since that date
there has been a loss on trading of Shs.784,400. Partners drawings from 1st January 20X0 to 1st
November 20X1 amounted to Shs.298,600. Juma is a limited partner who brought in capital of Shs
100,000. Wanja is a general partner, whose separate estate has been entirely absorbed in financing the
business. The loan from Kuria was made under an agreement by which he was to receive interest at a
rate varying with the profits.

For the purpose of the Statement of Affairs it was estimated that stock would realise Shs.85,000 and
fixtures Shs.10,000 while doubtful debts would produce Shs.10,000.

Add such explanatory notes to the Statement as are necessary to convey to creditors the true position of
affairs. (Total: 20 marks)

QUESTION THREE
Rucha and Mambo are in partnership trading as Ruma and they present their petition in Bankruptcy.
The following statements have been presented to you and you are asked to prepare the Statement of
Affairs and Deficiency Accounts of the Joint and Separate estates.

Ruma Rucha Mambo Ruma Rucha Mambo

Shs‗000 Shs‗000 Shs‗000 Shs‘000 Shs‘000 Shs‘000
Mortgage on Freehold 3,000 2,000
Free- Property
Hold Property 2,250 1,600 Plant 1,000
Bank Overdraft 1,500 Furniture etc. 500 600 700
Sundry Creditors 8,750 400 1,350 Stock 3,000
Capital – Rucha 500 Debtors 6,000
- 500 Partnership and
Mambo
Other
investments
Surplus _____ 1,500 150 _____ 900 800
13,500 3,500 1,500 13,500 3,500 1,500

The bank overdraft was secured by a second mortgage on the freehold property and by the deposit of
Rucha's investments and his personal guarantee.

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FINANCIAL ACCOUNTING III
 306 Bankruptcy and Liquidation

The estimated realisable value of the assets was as follows:

Ruma Rucha Mambo

Shs ‗000 Shs ‗000 Shs ‗000

Freehold property 3,250 2,350

Plant 400
Furniture etc 200 400 550
Stock 2,150
Debtors, Good 2,500
Doubtful, estimated Kshs.12 in KKshs.1 recoverable 1,500
Bad 1,000
Investments 850 650
Of the sundry creditors the following am ounts
Were preferential 250 100 50

(Total: 20 marks)
QUESTION FOUR
The Nyamole Company Ltd.'s unaudited Statement of financial position as at 31st July, 20X1 is shown
below:
Assets: Shs. Shs.
Land 130,000
Buildings less accumulated depreciation 900,000
Machinery less accumulated depreciation 1,200,000
Goodwill 200,000 2,430,000

Current Assets:
Cash 120,000
Debtors and prepayments 950,000
Investments 200,000
Stock – Finished goods 600,000
- Raw materials 400,000
2,270,000
Current Liabilities:
Creditors 942,000
Accrued Wages 150,000
Other payables 1,350,000
2,442,000

Net Current Liabilities 72,000

2,258,000
Financed by:
Share capital 1,000,000
Mortgage payable 1,300,000
Profit and Loss Account (42,000)
2,258,000
The following additional information is available:

1. The company is facing bankruptcy proceedings.

2. Cash includes a Sh.5,000 travel advance which has been spent.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Five 307

3. Debtors and prepayments of Sh.400,000 have been pledged in support of other payables in the
amount of Sh.300,000. Debit balances of Sh.50,000 are to be netted in the debtors and
prepayments total on account of being bad debts
4. Investments consist of Treasury Bills costing Sh.100,000 and 500 ordinary shares of Osense
Company shares. The market value of the Treasury bills is Shs 100,000 and the market value of the
shares is Shs 18 per share. The investments are collateral for a bank loan of shs.200,000 included in
other payables.
5. The creditors balances include accrued interest on mortgages of Shs 2,000.
6. The investments are collateral for a Shs 200,000 loan payable to the bank. The bank
7. loan is included in the other Payables balance.
8. Estimated realizable value of finished goods is Shs 500,000 and of raw material is Shs 300,000. For
additional out-of-pocket costs of Shs 100,000 the raw materials would realize Shs
599,000 as finished goods.
9. The market value of Land, Buildings and Machinery is as follows: Land - Shs 250,000:
Buildings - Shs 1,100,000: Machinery — Sh.650,000
10. Creditors include Sh.150,000 P.A.Y.E. deductions and Sh.60,000 due to the creditors who have
been reassured by the Managing Director that they would be paid. There are unrecorded P.A.Y.E.
deductions amounting to Sh.5,000.
11. Mortgages payable consist of Sh.1,000,000 on Land and Buildings and Sh.300,000 in connection
with a hire purchase agreement on machinery. Total unrecorded interest for these liabilities
amounts to Sh.24,000. interest on land and buildings mortgage is Shs 20,000 while that of the
machinery mortgage is shs.6,000
12. Probable judgement on a pending damage suit is estimated at Sh.500,000.
13. Expenses in connection with the liquidation are estimated at Sh.100,000.
14. The auditors have not submitted a fee note for Sh.50,000 in connection with the annual audit for
the year ended 30th April, 20X1.
15. The receiver estimates the liquidation work to cost Sh.10,000.

Required:
(a) A Statement of Affairs for Nyamole Company Ltd. as at 31st July, 20X1. (18 Marks)
(b) A Deficiency Account of Nyamole Company Ltd. in respect of unsecured creditors. (7 Marks)
(Total: 25
Marks)

QUESTION FIVE
a. In the bankruptcy of Mr. A, the trustee, having obtained the consent of the committee of
inspection, has decided to make a first dividend payment to unsecured creditors. Details of the
bankruptcy transactions to date are as follows:

Shs‘000
Business receipts, less payments 1,250
Payments to preferential creditors 340
Court fees and taxed costs 255
Proceeds of sale of assets (including business)
(gross) 5,300
Auctioneer‘s fee for sale of assets 300

Assets remaining unsold are estimated to realise Shs.2,760,000. Unsecured creditors (non—
preferential) have claims amounting to Shs.10m.
The trustee's remuneration has been agreed at:

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FINANCIAL ACCOUNTING III
 308 Bankruptcy and Liquidation

i. 4% on realisations;
ii. 8% on dividends to unsecured creditors.

On the assumption that the trustee wishes to retain at least Shs 75,000 (to cover outgoings),
prepare the statement which is required to accompany the dividend payment. (8 Marks)

b. Later, the trustee realizes the remaining assets for Shs. 2,450,000 (gross), and agents' fees and other
outgoings (excluding the trustee's remuneration) total Shs. 160,000.
The trustee now wishes to obtain his discharge. Prepare the summary of the trustee's cash book
giving details of the receipts and payments for the whole trustship (including the final dividend paid
to creditors). (7 Marks)

CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY PACK

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 309

LESSON SIX

EXECUTORSHIP LAW AND ACCOUNTS

OBJECTIVES
At the end of this lesson, you should:

 Know the provisions of the law of succession;

 Know how to prepare the accounts of executors and administrators of the estate of deceased
persons.

CONTENTS
 Read the study text below.
 Attempt reinforcing questions at the end of the lesson.
 Compare your solutions with those given in Lesson 9.

STUDY TEXT

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FINANCIAL ACCOUNTING III
 310 Executorship Law and Accounts

EXECUTORSHIP LAW: THE LAW OF SUCCESSION

7.1 EXECUTORSHIP
Executorship is the body of statute law, case law and practice concerning the management of the estate
of a deceased person. In what follows, we shall express the law as applying to a masculine person, but it
applies equally to women, whether married or not.
When a person dies, he dies:-

(a) TESTATE — he leaves a valid will, which disposes of all his free property (i.e the property
of which he was legally competent to dispose during his lifetime, and in
respect of which his interest does not terminate by his death)
OR

(b) INTESTATE — he does not leave a valid will, or the will does not dispose of all his
free property.

Since the vast majority of people in Kenya die intestate i.e. without leaving a will, we will deal with this
situation first.

7.2 DISTRIBUTION UNDER THE INTESTACY PROVISIONS

When a person dies without leaving a will, his estate is distributed according to the Law of Succession
Act.
When a person dies, four situations can be distinguished:

1. The intestate leaves no spouse and no children;

2. The intestate leaves no spouse but children;
3. The intestate leaves one surviving spouse, but no children;
4. The intestate leaves one spouse and children (or in the case of a male intestate who married under
any system of law which permits polygamy, a number of wives and children).

The rules of intestacy:

Agricultural land, crops and livestock in certain areas of Kenya are not covered by these rules; they are
distributed according to the law or custom of the tribe or community to which the deceased belonged.

(a) The intestate leaves no spouse and no children

The net estate devolves as follows: to his

1. Father; or if dead
2. Mother; or if dead
3. Brothers and sisters, and any child or children of deceased brothers and sisters, in equal
shares; or if none
4. Half—brothers and half—sisters and any child or children of deceased half—brothers and
half—sisters, in equal shares; or if none
5. Relatives who are in the nearest degree of consanguinity up to and including the sixth
degree, in equal shares; or if none
6. The Consolidated Fund of the Government.

Example;

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 311

A dies intestate; he never married. His father and brother have pre-deceased (i.e died before)
him.
A is survived by his brothers C and D, and sisters E and F; his brother B pre-deceased him, but
left a wife K and children L and M. His net estate was worth Shs. 3m. How will it be divided on
his death?
His brothers and sisters and the children of his deceased brother receive equal shares i.e C, D, E,
F, L and M each receive Shs.500,000, to give a total of Shs.3m.

Note
Section 39(1)(c) of the Law of Succession Act (on which this example is based) is not in accordance
with recommendation No. 41 of the Report of the Commission on the Law of Succession; whether
the difference is intentional or accidental is difficult to say.

(b) The intestate leaves no spouse but children

The net estate devolves upon the surviving children and is divided equally between them. If any
child has not, at the time of intestate's death, reached his majority, his share of property will be held
in trust until he reaches the age of 18 years, or, in the case of a female until she marries under that
age.

Example
Mr A dies intestate; his wife Mrs A died some years ago. Mr A is survived by his sons B (22 years
old) and C (18 years only). His daughter is at school; she is not yet married. His net estate is worth
Shs.3m. How will his property be divided?

It will be divided equally between B, C and D. D's share will be held in trust see Chapter 8) until she
reaches the age of 18 years, or until she marries, if she marries before she reaches the age of 18.
If a child of the deceased intestate predeceases him, but leaves his or her own issue (i.e. children,
grandchildren, etc.), then the issue take, through degrees, in equal shares, the share which their
parent would have taken had he not pre-deceased the intestate (PER STIRPES RULE).

Example
Mr K dies intestate; his wife Mrs K died two weeks before Mr K. Mr K's eldest son, M, died some
years ago; M's children P, Q and R are alive at the time of Mr K's death. B, C and D, Mr K's other
children were all alive when Mr K died. His net estate is worth Shs.3.6m; how will it be divided?

B, C and D will each receive one quarter of the estate i.e Shs.900,000 each. If M had been alive he
would also have received Shs 900,000. Since M predeceased his father, but left issue alive at the
time of his father's death, his children will share the Shs.900,000 equally i.e. P, Q and R will each
receive Shs.300,000.
If the intestate during his life—time or by will paid to, gave to or settled any property on a child,
grandchild or house, that property shall be taken into account in determining the share of the net
intestate estate finally accruing to the child, grandchild or house.

Example
Mr K dies intestate, his wife and eldest son J having predeceased him. Mr K is survived by A and B
the son and daughter of this eldest son J, and his own sons M and N. During Mr. K's life—time, he
(Mr. K) had made gifts of Shs.1m. to N, and Shs 500,000 to B. Mr. K left net estate worth Shs.5m:
How would it be divided?

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FINANCIAL ACCOUNTING III
 312 Executorship Law and Accounts

Total J M N
Shs m Shs m Shs m Shs
m
Mr. K Net Estate 5
Add:
Advancement
To N 1
Total 6 2 2 2
Deduct:
Advancement (1) (1)
5 2 2 1

A B
Add:
Advancement
To B 0.5
Total 2.5 1.25
1.25
Deduct:
Advancement (0.5) (0.5)
2.0 1.25 0.75

(c) The intestate leaves one surviving spouse, but no child or children.
The surviving spouse is entitled to:

1. The personal and household effects of the deceased absolutely: "personal and household
effects" are: clothing and articles of personal use and adornment, furniture, appliances, pictures,
ornaments, food, drink, utensils and all other articles of household use or decoration normally
to be associated with a matrimonial home, but not any motor vehicle or any other thing
connected with the business or profession of the deceased; and
2. The first Shs.10,000 out of the residue of the net intestate estate, or 20% thereof, whichever is
the greater; and
3. A life interest in the whole of the remainder; if the surviving spouse is a widow, this life interest
ceases upon her re—marriage to any person. When the spouse dies (or re—marries, if a
widow), the property subject to the life interest devolves in the order of (a) above.

(d)

1. The intestate leaves one surviving spouse and children

The surviving spouse is entitled to:

a. The personal and household effects of the deceased absolutely;

b. A life interest in the whole residue of the net intestate; if the surviving spouse is widow, this
interest ceases upon her re—marriage to any other person. On the death of the surviving
spouse (or on her re—marriage if she is a widow), the residue of the net intestate estate is
equally divided among the children alive at the moment of death (or re—marriage) of the
surviving spouse.
2. The intestate leaves several wives, married under any system of law which permits
polygamy

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 313

His personal and household effects and the residue of the net intestate estate shall first be divided
among the houses ("house" means family unit, comprising a wife, whether alive or dead at the date
of death of the husband, and the children of that wife) according to the number of children in each
house, but also adding any wife surviving him as an additional unit to the number of children.
The personal and household effects and the residue of the net intestate estate are distributed within
each house as above.

Example
Mr O dies intestate, leaving two wives, A and C whom he married under a system of law which permits
polygamy; a third wife B had predeceased him.A has children P, Q and R; B had children S and T; C has
no children.
All the children are alive at the time of Mr O's death. The value of his personaland household effects
was Shs.700,000 and the value of the net residue of theestate was Shs.2,800,000. How should his estate
be divided?

House 1 2 3
Total(units)
Wife A B(dead) C 2 units
Children P:Q:R S:T NONE 5 units
7 units
To wife absolutely:

1. Personal and 4/7 x Shs 700,000 1/7 x Shs 700,000

household
effects = Shs 400,000 N/A = Shs 100,000

2. 20% of the
Residue N/A N/A 1/7 x Shs2.8m x
20%
= Shs 80,000

Wife's life 4/7 x Shs 2.8m 1/7 x Shs 2.8m -

interest in Shs 80,000
the whole residue = Shs 1.6m N/A = Shs 320,000
or remainder

To be shared
between S and
T absolutely:

Personal and N/A S:Shs 100,000 N/A

household T:Shs 100,000
effects Shs 200,000

Residue N/A S:Shs 400,000 N/A

T:Shs 400,000
Shs 800,000

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FINANCIAL ACCOUNTING III
 314 Executorship Law and Accounts

Example
WILLS
Definition:
A will is the legal declaration by a person of his wishes or intentions regarding the disposition of his
property after his death, duly made and executed according to the provision of the Law of
Succession Act.
Requirements of a valid will:

1. In order to make a will, a person must be of sound mind and have reached his majority.
2. A person may dispose of all or any of his free property by will and may make any disposition by
reference to any secular or religious law that he chooses.
3. A female person (whether married or not) has the same capacity to make a will as a male.
4. When a person makes or purports to make a will, he shall be deemed to be of sound mind
unless, at the time of executing the will, he is in such a state of mind, whether arising from
mental or physical illness, drunkenness or from any other cause, as not to know what he is
doing. The burden of proof that a testator (i.e. the person who makes the will) was, at the time,
not of sound mind, shall be upon the person who so alleges.
5. A person may, by will, appoint an executor or executors. An executor is a person to whom the
execution of the last will of a deceased person is, by the testator's appointment, confided.
6. If a will, or any part of a will, was made by fraud or coercion, or by such importunity as takes
away the free agency of the testator, or has been induced by mistake, the will, or that part of it,
is void.
7. A will may be made:
Orally; it will not be valid unless:

1. It is made before two or more competent witnesses (i.e. persons of sound mind and full age); and
2. The testator dies within 3 months of the date of making the will;
3. An oral will made by a member of the armed forces or merchant marine during a period of active
service (i.e. service on a field of military operations or at sea, or proceeding to or from, or under
orders to proceed to, or being in some place for the purpose of proceeding to, a field of military
operations or sea) is valid for more than three months after the date of making the will, provided
he dies in the same period of active service.
4. If an oral will is made after a written will has not been revoked, the oral will is not valid in so far as
it is contrary to the written will; if a written will is made after an oral will, the written will be the
valid will (unless some property disposed of by the oral will is not disposed of by the written will.)
5. If there is any conflict in evidence of witnesses as to what was said by the deceased in making an
oral will, the oral will is not valid except so far as its contents are proved by a competent
independent witness (an independent witness is one who is not a beneficiary or the spouse of a
beneficiary under a will).

In writing: a written will is not valid unless it fulfills the following conditions.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 315

1. The testator must sign the will; or he must affix his mark to the will (i.e. affix his thumbprint or
his stamp or his ring—mark); or the will must be signed by some other person in the presence
and by the direction of the testator (The testator must have animus testandi i.e. the desire to make
a will).
2. The signature or mark of the testator, or the signature of the person signing for him, must be so
placed that it shall appear that it was intended thereby to give effect to the writing as a will.
(Normally the signature or mark should be put at the foot of the will).
3. The will must be attested by two or more competent witnesses, each of whom must have seen
(they cannot therefore be blind) the testator sign or affix his mark to the will, or have seen some
other person sign the will in the presence and by the direction of the testator, or have received
from the testator a personal acknowledgement of his signature or mark, or of the signature of that
other person. Each of the witnesses must sign the will in the presence of the testator. It is not
necessary that more than one witness be present at the same time, and no particular form of
attestation is necessary.
4. A testator may refer in a will or codicil (a codicil is a testamentary instrument made in relation to a
will, explaining, altering or adding to its dispositions or appointment; it must be made in
accordance with the provision laid down for a written will) to another document then actually
written which expresses any part of his intention. If this document is clearly identified as the
document to which the will refers, it shall be considered as forming part of the will or codicil in
which it is referred to.
5. If one of the persons attesting the will or his spouse, is also a beneficiary of the will, or is
appointed executor in the will, the will is valid as to the number of witnesses. However, a bequest
to an attesting witness (including any direction as to payment of costs or charges) or a bequest to
his or her spouse shall be void unless the will is also attested by at least two additional competent
independent witnesses, in which case the bequest shall be valid.
6. If a person is appointed an executor of a will, he is not thereby disqualified as a witness to prove
the execution of the will or to prove its validity or invalidity.
7. A will, drawn up in a foreign country in accordance with the laws of the country, shall be deemed
to be valid in Kenya, even though it is not drawn up as above; it is valid to property in that
country; it is valid if the testator is a national of that country, either at the time the will was made,
or at the time of his death.

(h) Revocation, alteration and revival of a will

1. A will may be revoked or altered by the maker of it at any time when he is competent to dispose
of his free property by will. (A will is said to be ambulatory).
2. A will is revoked by the later marriage of the maker, unless the will is expressed to be made in
contemplation of marriage with a specific person (and the subsequent marriage is to that person).
3. A will or codicil, or any part of it, can be revoked only by making another will or codicil declaring
an intention to revoke it, or by burning, tearing or otherwise destroying the will with the intention
of revoking it by the testator, or some other person at his direction, or by subsequent marriage as
in (ii) above.
4. A written will can never be revoked by an oral will.
5. No obliteration, interlineation or other alteration made in a written will after the execution of it
(signed by the testator and witnesses) shall have any effect unless the alteration is signed and
attested as required for a will. If a will is so altered, then the will is deemed to be duly executed if
the signature of the testator and the subscription of the witnesses is made in the margin or on
another part of the will opposite or near to the alteration, or is referred to in a memorandum
written at the end or some other part of the will and is so signed and attested.
6. Where a typewritten or printed will purports to have been executed by the filling in of any blank
spaces, there shall be a presumption that the will has been duly executed.

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FINANCIAL ACCOUNTING III
 316 Executorship Law and Accounts

A will which has been wholly revoked in any manner cannot be revived except by re—executing the will.
Where any part of the will has been revoked, that part shall not be revived otherwise then the re—
execution of that part, or by a subsequent will or codicil showing an intention to revive it.

7.2.1 Characteristics of a will:

(a) Dispositionary: A will disposes the deceased‘s property.
(b) Formality: For a will to be valid, it must be written and signed by the deceased and appropriate
witnesses. Oral wills area only valid if the testator dies within three months of making the will.
(c) Alterations: Alterations to the will e.g. in form of codicils, need to be signed and witnesses
appropriately.
(d) Posts-humous effect: A will only takes effect after the testator is dead. Thus, it is often said that
a will is a device through which the dead can rule the living fro their graves.
(e) Capacity: The testator must have the capacity to make a will at the time that he makes the will
e.g. he must be of sound mind.
(f) Legality: The will must be legal for it to be upheld in law.

7.3 TYPES OF GIFT BY WAY OF A WILL

(a) A special (or specific) legacy is a testamentary gift of a particular part of the property of the
testator, which identifies that part by a sufficient description, whether in specific or in general
terms and manifests an intention that that part shall be enjoyed as taken in the state and condition
indicated by the description.

E.g. I leave my house in Buru Buru, Nairobi, to my eldest son Maina.

(b) A general legacy is a testamentary gift, whether specific or general, of property described in
general terms to be provided out of the general estate of the testator, whether or not also charged
on any specific part of his estate. A pecuniary legacy includes an annuity, a general legacy, a
demonstrative legacy so far as it is not discharged out of the specified fund or property and any
other general direction by the testator for the payment of money, including all death duties free
from which any gift is made to take effect.

E.g. 1. I leave Shs 200,000 to my youngest daughter June.

2. I leave a bicycle to my son Juma (NOT MY bicycle NOR THE bicycle, but a
bicycle).

(c) A demonstrative legacy is a testamentary gift which is in its nature general but which manifests an
intention that the gift shall be primarily satisfied out of a specified fund or a specified part of the
property of the testator, but shall, upon failure of that fund or property, be met from the general
estate.

Example
A leaves Shs 100,000 to B payable out of his holding of ordinary shares in Kenya Breweries
Limited.

If A owns ordinary shares in Kenya Breweries Limited at the time of his death, the gift of Shs
100,000 is deemed to be a specific legacy. If no Kenya Breweries Limited shares are owned by A
at the time of his death, then the gift of Shs 100,000 will not fail due to ademption (see below),
but will be paid as a general legacy. If A's shares in Kenya Breweries Limited realize only Shs

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 317

40,000, then Shs 40,000 is deemed to be a specific legacy and Shs 60,000 (the remaining part of
the gift) is deemed to be a general legacy.

In a U.K case (Mullins v. Smith), it was held that a legacy described as "Kshs.100 Consols out of
my Kshs.500 Consols", or "Kshs.100, part of my Kshs.500 Consols", is a specific legacy. In
another case (Re. Boyd, Boyd v. Boyd) it was held that the will may show an intention to
bequeath the identical asset; certain pecuniary legacies amounting to Kshs.710 were directed by
the will to be paid "with and out of the proceeds" of the sale of the testator's investments
comprising stocks and shares; these realized only Kshs.487; it was held that, as the fund specified
for payment of the legacies was insufficient, they must abate rateably inter se (amongst
themselves) and they were not payable out of the general estate. Whereas a legacy of "Kshs.100
payable out of my Kshs.500 Consols" is a demonstrative legacy (Kirby v. Potter).

(d) A gift of residue

Where property is not given by a specific legacy nor by a general legacy, it makes up the residue of
the testator's estate. If the testator fails to make a gift of his residue, he dies partially intestate.
The rules of intestacy will apply to the property comprising his residue. If a gift of property fails
due to lapse or uncertainty, the property falls into the residue.

A "general residuary bequest" is defined as a testamentary gift of all property of the testator not
otherwise disposed of.

(e) Types of interest given under a will

The interest given in a legacy, devise or gift of residue may be of the following kinds:-

1. VestedA vested interest gives an immediate indefeasible title although possession might be
deferred. An illustration is the interest of a remainderman while the life tenant is still alive.
2. Contingent
A contingent interest is dependent on the happening of some specific event. An example is
the interest of the second life tenant of a trust while the first is still alive.
3. Absolute
An absolute interest gives full power over property including the power to dispose.
4. Limited
A limited interest gives only the power of enjoyment for a limited period of time.
5. Conditional
A conditional interest is dependent on the beneficiary fulfilling some condition before his title
is made absolute.

(f) Cumulative and substitutional legacies and devises

Where a will makes two gifts of unequal amounts to the same person, they are assumed, in the
absence of a contrary indication, to be cumulative.
Where a will makes two gifts of equal amount to the same person, the presumption is that the
second was in substitution for the first, unless evidence to the contrary is shown.
If two clauses of a will are irreconcilable, so that they cannot stand together, the last shall prevail.
Obvious clerical errors can be corrected.

7.4 CAUSES OF FAILURE OF LEGACIES AND GIFTS OF RESIDUE

a. Ademption
If property which has been specifically bequeathed does not belong to the testator at the time of his
death, or has been converted into property of a different kind, the gift cannot take effect by reason of
the subject of the gift having been withdrawn from the operation of the will; where a gift fails on this

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account, it is said to be "adeemed". There must be a substantial change in the subject of a specific legacy
to cause ademption and a merely nominal change shall not have that effect.

The gift of an interest in a fund shall not be adeemed by any sale or change of investment of the fund by
the persons having control thereof, nor shall it be adeemed by the testator receiving it before his death,
whether or not thereafter sold or re—invested by him, if it can at his death be followed and
distinguished.

A demonstrative legacy is not adeemed if the property on which it is charged by the will does not exist at
the time of the death of the testator, or has been converted into the property of a different kind; in these
cases, it is paid out of the general estate of the testator.

Where a testator makes a gift by will to any person for a specific purpose, or to any child or other person
to whom he stands in loco parentis (i.e. in the place of that person's parent) by way of portion ("portion"
means provision by a parent or person in loco parentis to establish a child in life) and after the date of
execution of the will, provides by deed or settlement or otherwise for the same purpose or by way of
portion for the same child or other person, there shall be a presumption that the gift is adeemed by the
subsequent provision, so far as the subsequent provision extends.

b. Uncertainty
A gift or disposition not expressive of any definite intention shall be void for uncertainty, i.e A gift under
a will fails where there is uncertainty as to:

i. What is being given

ii. To whom it is being given, or
iii. The quantity of the interest being given

E.g. A leaves some of his property to B; or A leaves his house in Karen to some of his children.
However, no gift for charitable purposes is void because of uncertainty of the object. Also, no gift
whereby the legatee is expressly or impliedly given a right of selection, purchase or disposition is void
merely by reason of the uncertainty arising from that right. Where property is bequeathed to any person,
the gift shall be presumed to comprise the whole interest of the testator in that property, unless it
appears from a will that only a restricted interest was intended for him. The object of a gift which refers
to a person or persons as existing, shall be construed as at the date of the will, unless a contrary intention
clearly appears therein.

c. Disclaimer
A beneficiary can always disclaim a legacy and probably would do so if the gift involves onerous
conditions. He may also do so when he wishes to increase the share of residue passing to some other
beneficiary.

d. Lapse
If the legatee pre-deceases the testator, the gift fails; it is said to "lapse".

E.g. In his will, A leaves B Shs 100,000. B dies before A; A then dies. Since it is useless to pass
money to a dead person, the gift fails due to "lapse"; the gift is said to "lapse".

The subject of the gift, in this case Shs 100,000, passes into the residue.

Exceptions to the rule of lapse:

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There is no lapse in either of the following cases:

1. Where the gift or disposition is made in discharge of a moral obligation recognised by the testator;
or
2. Where the gift or disposition is in favour of any child or other issue of the testator, for any estate or
interest not determinable at or before the death of the child or other issue and the child or other
issue leaves issue surviving the testator.

In either case, the gift or disposition takes effect as if the deceased legatee had died immediately after the
testator.

E.g. In his will, K left his house to his eldest son M. M pre-deceases his father, but leaves his children
P an Q who are alive at the time of his father's (i.e. X's death). In his will, M leaves all of his estate to his
wife Mrs. M. The fact that P and Q are alive at K's death keep in place the gift to M; the house passes to
M's estate, and by means of M's will, passes to Mrs. M (Carefully contrast this position with the per
stirpes rule in intestacy).

e. Gifts subject to an illegal condition

A gift will fail if it has an illegal condition attached to it.

E.g. I give Shs.100,000 to Mwangi provided the murders his house-keeper.

f. Gifts subject to a condition which is contrary to public policy.

Where a gift is subject to a condition which is contrary to public policy, the gift will not fail but the
beneficiary will take without the condition.

E.g. I give Shs.1m. to my wife on the condition that she shall not marry again.
The wife will take the legacy but remain free to marry again.

g. Abatement: In case the legacy is not adequate to meet all the dues of the beneficiaries, the dues will
be reduced in proportion to what is available fro the legacy.

7.5 ABATEMENT OF LEGACIES

(a) If the assets, after the payment of debts, necessary expenses and specific legacies, are not
sufficient to pay all the general legacies in full, the latter abate in equal proportion, and the
personal representative has no right to pay one legatee in preference to another nor to retain any
money on account of a legacy to himself or to any other person for whom he is a trustee;
however, if the personal representative is entitled to a priority in respect of his remuneration, that
priority is upheld.
(b) For the purposes of abasement, a legacy for life, a sum appropriated by the will to produce an
annuity, and the value of annuity when no sum has been appropriated to produce it, shall be
treated as general legacies.
(c) Where there is a specific legacy and the assets are sufficient for the payment of debts and
necessary expenses, the thing specified must be delivered to the legatee without any abatement.
(d) Where there is a demonstrative legacy, and the assets are sufficient for the payment of debts and
necessary expenses, the legatee shall have a preferential claim for payment of his legacy out of the
fund from which the legacy is directed to be paid until the fund is exhausted, and if the fund is
exhausted, but part of the legacy still remains unpaid, he shall be entitled to rank for the remainder
against the general assets as for a legacy of the amount of the unpaid remainder.

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(e) If the assets are not sufficient to answer the debts and the specific legacies, an abatement shall be
made from the latter rateably in proportion to their respective amounts.

(f) Where personal representatives have given such notice as may be prescribed for creditors and
others to send in their claims against the estate of the deceased, the personal representatives can
distribute the assets of the estate at the expiration of the time stated; they shall not be liable for the
assets so distributed to any person of whose claim they have not had notice at the time of
distribution. The creditor or claimant has the right to follow the asset in the hands or persons
who received them.
(g) Where personal representatives have paid any legacy which, but for the payment, would have been
liable to abatement as above, they shall be entitled to call upon the legatee to refund the amount
by which the legacy should have abated only if:

i. The legacy was paid under any order of the court; or

ii. If and so far as the abatement is rendered necessary by discovery of a debt of which the
personal representative had no notice at the time of voluntary payment of the legacy.

7.6 PRESUMPTION OF SURVIVORSHIP

Where two or more persons have died in circumstances rendering it uncertain which of them survived
the other or others, the deaths shall, for all purposes of the Succession Act, be presumed to have
occurred in order or seniority, and accordingly the younger shall be deemed to have survived the older;
however, in the case of spouses who die in these circumstances, the spouses shall be presumed to have
died simultaneously.

7.7 INVESTMENT OF FUNDS TO PROVIDE FOR LEGACIES AND INTEREST ON

LEGACIES
(a) Where a general legacy is given for life, the sum bequeathed shall, at or before the end of a year
after the death of the testator, be invested in any authorised investment; however, when an
annuity is given and no fund is charged by the will with its payment, or appropriated by the will to
answer it, a sum sufficient to produce the annuity shall be invested in any authorised investment.
(b) Where a general legacy is given to be paid, at a future time, the personal representative shall invest
a sum sufficient to meet it in any authorised investment. The intermediate interest from the
investment shall, unless expressly or by implication be payable to the legatee or another, form part
of the residue of the testator's estate.
(c) Where a gift is contingent, the personal representatives shall not be bound to invest the amount
of the legacy, but may transfer the whole residue of the estate to the residuary legatee, if any, on
his giving sufficient security for the payment of the legacy if and when it becomes due.
(d) Where a testator has given any property to a person for life without any direction to invest it in
any particular securities, so much thereof as is not at the time of the testator's death invested in an
authorised investment, shall be converted into money and invested in such an investment. Until
conversion and investment are completed as above, the person, who would for the time being be
entitled to the income of the fund when so invested, shall receive interest at 6% per annum upon
the market value at the testator's death of such part of the fund as has not been so converted and
invested.
(e) A contingent of future, as well as an immediate specific legacy and a residuary bequest not
contingent in its terms of property, whether immovable or movable, shall carry the intermediate
income of that property from the death of the testator, except so far as the income, or any part
thereof, may be otherwise expressly disposed of.

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(f) Where no time has been fixed for the payment of a general legacy, interest shall begin to run from
the expiration of one year from the testator's death; where a time has been fixed for payment,
interest shall begin to run from the time fixed. In either case, the interest up to that period shall
form part of the residue of the testator's estate. However, interest shall run from the death of the
testator where:

i. The legacy is bequeathed in satisfaction of a debt; or

ii. The testator was a parent or more remote ancestor of the legatee or has put himself in the
place of the parent of the legatee, and the legatee is a minor, and no specific sum is given by
the will for maintenance; or
iii. The legacy is bequeathed to a minor with a direction to pay for his maintenance thereout.

(g) No interest shall be payable on the arrears of an annuity within the first—year from the death of
the testator although a period earlier than the expiration of that year may have been fixed by the
will for making first payment of the annuity.

(h) Where a sum of money is directed to be invested to produce an annuity, interest shall be payable
on that sum from the death of the testator until so invested.

The rate of interest payable under paragraphs (e) to (f) inclusive shall be 6% per annum, unless otherwise
expressly stated.

Paragraphs (e) to (h) inclusive apply in so far as a contrary intention does not appear from the will.
7.8 PROTECTION OF PROPERTY OF A DECEASED PERSON
(a) No person may take possession of or dispose of or otherwise intermeddle with, any free property
of a deceased person, unless he is expressly authorised by the Succession Act or by some other
Act.
(b) If a person contravenes the above he is guilty of an offence and is answerable to the rightful
executor or administrator to the extent of the assets with which he has intermeddled after
deducting any payments made in the due course of the administration.
(c) Whenever it becomes known to any police or administrative office that any person has died, he
shall forthwith report the fact of his death to the administrative officer of the area (unless he
knows that this has already been done).
(d) If the administrative officer is requested by any person who appears to have a legitimate interest
in the estate or if no application for representation in respect of the estate has been made within
one month of the date of death of the deceased, the officer will proceed to the last known place
of residence of the deceased and take all necessary steps for the protection of his free property
found there, for ascertainment of his other free properties (if any), for ascertainment of all
persons appearing to have any legitimate interest in succession to or administration of his estate
and for the guidance of prospective executors or administrators as to formalities and duties.
(e) The High Court has jurisdiction to deal with any application and determine any dispute under the
Succession Act.

7.9 APPLICATION FOR GRANT

(a) An application for a grant of representation ("representation" means the probate of a will or the
grant of letters of administration) is made in such a form as is prescribed, signed by the applicant
and witnessed in the prescribed manner. Probate is the certificate of a court of competent
jurisdiction that a will, of which a certified copy is attached in the case of a written will, has been
proved a valid will with a grant of representation to the executor in respect of the estate.

The application must include information as to:

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1. The full name of the deceased;

2. The death and place of his death;
3. Whether or not the deceased left any will;
4. The relationship (if any) of the applicant to the deceased;
5. Whether or not the deceased left any will;
6. The present addresses of any executors appointed by any such will;
7. In cases of total or partial intestacy the names and addresses of all surviving sponsors,
children, parents, brothers and sisters of the deceased, and of the children of any child of
his or hers then deceased.
8. A full inventory of all the assets and liabilities of the deceased; and,
9. Such other matters as may be prescribed.

(b) If in the application it is claimed that the deceased left a valid will, then

1. If it was written the original will must be annexed to the application, or it is alleged
to have been lost or destroyed otherwise than by revocation, or if for any other
reason the original cannot be produced, then either

i. An authenticated copy thereof shall be annexed; or

ii. The names and addresses of all persons alleged to be able to prove its
contents shall be stated in its application.

2. If it was oral, the names and addresses of all alleged witnesses shall be stated in the
application.

(c) No permission of any information from an application shall affect the power of the court to
entertain the application.
(d) Any person who makes an application and willfully or recklessly makes a statement in it which is
false is guilty of an offence punishable by a fine of Shs.10,000 or to up to a year, or both.
(e) A court may:

1. Wherein a deceased person is proved whether by production of a will or

authenticated copy of the will or by oral evidence of its content, to have left a will,
grant, in respect of all property to which the will applies either:

i. Probate of the will ("Probate" means the certificate of a court of competent

jurisdiction that a will of which a certified copy is attached in the case of a
written will, has been proved a valid will with a grant of representation to the
executor in respect of the state) to one of more of the executors name
therein; or
ii. Where there is no providing executor, letters of administration, with the will
annexed; and

2. If and so far as there may be intestacy letters of administration in respect of the

intestate estate.

(f) A court may limit a grant of representation which it has jurisdiction to make, as follows:

1. Where the will has been lost or mislaid since the testator's death or has been destroyed by
wrong or accident and not by any act of the testator and a copy of the draft of the will has

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been preserved, probate may be granted of the copy or draft limited until the original or a
properly authenticated copy of it is produced;
2. When a will is in the possession of a person residing outside Kenya who has refused or
neglected to deliver it, but a copy has been transmitted to the executor, and it is necessary for
the interest of the estate that probate should be granted without waiting for the arrival of the
original, probate may be granted of the copy so transmitted; limited until the will or an
authenticated copy of it is produced;
3. Where no will of a deceased is forthcoming, but there is reason to believe that there is a will
in existence, letters of administration may be granted, limited until the will or an authenticated
copy of it is produced;
4. When any executor is absent from Kenya and there is no executor in Kenya willing to work,
letters of administration with the will annexed may be granted to the attorney of the absent
executor for the use and benefit of his principal, limited until he shall obtain probate or letters
of administration granted to himself;
5. When a minor is sole executor or sole residuary legatee, letters of administration with the will
annexed may be granted to the legal guardian of the minor or to such other person as the
court think fit until the minor has attained full age at, which time, and not before, probate of
the will is granted to him; in the case of several minors, when the others reach full age;

6. When a sole executor is a person of unsound mind, letters of administration with the will
annexed is granted to the person to whom the care of the executor's estate has been
committed by a competent authority, or if there is no such a person, to such other person
as the court thinks fit, until the executor becomes a sound mind;
7. Where there is a suit touching the validity of the will or obtaining or revoking any probate
or any grant or letters of administration, the court may appoint an administration of the
estate of the deceased person who shall have all the rights and powers of a general
administration other than the right of distributing the estate; the administrator is subject to
the immediate control of the court act under its direction;
8. If an executor is appointed for a limited purpose specified in the will, the probate shall be
limited to that purpose;
9. If an executor appointed generally gives an authority to an attorney to prove a will on his
behalf and the authority is limited to a limited purpose, the letters of administration, with
the will annexed shall be granted subject to the exception;
10. Whenever a grant, with exception, of probate or letters of administration with or without
the will attached has been made, the person entitled to probate or administrator of the
remainder of the deceased's estate may take a grant of probate or letters of administration
of the rest of the deceased's estate;
11. If the executor to whom probate has been granted dies leaving part of the testator's estate
unadministered, a new representation may be appointed for the purpose of administering
that part of the estate;
12. When a limited grant has expired by effluxion of time, or the happening of the event or
contingency on whom it was limited, and there is still some part of the deceased's estate
unadministered, letters of administration shall be granted to those persons to whom the
original grant might have been made.

(g) No grant of representation shall be made to;

i. A person who is a minor, or of unsound mind, or a bankrupt; or

ii. To more than four persons in respect of the same property.

(h) No grant of letters of administration, with or without the will annexed, shall be made to a body
corporate other than the public trustee or a trust corporation.

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(i) No grant of representation shall be made to a syndicate or nominee on behalf or a body

corporate.
(j) A person who has been appointed by a will, as an executor thereof, may either by oral declaration
before the court or by writing under his hand denounce executorship and shall there after be
precluded from applying for grant of probate of that will.
(k) Where several executors are appointed, probate may be granted to them all simultaneously or at
different times.
(l) Where a deceased has made a will; but:

1. He has not appointed an executor; or

2. The only executors appointed are legally incapable of acting, or have died before the
testator; or before receiving a grant of probate of the will, or have failed within the
time limited by a citation to apply a probate thereof; or
3. All proving executors have died before completing administration of all the
property to which the will applies,
A universal or residuary legatee may be admitted to prove the will and letters of
administration with the will annexed may be granted to him of the whole estate or
of so much as may be unadministered.

(m) When a deceased has died intestate, the court has a final discretion as to the person or persons to
whom a grant of letters of administration is made, in the best interest of all concerned.

As a general guide, the following order of preference is given.

i. The surviving spouse with or without association of other beneficiaries;

ii. Other beneficiaries entitled on intestacy with priority as per the priority to property on an
intestacy;
iii. The public trustee;
iv. Creditors.

When there is partial intestacy, letters of administration in respect of the intestate estate shall be granted
to any executor(s) who prove the will.

7.10 POWERS AND DUTIES OF PERSONAL REPRESENTATIVES

(a) Personal representation shall have the following powers:

1. To enforce for the deceased's estate by suit or otherwise all causes of action that survive the
deceased or arise out of his death;
2. To sell all or any of the assets valued in them as they think best; however

a. The purchase by them of any such assets shall be voidable at the instance of any other person
interested in the assets to purchase.
b. No immovable property shall be sold before confirmation of the grant.

3. To assent, at any time after the confirmation of the grant, to the vesting of a specific legacy in the
legatee thereof:

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4. To appropriate, at any time after confirmation of the grant, any of the assets valid in them in the
actual condition or state of investment thereof at the time of appropriation in or towards
satisfaction of any legacy bequeathed by the deceased or any other interest or share in estate,
whether or not the subject of a continuity trust, as may seem just and reasonable to them
according to the respective right to the persons interested in the estate of the deceased and for
that purpose to ascertain and fix (with the assistance of a duly qualified valuer, where necessary)
the value of the respective assets and liabilities of the estate, and to make any transfer that may be
required to give effect to the appropriation.

However,

a. No appropriation shall be made so as to effect adversely any specific legacy (unless expressly
provided in the will);
b. No appropriation shall be made for the benefit of a person absolutely and beneficially
entitled in possession, without his consent, nor for the purpose of a continuity trust without
the consent of either the trustees thereof or the person for the time being entitled to the
income thereof;

(b) Personal representation have the following duties;

1. To provide and pay out of the estate of the deceased, the expenses of a reasonable funeral for
him;
2. To get in all free property of the deceased, including debt owing to him and money payable to his
personal representatives by reason of his death,
3. To pay out of the estate of the deceased all expenses of obtaining their grant of representation
and all other reasonable expenses of representation administration (including estate duty if any);
4. To ascertain any pay out of the estate of the deceased all his debts;
5. within six months of the date of the grant, to produce to the court, a full and accurate inventory
of the assets and liabilities of the deceased and a full and accurate account of all dealings therewith
upto to the date of the account;
6. to distribute, or to retain on trust (as the case may require) all assets remaining after the payment
of expenses and debts as provided by above including the income therefrom, according to the
respective beneficial interest therein or under the will or on intestacy as the case may be.
7. within six months of the grant, or such longer period as the court may allow, to complete the
administration of the estates in respect of all matters other than continuing trust, and to produce
to the court, a full and accurate account of the completed administration.
7.11 EXECUTORS' ACCOUNTS
(a) Stewardship
The main object or preparing Estate Accounts is to record the assets which have been entrusted
to the "stewards" — the executors — and the manner in which they have been applied.

(b) Distinction between income and capital

Where the estate has both a life tenant and a remainderman, it is necessary to segregate so as to
distinguish between the interest of the life tenant in the income and that of the remainderman in
the capital. Segregation is achieved either by the use of columns separating income from capital
or separate accounts.
Where there is no life interest, this apportionment is not necessary.

(c) Apportionment
Apportionment may be according to statutory rules or those established in equity.

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With the majority of items, it is relatively easy to decide whether they are capital or income, but in
a few cases it is not possible to allocate them completely to either section.
In these cases it is necessary to apportion the item between income and capital.
The Apportionment Act sets out a number of situations in which an apportionment is to be made
and such division between income and capital is termed a statutory apportionment.There are
also a number of situations where the statutory apportionments do not apply.
In these cases, the courts have laid down rules as to how the division is to be made and these are
termed equitable apportionments.

(d) Accounts required

The basic accounts required for an estate or trust are as follows:—

i. Estate capital account;

ii. Estate income account;
iii. Estate cashbook;
iv. Various accounts for the assets and liabilities, income and expenditure of the estate or
trust.

(e) Executors' accounts and trustees' accounts

Executors' and trustees' accounts are in many respects similar. Both distinguish between income
and capital but may do so for different reasons.
Estate accounts arise because of the death of a person.
Trustees' accounts may arise simply as an extension of estate accounts, where part of the
deceased's property is held in trust. Alternatively, trust accounts may arise as a result of a
settlement inter vivos.

Note particularly the following differences between estates and trusts:—

1. Estate: on the death of a testator or an intestate, all assets, including income accrued up to
the date of death, are capital: income arising after death is income.
2. Trust:
i. On the death of a life tenant under a settlement, if followed by a remainderman, all
income up to the date of death belongs to the life tenant's estate:income arising after
the death of the life tenant, together with the assets of the trust, is due to the
remainderman;
ii. On the death of a life tenant under a settlement who is succeeded by a further life
tenant, income accrued up to the death of the former life tenant is due to his estate:
income accruing after his death is due to the succeeding life tenant.
(f) The opening entries

1. Assets of the estate or trust

In both cases the various assets of the estate or trust are debited to appropriate accounts and credited to
the Estate Capital Account;

The value at which assets are introduced is as follows:—

a) In the case of an estate or a trust following an estate — probate value;

b) In the case of an inter vivos settlement — market value at the date of the settlement.

2. Liabilities of the estate or trust

The various liabilities of the estate or trust are credited to appropriate accounts and debited to
the Estate Capital Account.

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3. Balance on Estate Capital Account

The balance on the capital account of an estate will represent the net value of the deceased's
estate.
When Estate Duty used to be charged in Kenya, the balance on the estate capital account was the
figure on which Estate Duty was charged, subject to adjustments (in exactly the same way as
Income Tax is charged on the net profit of a business, subject to adjustments).

7.12 APPORTIONMENT
(a) The purpose of the apportionment rules
The purpose of the various rules of apportionment is to provide a fair and reasonable basis for
dividing certain items between the conflicting interests of the life tenant and the remainderman.

The rules may be considered under the following three headings;

i. Statutory apportionments;
ii. Variation of securities;
iii. Equitable apportionments.

(b) Statutory apportionments

Where income has been received in respect of a period which "bridges" the date of a death, it
must be apportioned between the two parts of the period on a time basis. This applies to all
rents, annuities, dividends and similar items.

The following possibilities can be distinguished in the estate of a deceased person:—

1. Investment with cum.div. quotation will be debited to the investment account at its full
value. When the dividend is subsequently received it is apportioned:

i. Amount accrued to death being credited to capital column of the investment

account
ii. Amount accrued after death being credited to the income column.

The amount apportioned to capital should be transferred out of the Investment Account
(thus maintaining the investment at its probate value) and credited to Estate Capital Account.

Example Date of death: 30th June, 20X5

Stock: 6% Treasury Stock
Interest paid: 1st March
30th September
Holding: Shs 2m quoted at 94-96

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FINANCIAL ACCOUNTING III
 328 Executorship Law and Accounts

Investment Account

Nominal Income Capital Nominal Income Capital

20X5 Sh'000 Sh'000 Sh'000 20X5 Sh'000 Sh'000 Sh'000

June Estate Sept Estate

30 Capital 30 Cash
Account Book
(stock (interest
at pre-death) 30
death) 2,000 1,890

Sept post-death 30
30 Estate
Capital
Account 30

2. Investment with ex. div. quotation will be debited to the investment account at its ex. div. value.
The full impending dividend will also be debited to the Investment Account. When the dividend is
subsequently received it is apportioned in the same way as a) above. A journal transfer is then made
from the Capital column of the Investment Account to the debit of the Estates Capital Account in
order to restore the book value of the investment to its probate (quarter—up) value.

Exanple Date of Death: 30th June, 20X5

Stock: 3% Kenya Stock

Interest paid: 31st January
31st July
Holding: Shs 6m quoted at 86—88 ex.div.

Investment Account
Nominal Income Capital Nominal Income Capital
20X5 Sh'000 Sh'000 Sh'000 Sh'000 Sh'000 Sh'000

June Estate July Estate

30 Capital 31 Cash
Account Book
(stock (interest
at pre-
death) 6,000 5,190 death 75
post-death 15

(interest July Estate Capital

due) 90 31 Account
15

3. An interim dividend may have been received by the deceased before death. This cannot be
apportioned and belongs exclusively to capital. The interim dividend must be brought into account
when apportioning any final dividend between income and capital.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 329

Example Date of death: 30th June, 20X5

Stock: BAT(K) Ltd. ordinary shares
Holding: 2,000 ordinary shares of Sh10 each quoted at
Sh129 — Shs133
Dividends received: Interim of 25% for year to 30th September 20X5,
received on 31st May 20X5.
Final of 100% for year to 30th September 20X5,
received on 30th November, 20X5

Income Capital
Shs Shs Shs
20X5
Nov.30 100% Final Dividend for
year to 30th Sept. 20X5 2,000

Add: — 25% Interim dividend

received before death. 5,00

Pre—death (9 months) 18,750

Post—death (3 months) 6,250
Deduct: - Interim dividend 5,000
6,250 13,750

BAT (K) Ltd

as above BUT
Interim Dividend of 11%
Final Dividend of 15%

Income Capital
Shs Shs Shs
20X5
Nov.30 15% Final Dividend for
year to 30th Sept.20X5 3,000

Add: — 110% Interim dividend

received before death 22,000
25,000

Pre-death (9 months) 18,750

Post-death (3 months) 6,250

As interim dividend exceeds amount apportionable to capital, the whole final dividend of
Shs3,000 goes to income.

3. Arrears of preference dividend are apportioned according to the period of the Income statement
out of which they are paid (not the period to which they relate). (Re.Wakley)

E.g. Date of death: 30th June, 20X5

Stock: Kenya Power and Lighting Co. Ltd.
6% cumulative preference shares of Shs 20 each
Holding: 10,000 shares quoted at Shs7.95 — Shs8.15

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FINANCIAL ACCOUNTING III
 330 Executorship Law and Accounts

Dividend received: 30th November 20X5. 24% dividend being 4 years arrears of
cumulative preference dividend paid out of the profits for the
year to 30th September 20X5

Income Capital
Shs Shs
20X5 26% dividend paid out of profits
30th Nov. for year to 30th Sept. 20X5
Pre-death (9 months) 39,000
Post-death (3 months) 13,000

5. Dividends out of the capital profits are apportioned on the same basis as dividends out of
income (Re. Doughty).

(a) Variation of securities

It would seem logical to carry out a strict apportionment between income and capital every time
investments are bought or sold. If this were done, it would be necessary to divide the purchase
price or sale proceeds between the pure capital element and the adjustment of income rights.

In practice, this is not done, following the rules of convenience, on the grounds that it
unnecessarily complicates the accounts. The situation is, therefore, as follows:

1. Purchase of investment cum. div. The life tenant is entitled to the whole income when
received, except where the investment is purchased cum. div. after the dividend has been
declared, when the whole dividend goes to capital (Re. Peel's Settled Estates).
2. Disposal of investment cum. div. The life tenant is not entitled to any of the sale proceeds
(Scholefield v. Redfern).
3. Disposal of investment ex. div. The whole dividend received after disposal belongs to the life
tenant.
Any organized course of action to the detriment of the life tenant or the remainderman would be
actionable by that party as a breach of trust.
(b) Equitable apportionments

There are five leading cases where the courts have laid down rules to meet specific situations in
which there is a conflict of interest between life tenant and remainderman.
Equitable apportionments may be (and frequently are) barred by the will.
The five leading cases are as follows:—

i. Howe v. Earl of Darmough — where an estate contains unauthorized investments of a

hazardous or wasting nature;
ii. Re. Earl of Chesterfield's Trusts — where an estate contains non—income producing
assets;
iii. Allhusen v. Whittell — concerning the payment of expenses out of the estate;
iv. Re. Perkins — concerning the payment of annuities out of the estate;
v. Re. Atkinson — where one of the assets of the estate is a mortgage for which there is
insufficient security and a loss eventually accrues to the trust.
It is not necessary to know these rules in detail.
Example
With reference to the provisions of the law of succession:
Define a will; (2 marks)
Give two short explanation of failure of legacies. (4 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 331

Mr Ruare dies intestate, leaving his two wives Luky and chity whom he married under a system of law
which permits polygamy. A third wife Beaty had predeceased him. Luky has three children
Peter, Lowe and Ricci. Beaty had two children Short and Tall. Chity has no children.

All the children are alive at the time of Mr. Ruare‘s death. The value of his personal and
household effects was Sh.350,000 and the value of the net intestate estate was Sh.3,150,000.

Required:
A clear statement to show how Mr. Ruare‘s property would devolve. (15 marks

Solution
(a) (i) A will is a legal declaration by a person of his wishes and intentions regarding the disposition
of his property after his death duly made and executed according to the provisions of the law
of Succession Act.
(ii) Reasons for failure of legacies:

Ademption

When the gift specifically bequested does not exist within the testator‘s property at the time of death,
the gift is said to have ―adeemed‖. However, if the gift had been converted into property of a
different kind, and such new property falls into the category ―traceable‖ such new property will
replace the original gift and be handed over to the beneficiary.

Lapse

Where the beneficiary (legatee) predeceases the testator (legator) the gift is said to fail due to ―lapse‖.
There are two exceptions to the rule:
If the legatee is an issue of the testator; and the legatee, although deceased, left surviving issue
of their own, the gift will pass to such surviving issue form the testators estate).
The testator felt a moral need (or recognised a moral obligation) towards the legatee.

Uncertainty
A gift not expressive of any definite intention shall be void for uncertainty; such uncertainty arising as
to:
What is being given
To whom it is being given
The quantity of the interest being given.

Disclaimer
A beneficiary can always disclaim a legacy – and will probably do so if the gift is subject to unfair or
unreasonable conditions.

Gifts subject to illegal conditions

A gift will fail if it has an illegal condition attached to it, eg ― I leave Sh.20,000 to my gardener Mwangi
provided he murders my wife‖. However if the gift is only subject to a condition contrary to public
policy (repugnant to equity and justice) the gift will pass whether the condition was fulfilled or not.

(b) Mr Ruare:

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FINANCIAL ACCOUNTING III
 332 Executorship Law and Accounts

The law of intestacy provides for the following situations:

A deceased intestate does not leave behind a spouse or children.
A deceased intestate is survived by a spouse but no children
A deceased intestate is survived by children but no spouse.
A deceased intestate leaves behind both a spouse and children.

NB: If a deceased intestate leaves behind several wives and children all wives married under a system
of law that permits polygamy, then his property is divided according to the ―households‖, after which
any of the 4 situations above may apply.

The division amongst the ―households‖ is based on the number of units in each household – where
―Unit‖ refers to surviving spouse or child.

In the case of Mr Ruare:

Households: House House House Total

A B C
Spouse: 1 unit 1 unit - 2 units
Children 3 units - 2 units 5 units
7 units
Property division
Fractions 4/7 1/7 2/7

Distribution of personal and household effects:

House A: Luky will obtain absolutely:
4/7 X 350,000 = Sh. 200,000 of household effects.

House B: Chity will obtain absolutely:

1/7 X 350,000 = Sh. 50,000 of household effects.

House C: Short and Tall will each get absolutely

½ X 2/7 X 350,000 = Sh. 50,000 each in household effects.
(This is because their mother Beaty had already died).

Distribution of intestate‘s net estate

House A: Luky will get a life interest in the net estate worth.
4/7 X 3,150,000 = Sh. 1,800,000

Upon her death (or remarriage) it will be divided equally amongst Peter, Lowe and Ricci – each getting
Sh. 600,000 worth of property.

Household B:
Chity will get a life interest in property worth
1/7 X 3,150,000 = Sh. 450,000.
Upon her death, (or remarriage) it will devolve as follows:
To Mr Ruare‘s father; or if dead
To Mr Ruare‘s mother; or if dead
To Mr Ruare‘s brothers and sisters and children of deceased brothers and sisters in equal shares; or if
none.
To Mr Ruare‘s half brothers and half sisters and children of deceased half brothers and half sisters in
equal shares; or if none.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 333

To relatives who are in the nearest degree of consanguinity up to and including the sixth; or if none
To the consolidated fund of the government.

Household C:
Beaty‘s children short and Tall will each obtain property worth:
½ X 2/7 X 3,150,000 absolutely.
This amounts to Sh. 450,000 per person.

Luky Chity Peter Lowe Ricci Short Tall

Household
& Personal 200,000 50,000 - - - 50,000 50,000
(absolute) (absolute) (absolute) (absolute)

Net estate 1,800,000 450,000 600,000 600,000 600,000 450,000 450,000

(Life (Life interest) (Absolute upon death or (Absolute) (Absolute)
Interest) remarriage of luky)

Example
Mali Mengi (aged 57) died in a road accident on 31 December 1999. On 1 May 2000 after his
executors had paid all debts (except for the mortgage for his freehold house and debt to Mkopeshaji)
testamentary and funeral expenses, his estate was ascertained as follows:

Sh. ‗000‘
Cash in bank accounts 4,250
Freehold house 3,250
Toyota corolla 360
Nissan sunny 220
Television and music system 105
Debt due from Pungufu 40
Furniture and personal effects 302
10,000 ordinary shares in Cement Ltd. 1,200
4,500 ordinary shares in Soko Mjinga Ltd. 370
Sh.800,000 10% Kenya stock 165
Income received to date
Interest 230
Dividend from Soko Mjinga Limited 37
267
Less: Mortgage interest paid 31 march 2000 120 147
10,409

Extracts from Mali Mengi‘s will left bequests as follows:

1. To each of my sons. Kikwajuni, Mnazini, and Mwembeni Sh.1 million.

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FINANCIAL ACCOUNTING III
 334 Executorship Law and Accounts

2. To my wife Darajani, I leave my furniture, household and personal effects and the residue of
my estate.
3. To my daughter Nanjale, my freehold house free of all duties. The house was subject to a
mortgage of Sh.1 million carrying interest at 24% per annum payable 31 March and 30
September. Duty on the house amounts to Sh.130,000.
4. To my friend Kisitu, one of the motor cars owned by me at the time of my death he may
choose.
5. To my friend Mlungu Sh.100,000.
6. To my sisters-in-law Sh.300,000
7. To my cousin, Nipa, my painting of Mausoleum by Kikuvu.
8. To my driver Ndeleva Sh.150,000
9. To my friend Shimba, my holding of Sh.800,000 110% Kenya stock, Mali Mengi owed
Shimba Sh.100,000.
10. To my sister Malindi Sh.300,000
11. To my personal assistant, Sijapata half of my holdings in Cement Ltd.
12. To my niece Sinani, 4,000 ordinary shares from my holding of such shares in Cement Ltd.
13. To my nephew Shaibu Sh.200,000 payable out of my shares in Cement Ltd.
14. To my friend Mlungu Sh.50,000.
15. To my neighbour, Jirani Sh.50,000.
16. To my sister Dada, Sh.100,000 to establish a business.

Mali Mengi executors ascertained the following beneficiaries were dead:

 Son Mnazini died in 1997 leaving a wife and two children.
 Son Mwembeni died in 1998 leaving a wife.
 Sister Malindi died in 1996 leaving two daughters.
 Driver, Ndeleva aged 60 died in the same accident as Mali Mengi. It was impossible to
determine the order in which Mali Mengi and Ndeleva died.

The executors also advise you that:

(i). Kisitu chose the Toyota corolla
(ii). Mali Mengi sold his painting of the mausoleum using the proceeds to purchase his holding in
Soko Mjinga Ltd.
(iii). There is no such investment as 110% Kenya stock. The referees in the will to 110% is
thought to be a typing error not previously noticed.
(iv). Jirani replied in writing that he did not want anything from Mali Mengi because Mali Mengi
was a bad neighbour.
(v). Mali Mengi paid the Sh.100,000 during his life to his sister Dada to establish a business.

Required:
(a) A statement showing the distribution of Mali Mengi‘s estate on 1 May 2000. (16 marks)
(b) A list of legacies to which the executors should not assent, briefly give reasons for the decision.

(4 marks)
(Total: 20 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 335

Solution

(a) RE: MALI MENGI

STATEMENT OF DISTRIBUTION AS AT 01.05.2000
Sh.000 Sh.000
Assets
Cash and bank a/c 4,250
Freehold house 3,250
Toyota Corolla 360
Nissan Sunny 220
TV and Music system 105
Debt due from Pungufu 40
Furniture and Personal effects 302
10,000 ordinary shares in Cement Ltd 12,000
4,500 ordinary shares in Soko Mjinga 370
Sh.800,000 10% Kenya Stock 165
Income received to date 147
Recoverable from Nyanjale (W1) 60
10,469
LIABILITIES
1,000
Mortgage and house
130
Duty payable on house
20 (1,150)
Mortgage interest due for April (20% x 1000 x 1/12)
9,319
SPECIFIC LEGACIES
407
Wife Darajani: Furniture, TV & Music system 3,250
Daughter Nyanjale: Freehold house 165
Friend Shimba – Sh.800,000 10% Kenya stock 600
Personal Assistance Sijapata: 5,000 shares in Cement 480
Niece Sinani: 4,000 ordinary shares in Cement 120
Nephew Shaibu: Proceeds on sale of 1,000 shares in 360 5,383
Cement 3,937
Friend Kisitu: Toyota Corolla
1,000
GENERAL LEGACIES 1,000
150
Son Kikwajuni
80 _____
Son Mnazini
Friend Mulungu (100 + 50)
Nephew Shaibu: Balance (200 – 120)
Wife Daranjani 1,707

W1: Interest paid from 1st October 1999 to 31st March 2000
24% x 1,000 x 6/12 = 120
Interest from 1st October 1999 to 31st December 1999 = 60
60

(b)  The house is to be given to Nyanjale free of duties i.e mortgage interest and duty

 Sh.1 million to Mwembeni will fail due to lapse.

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FINANCIAL ACCOUNTING III
 336 Executorship Law and Accounts

 The legacy to ―som of sisters in law‖ will fail due to uncertainty of recipient.

 The gift to cousin Nipa will fail due to ademption. It was not owned by the testator at
the time of his death.

 The legacy to Neleva will fail due to lapse. It is assumed that Ndeleva predeceased the
testator because he was older.

 The legacy to sister Malindi will fail due to lapse.

 The demonstrative legacy will pass in 2 stages:

(i) Sh.12,000 when the balance of shares in Cement Ltd are sold
(ii) Sh.8,000 as a general legacy

 The gift to Jirani will fail due to disclaimer

 The gift to Dada will fail due to ademption.

Example

7.13 PRO—FORMA ACCOUNTS

Estate of Maina deceased

Date of death 30th June 20X4

Terms of will Shs 500,000 and chattels to wife, residue to two children for life with remainder
over to grandchildren.
Equitable apportionments barred.
(a) Estate Capital Account
The purpose of this account is to show the capital of the estate or trust at any time, based on the book
value of the various assets. The account opens with the net value of the estate and shows any changes in
this value caused by profits or losses on disposal. It also shows the manner in which the estate has been
dealt with in respect of estate duty paid, legacies paid, residue distributed and property retained in trust.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 337

PRO—FORMA ESTATE CAPITAL ACCOUNT

20X4 Shs'000 20X4 Shs'000

Jun.30 Liabilities at death Jun.30 Assets at death

Debts and funeral Freehold house
expenses account 200 account 3,000
Balance c.down 12,545 Sh2m 6% Treasury
Stock @ 94—96
account 1,890
Sh6m 3% Kenya
Stock @ 86—88 xd.
account 5,190
Add Whole of
impending
interest 90 5,280
Chattels account 200
Cash at bank
account 300
Life policy
account 2,000
Income due from
trust (of which
deceased was
life tenant)
_____ account 75
12,745 12,745

20X4 20X4
Jul.31 3% Kenya Stock Jun.30 Balance b/down 12,545
account 15 Sep.30 6% Treasury Stock
account 30

Aug.31 Estate cash account 5,225 Sep.30 Freehold house

estate duty account (profit
on disposal) 200

20X5 20X5

Jun.30 Legacies account Apr.30 6% Treasury stock

(distribution to account
widow) 7,00 (profit on sale) 3

Jun.30 Balance c/f

(residue held in
trust) 6,838 ___
12,778 12,778

(b) Estate Income Account

The purpose of this account is to show the income of the estate or trust. Income received is credited
gross to the account. Tax suffered together with tax to be paid under assessment is debited to the

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FINANCIAL ACCOUNTING III
 338 Executorship Law and Accounts

account. Expenses properly chargeable to income are also debited. If a person is entitled to an annuity
out of the income of the trust, this is debited gross to the account. The balance on the account is the
amount due to the life tenant(s) and is transferred to their personal accounts.

PRO—FORMA ESTATE INCOME ACCOUNT

for the year ended 30th June 20X5

Shs'000 Shs'000
Bank charges and 4 Interest receivable
interest (gross)
Payments on account 6% Treasury stock 111
to life tenants 100 3% Kenya Stock 180
Balance carried
forward 187
291 291

(c) Estate Statement of financial position

PRO—FORMSTATEMENT OF FINANCIAL POSITION— 30th June 20X5

Kshs. Sh'000 Sh'000

Estate capital 67,855 Investments
account 6% Treasury stock
Sh1.4m nominal 1,323
3% Kenya Stock
Sh6m nominal 5,190
Cash at bank
(capital) 325 6,838
Estate income 337 Cash at bank (income) 91
Account Kshs.68,192 Accrued interest:
6% Treasury Stock 21
3% Kenya Stock 75 187
7,025

Estate Capital Account 6,838

Estate Income Account 187
7,025

(d) Estate cashbook

This records all payments and receipts. A strict division between income and capital is maintained
by the use of separate columns.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 339

PRO—FORMA ESTATE CASH BOOK

Income Capital Income Capital
20X4 Sh'000 Sh'000 20X4 Sh'000 Sh'000
Jun.30 Estate Aug.31 Estate
Capital Capital
Account Account
(opening (Estate
balance) 3,00 duty) 5,225
Jul.31 3% Kenya
Stock Acc.
(interest)
(pre-death) 75
(post-
death) 15
Jul.31 Life Sep.30 Debts and
Policy funeral
Account expenses acc.
(proceeds of (debts and
life funeral exp.
policy) 2,000 paid) 200
Sep.30 6% Treasury Dec.31 Estate income
Stock Account account
(interest) (bank charges
(pre-death 30 and interest) 4
(post-
death) 30
Sep.30 Freehold
house
account
(sale of
house) 3,200
20X5 20X5
Jan.31 3% Kenya Stock May 31 Estate income
account account
(interest) Sh50,000 paid
(all post- on account to
death) 90 each life
tenant) 100
Mar.31 6% Treasury Jun.30 Legacies account
Stock acc. (cash legacy to
(interest) widow) 500
(all post-
death) 60
Apr.30 6% Treasury Jun.30 Balances
Stock acc. c.fwd 91 325
(saleSh0.6m
nominal
@ 95-96) 570
Apr.30 Income due
from trustaccount(income due
to deceased
at death) ____ 75 ____ _____
195 6,250 195 6,250

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FINANCIAL ACCOUNTING III
 340 Executorship Law and Accounts

(e) Other estate accounts

PRO—FORMA INVESTMENT ACCOUNT

6% Treasury Stock Interest paid 31st March-30th September

Nom— Inc— Capital Nom— Inc Cap—

inal ome inal ome ital

20X4 Shs Shs Shs 20X4 Shs Shs Shs

'000 '000 '000 '000 '000 '000
Jun.30 Estate Sep.30 Estate
Capital Cash
acc. Acc.
(probate (interest)
value of (pre—
invest— death 30
ment 2,000 1,890 (post—
death) 30

Sep.30 Estate
Capital
Account
30

20X5 20X5

Apr.30 Estate Mar.31 Estate

Capital Cash
Acc. Acc.
(profit (interest)
on sale) 3 all post—
death 60

Jun.30 Estate Apr.30 Estate

income cash
acc. acc.
(income (sale of
for yr- stock) 600 570
gross 111

Jun.30 Balance
_____ ___ ____ c.fwd 1,400 21 1,323
2,000 111 1,923 2,000 111 1,923

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 341

PRO—FORMA INVESTMENT ACCOUNT

3% Kenya Stock Interest paid 31st January-31st July
Nom- Inc- Cap- Nom- Inc- Cap-
inal ome ital inal ome ital

Shs Shs Shs Shs Shs Shs

20X4 '000 '000 '000 20X4 '000 '000 '000
Jun.30 Estate Jul.31 Estate
Capital Cash
Account Account
(probate (interest)
value of (pre-
invest- death) 75
ment) 6,000 5,190 (post-
death) 15

Jul.31 Estate
Capital
Account 15
Add:
impending
interest 90

20X5 20X5

Jun.30 Estate Jan.31 Estate

Income Cash
Account 180 Account
(interest)
all post-
death) 90

Jun.30 Balance
c.fwd 6,000 75 5,190
____ ___ _____ _____ ___ __
6,000 180 5,280 6,000 180 5,280

PRO-FORMA DEBTS AND FUNERAL EXPENSES ACCOUNT

20X4 Shs'000 20X4 Shs'000

Sept.30 Estate June 30 Estate

Cash Capital
Account Account
(debts and (debts and
funeral funeral
expenses expenses
paid) 200 due) 200

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FINANCIAL ACCOUNTING III
 342 Executorship Law and Accounts

PRO-FORMA LEGACIES ACCOUNT

20X5 Shs'000 20X5 Shs'000

June 30 Estate June 30 Estate

Cash Capital
Account 500 Account
June 30 Chattels (distri-
Account 200 bution to
widow) 700
___ _
700 700

Example
QUESTION FIVE
Kombo died on 31 October 2000 and left his estate as follows:

Sh
Household furniture 90,000
Cash in house 2,000
Cash at bank 250,000
10,000 ordinary shares of Sh.20 each in KFC Ltd. Valued
at Sh.30 per share. 300,000
Investment at 5% on freehold property securities (interest
thereon paid to 30 June 2000) 400,000
Share in business of Kombo & Co. valued at death 1,226,000
Sundry debtors 20,000
His liability amounted to 5,000
Funeral expenses 10,000

The following additional information is available:

1. A legacy of Sh.20,000 was bequeathed to his executor and was paid on 28 January 2001.
2. The residue of the estate was left in trust for his infant son.
3. The household furniture was sold on 15 December 2000 for Sh.96,000.
4. The shares were sold on the same date at Sh.29 ex div: a dividend being received on 25 January
2001 at 10% for the year ending 31 December 2000.
5. Interest on investment in freehold property securities was received on 31 December 2000, on
which date the shares in the business of Kombo & Co. was received with interest at 5% per
annum.
6. The liabilities and funeral expenses were discharged on 20 December 2000 on which date
Sh.10,000 of the debts due were received. The balance being unpaid at the date of preparation of
the accounts.

Required:
(a) Journal entries to record the above transactions (5 marks)
(b) The Estate cash book (4 marks)
(c) The Estate income account (3 marks)
(d) The Estate income account (5 marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 343

(e) Statement of financial position of Kombo: deceased as at 31 January 2001 (3 marks)

(Total: 20 marks)
Solution
INCOME APPORTIONMENT

(i) Dividends from K.F.C. shares

= 10% x par value
= 10% x (10,000 x 20)
= 20,000

The entire amount shall be accounted for as income since dividend received is account for as
income at the point where it is received; unlike interest which accrues (and is apportioned) on
a time basis.

(ii) Interest from freehold property securities

1/7/2000 – 31/12/2000 = 5% x 400,000 x 6/12 10,000

Pre-death (estate capital) = 4/6 x 10,000 6,667
Post – death (income) = 2/6 x 10,000 = 3,333
10,000

(iii) Interest from shares of Kombo and company

Note 5, the shares were received with interest of 5%

Therefore 105% of the principal = 1,226,400
1,226,400
Principal = x100
105
= 1,168,000; Interest = 5% x 1,168,000= 58,400

Interest for 10 months (Estate capital)

= 10/12 x 1,168,000 x 5% = 48,667

Interest for 2 months (2/12 x 58,400) = 9,733

58,400

JOURNAL ENTRIES
Sh. Sh.
1. Household furniture a/c 90,000
Cash in house 2,000
Cash at bank 250,000
Investment in freehold property 300,000
Share in Kombo & Co. a/c 1,226,400
Debtors 20,000
Liabilities 5,000
Provision for funeral expenses 10,000
Estate capital 2,273,400
To record he initial account balances

2. 15th Dec. 2000

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FINANCIAL ACCOUNTING III
 344 Executorship Law and Accounts

Cash capital 96,000

Furniture 90,000
Gain (capital estate) 6,000
To record sale of furniture

3. 15th Dec. 2000

Cash capital 290,000
Estate capital 10,000
Share in KFC 300,000
To record loss on disposal of investment

4. 20th Dec. 2000

Liabilities A/c 5,000
Provision for funeral expenses 10,000
Cash capital 15,000
To record discharge of expenses above

5. Cash a/c capital 10,000

Debtors a/c 10,000
To record receipt of a debt

6. 31st Dec. 2000

Cash capital – Estate cash book 6,667
Estate cash book 3,333
Estate capital 6,667
Estate income 3,333
To record interest from

7 Cash capital (1,226,400 + 48,667) 1,275,067

Cash income 9,733
Share in Kombo & Co. 1,226,400
Estate capital 48,667
Estate income 9,733
To record interest on shares of Kombo & Co.

ESTATE CASH BOOK

2000 Sh. Sh. Sh. Sh.
31/10 Estate capital 252,000 20/12 Liabilities 5,000
15/12 Furniture a/c 96,000 20/12 Funeral expenses 10,000
15/12 KFC Shares 290,000
20/12 Debtors 10,000
31/12 Invest in F Pro 6,667 3,333
31/12 Inv in Kombo 1,168,000
Invest in Kombo 48,667 9,733
2001 2001
28/1 Distribution 20,000
25/1 Dividends KFC _______ 20,000 31/1 Bal c/d 1,836,334 33,066
1,871,334 33,066 1,871,334 33,066

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 345

ESTATE INCOME A/C

Sh Sh
31/12 Investment in Kombo & Co. 9,733
31/12 Investment in freehold property 3,333
2001 2001
31/1 Bal c/d 33,066 25/1 Investment in KFC Ltd Shares 30,000
33,066 33,066

ESTATE CAPITAL ACCOUNT

2000 2000
Sh Sh
15/12 Investment in KFC – Loss 1/1 Net estate b/d 2,273,400
on disposal 10,000 15/1 Gain on sale of furniture 6,000
31/12 Investment in Kombo 9,733 31/12 Income from property 6,667
2001 2001
28/1 Distribution 20,000
31/1 Bal c/d 2,246,334 ______
2,286,067 2,286,067

Kombo (deceased) Died on 31 October 2000

Statement of financial position
As at 31 January 2001
Sh. Sh.
Capital assets
Investment on freehold property securities 400,000
Sundry debtors (20,000 – 10,000) 10,000
Cash at bank/in hand 1,836,334 2,246,334

Income assets
Cash at bank or in hand 33,066
2,279,400

Estate capital 2,246,334

Estate income 33,066
2,279,400

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FINANCIAL ACCOUNTING III
 346 Executorship Law and Accounts

REINFORCING QUESTIONS
QUESTION ONE
Andrew, a widower, died on 28 February 20X4, and by his will executed ten years earlier made the
following bequests:

(a) `To my brother George, my record collection.'

(b) `To my brother David, on his wedding day, Shs.50,000.'
(c) `To my dearest sister-in-law, my furniture and other personal chattels, not otherwise bequeathed.'
(d) `To my nephew Peter, a Mini Metro motor car.'
(e) `To my niece Sandra, Shs.200,000 payable out of my account with the Lukenya Building Society.'
(f) `To my nephew Timothy, Shs.100,000 in my deposit account at Trust Bank.'
(g) `To my cousin Patrick, my 1,000 ordinary shares in Kakuzi Ltd.
(h) `To the All Saints Cathedral, Shs100,000 for the refurbishment of the choir stalls.'
(i) `To each of my sons Edward and Francis, Shs.1.5m.
(j) `The residue of my estate on trust to provide an annual income for my daughters Barbara and
Caroline, until they marry, and thereafter to my grandchildren in equal shares.'

You ascertain the following:

i. George and Edward both predeceased Andrew. Each had two children living at the date of
Andrew's death.
ii. David is a confirmed bachelor. He declares that `having failed to get me married while he was
alive, Andrew will not bribe me into marriage now he is dead.'
iii. Andrew had three sisters-in-law, all of whom he saw regularly prior to his death.
iv. At the date of the will Andrew had owned a Datsun car, two years ago he replaced it with a
Toyota; he has never owned a Mini Metro car.
v. The Lukenya Building Society account had been closed on 30 September 20X3.
vi. On 28 February 20X4 there was only Shs.72,000 in the deposit account at Trust Bank.
vii. Kakuzi Ltd had converted each of its Shs.20 ordinary shares into 4 units of Shs.5 ordinary stock
in October 20X2. Andrew owned exactly 4,000 units of Kakuzi Ltd ordinary stock at the date of
his death.
viii. The choir stalls at the All Saints Cathedral had been refurbished fully the previous autumn at
which time Andrew had contributed Shs.120,000 to the Refurbishment Fund.
ix. Both Andrew's daughters had married prior to his death and Andrew had a total of five
grandchildren alive at 29 February 20X4, the eldest of whom was eight years of age.
x. In addition to the assets specifically referred to above, Andrew's estate also included a freehold
house together with cash and investments totalling Shs.7m, after payment of debts and funeral
expenses.

Required:
In relation to each bequest in Andrew's will, state the type of legacy referred to and explain whether or
not the executors should give their assent to the gift. (Total: 20 Marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 347

QUESTION TWO
Robin (aged 54) died in a road accident on 31 December 20X1. On 1 May 20X2 after his executors had
paid all his debts, (except for the mortgage on his freehold house referred to below) testamentary and
funeral expenses, his estate was ascertained as follows:
Shs'000 Shs'000
Cash on bank accounts 8,500
Freehold house 6,500
Jaguar motor car 720
Mercedes motor car 1,260
Stamp collection 850
Debt due from William 120
Furniture and other personal effects 1,345
10,000 Ordinary Shs.10 shares in Kenya Breweries Limited 1,200
4,500 Ordinary Shs.10 shares in Nation Printers Limited 740
Shs.800,000 5% Kenya Stock 235
Income received to date:
Bank interest 230
Dividend from Nation Printers Limited 37
267
Less: Mortgage interest paid 31 March 20X2 120
147

Extracts from Robin's will left bequests as follows:

(a) 'To my wife Annie, I leave my furniture and other personal effects and the residue of my estate,
after payment of my debts and expenses.'
(b) 'To each of my sons, David, Jack and Stuart, Shs.1m.
(c) 'To my unmarried daughter, Clare, my freehold house subject to any mortgage thereon.' The
house was subject to a mortgage of Shs.2m. carrying interest at 12% per annum payable 31 March
and 30 September.
(d) 'To my friend Tony, whichever of the motor cars owned by me at the time of my death he may
choose.'
(e) 'To my good friend Gerry Gangla, Shs.100,000.
(f) 'To my friend Ben, some of my furniture.'
(g) 'To my cousin Susan, my painting of the "Street Scene" by Renoir.'
(h) 'To my friend Dennis, Shs.200,000 on condition he gives up the bad habit of smoking.'
(i) 'To my brother Joseph, 1,000 shares in Brooke Bond(K) Ltd.'
(j) 'To my sister Elsie, Shs.600,000.'
(k) 'To my secretary Betty, half of my holdings of Ordinary Shs.10 shares in Kenya Breweries Ltd.'
(l) 'To my cousin Miriam, my holding of Shs.800,000 5 1/2% Kenya Stock and my holding of shares
in Cassava Ltd.'
(m) 'To my chauffeur, Malcolm, Shs.300,000.
(n) 'To my gardener Jeremiah, Shs.150,000 if still in my employ at the death of my death.'
(o) 'To my friend Eric, my 6,000 Ordinary shares in Printers Ltd.'
(p) 'To my nephew Frank, 4,000 Ordinary Shs.10 shares from my holding of such shares in Kenya
Breweries Ltd.'
(q) 'To my niece Tracey, Shs.200,000 payable out of my holding of Shs.10 Ordinary shares in Kenya
Breweries Ltd.'
(r) 'To my friend Timothy, Shs.150,000.'
(s) 'To my cousin Hazel, the Shs.120,000 which William owes me.'
(t) 'To St. Peter's Church Shs.100,000 to provide a stained glass window in memory of my mother.'

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FINANCIAL ACCOUNTING III
 348 Executorship Law and Accounts

(u) 'To my good friend Gangla Shs.150,000 for looking after my house for many years when I went
on holiday.'

Robin's executors ascertained that the following beneficiaries were dead:

 Son Jack, died 1989, leaving a wife and two children.

 Son Stuart, died 1988, leaving a wife.
 Sister Elsie, died 20x6, leaving a husband and two daughters.
 Chauffeur Malcolm (aged 60) killed in the same accident as Robin. It was impossible to determine
the order in which Robin and Malcolm died.

The executors also advise you that:

i. Tony elected to have the Mercedes car.

ii. Robin sold the Renoir painting in 1987 for Shs.3m.

iii. Dennis replied in a letter to the executors that he had no intention of giving up smoking.
iv. Robin owned no shares in Brooke Bond Ltd. The value of 1,000 shares in that company is
Shs.330,000.
v. There is no such investment as 5 1/2% Kenya Stock. The reference in Robin's will to 5 1/2% is
thought to be a typing error not previously noticed.
vi. Robin sold his shares in Cassava Ltd. using the proceeds of Shs.900,000 to purchase his
shareholding in Kenya Breweries Ltd.
vii. The gardener Jeremiah retired in June 20X0.
viii. In early 1990, Printer Ltd. merged with Nation Ltd. to form a new company Nation Printers Ltd.
and Robin received 4,500 new Ordinary shares in Nation Printers Ltd. in exchange for his 6,000
Ordinary shares in Printers Ltd.
ix. Timothy replied in a letter that he 'didn't' want anything from Robin's estate because actually he
hated the sight of him.'
x. In 1989 Robin had paid Shs.125,000 for a stained glass window in St. Peter's church in memory
of his mother.
xi. His daughter Clare had married in April 1989.
xii. Gerry Gangla claimed both legacies.

Required:

(a) A statement showing the distribution of Robin's estate on 1 May 20X2. (12 Marks)
(b) A list of legacies to which the executors should not assent, briefly explaining the reason why the
legacy is invalidated. (8 Marks)
(Total: 20 Marks)

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 349

QUESTION THREE
Estate Duty is not charged in Kenya at the present time. Estate Duty is included in the following
questions to show how it would be accounted for.
Jackson died (intestate) on 1 April 20X8, survived by his widow and two infant children, Janet and
James.

His estate consisted of:

Kshs.
Kshs.28,000 9% Funding Stock 20X6 - X8 23,100
(interest 1 February and 1 August)
Kshs.24,000 2 1/2% Savings Bonds 20X4 - X7 (interest 1 May and 1 Nov.) 20,020
Policy on his life for 30,000
Building society deposit at 8% (interest 1 January and 1 July) 4,500
Accrued interest thereon 90
Balance at bank 4,735
Household furniture and effects 3,000
85,445
Less: Debts and funeral expenses 650
Kshs.84,795

Interest on the Government Stocks was received on the due dates.

In addition, the following transactions took place during the year ended 31 March 20X9:

20X8

31 May Estate Duty of Kshs.11,163 was paid by means of a temporary overdraft at the
bank.
15 June The sum assured by the life policy was received.
30 June The building society deposit was repaid to the personal representative, together
with interest to date.
12 July Kshs.18,000 9% Funding Stock 20X6 - X8 was sold ex interest due 1 August,
the net proceeds amounting to Kshs.14,760.
10 August The debts and funeral expenses were paid.
30 September The bank debited the personal representative's account with interest amounting
to Kshs.67 (chargeable to income).
2 October Effect was given to the widow's statutory rights in the capital of the estate.

20X9

31 January Administration expenses of Kshs.400 (all chargeable against capital) were paid.

You are required to:

(a) Write up the cash book and estate capital account for the year ended 31 March 20X9; and
(b) Prepare the statement of financial position as on that date, the widow and children being still
alive.

Ignore income tax. (15 Marks)

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FINANCIAL ACCOUNTING III
 350 Executorship Law and Accounts

QUESTION FOUR
When Neville died on 1 May 20X8; his estate for probate purposes was as follows:
Kshs.
4,000 ordinary shares of 25p each in Weasel Income statement - quoted 73p-77p 2,960
7,000 ordinary shares of Kshs.1 each in Mouze Income statement - quoted 342p-346p 24,010
4,000 ordinary shares of 50p each in Frog Ltd. - valued at 4,600
1,000 ordinary shares of Kshs.1 each in Rat Ltd. - valued at 8,000
Middling Building Society - ordinary share account 25,000
- interest accrued to date 654
Balance at bank 32,000
Personal chattels 2,000
Office building owned jointly with Beakie, who takes as survivor - valued at 40,000
Debts and funeral expenses 490

Neville's will provides:

1. That the following legacies be paid immediately:

i. 'To my wife Gloria the sum of Kshs.30,000 together with my personal chattels;
ii. To Beakie my holding of shares in Rat Ltd;
iii. To Greta my country cottage;
iv. To my friend Harold the sum of Kshs.10,000;
v. To my sister Edna the sum of Kshs.15,000.

2. That the executors have full discretionary powers investment, and after paying all debts duties and
legacies, the balance is to be held in trust for the benefit of my children absolutely in equal shares
until they attain the age of eighteen years.'

You also obtain the following information:

i. Edna died on 1 April 20X8.

ii. The country cottage was sold in 20X7 for Kshs.20,000.
iii. Neville is survived by his wife Gloria and two sons, David and Donald, who are aged 16 and 14
years respectively.
iv. Neville had not made any chargeable transfers during his lifetime.

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 351

20X9

January 31 Received dividend of 15p per share on holding in Owl Income statement for
year to 30 November 20X8. Received interim dividend of 16p per share on
holding in Mouse Income statement for year to 31 January 20X9.

February 28 Received final dividend of 6p per share on holding in Weasel Income statement
for the year to 31 December 20X8.

April 30 Paid administration expenses Kshs.1,700 (capital Kshs.1,500; income Kshs.200).

You are required to prepare for the year ended 30 April 20X9:

(a) Estate Capital Account; (7 Marks)

(b) Estate Income Account; (2 Marks)
(c) Estate Cash Account; and (8 Marks)
(d) Statement of financial position as on that date. (3 Marks)

Note: Ignore income tax. (TOTAL 20 Marks)

QUESTION FIVE
Walter died on 1 February 20X8 leaving the following estate:
Probate value
Kshs.
Building society deposit 5,042
Interest accrued to date 39
Balance at bank 4,965
Personal chattels 3,600
Freehold house 24,000
Kshs.60,000 10% Government Stock 42,000
7,000 ordinary shares of Kshs.1 each in Walters Ltd 10,000
3,000 ordinary shares of Kshs.1 each in Charles Ltd 3,000

Debts and funeral expenses amounted to Kshs.1,046.

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FINANCIAL ACCOUNTING III
 352 Executorship Law and Accounts

His will included the following legacies:

i. To his wife, Jane the freehold house, personal chattels, the ordinary shares in both Walters Ltd.
and Charles Ltd., and the sum of Kshs.15,000 (note: transfers between spouses are exempt from
Estate Duty);
ii. To his daughter Susan, his country cottage and the sum of Kshs.21,600;
iii. To his sons George, Harold and Frederick the sum of Kshs.12,000 each;
iv. To his sister Josephine the sum of Kshs.10,000;
v. To his friend Charles the sum of Kshs.2,400;
vi. To his brother Victor his holding of Kshs.5,000 Savings Bonds.

His will also directed that the residue and any income arising during the administration of the estate
should go to his wife Jane.

You ascertain that the country cottage was sold for Kshs.15,000 in 20X6 and the Savings Bonds
encashed in 20X7. His sister Josephine had died in 20X5 and his son Harold died in 20X4, leaving two
sons John and Philip. All beneficiaries are of full age.

The following transactions took place during the three month period ended 30 April 20X8:

28 February Received dividend of 10p per share for the year ended 31 March 20X7 on shares
in Walters Ltd.

31 March Received proceeds of sale of Government Stock Kshs.41,000. Paid Kshs.2,250

Estate Duty, being the whole amount arising on death.

30 April Withdrew balance of Kshs.5,157 from building society account including

interest to date. Paid debts and funeral expenses. Distributed all legacies and
completed the administration of the estate.

You are required to prepare the Estate Capital Account and Cash Account for the period ended 30 April
20X8, showing the administration of the Estate.

Ignore Income Tax. (20 Marks)

CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY PACK

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 353

COMPREHENSIVE ASSIGNMENT NO. 3

TO BE SUBMITTED AFTER LESSON 6
To be carried out under examination conditions and sent to the Distance Learning
Administrator for marking by the University.

TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS

QUESTION ONE
Korir carrying out a business as a trader in Nairobi finds himself insolvent and on 15 March 2001 files
his own petition in bankruptcy. The following balances are extracted from the books of his business
on that date:

Sh. Sh.
Capital 180,000 Shop, loan and buildings 600,000
Mortgage on shop –land and building 450,000 Furniture and fittings 150,000
Loan ICDC 180,000 Stock of goods 81,405
Loan – Barclays Bank 90,000 Debtors 96,195
Loan – Co-operative Society 30,000 Korir – drawings 197,100
Loan – A Kariuki 15,000 Cash in hand 300
Loan – W. Kuria 3,000
Trade creditors 171,000
Salaries, wages payable 2,700
NHIF, NSSF, PAYE 540
Bank overdraft 2,7600 _______
1,125,000 _
1,125,000

The following additional information is available:

1. Trade creditors include Sh.4,500 owing to Nairobi City council in respect of rates for the current
period and a small loan from his friend Macharia Sh.1,500.
2. The amount owing for salaries, wages and payroll deductions are for 2001
3. There is Sh.31,500 interest unpaid on the mortgage as at 15 March 2001 which has not been
recorded in books.
4. The loan from ICDC is secured by a second mortgage on the shop, land and building. The
unrecorded interest owing as at 15 March 2001 is Sh.14,400.
5. The loan from the Co-operative society was obtained when Korir pledged his wholly owed farm
as security. The farm is valued at Sh.45,000. There is no interest outstanding on his loan.
6. The interest on the loan from A Kariuki was to vary with profits, but since the business has been
operating at loss, there is no interest due.
7. There is no interest outstanding on the loan from Barclays Bank.
8. W. Kuria is Korir‘s brother-in-law.
9. The value assets are estimated to be:

Sh
Shop, land and building 630,000
Furniture and fittings 120,000
Stock of goods 30,000

10. Of the debtors, Sh.60,000 are thought to be good and Sh.30,000 doubtful of which Sh.22,500
should be collectable.

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FINANCIAL ACCOUNTING III
 354 Executorship Law and Accounts

11. Korir‘s uncle died recently and he will be receiving Sh.7,500 as an inheritance.
12. Korir has no personal creditors outside the business but he has other personal assets as well as the
small piece of land amounting to Sh.9,000 exclusive of household and personal effects.

Required:
(a) A statement of affairs for Korir as at 15 March 2001 in good form (10 marks)
(b) A deficiency account. (8 marks)
(c) A detailed listing of the amounts you have included as unsecured preferential creditors (2 marks)
(Total: 20 marks)

QUESTION TWO
A creditor of Polepay Traders, a partnership owned by Peter Ole Lemsio and Patrick Ayimba,
presented a petition in bankruptcy against the partnership on 1 April 2001. On 30 April 2001, the
High Court made out a Receiving order against the partnership and the two partners.

The statement of financial positions of the partnership and the individual partners as at 30 April were
as follows:

Polepay Lemasio Ayimba Polepay Lemasio Ayimba

Assets: Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Liabilities: Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Land and building 12,450 Bank overdraft 4,600
Houses 5,500 4,800 Creditors 27,270 670 450
Plant & 14,600 Long-term 11,200 3,300 3,840
Equipment loans
Furniture, etc, 650 400 Car loans 380 600
Inventory 19,600 Excess of assets
Trade receivables 20,240 Over liabilities 24,000 15,990 15,550
Cash 180 90 140
Investments 13,600 14,200
Motor cars ______ 500 900 _______ ______ ______
67,070 20,340 20440 67,070 20,340 20,440

Additional information:

1. Lemasio and Ayimba have contributed equal amounts of capital to the partnership; always draw
the same amount from the partnership and share profits and losses equally. The partners‘ capital
included in their personal assets under the title investments,

2. The estimated realizable values of the assets stated above are as follows:

Polepay Lemasio Ayimba

Assets: Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Land and building 8,000
Houses 4,000 3,500
Plant and Equipment 7,500
Furniture 180 100
Inventory 13,500
Trade receivables 13,100
Other investments 700 1,000
Motor cars 250 300

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 355

3. The long term loan in the books of the partnership is secured on the partnership land and
buildings. The long-term loan to the individual partners are secured on the individual partner‘s
houses. The partnership overdraft was secured by a second mortgage on the partnership land and
building and by the personal guarantee of Ayimba and the deposit of his investments. The car
loans are secured on the partners‘ car individually.

4. Of the sectors of Polepay, Lemasio and Ayimba, preferential creditors amounted to Sh.20,000,
Sh.590,000 and Sh.380,000, respectively, and represent amounts due for taxation.

Required:
Prepare statements of Affairs and Deficiency or surplus Accounts for the partnership and for the
individual partners, using the format laid down in the Bankruptcy Act and showing the legal position.
(20 marks)

QUESTION THREE

A trading company Endesha Ltd. has experienced severe financial difficulties in recent times and is
currently insolvent. A voluntary winding up petition will soon be filed and management is considering
either liquidation or reorganisation. The chief accountant has produced the following statement of
financial position as if the company were a going concern:

Statement of financial position as at 31 March 1999

Sh. ‘000’ Sh. ‘000’

Ordinary share capital 100,000 Fixed assets:
Retained earnings (deficit) (64,000) Land 100,000
36,000 Building (NBV) 110,000
Long term liabilities: Equipment (NBV) 80,000
Note payable (secured by lien on Intangible assets 15,000
land and buildings) 200,000 305,000
Investments in securities 15,000
Current liabilities: Current assets:
Creditors 60,000 Stocks 41,000
Accrued expenses 18,000 Debtors 23,000
Note payable (secured by stocks) 75,000 Prepaid expenses 3,000
Cash at bank 2,000
389,000 389,000

Additional information
1. The land and buildings are in the prime location and can be sold for 10% more than their book
value. But the equipment may not get a buyer unless the price is reduced. It is expected to fetch
only 40% of its current book value.
2. Administrative costs of Sh.21.5 million are projected if liquidation of the company does occur.
3. By spending Sh.5 million for repairs and marketing costs, stocks currently held can be sold for
Sh.50 million.
4. Accrued expenses include salaries of Sh.13 million. Of this figure, one executive is owed a total of
Sh.3 million but is the only employee whose amount due is in excess of the statutory limit. Payroll
taxes withheld from salaries and wages but not yet remitted to the Kenya revenue Authority total
Sh.3 million. However, company records currently show only Sh.1 million portion of this liability.

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FINANCIAL ACCOUNTING III
 356 Executorship Law and Accounts

5. The investments reported on the statement of financial position have appreciated in value since
acquisition and are now worth Sh.20 million. Dividends of Sh.500,000 are currently due from
these investments, but not yet recognised.

6. Interest of Sh.5,000,000 on the long-term liabilities has not been accrued for the current financial
year.
7. Debtors are estimated to be collectible for Sh.12 million.
8. A refund of Sh.1 million will be received from the various prepaid expenses but the company‘s
intangible assets have no resale value.

Required:
A statement of affairs in accordance with the requirements of the company‘s Act, 1948, for 31 March
1999. (20 marks).

QUESTION FOUR

Matatizo Ltd. went into voluntary liquidation on 30 November 2003. Its statement of financial
position as at that date was as follows:
Sh.
Assets:
Land and building 5,000,000
Plant and machinery 12,500,000
Patents 2,000,000
Stock 2,750,000
Sundry debtors 5,500,000
Cash at bank 1,500,000
Income statement balance 5,625,000
34,875,000

Equity and liabilities:

Issued and subscribed capital
100,000 10% cumulative preference shares of Sh.100 each, fully paid 10,000,000
50,000 equity shares of Sh.100 each, Sh. 75 paid 3,750,000
150,000 equity shares of Sh.100 each, Sh. 60 paid 9,000,000
15% debentures secured by floating charge 5,000,000
Interest outstanding on debentures 750,000
Creditors 6,375,000
34,875,000
Additional information:
1. Preference dividends were in arrears for two years and the creditors included preferential
creditors of Sh.760,000.
2. The assets were realized as follows:
Sh.
Land and building 6,000,000
3. Plant and expenses
Liquidation machineryamounted to Sh.545,000. The liquidator is entitled to a 10,000,000
commission of 3% on assets realized exc
Patents 1,500,000
4. Stock 3,000,000
The final payments (including those relating to debentures) were made on 31 May 2004.
Sundry debtors 4,000,000
Required:

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Six 357

The liquidator‘s final statement of account as at 31 May 2994. (Total: 15 marks)

QUESTION FIVE

(a) Explain the term abatement and rule of lapse as used in accounting for executorships (5 marks)
(b) Kombo died on 31 October 1999 and was survived only by Kwetu his grandson. By his will
which barred equitable apportionment and was silent on the date of payment of legacies he left
his estate as follows:

To my cousin Musa my beach plot

To my friend Naomi my car
To my nephew Penny my boat
To each of my brother-in-law Sh.40,000
To each of my two sons Sh.200,000
To my housekeeper Ali if still in my employment Sh.400,000
To the pastor of my church Paul Sh.100,000
To my local church Sh.100,000 to buy a piano in memory of my late mother.
To my shamba boy, Juma if still in my employment Sh.40,000.
To each of my neighbours Faith, Peter and Tom Sh.20,000;
To the water games club, my outboard engine; and
To my grandson Kwetu, the residue absolutely.

On 30 April 2000, the executors, having paid all the liabilities of the estate and the expenses of
administration were ready to assent to the legacies. The property in their possession and its value at
the date was:

Sh.
Car (van) 180,000
Car (saloon) 100,000
Boat 50,000
Furniture, jewellery etc 190,000
Farm 80,000
Beach plot 24,000
Sh.3,000,000 6% Government stock 2,400,000
Balance at bank 1,376,000
4,400,000
The following additional information is available:

1. Penny died on 30 March 1999.

2. Kombo had two brothers in law surviving at 31 October 1999.
3. Ali was still employed at 31 October 1999
4. During his lifetime, Kombo provided his church with a local piano in memory of his late mother
5. Juma retired on 31 October 1997.
6. Faith and Juma both predeceased Kombo.
7. The farm had been purchased by Kombo with precedes of the sale of the outboard engine.

Required:
A schedule showing the distribution of the estate. Give your reasons should you decide that the
executors should assent to any legacies (ignore taxation)

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FINANCIAL ACCOUNTING III
 358 Executorship Law and Accounts

END OF COMPREHENSIVE ASSIGNMENT No. 3

NOW SEND YOUR ANSWERS TO THE DISTANCE LEARNING ADMINISTRATOR
FOR MARKING

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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Seven 359

LESSON SEVEN

TRUST LAW AND ACCOUNTS

OBJECTIVES

At the end of this lesson, you should:

 Know the law of trusts;

 Know how to prepare trust accounts.

CONTENTS

 Read the study text below.

 Attempt reinforcing questions at the end of the lesson.
 Compare your solutions with those given in Lesson 9.

STUDY TEXT

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 360 Trust Law and Accounts

DEFINITION
There is no generally accepted definition of a trust, although many have attempted. Underhill defines a trust
as"an equitable obligation binding a person (who is called a trustee) to deal with property over which he has
control (which is called the trust property) for the benefit of the persons (who are called the beneficiaries ......) of
whom he may himself be one, and any one of whom may enforce the obligation".

8.2 CLASSIFICATION
TRUSTS

Express Arising by Operation of Law

Public Private Statutory Implied Constructive

(Charitable) (e.g on a fiduciary (or Resulting) (arising out of intestacy)
relationship e.g.
KeechV Sandford

Where express trusts Where express Where one person buys

do not exhaust trust fails property in the name of
beneficial interest another (property held on
implied trust for purchaser
presumption of advancement
applies)

8.3 EXPRESS TRUSTS

(a) Creation
An express trust is "created not by facts and circumstances, but by the express words of the settlor".
(Fitzgerald v Stewart)

It may be created in the following ways:

1. A declaration of trust by the settlor whereby he makes himself the trustee of property for the
benefit of some person; or
2. The transfer by the settlor of the ownership of the trust property to trustees, and the
communication to the trustees of the terms upon which they are to hold that property; or
3. By will.

(b) Completely and incompletely constituted trusts

In all cases the trust must be completely constituted. A trust is completely constituted when the trust
property has been vested in trustees for the benefit of the beneficiaries. Where there is merely a contract
or covenant to create a trust, the trust is said to be incompletely constituted.
A completely constituted trust may be enforced by any beneficiary, including a volunteer; an incompletely
constituted trust can only be enforced by a beneficiary who has given value. Thus a trust is incompletely
constituted where there is merely a covenant by a settlor to settle property which he expects to acquire. If
the settlor does not settle the property when he eventually acquires it, although he will be liable in
damages to the intended beneficiaries, if they were parties to the covenant, and the covenant was under
seal, those beneficiaries,if volunteers, cannot enforce their expected beneficial interest in the property to
be settled. (Jeffreys v Jeffreys)
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FINANCIAL ACCOUNTING III
 Lesson Seven 361

(c) Form
No special form is normally required for the creation of a trust except that a declaration of trust respecting land
or any interest therein must be manifested and proved by some writing signed by some person who is able to
declare such trust or by his will:
The following points should be noted:

1. Applies to "land or any interests therein". No writing is necessary to create an inter vivos trust of pure
personality.
2. This does not affect the creation or operation of resulting, implied or constructive trust;
3. A trust caught by this provision need not be declared by writing; it need only be evidenced (i.e. proved by
some writing);
4. Absence of writing does not render the declaration of the trust void, merely unenforceable;
5. The writing must contain all the material terms of the trust;
6. The writing must be signed by some person who is able to declare the trust: the signature of an agent is
unacceptable;
7. A trust of any property to arise on death must be created by will.

(d) The three certainties

A trust will be valid only if the three certainties are present i.e. certainty of words, certainty of subject, and
certainty of objects.

1. Certainty of words
i. There is no need for a settlor to use the word "trust" in order to constitute a trust; it is enough if the
words used in the instrument clearly establish an intention to create a trust.
ii. The words must be imperative and not merely a request i.e. precatory words.(Re Adams and the
Kensington Vestry)

2. Certainty of subject matter

i. Where the property subject to the purported trust cannot be identified there will be no trust. (Sprange v
Barnard).
ii. Where the beneficial interests to be taken by the beneficiaries are not certain, the trust will a resulting
trust for the settlor (Boyce v Boyce).

However there is no uncertainty in the following cases:-

a. Where the trustees are empowered to determine the beneficial interest to be enjoyed;
b. Where the court is able to apply the maxim "Equality is Equity", and divide the property into equal
shares.

3. Certainty of objects
The objects of a trust must be certain i.e. a trust will only be valid if it can be said with any certainty that any
given individual is or is not a member of the class of beneficiaries. Generally, trusts which fail to meet this
requirement are void for uncertainty.

Charitable trusts constitute an exception to this rule. However, such trusts do fail if the gift in not exclusively
for charitable purposes (Re Astor's Settlement Trusts).

(e) Absence of the certainties

i. In the absence of certainty of words the donee generally takes beneficially.

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STRATHMORE UNIVERSITY● STUDYPACK
 362 Trust Law and Accounts

ii. In the absence of the other certainties there is generally a resulting trust in favour of the settlor or his
estate.

4 SECRET TRUSTS

(a) Introduction
The initial basis of the doctrine of secret trusts was the refusal of equity to permit a statute to be used as
an engine of fraud (e.g. Bannister v Bannister). Certain formalities are necessary for the creation of
inter vivos trusts of land for testamentary dispositions. A trust of land must be evidenced in writing; and
all testamentary dispositions must comply with the Law of Succession Act. In the case of wills, secret
trusts are of two types, fully secret trusts and half secret trusts.
(b) Fully secret trusts
This is where neither the existence nor the terms of the trust are disclosed in the will.
The trust will be enforced only if the following conditions are complied with.

1. The testator must leave property by will to the secret trustee apparently for his own benefit;
2. The testator must tell the secret trustee that he wants him to hold the property on trust for the
secret beneficiary: this communication must take place during the testator's lifetime: but whether it
is before or after the date of the will is immaterial;
3. The secret trustee must promise to carry out the testator's intention: such promise may be express
or implied: silence after hearing the testator's intention will normally be treated as an implied
promise (moss v cooper);
4. The testator's decision to make a disposition in favour of the secret trustee or to leave an existing
disposition unaltered must be made on the faith of the secret trustee's promise;
5. No trust will arise if the alleged trustee only learns of the alleged trust after the testator's death
(wallgrave v tebbs)

(c) Half secret trusts

In this type of trust the will states that the gift is on trust, but the name of the beneficiary is not specified.
Since the existence of a trust is disclosed, the trustee is unable to claim the property for himself. The
following points should be noted:-

1. Evidence tending to establish a half-secret trust is inadmissible if it contradicts the terms of the will
(Re Keen);
2. Communication of the trusts to the trustees will be ineffective if it takes place after the will has
been executed (Johnson v Ball);
3. Where there is no proper communication to the trustees, the property belongs to the residuary
legatee or, if no such person, the testator's next of kin (Johnson v Ball).

Note Secret trusts operate outside the will. Thus:

(a) A beneficiary under a secret trust does not lose his interest if he witnesses the will or if he
predeceases the testator;
(b) Where a secret trustee predeceases the testator, the legacy and the trust fail.

8.5 PROTECTIVE TRUSTS

The income of property may be settled on such terms as to restrict its availability to creditors of the beneficiary
in the following ways:

(a) Determinable interests

In this case the interest of the beneficiary ceases on alienation or bankruptcy. Note that a person
cannot settle property on himself until bankruptcy since this would defeat the claims of his creditors.
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FINANCIAL ACCOUNTING III
 Lesson Seven 363

(b) Discretionary trusts

In this case the trustees have a complete discretion whether to pay the income to the beneficiary or not.
(c) Protective trusts
If income is settled on "protective trusts", this operates to give –

1. A life interest for the principal beneficiary determinable on alienation or bankruptcy; and thereafter;
2. A discretionary trust for the trustees to apply the income for the benefit of the principal beneficiary, his
spouse and issue, or, if there is no spouse or issue then for the benefit of the principal beneficiary and
those who would be entitled to the trust property or the income thereof were he dead (S.35 Trustee Act,
Cap.167).

8.6 IMPLIED TRUSTS

(a) Definition
An implied trust arises where the settlor's intention is inferred from his words and his conduct (Barclays
Bank Ltd. v Quistclose Investments Ltd.)
Some implied trusts are also called "resulting trusts": this is because the beneficial interest results to the
settlor.
(b) Resulting trusts
Resulting trusts occur where equity regards the property which is held by a trustee as belonging in
equity to the person who transferred it to, or caused it to be vested in, the trustee.

They may arise in four situations -

1. Purchase of property by one person in the name of another

i. Where a person buys land or pure personalty and has it conveyed into the name of another, or into
the joint names of himself and another, there is a presumption that the property is held on trust
for the person supplying the purchase money;
ii. If two people advance money to purchase property, but the conveyance is taken in the name of
one only, the other takes a beneficial interest in the property in proportion to the money
advanced by him.
In some cases the relationship between the two parties will raise a presumption of advancement
which displaces the presumption of a resulting trust i.e where the person supplying the
purchase money is under an obligation to maintain the other e.g. a father or a husband.

2. Voluntary transfer of personal property by the owner into the name of another or into their joint names
(e.g Re Vinograndoff).
3. Failure to exhaust the beneficial interest. The settlor fails to dispose of the whole of the beneficial
interest in the trust fund. The undisposed of part is held by the trustees on resulting trust for the
settlor or his estate (Re Abbots Fund).
4. Where a private express trust fails for uncertainty of objects or for non-compliance with statutory
formalities there will be a resulting trust in favour of the settlor.

8.7 CONSTRUCTIVE TRUSTS

A constructive trust is a trust imposed by equity regardless of the intention of the owner of the property: it arises
by operation of law. The concept has been applied in a number of situations:

1. It is a rule of equity that a trustee must not permit his interests to conflict with his duties: note
particularly, a trustee may not profit from his trust: where he does so he holds the gains on a
constructive trust (Keech v Sandford);
2. If a person who is not a trustee obtains information with the help of a trustee which enables him to make
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STRATHMORE UNIVERSITY● STUDYPACK
 364 Trust Law and Accounts

a profit, he holds the proceeds on constructive trust: (Boardman v Phipps);

3. If a person receives trust property with knowledge (actual or constructive) that it is trust property, and it
is transferred to him in breach of trust, he holds the property as trustee;
4. A person who does not actually receive trust property but assists a trustee to fraudulently dispose of it is
liable as a trustee.

Note Strangers are not to be made constructive trustees merely because they act as the agents of trustees in
transactions within their legal powers, e.g a solicitor who creates a fraudulent document on the
instructions of the trustee. They will be liable only if:-

(a) They receive the trust property; or

(b) Act in a manner consistent with that of a trustee; or
(c) Assist with knowledge in a dishonest and fraudulent design on the part of the trustees.

8.8 APPOINTMENT OF TRUSTEES

(a) Capacity

Any person with legal capacity to hold property may be a trustee, except an infant. But the court will not
appoint, and may remove:

1. Persons under a disability;

2. Persons resident abroad; or
3. Beneficiaries or their spouses or solicitors.

(b) Numbers
If the trust property includes land, the maximum number is four (in the case of a private trust; (s.36) and the
minimum two, or a trust corporation (a sole trustee cannot give a receipt for capital money arising
under a trust for sale of land or under a settlement of land; s.15. If not, there is no maximum or minimum
number, but:

1. Additional trustees may not be appointed to take the number above four, and
2. A trustee cannot retire to leave only one trustee, unless a sole trustee was originally appointed.

(c) Original trustees

These are appointed by the settlor; if he fails to appoint, he or his personal representatives act as trustees. The
settlor has no power to make subsequent appointments unless he reserves the power to do so.

(d) New trustees

New trustees may be appointed in writing to replace a trustee who:

1. Is dead;
2. Remains continuously out of kenya for more than one year;
3. Desires to be discharged;
4. Refuses to act;
5. Is (legally) unfit to act, e.g. Bankrupt;
6. Is (physically) incapable of acting, e.g infirm;is removed under a power in the trust instrument; or
being a corporation, is dissoverd.

The appointment is made by-:

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FINANCIAL ACCOUNTING III
 Lesson Seven 365

1. Persons having power to appoint under the trust instrument; or if no such person, or no such person is
willing and able to appoint, then
2. The surviving trustee or trustees; or
3. The personal representatives of the last trustee. S.37 (1) – (3)

(e) Additional trustees

Apart from the appointment of the trustees (above), additional trustees may be appointed in
writing at any time by:

1. Persons given power to appoint by the trust instrument; or if no such person

willing and able to act then
2. The trustees for the time being; provided that –

i. No existing trustees is a trust corporation; and

ii. The total number of trustees will not exceed four.

(f) Appointment by court

The court may appoint trustees:

1. Whenever it is difficult, inexpedient or impracticable to appoint without the court‘s assistance, on

the application of a trustee or a beneficiary e.g. in substitution for a trustee who is bankrupt, mentally
defective or a convicted criminal S.42.
2. A judicial trustee (an officer of the court), on application by settlor, trustee or beneficiary, in
substitution for all or any of the existing trustees;
3. The public Trustee, on application of a trustee or beneficiary even though this is forbidden in the trust
instrument.

(g) Appointment by beneficiaries

The beneficiaries have no power to appoint or to direct the trustees to do so
(e.g. re Brockbank) but –

1. If all are sui juris and absolutely entitled , they may terminate the trust; and otherwise
2. They may apply to the court to appoint or remove a trustee (see above).

8.9 TERMINATION OF APPOINTMENTS

A trustee may cease to hold office in the following ways:

(a) Disclaimer
At any time before acceptance of the trusts.

(b) Retirement

Either –

1. Under the trust instrument; or

2. With the consent of all beneficiaries, being sui juris, or
3. With the consent of the court; or
4. By deed under S.40, provided that –

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 366 Trust Law and Accounts

i. There remain a trust corporation or at least two trustees; and

ii. He obtains consent by deed of his co-trustees and of any person with power to appoint new
trustees.

(c) Release and replacement

This may take place under S.37 (see paragraph 8.8 (d) above).
(d) Removal
The trustee may be removed by the court under its inherent power to protect beneficiaries,
even though he may have committed no breach of trust.
(e) Discharge
The trustee is automatically discharged on completion of the trust.
(f) Death of trustees

8.10 VESTING OF PROPERTY IN TRUSTEES

The settlor must transfer the property to the original trustees in the proper legal manner. Similar transfers must
be made on a change of trustee; but if a new trustee is appointed by deed, this operates to vest property
automatically, except for:

1. Land conveyed by way of mortgage to secure trust moneys lent;

2. Leasehold land held under a covenant not to assign without consent (unless consent is obtained); and
3. Registered stocks and shares, which must be transferred in the proper manner S.41.

The court has power to make vesting orders in appropriate circumstances.

8.11 POWERS AND DUTIES OF TRUSTEES

Powers and duties may be imposed or conferred on trustees either:

1. By the trust instrument, or

2. By the general law.

Duties impose an obligation upon the trustees to act;

powers give them a discretion, which they can only exercise if they are unanimous (re Hilton)
A power may be coupled with a duty, in which case the trustees must act, but have a discretion as to the
manner of acting (e.g in relation to investment of trust funds).

8.12 POWERS OF INVESTMENT

The trustees have a duty to obtain control of trust assets and to invest trust funds in authorised securities.

The trustees may invest in such securities as are authorised in the trust instrument or by the Trustee Act. In any
case, they must have regard to -

1. The need for appropriate diversification; and

2. The suitability of the proposed investments to the trust.

(a) Investments under the Trustee Act

The act defines the categories of investment as follows:

1. Fixed interest securities are:

i. Securities which under their terms of issue, bear a fixed rate o f interest; or
ii. Mortgages of immovable property; or
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FINANCIAL ACCOUNTING III
 Lesson Seven 367

iii. Deposits, whether fixed-term or otherwise, with a bank or financial institution building society or the
Kenya Post Office Savings Bank.

2. ―Wider Range ―, i.e. building society shares, units of authorise unit trusts, and
stocks and shares issued by Kenyan companies if:

i. Company has issued and paid up capital of at least Shs.10 million.

ii. Dividends have been paid on the shares in each of the preceding fiveyears; and
iii. The shares are quoted on the Nairobi Stock Exchange.

In addition, immovable property in Kenya for an estate in fee simple or

for a term of years of which not less than 40 years is unexpired

3. Special-range property - property represented by any power of investment

exercisable by a special investment clause contained in the trust instrument e.g. power to invest in the
shares of a private company. This property musts be placed in a separate part of the fund and the
provisions for division of the fund into ―narrower‖ and the ―wider‖ range parts will only apply to the
residue of the fund. If special range property is realised and converted into property other than special
range property e.g. sale precedes, the balance between ―fixed interest‖ and ―wider range property must b
e maintained.

Note
1. No investment can be made in ―wider range‖.
2. No more than 50% of trust funds to be invested in ―wider range‖.
3. No investment can be made in ―wider range‖ securities unless ―proper advice‖ has been obtained and
considered i.e. written advice of a person reasonably believed by the trustees to be qualified by his
ability in and practical experience of financial matters.
4. Additions to t he fund, such as bonus shares, arising from an investment already held in one part of the
fund will accrue to that part of the fund which contains the investment; in other cases an addition to the
fund must be divided equally between the ―fixed interest‖ and ―wider‖ range parts, or compensating
transfer must be made.
5. Property can only be transferred from ― fixed interest‖ to ―narrower‖ range or vice versa if a
compensating transfer is made at the same time.
6. Withdrawals from the trust fund e.g. to pay a beneficiary – the trustees have discretion as to whether they
sell ―narrower‖ or ―wider‖ range investments in order to meet the debt; consequently the 50/50 balance
may be upset.

(b) Other powers of investment

1. Shares and debentures: A trustee may:

i. Invest in bearer securities if these would otherwise be authorised;

ii. Acquiesce in an amalgamation or reconstruction; and
iii. Take up or assign ―rights‖ issues.

2. Not more than one-eighth of the value of trust fund or Shs.10,000, whichever is t he
greater, shall be invested in the securities of any one company or unit trust.
3. Mortgages: These are authorised under the Trustee Act if given in respect of freehold
land or leasehold land with at least 40 years unexpiered; the trustee may lend up to
two-thirds the value of the land as assessed by a competent surveyor or valuer.
4. Retention of securities: A trustee is not liable simply for retaining an investment
which has cease to be authorised; but he must review periodically – with advice –
wider range.
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 368 Trust Law and Accounts

8.13 DELEGATION
A trustee cannot deleget unless:

1. It is necessary or in the ordinary course of administration; or

2. Authorised by the trust instrument; or
3. Authorised by statue: the statutory powers of delegation are:

i. He may employ and pay an agent, e.g. a solicitor, banker ore or stockbroker to do any necessary act
without liability for the agent‘s default if he was employed in good faith;
ii. He can, by means of a power of attorney, delegate the exercise of all or part of his trust for up to 12
months. He may not delegate to a sole co-trustee unless it is a trust corporation. The power of
attorney musts be witnessed by at least one person. Notice of the delegation must be g iven within 7
days to co-trustees and persons with power to appoint new trustees. The must musts specify the date
of commencement, duration, the delegate, reason for delegation, and, if delegation is partial, which part
of the trust is delegated. The trustee remains personally liable.

iii. He may appoint a competent and independent surveyor or valuer to value property mortgaged as
security for trust money lent, and is not liable if he lends more than two-thirds of the valuation and the
valuer‘s or surveyor‘s report advised the loan;
iv. Trustees for sale of land my delegate powers of leasing and management to the person entitled to
possession, being of full age, without liability for his acts or defaults.

8.14 MAINTENANCE
Trustees may pay to the parent or guardian out of income of a fund held on the trust for an infacnt reasonable
sums for his maintenance and education, having regard to his age and station in life, subject to the following
conditions:

1. The power is subject to any prior interest or charge affecting the property;
2. A payment must be in proportion to amounts paid from other available funds (if any);
3. The power is not affected by the existence of a person bound by law to maintain or educate the infant; nor
it is affected by the fact that particular sums have already been set aside for this purpose;
4. The power exists whether the infant‘s interest is vested or contingent (provided, in the latter case, that the
trust carriers the intermediate income);
5. Payments out of capital may be valid, but should normally only be made under S.34 (see below) or with the
consent of the court;
6. The residue of the income must be accumulated and invested;
7. The trust instrument may exclude this power.

8.15 ADVANCEMENT
Trustees may apply not more than half of the presumptive or vested share of the capital held in trust for
any person (infant or adult) for his advancement or benefit (including maintenance) on the following
conditions:

1. The trust property consists of money or securities or property held on trust for sale;
2. No advance can be made to prejudice any person with a prior interest, unless that person is
of full age and gives his written consent;
3. The interest may be vested or contingent;
4. The advance must be brought into account on his becoming absolutely entitled;
5. The power may be excluded by the trusts instrument S .34.

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FINANCIAL ACCOUNTING III
 Lesson Seven 369

8.16 INSURANCE
Trustees may insure trust property against loss or damage by fire subject to the following conditions:

1. The insurance must not exceed the full value of the property;
2. The trustees must not insure if:

i. The trust instrument forbids this, or

ii. The trustees are bound to convey the property absolutely to the beneficiary on request;

3. Premiums may be paid out of income of the trust property (not necessarily the property insured);
4. Insurance money received is to be treated as capital, and held on the same trusts as the property insured.

8.17 PROTECTION AGAINST CLAIMS

The trustees may protect themselves against claims after discharge in the following ways:

1. As regards liability for rent and other obligations under a lease or rent charge, they may pay all
outstanding liabilities and make provision for fixed and ascertained future claims, and may then
distribute the property to a beneficiary or purchaser entitled thereto without any further provision S.28.

2. Before conveying or distributing the trust property they may advertise for claims in the Gazette
and a local paper requiring interested parties to send in particulars of their claim within a stated
time, being not less than 2 months, and are not liable after the time limited in the
advertisements to persons of whose claims they have no notice; but they must make all proper
searches and enquiries S.29.
3. They may pay into court monies or securities remaining in their hands, and the receipt of the
appropriate officer of the court operates as a good discharge S.63.

8.18 DEPOSIT OF DOCUMENTS

Trust documents may be deposited for safe custody with a banker or company whose business includes the
taking of documents for safe custody, and the costs thereof paid out of income S.22.

8.19 SETTLEMENT OF LIABILITIES

Wide powers of compromise are granted to trustees by the Trustee Act. Two or more trustees or a sole
trustee, where authorised, may:

1. Pay or allow any claim on any evidence they think sufficient;

2. Accept a composition or a security, real or personal, for any claim;
3. Allow any time for payment of a debt;
4. Compromise, compound, abandon, submit to arbitration, or otherwise settle a claim.

For these purposes they may enter into any agreement or arrangement, or do any other thing as seems
expedient, without liability for any loss incurred while acting in good faith S.16.

8.20 DUTIES OF TRUSTEES

(a) Not to profit from the trust

A trustee may not receive remuneration except:

1. By order of the court, if the trust is very onerous or the services of the trustee very valuable;
2. Under authority in the trust instrument;
3. By consent of all the beneficiaries, being all sui juris and absolutely entitled;
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4. In the case of the Public Trustee, whose fees are fixed by the Treasury; moreover, where the court
appoints a corporation to be a trustee, the corporation may charge such remuneration as the court
authorises;
5. In the case of an advocate-trustee who may charge his costs unless acting alone; moreover the partner of
an advocate-trustee may be employed by him on trust work and be paid his charges, so long as the
partner alone is entitled to any profit;
6. If the trust property is situated abroad and the foreign law permits payment.

Trustees have, however, a right to be indemnified:

1. Out of trust property, for all expenses properly incurred in the execution of the trust e.g. insurance
premium paid S.32(2);
2. Against a beneficiary if -

i. The trustee accepted the trust at the request of the beneficiary and the beneficiary is the
settlor; or
ii. The beneficiary is the sole beneficiary, sui juris, and absolutely entitled;
iii. The expense was incurred at the request of all beneficiaries, being sui juris and absolutely
entitled.

3. For the cost of litigation brought or defended with leave of the court or otherwise properly for the
benefit of the estate - the indemnity here comes out of the trust estate.

(b) To keep and audit accounts

Trustees must keep accounts and produce them to any beneficiary together with all reasonable
information as to the financial position of the trust.
The trustee may have the accounts audited by an independent accountant, but not more than once every
three years, unless the nature of the trust makes more frequent audits reasonable S.23.

(c) To observe terms of trust

Trustees must comply with the trust instrument and the rules of equity; they need not consult the
beneficiaries or take instructions from them; but they may not depart from the terms of the trust unless
authorised by the court, either:

1. Where a particular transaction is expedient for the trust as a whole, but the trustees have no power
to effect it S.56; or
2. Under the Trustee Act, which empowers the Court to sanction any agreement for varying or
revoking all or any of the trusts, or enlarging the management and administration powers of
trustees on behalf of beneficiaries who are, as yet, unascertained or who are under a disability such
as infancy.

8.21 BREACH OF TRUST

(a) Remedies available to beneficiary

1. Injunction - to prevent unauthorised action by trustees;

2. Personal action - a trustee is only liable for his own acts and defaults, and not for those of an
agent or co-trustee unless these take place with his knowledge or by reason of his own "wilful
defaults" (re Munton).

If a trustee commits a breach of trust he must -

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FINANCIAL ACCOUNTING III
 Lesson Seven 371

i. Make good any capital loss, with interest at 4% or 5% if he has used the money for his own
purposes or been guilty of fraud, and
ii. Account for any profit he has made.

3. Criminal liability for fraudulently converting trust property.

(b) Defence of trustee

1. He may be relieved from liability if, in the opinion of the court, he acted honestly and reasonably
and ought to be excused;
2. He may also be released by any beneficiary, being sui juris and with knowledge of the facts,
from liability to that beneficiary only;
3. Lapse of time: an action for breach of trust is statute-barred after six years except when a
beneficiary under a disability, such as infancy, when time does not begin to run until the disability
ceases: moreover there is no limitation periods where:

i. Trustee was fraudulent; or

ii. To recover from the trustee trust property or the proceeds thereof in his possession or
previously received by him and converted to his own use.

(c) Contribution and indemnity

Generally the trustees are jointly and severally liable to the beneficiaries and a trustee sued may claim
contribution from the others where although two or more trustees are liable, one has paid more than his
fair share of the loss; or a complete indemnity against -

1. A trustee who actually committed and obtained the benefit of the breach; or
2. An advocate trustee who advised the breach; or
3. A trustee who is also a beneficiary, to the extent of his beneficial interest.

(d) Tracing trust property

Apart from suing the trustee, in the event of a breach of trust, the beneficiary may follow the trust
property and recover it from third parties, or the proceeds thereof from the trustee. But he cannot follow
property which has ceased to be identifiable, or which has passed into the hands of a person taking for
value without notice of his interest. Some rules of tracing:

1. Where the trustee mixes the funds of two separate trusts in one bank account, the presumption is
that the first trust money paid into the account is the first drawn out, the Rule in Clayton's Case;
2. Where a trustee mixes trust funds with his own in a single bank account and draws upon that account
for his own purpose, the presumption is that he has drawn on his own money first even if it was paid
in more recently than the trust money - (re Hallett's Estate);
3. Where a trustee mixes trust funds with his own, the beneficiaries will have a first charge on the mixed
fund for the trust money;
4. Where a trustee purchases property with his own money and with trust money, the beneficiaries will
have a first charge on the property purchased.

8.22 TRUST ACCOUNTS

(a) Object of trust accounts

1. To demonstrate that the trust funds have been applied in accordance with the trust instrument;
2. To give details of transactions to trustees, beneficiaries and other interested parties.
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STRATHMORE UNIVERSITY● STUDYPACK
 372 Trust Law and Accounts

(b) Accountability
The accounts of a trust should include all the property of the trust whether or not in the hands of the
trustees. For example, interests in expectancy and foreign property may not be under the trustees'
control but should still be shown.
(c) Income and capital
In many trusts different persons are entitled to the income and the capital and this necessitates a careful
distinction between the two.
(d) Form of the accounts
The accounts should be as simple as possible for the benefit of trustees and beneficiaries who are not
trained in accounting.
Trust accounts and supporting books and vouchers should be kept for a longer period than would be
the case with commercial documents.
(e) History of trust
The following general information should be kept with the trust documents:

1. Summary of will or trust deed;

2. Short history of the trust;
3. Trustees‘ names and addresses;
4. Names and addresses of beneficiaries (present and future) together with dates of birth, marriage and
death and relationship to settlor.

(f) Accounting Date

In determining the accounting date of the trust, the trustees will consider the following:

1. Date of death (accounts to anniversary of death);

2. Fiscal year-end (accounts to 31st December);
3. Due date for payment of annuities;
4. Beneficiaries‘ income requirements.
(g) Content of accounts
Periodical accounts should normally consist of:

1. Statement of financial position of the whole trust;

2. Capital account;
3. Income account;
4. Schedules and subsidiary accounts explaining, where appropriate, items 1 to 3 above.

8.23 STATEMENT OF FINANCIAL POSITION

(a) Grouping of items

Items in the Statement of financial position should be grouped under appropriate headings. In particular,
a trust operating the provisions of the Trustee Act will have headings for:

1. The fixed interest securities and fund;

2. The wider range securities and fund;
3. The special range securities and fund.

The Statement of financial position will also clearly distinguish between items representing income and
those representing capital.
(b) Comparative figures
Comparative figures should be shown where relevant.
(c) Capital account
Where the Trustee Act has been applied, the capital account will be divided between the fixed interest,
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FINANCIAL ACCOUNTING III
 Lesson Seven 373

wider and special ranges. The balance on the capital account shows the total book value of the capital
funds.
(d) Liabilities
Careful distinction should be made between liabilities on capital account and those on income account.
(e) Assets

1. The classification of investments in the Statement of financial position will be under a few
broad headings with schedules listing the individual assets. Where the Trustees Act has been
applied all investments must be clearly allocated to their appropriate fund;
2. Unauthorised investments held under a power of postponement should be separately shown;
3. The book value of investments will be as follows:

i. Devolving on trustees as part of deceased's estate - PROBATE VALUE;

ii. Part of a gift by a living settlor - MARKET VALUE at date of gift;
iii. Purchased by trustees - COST

4. Revaluation of investments will normally take place in the following circumstances;

i. Where trustees decide to apply provisions of Trustee Act;

ii. Distribution to a beneficiary under the trust instrument.

5. Cash and bank balances should be distinguished between income and capital.

8.24 INCOME ACCOUNT

(a) Classification
Income will be classified under appropriate headings:

1. Rents;
2. Interest on Government securities;
3. Dividends;
4. Interest on mortgages.
(b) Taxation
Income should be stated gross i.e. before tax has been charged on it. Provision for the total liability to
tax should be shown as a charge against total income. When income is received net of withholding tax,
for accounting purposes the income is grossed by and tax is shown as a pre-payment.
(c) Accruals
It is a golden rule that income is NOT provided for until received but expenditure is accrued. In the
USA, both income and expenditure are accrued in accordance with Generally Accepted Accounting
Principles. In the UK, expenditure is accrued in accordance with the accruals concept, but income is
recorded only when it is received. In Kenya, the Explanatory Forward to Kenyan Accounting Standards
states that Kenyan Accounting Standards are intended for application to all financial statements issued by
estates and trusts; the accrual assumption is recognised in Kenya Accounting Standard Number 1 as one
of the fundamental accounting assumptions; hence, in Kenya, income should be accrued to the Statement
of financial position date.
(d) Statutory apportionments
Investments should be maintained at their probate value and where an apportionment to capital has been
made, a transfer should be made to the estate capital account to restore the investment to probate value.

8.25 ACCOUNTS UNDER TRUSTEE

(a) Authorised investments
The investments which trustees are permitted to hold may be specifically stated in the will or deed
constituting the settlement.
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STRATHMORE UNIVERSITY● STUDYPACK
 374 Trust Law and Accounts

Where the will or deed is silent on the matter, the authorised investments are as provided by statute.
The Trustee lays down the scope for trustees' investments but has also introduced safeguards to prevent
excessive losses to trust funds from unsuitable investments.
(b) Division of the trust
The safeguards consist in the division of the trust funds into portions. Before this division takes place,
the investments are revalued in order to determine the total value of the funds as at the date of division.
Any investments which are acquired or retained under a specific power in the will or settlement are
designated as special range property and are kept quite separate from the other investments. The
remainder of the property is to be divided into two equal parts, the fixed interest and the wider range.
The fixed interest part of the trust must contain fixed interest securities only.
The wider range part of the fund may contain either fixed interest or wider-range investments.
When special range property is realised, the proceeds must be invested equally in fixed interest and wider-
range securities.

(c) Fixed Interest Securities - no advice in writing is required before an investment in fixed interest securities
is made.

1. Kenya Government Securities.

2. Treasury Bills.
3. Fixed interest securities guaranteed by the Kenya Government.
4. Fixed interest securities quoted on the Nairobi Stock Exchange issued by a company incorporated
in Kenya which has a paid-up capital of not less than Shs10m and which has paid a dividend in
each of the preceding 5 years.
5. Fixed interest securities issued by Kenya Railways or the Industrial Development Bank.
6. Local Authority loans.
7. A deposit, whether fixed term or otherwise, with a bank or financial institution, building society or
the Kenya Post Office Savings Bank.
8. Mortgages of freehold property or leasehold property having not less than 40 years unexpired.

(d) Wider-range Investments

(requiring advice in writing from a properly qualified person)

1. Quoted shares of a Kenya company with a paid-up capital of not less than Shs10m and has paid
dividends on all issued capital for the past five years.
2. Shares in approved building societies.
3. Units issued by authorised unit trusts.

(e) Dealing with changes in the trust

1. Profits or losses on disposal of investments should be treated as belonging to that part of the
fund out of which they accrued.
If not applicable to either part, the accrual must be divided between each fund.
2. Compensating entries must be made to restore the original status quo if the proceeds of fixed
interest investments are re-invested in wider-range investments or vice versa.
3. Property taken out of trust may be taken from either part, without any necessity for
compensating entries.
4. IT SHOULD BE NOTED THAT THE ONLY TIME AT WHICH THE NARROWER
AND WIDER RANGE PARTS WILL NECESSARILY BE EQUAL IS WHEN THE
FUNDS ARE FIRST DIVIDED INTO TWO HALVES.

(f) Pro-forma accounts under Trustee Act

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FINANCIAL ACCOUNTING III
 Lesson Seven 375

I. PRO-FORMA STATEMENT OF FINANCIAL POSITION

Fixed Interest investments Shs'000

(detailed) 2,120
Cash at bank 900 3,020

Wider range investments

(detailed) 5,450
Cash at bank 550 6,000

Special range investments

(detailed) 500

Cash at bank
(income) 30
9,550
Estate Capital account
Fixed interest range 3,020
Wider range 6,000
Special range 500
9,520

Estate Income account 30

9,550

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STRATHMORE UNIVERSITY● STUDYPACK
 376 Trust Law and Accounts

II. PRO-FORMA ESTATE CAPITAL ACCOUNT

Fixed Wider Special Fixed Wider Special

Interest Interest
Shs'000 Shs'000 Shs'000 Shs'000 Shs'000 Shs'000

Contra Bal b/f 4,800 5,300 1,100

(transfer of
Special Range
realisation Investment
proceeds Account
equally to
fixed interest (profit on
and Wider disposal of
Range) 700 Special Range
investments) 100

Investment
Account Contra

(loss on (transfer of
disposal of Special Range
fixed Interest realisation
Range proceeds
Investments) 40 equally
to Fixed
Interest
and Wider
Range 350 350

Distribution Investment
Account Accounts
Accounts

(distribution of proceeds (revaluation of

of realisation investments in
Fixed Interest order to
Investments ascertain share
to person attribute
absolutely to beneficiary
entitled) 2,380 absolutely
Bal.c/d 3,020 6,000 500 entitled) 290 350
5,440 6,000 1,200 5,440 6,000 1,200

Bal.b/d 3,020 6,000 500

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FINANCIAL ACCOUNTING III
 Lesson Seven 377

III. PRO-FORMA ESTATE CASH BOOK

Fixed Wider Income Fixed Wider Income

Interest Interest

Shs'000 Shs'000 Shs'000 Shs'000 Shs'000 Shs'000

Balance b/f 100 200 50 Estate

Income a/c

(payment on
account to
Investment a/c life tenants) 620

(realisation of
Special Range Distribution a/c
Investments to
be re-invested (payment of
equally in capital due to
Fixed Interest beneficiary
and Wider absolutely
Range) 350 350 entitled) 2,380

Investment a/c

(income Bal.c/d 90 550 30

received on
Fixed Interest
and Wider
Range
Investments) 600

Investment a/c

(disposal of
Fixed Interest
investment) 2,020
2,470 550 650 2,470 550 650

Bal.b/d 90 550 30

8.26 ACCUMULATION ACCOUNTS FOR MINORS

(a) Income accumulations

When property is left in trust for minors, the income earned for the period will be divided equally or
according to the terms of the will or trust deed. These shares of income will be credited to the accounts
of the infant beneficiaries, usually called Income Accumulation Accounts.
(b) Maintenance payments
Any amounts paid for maintenance (either by the terms of the will or trust deed or under S.33 of the
Trustee Act will be debited to the respective Income Accumulations Accounts.
(c) Investment of accumulated income
The income accumulations must be invested from time to time and the investments earmarked as being
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STRATHMORE UNIVERSITY● STUDYPACK
 378 Trust Law and Accounts

on Accumulations Account.
The income arising on accumulation investments should be credited to Income Accumulations Account
and divided between the infants in proportion to the balances on Accumulations Account at the
commencement of the year.

It will be appreciated from the above that the Income Accumulations Account is merely an
income account ruled with columns to distinguish the income belonging to each beneficiary. The
total balances on this account will be represented by Accumulation Investments and cash at bank.

(d) Distribution to a beneficiary

Before distribution to a beneficiary, the investments will be re-valued and the profits or losses divided
between the beneficiaries as follows:-

i. Capital investments, equally, or according to the terms of the will or trust deed;
ii. Accumulation investments, according to the balances on the Income

Accumulations Account at the commencement of the year.

A beneficiary may be paid out the share due to him in one of the following ways:-

i. Exact division of each investment,

ii. Appropriation in specie by agreement and adjusting either way in cash,
iii. All investments realised and the amount due to the beneficiary paid to him.

(e) Pro-forma accounts

Accumulation trust with three beneficiaries A,B & C, entitled equally

1. PRO-FORMA ESTATE CAPITAL ACCOUNT

A B C A B C

Shs'000 Shs'000 Shs'000 Shs'000 Shs'000 Shs'000

Distribution a/c Bal.b/f 2,000 2,000 2,000

(transfer of Investment
amount due to Accounts
beneficiary A (profit on
on attaining revaluation
his majority) 2,200 credited to
beneficiaries
in proportions
directed in
will or trust
Bal.c/f — 2,200 2,200 deed) 200 200 200
2,200 2,200 2,200 2,200 2,200 2,200

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FINANCIAL ACCOUNTING III
 Lesson Seven 379

PRO-FORMA INCOME ACCUMULATIONS ACCOUNT

A B C A B C

Shs'000 Shs'000 Shs'000 Shs'000 Shs'000 Shs'000

Cash Bal.b/f 100 100 50

(maintenance
payments) 40 30 15 Investments
on Capital a/c
Distribution a/c (income
(balance due received on
to A) 190 capital
investments
divided in
proportion
prescribed in
will or trust
deed)
Shs.300,000 100 100 100

Bal.c/f - 200 150 Investments

on accumula-
tions a/c
(income received
on accumulations
investments in
proportion to
balance on
Income Accumula-
tions Account at
beginning of year)
Shs.25,000 10 10 5

Investments on
Accumulations
Account
(profit on
realisation and
revaluation of
accumulation
investments in
proportion to
balance on
income Accumula-
tions Account at
beginning of year)
Shs50,000 20 20 10
230 230 165 230 230 165

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STRATHMORE UNIVERSITY● STUDYPACK
 380 Trust Law and Accounts

3. PRO-FORMA DISTRIBUTION ACCOUNT

Shs'000 Shs'000

Investment A/cs Estate Capital a/c

(investments (balance due to
transferred to beneficiary on
beneficiary at capital account) 2,200
re-valuation
figures) 2,200 Income Accumulation
Cash Account
(balance due to (balance due to
beneficiary) 190 beneficiary on
accumulations a/c 190 _____
2,390 2,390

4. PRO-FORMA STATEMENT OF FINANCIAL POSITION

Shs'000 Shs'000
Investments on Capital
Account
(detailed) 4,400

Investments and Cash

on Accumulation Account
(detailed) 350
4,750

Estate Capital Account 4,400

Income Accumulation accounts

B 200
C 150 350
4,750

Example
When both parents of Alice and Beatrice died in a car accident, their rich uncle set up a trust to provide for
them until they married. They were to share income equally. When Alice and Beatrice married the capital was
to pass equally to the children of his nephews and nieces.

The uncle directed the trustees to invest only in investments authorised by the Trustees Act (Cap.167 of the
Laws of Kenya) except:

1. they could retain at their absolute discretion 10,000 shares of Sh.10 each in Updown Limited, a
private company;

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FINANCIAL ACCOUNTING III
 Lesson Seven 381

2. they would not recall a loan of Sh.1,200,000 to Alice, unless Alice wished to repay the whole or part
of it; the loan was secured by a mortgage on Alice‘s leasehold house of which 15 years remain
unexpired. After the trust had been in existence for 2 years, the statement of financial position at 31
March 1996 was as follows:
Fixed interest investments Sh. ‗000‘ Sh. ‗000‘
Sh.3 million 12% Kenya stock at cost 2,955
Cash at bank 45
3,000
Water range investments:
30,000 shares in BAT (K) Ltd. 3,000
Special range investments:
15% mortgage loan to Alice 1,200
10,000 shares of Sh.10 in Updown Ltd. 150 1,300
Income cash 72
7,422
Trust capital:
Fixed Interest Fund 3,000
Wide Range Fund 3,000
Special Range Fund 1,350 7,350
Life Tenants‘ Accounts
Alice 36
Beatrice 36 72
7,422

Interest on the Kenya Stock was received on 30 June 1996 and 31 December 1996. The interest on
the mortgage loan to Alice was due on 31 March each year. She had paid interest due on 31 March
1996, but negotiated with the trustees that she would not draw out any income from the trust in
respect of the year 31 March 1997. Instead her share of the income would be used to pay the interest
on the loan and to pay any repairs relating to the house; any balance remaining would be used to pay
part of the loan.

The trust‘s other receipts and payments were as follows:

1996 Sh. ‗000‘

April 15 Amount paid to life tenants 72
April 30 Dividend of 60% on the share of Updown
Ltd. for the year ended 31 December 1995
May 28 Amount paid for repair for Alice‘s house 24
June 29 Proceeds of sale of 30,000 shares in
BAT (K) Ltd. 3,600
July 5 Purchase of 36,000 Sh.10 ordinary shares in
Nation (Kenya) Ltd. a wider range
investment. 3,600
September 15 Receipt of interim dividend of 30% on the
shares in Nation (K) Ltd., for the year to
31 December 1996.
December 14 Receipt of proceeds of sale 10,000 shares in
Updown Ltd. 360
December 31 Purchase of Sh. 450,000 nominal of 12%
Kenya Stock at 90
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STRATHMORE UNIVERSITY● STUDYPACK
 382 Trust Law and Accounts

1997
January 20 Paid to Beatrice in respect of income 150
March 31 Paid out of income administration expenses
for the year 60

Required
(a) Write up the trust cash account, the income account, the life tenants‘ account and the trust
capital account for the year ended 31 March 1997. (12 marks)

(b) Prepare the trust statement of financial position as at 31 March 1997. (8 marks)
(Total: 20 marks)

Solution
TRUST INCOME ACCOUNT
1996 Sh.‘000‘ 1996 Sh.‘000‘
April 30 Cash book
Dividend from up down 60

June 30 Cash book

12% Kenya stock interest 180

15 Sept Cash book

Dividend from nation 108

Dec 31 Cash book

12% Kenya stock Interest 180
1997 1997
Mar 31 Cash book – Expenses 60 March 31 Life tenant
Mar 31 Life tenants: Interest on loan to Alice 180
Income division (A) 324
(B) 324 ___
708 708

LIFE TENANT ACCOUNT

1996 Alice Beatrice Alice Beatrice
Sh.‘m‘ Sh.‘m‘

April 15 CB: Maintenance 36 26 1996 36 36

May 28 Cash Book – repaid 24 April 1 Bal b/d
1997
Jan 20 CB Maintenance - 150 1997
Mar 31 Mortgage Int (Income 180 Mar 31 Income A/c
Mar 31 A/c) 120 Division of 324 324
Mar 31 Mortgage A/c - 176 income
Bal c/d
360 360 360 360

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FINANCIAL ACCOUNTING III
 Lesson Seven 383

TRUST CASH BOOK

Income Special Wide Fixed Income Special Wide Fixed
range Range interest range Range interest
1996 1996
Apr 1 Bal b/d 72 Apr 15 Tenants 72 - -
Ap 30 Income A/c 60 May 28 Tenants 24
Jul 29 BAT Jul 5 Investment in
Investment 3,600 Nation 3,600
Jun 30 Income Int. 180 Central 360
Dec 14 Inv in Dec 31 Inv. In 12%
Updown 360 180 180 K Stock 180 225
Sep 15 Nation 108
Dec 31 Investment
in 12% 180
1997 1997
Mar 31 Central _ __ 60 60 Jan 20 Tenant 150
Mar 13 Income a/c 60
Mar 31 Central 120
__ _ ____ ___ Mar 31 Bal c/d 124 ____ 60 ___

600 360 3,840 225 600 360 3,840 225

TRUST CAPITAL A/C

SR F1 WR SR F1 WR
1996
Dec 14 Contra 360 Apr 1 Bal c/d 1,350 3,000 3,000
Mar 31 Contra 120 Jun 29 Invest. In BAT 600
Dec 14 Invest in
updown 210
Mar 31 Bal c/d 1,080 3,240 3,840 Contra 180 180
1997
Mar 31 Contra 60 60
1,560 3,240 3,840 1,560 3,240 3,840
Bal b/d 1,080 3,240 3,840

WORKING

UPDOWN A/C
Sh.‘000‘ Sh.‘000‘
B/F 150 C.B 360
Spearl range fund 210 ___
360 360

MORTGAGE LOAN A/C

Sh.‘000‘ Sh.‘000‘
Bal b/d 1,200 Life tenant 120
____ Bal c/d 1,080

1,200 1,200

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STRATHMORE UNIVERSITY● STUDYPACK
 384 Trust Law and Accounts

B.A.T A/C
Sh.‘000‘ Sh.‘000‘
Bal b/f 3,000 Cash book 3,600
Wide range fund 600 ____
3,600 3,600

ALICE AND BEATRICE

STATEMENT OF FINANCIAL POSITION AS AT 31 March 1997
Sh. Sh.
FIXED INTEREST INVESTMENTS
3,180
3,250,000 (W) 12% Kenya stock
60 3,240
Cash at bank

WIDER RANGE INVESTMENTS

3,600
36,000 ordinary shares of Sh.10 in Nation 180
200,000 (N) 12% Kenya stock 60 3,840
Cash at bank

SPECIAL RANGE INVESTMENTS 1,080 1,080

15% mortgage loan to Alice
174
INCOME ASSETS
8,334
Cash at bank
3,240
Trust Capital: 3,840
Fixed interest 1,080
Wider range 8,160
Special range 174
Life tenant account balance 8,334

Example
Kahari and Ligaga two brothers are the life tenants of a trust set up by their rich uncle, Maundu.
Maundu had never married. He set up the Maundu Trust with the following terms

The trustees were to have unrestricted powers of investment:

The trustees were to share any income that arose equally between Kahari and Ligaga.
Kahari and Ligaga were to receive income until their deaths, on the death of either of the life tenants; one half
of the capital passes absolutely to Nzau, Maundu‘s youngest brother.

The statement of financial position of the trust was as follows on 30 September 1999

CAPITAL ASSETS: SH. ‗000‘

House in Milimani, Nairobi 5,400.00
Sh 9 million 12% Kenya Treasury stock 8,820.00
60,000 Sh.10 ordinary shares in Uchumi Limited 3,870.00
24,000 Sh.10 ordinary shares in Media Group Ltd. 2,040.00
Cash at bank:: Capital 1,410.00
Income 120.00
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FINANCIAL ACCOUNTING III
 Lesson Seven 385

21,660.00

Trust capital 21,540.00

Trust income 120.00
21,660.00

In the year ended 30 September 2000, the following transactions took place:
Interest on the 12% Kenya Treasury Stock was received on the due dates, 31 December and 30 June.
The trustees sold Sh 3million 12% Kenya Treasury Stock on 1 November 1999 to enable them to purchase a
further 50,000 Sh.10 ordinary shares in Uchumi Limited at Sh.69 per share. The 12% Kenya Treasury
Stock was sold at a price of 88. The shares in Uchumi Limited were purchased on 1 December 1999.
Kahari died on 31 January 2000. He had been living in the house in Milimani, Nairobi, owned by the trust,
paying rent of Sh.40, 000 per month, quarterly in arrears. He had paid 3 months‘ rent on 31 October
1999 but had not paid the rent due on 31 January 2000: This was to be offset against his claims on the
Trust. The house remained empty from 1 February 2000 onwards.
On 31 January 2000 the market values of the assets in the Trust were as follows:
House in Milimani Nairobi Sh.9, 600,000
12% Kenya Treasury Stock Sh.90
Sh.10 ordinary shares in Uchumi Limted Sh.75
Sh.10 ordinary shares in Media Group Ltd. Sh.100

Dividends of Sh.7.50 per share on the ordinary shares in Media Group Limited in respect of the year ended
31 December 1999 were received on 30 April 2000. Dividends of Sh.6 per share on the ordinary shares
in Uchumi Limited in respect of the year ended 31 March 2000 were received on 30 June 2000.
The Trustees paid to the executors of Kahari, the amount due to Kahari, on 1 September 2000. On the same
day, they paid the income due to Ligaga and distributed to Nzau the house in Milimani, Nairobi, 39,000
Sh.10 ordinary shares in Uchumi Limited and the remainder in cash. On 1 September 2000, the values of
the assets were the same as on 31 January 2000.

Required:
Cash book and the trust capital account for the year ended 30 September 2000. (7 marks)
Show how the available income will be divided between Kahari, Ligaga and Nzau. Apportionments should
be made on the basis of months.
The distribution account for Nzau and the Trust Statement of financial position as at 30 September 2000.
The trustees incorporated revaluation into the books of the Trust. (7 marks)
(Total: 17 marks)
Solution
Since the trustees were to have unrestricted powers of investment, there is no need to split the fund into fixed
interest or wider range or special range components.

1.10.99 O N D J F M A M J J A S

Trial balance
is given 31. Jan – K died; 30.April.2000
rent due from him dividends from 30.6.2000 1. Sept. 2000
Purchased 50,000 Sh. 120,000 media received Interest on 12% Distributed
31.10.99 – Received ord. Shares in Kenya Stock assets to
rent Sh. 120,000; Uchumi at sh. 69 received :- K‘s executors
1.11.99 – sold 3m(N)K 30 June 2000 :- L
stock 31.Dec.99 Dividends from :- N
Interest on 12% Kenya Stock Uchumi received
Received
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STRATHMORE UNIVERSITY● STUDYPACK
 386 Trust Law and Accounts

The trust statement of financial position at the beginning of the year will be redrawn as follows:
Capital Fund Income Fund
Shs. ‗000‘ Shs. ‗000‘
Milimani House 5,400
Sh. 9m (N) 12% K Stock 8,820
60,000 shares in Uchumi 3,870
24,000 shares in media 2,040
Cash at Bank 1,410 120

21,540 120

Trust Capital/Income 21,540 120

Trust Cashbook

1999 Capital Income 1999 Capital Income

Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Sh‘000‘
1 Oct bal b/d 1,410 120 1 Dec in DSC (Uchumi) 3,450
31 Oct Income: rent 120
1 Nov Inv in Kenya T Stock 2,640
31 Dec. Inv in Kenya T. Stock 360
2000 2000
31 April Inv. In media grp 180 1 Sept. Distribution a/c 600 78
30 June Inv in Kenya Stock 360 1 Sept. Life tenants - 1,402
30 June Inv in Uchumi ____ 660 1 Sept: Executors(K) ____ 320
4,050 1800 4,050 1800

Trust Capital

1999 Sh. ‗000‘ 1999 Sh. ‗000‘

1 Nov Loss on disp.(12% Tstock) 300 1 Oct Bal b/d 21,540
2000 2000
31 Jan Reval loss: 31 Jan Reval gain:
12% Kenya T. Stock 480 Milimani house 4,200
60000 Uchumi shares 630
31 Jan Distribution a/c (1/2) 13,125 50000 Uchumi shares 300
30 Sept. Bal c/d (1/2) 13,125 24000 Media shares 360
27,030 27,030

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FINANCIAL ACCOUNTING III
 Lesson Seven 387

Workings for revaluation gains/losses

Cost (Sh. ‗000‘) Market price (Sh. ‗000‘)

Gain/Loss(Sh.‘000‘)
Milimani House 5400 9600 4200G
60000 Uchumi shares 3870 4500 630 G
50000 Uchumi shares 3450 3750 300G
24000 Media shares 2040 2400 360G
Sh 9m (N) 12% Kenya
Stock 5880 5400 (480)L

Income a/c

1999 Sh. ‗000‘ 1999 Sh. ‗000‘

1 Oct Bal b/d 120
31 Oct. CB: Rent income 120
31 Dec CB: Interest on K. Stock 360
2000 2000
1 Sept. Life tenants: K 440 31 Jan Life tenants: Rent due 120
:L 1402 30 Apr Dividend from Media Grp 180
1 Sept. Distribution a/c: N 78 30 June Dividend from Uchumi 660
____ 30 June Int on 12% Kenya T Stock 360
1920 1920

Rental Income:

1 Oct. 99 4 months 31 Jan 00 8 months 30 September 00

4 months = 240 8 months = 0

K = 120 L = 120 Total =240 K=0 L= 0

Distribution a/c

1999 Sh. ‗000‘ 1999 Sh. ‗000‘

1 Sept: House in Milimani 9,600 31 Jan Trust capital 13,125
1 Sept: 39000 shares in Uchumi 1 Sept Trust Income 78
(at Sh. 75 per share) 2,925
1 Sept: Capital cash 600
1 Sept. income cash 78
13,203 13,203

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STRATHMORE UNIVERSITY● STUDYPACK
 388 Trust Law and Accounts

Interest on 12% Kenya Stock

1 Oct 99 31 Jan 00 30 Sept. 00

4 months 8 months
= 240 = 480

K = 120 L = 120 Total = 720 L = 480 N=0

Media Group Dividend

1 Oct. 99 4 months 31 Jan 00 8 months 30 Sept. 00

= 60 = 120

K = 30 L = 30 Total = 180 L = 120 N=0

Dividend from 39,000 shares in Uchumi

1 Oct. 99 4 months 31 Jan 00 8 months 30 Sept 00

= 78 = 156

K = 39 L = 39 Total = 234 L= 78 N = 78

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FINANCIAL ACCOUNTING III
 Lesson Seven 389

Dividend from 71,000 shares in Uchumi

1 Oct. 99 4 months 31 Jan 00 8 months 30 Sept. 00

= 142 = 284

K = 71 L = 71 Total = 426 L = 284 N=0

Summary of Income distribution

Life tenants Life tenants Distribution a/c

K L N
Balance b/d 60 60 -
Rental income 120 120 -
Interest on 12% K Stock 120 600 -
Media group dividend 30 150 -
Dividend on 39000
Uchumi shares 39 117 78
Dividend on 71000
Uchumi shares 71 355 -
440 1,402 78

Life Tenants

2000 K:sh. ‗000‘ L:Sh. ‗000‘ 2000 K:sh. ‗000‘ L:Sh. ‗000‘
31 Jan Income a/c: rent 120 - 1 Sept. Income a/c 440 1402
1 Sept. Cash book - 1402
1 Sept. Executor a/c 320 ____ ____ ____
440 1,402 440 1,402

Executors (K) a/c

2000 Sh. ‗000‘ 2000 Sh. ‗000‘

1 Sept. Cashbook 320 1 Sept. Life tenants 320

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STRATHMORE UNIVERSITY● STUDYPACK
 390 Trust Law and Accounts

Ligaga:
Trust statement of financial position as at 30 Sept. 2000
Capital investments: Sh. ‗000‘ Sh. ‗000‘
71000 Uchumi shares @75 5,325
24000 Media Group shares @100 2,400
Shs. 9m (Nominal) 12% Kenya Stock 5,400
13,125

Trust capital a/c 13,125

Example
Kena, Limo and Mara had been orphaned when both their parents died in a bus accident in April 1992. Their
uncle, Mr. Barua, a stockbroker on the Nairobi Stock Exchange, organised a harambee for them in June 1992
and raised Sh.1, 980,000. He invested this amount as follows:
Sh.
9,600 Sh.10 Ordinary Shares in KAB Ltd. 432,000
12,600 Sh.10 Ordinary Shares in BBB Ltd. 756,000
13,200 Sh.10 Ordinary Shares in TEA Ltd. 792,000
1,980,000

He established an accumulation and maintenance trust to hold these investments on behalf of the children. The
trust had a wide investment clause. He ruled that accounts be made up to 31 May each year. When each child
reached the age of 21, the trustees were to transfer to him his share of the fund at that date. Kena turned 21 years
on 31 May 1996.

The balances on the Accumulation Accounts of Kena, Limo and Mara at 1 June 1995 were Sh.207, 900,
Sh.103,950 and Sh.34,650. To this date, the trustees had used accumulated income to purchase 5,775 Sh.10
Ordinary Shares in TEA Ltd. On 1 June 1995, there was no cash in the income account in the bank.

In the year to 31 May 1996, Sh.222, 750 was received from Capital Investment and Sh.62,370 from
Accumulation Investments and maintenance payments made on behalf of Kena, Limo and Mara were Sh.77,
000, Sh.81, 000 and Sh.94,000, respectively. On 31 May 1996, the market values of the shares in KAB Ltd.,
BBB Ltd and TEA Ltd, were Sh.60, Sh.80, and Sh.70 respectively.
Kena was to receive 10,000 Sh.10 Ordinary Shares in BBB Ltd. and the balance due to him on capital would
be made up of shares in KAB Ltd. Out of the accumulation assets, Kena was to receive Sh.32, 222 in cash
and the balance in shares in TEA Ltd.

Required:
The beneficiaries‘ accumulation accounts for the year ended 31 May 1996 and distribution statements for the
capital and accumulation assets as at 31 May 1996.

Solution
NB: The fact that the trust had a wide investment clause means there is no need to divide the fund into
―fixed interest‖, ―wider range‖ or ―special range‖ sections.

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FINANCIAL ACCOUNTING III
 Lesson Seven 391

June 1992: 1 June 1995 31 May 1996

Fund is established

Accumulation investments Accumulation a/cs balance K turned

Made = 5775 Shares =K 207900 21 years
in TEA =L 103950
=M 34650

Distribution Statement: Capital Assets

Total Distribution To K To remain in Trust

Nominal/No Value Nominal/No Value Nominal/No Value
Shs. Shs. Shs.
Ordinary Shares
in KAB 9,600 576,000 600 36,000 9,000 540,000
Ordinary shares
in BBB12,600 1,008,000 10,000 800,000 2,600 208,000
Shares in
TEA 1 3,200 __924,000 - ______- 13,200
2,508,000 836,000 924,000
1,672,000

Distribution Statement: Accumulation assets

Total To K To remain in trust

Nominal/No. Value Nominal/No Value Nominal/No. Value
Ordinary shares in Shs. Shs. Shs.
TEA 5,775 404,250 3,500 245,000 2,275 159,250
Cash 33,120 32,222 898
437,370 277,222 160,148

* (222750 + 62370 – 77000 – 81000 – 94000) = 33,120

Beneficiaries‘ Accumulation a/cs

K(sh) L(sh) M(sh) K(sh) L(Sh) M(sh)

Maintenance payment 77,000 81,000 94,000 Bal b/d 207,900 103,950 34,650
Distribution a/c 277,222 Income (Caps) 74,250 74,250 74,250
Income (Acc) 37,422 18,711 6,237
Bal c/d -_____ 133,236 26,912 Reval gain (TEA) 34,650 17,325 5,775
354,222 214,236 120,912 354,222 214,236 120,912

Trust Capital a/c

Shs. Shs.
Distribution a/c 836,000 Bal. b/d 1,980,000
Reval gain: (KAB) 144,000
: (BBB) 252,000
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STRATHMORE UNIVERSITY● STUDYPACK
 392 Trust Law and Accounts

Bal c/d 1,672,000 : (TEA) 132,000

2,508,000 2,508,000

Trust Income a/c

Shs. Shs. Shs. Shs.

Capital Accumulation Capital Accumulation
Accum. a/c K 74250 37422 Investment a/c 222750 62370
L 74250 18711
M 74250 6237 ______ ____
222750 62370 222750 62370

Trust Cashbook
Shs. Shs. Shs. Shs.
Capital Income Capital Income
Inv.a/c:Income - 222,750 Accum a/c: Maint. - 252,000
Inv a/c:Income 62,370 Distribution a/c - 32,222
Bal. c/d - 898
- 285,120 - 285,120

Example
Aviha died in 1997 and left, by his will, the residue of his estate to his children, Reuben and Levi, in equal
shares. The will directed that a child‘s share of the estate should be ascertained and discharged on
reaching twenty one years of age. The trustees were empowered to maintain the children out of the
income and to use their unfettered discretion in the choice of investments.

The trial balance extracted from the books of the trust as at 31 July 2003 was as follows:

Sh. ―000‖ Sh. ―000‖

Investment on estate capital account
20,000 shares of Sh.100 each in ABC Ltd. 2,200
30,000 shares of Sh.100 each in Mapingo Ltd. 2,800
Investment on accumulation accounts:
1,000 shares of Sh.100 each in ABC Ltd. 110
1,000 shares of Sh.100 each in Mapingo Ltd. 90

Bank balances:
On estate capital account 200
On accumulation accounts 50
Estate capital account 5,200
Accumulation accounts:
Reuben 150
Levi ____ 100
5,450 5,450

Reuben attained the age of twenty one years on 31 October 2003, on which date the market prices of the
investments were

ABC Ltd shares Sh. 125

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FINANCIAL ACCOUNTING III
 Lesson Seven 393

Mapingo Ltd. Shares Sh. 100

Transactions in the three months to 31 October 2003 comprised:

1 August 2003: Receipt of dividend of sh. 5 each share inABC ltd.

31 August 2003: Maintenance payment of sh 30,000 and sh.20,000 for Reuben and Levi
respectively.
31 October 2003:The trustees revalued all of the investments and discharged their liability to Reuben by the
transfer to him of:
- One half of each of the investments held on capital accounts
-3/5ths of each of the investments held on accumulation accounts.
-Cash for the balance due to him.

Required:
(i) Estate capital account.
(ii) Accumulation accounts.
(iii) Distribution to Reuben account.
(15 marks)
Solution
(i) Trust Capital
Sh.‘000‘ Sh.‘000‘
Distribution (½) 2,850 Bal b/d 5,200
Bal c/d 2,850 Revaluation gains 500
5,700 5,700

Workings for Revaluation Gains

Capital Initial Increased Increases No. of Gain
MPS MPS Sh. shares Sh.‘0
Sh. Sh. Sh.‘000‘ 00‘
ABC Ltd 110 125 15 20 300
Mapingo Ltd 93⅓ 100 6⅔ 30 200
Total 500
Accumulation
ABC 110 125 15 1 15
Mapingo Ltd 90 100 10 1 10
191,434 191,434 237,046 237,0
46

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STRATHMORE UNIVERSITY● STUDYPACK
 394 Trust Law and Accounts

(ii) Accumulation A/c

Reuben Levi Reuben Levi
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Maintenance 30 20 Bal b/d 150 100
Distribution 188 - Dividend income(Capital) 50 50
Bal c/d - 142 Dividend income (Accum) (3:2) 3 2
Revaluation gain:
ABC: (3:2) 9 6
Mapengo:(3:2) 6 4

218 162 218 162

(iii) Distribution A/c

Sh.‘000‘ Sh.‘000‘
Capital investments: Trust capital 2,850
10,000 ABC shares 1,250 Accumulation A/c 188
15,000 Mapingo shares 1,500
Cash 100
Accumulation investments
600 Mapingo shares 60
Cash 53 _____
3,028 3,038

Cash A/c
Sh.‘000‘ Sh.‘000‘
Bal b/d 200 50 Maintenance 50
Dividends (ABC) capital 100 Reuben distribution 100 53
Dividends (ABC) ___ 5 Bal c/d 100 52
200 105 200 105

Statement of financial position as at 01.11.03

Sh.‘000‘ Sh.‘000‘
Assets
Capital investments:
10,000 shares in ABC Ltd @Sh.125 1,250
15,000 shares in Mapingo Ltd @ Sh.100 1,500
2,750
Accumulation Investment
400 ABC shares @Sh.125 50
400 Mapingo shares @ Sh.100 40 90
Cash: Capital 100
Income 52 152
2,992
Trust capital 2,850
Accumulation a/c 142 ______
2,992

Tutorial note: The last 2 accounts are not required by the examiner, they are illustrative.
Example

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FINANCIAL ACCOUNTING III
 Lesson Seven 395

Kiura and Maina are life tenants of a trust set up by their uncle. The trustees have investment powers
restricted to those contained in the Trustee Act (Chapter 167 of the Laws of Kenya) except they could hold at
their absolute discretion 300,000 shares of Sh.10 each in Kilimanjaro Enterprises Limited, a horticultural
exporting company run by the uncle..
On 31 March 2002, the statement of financial position of the trust was as follows:

Sh.‘000‘ Sh.‘000‘
Fixed interest investment: Sh.2 million 10% Kenya stock 2007 (cost) 2,000
Sh.2 million 9% Kenya stock 2006 (cost) 1,800
Cash at bank 200
4,000
Wider range investments: 40,000 shares of Sh.100 in E.A. Breweries Ltd (cost) 4,000
Special range investment: 300,000 shares in Kilimanjaro Enterprises Ltd. (cost) 3,000
11,000
Trust capital 4,000
Fixed interest fund 4,000
Wider range fund 3,000
Special range fund 11,000

In the year to 31 March 2003, the following occurred:

2002
30 June Interest for the year ended 30 June 2002 was received on 10% Kenya stock.
School fees for Kiura and Maina were paid immediately using the whole amount
received.

30 September A final dividend of 75% for the year ended 30 June 2002 was received from E.A.
Breweries Ltd. (payout rate 10%).

30 September The E.A. Breweries Ltd. shares were sold at Sh.110 each. At the same time, a
satisfactory buyer was found for the 300,000 shares in Kilimanjaro Enterprises
Limited – these shares were sold for Sh.15 each. Some high yielding 12%Kenya
stock 2008 was available at par on this date. It was decided to use all the wide
range cash available to purchase this stock and designate it a wider range
investment.

31 December Interest was received for the year on the 9th Kenya stock and Sh.42,000 interest
was received on the fixed interest cash at bank.

2003
28 February 61,250 Sh.10 ordinary shares in ICDI Limited were purchased for Sh.40 per share
using the fixed interest cash and a suitable swich was made to ensure adherence to
the requirements of the Trustee Act. The market value of the 12% Kenya stock
on this date was still par.

31 March All remaining income cash was paid across to the life tenants, after trust
administration expenses of Sh.120,000 were paid for the year.

Required:
(a) Write up the trust cash account, the income account (showing payments to beneficiaries in this
account) and the trust capital account for the year ended 31 March 2003.
(9 marks)
(b) Prepare the trust statement of financial position as at 31 March 2003. (6
marks)
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STRATHMORE UNIVERSITY● STUDYPACK
 396 Trust Law and Accounts

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FINANCIAL ACCOUNTING III
Lesson Seven 397

Solution
(a) Trust Cash Account
2002 Income F1 WR SR 2002 Income F1 WR SR
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Apr.1 Bal. b/f 200 Jun.30 Income A/c Distrib. 200
Jun.30 Income A/c 200 Nov.30 Contra 4,500
Sep.30 Income A/c 300 Nov.30 12% Kenya stock 6,650
Nov.30 E.A.B. Ltd 4,400 2003
Nov.30 K.E Ltd. 4,500 Feb.28 Inv. In ICDCI shares 2,450
Nov.30 Contra 2,250 2,250 Mar.31 Inc. A/c expenses 120
Dec.31 Income A/c 180 Mar.31 Inc. A/c – K 201
Dec.31 Income A/c 42 _____ _____ _____ Mar.31 Inc. A/c – M 201 402 ____ ____ ____
722 2,450 6,650 4,500 722 2,450 6,650 4,500

Income Account
2002 Sh.‘000‘ 2002 Sh.‘000‘
June 30 CB: School fees paid for K & M 200 June 30 CB: Interest on 10% Kenya Stock 200
2003 Sep. 30 CB: Final dividend on EABL shares 300
Mar. 31 CB: Expenses for the year paid 120 Dec. 31 CB: Interest on 9% Kenya Stock 180
Mar. 31 Distribution to K 201 Dec. 31 CB: Interest on Bank Deposit. 42
Mar. 31 Distribution to M 201 ___
722 722

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STRATHMORE UNIVERSITY● STUDYPACK
 398 Trust Law and Accounts

Trust Capital Account

2002 FIF WRF SRF 2002 FIF WRF SRF
Sh.‘000‘ Sh.‘000‘Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
April Bal b/f 4,000 4,000 3,000
1 Inv. In EAB
Nov, Contra 4,500 Nov. Ltd 400
30 30 Shares: Surplus
Inv. In 1,500
2003 Bal. c/d 6,250 6,650 ____ Nov. Kilimanjaro 2,250 2,250 -
Mar 30 Ent: surplus
31 Contr
Nov.
30
6,250 6,650 4,500 6,250 6,650 4,500
2003
Apr.1 Bal b/d 6,250 6,650

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FINANCIAL ACCOUNTING III
 Lesson Seven 399

(b) Trust Statement of financial position

as at 31 March 2003

Sh.‘000‘ Sh.‘000‘
Fixed interest investment Sh.2 million 10% Kenya stock 2007 2,000
Sh.2 million 9% Kenya stock 2006 1,800
Sh.2 million 12% Kenya stock 2008 2,450
6,250
Wider range investments Sh.4.2 million 12% Kenya stock 2008 4,200
61,250 Sh.10 Ordinary shares in ICDCI ltd 2,450
6,650
12,900
Trust capital:
Fixed interst fund 6,250
Wider range fund 6,650
12,900

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STRATHMORE UNIVERSITY● STUDYPACK
 400 Trust Law and Accounts

REINFORCEMENT QUESTIONS

QUESTION ONE
Onyango died ten years ago and by his will left the residue of his estate in trust for his children Abel and
Beatrice in equal shares. The will directed that a child's share should be ascertained and discharged on reaching
21 years of age. The trustees were empowered to maintain the children out of income and to use their unfetted
discretion in the choice of investments.

The following trial balance was extracted from the books as on 31st December 20X3:

Shs Shs
Investments on Estate Capital Account:
20,000 shares of Shs.10 each in K Ltd. 220,000
30,000 shares of Shs.10 each in L Ltd. 280,000

Investment on Accumulation Accounts:

1,000 shares of Shs.10 each in K Ltd. 10,100
1,000 shares of Shs.10 each in L Ltd. 9,000

Balance with bankers:

on Estate Capital Account 20,000
on Accumulation Accounts 5,000

Estate Capital Account 520,000

Accumulation Accounts:
Abel 15,000
Beatrice 10,000
545,000 545,000

Abel attained 21 years of age on 31st March 20X4, on which date the middle market prices of the investments
were:

K Ltd. Shs.12.50
L Ltd. Shs.10

Transactions in the three months ended 31st March 20X4 comprised:

a. 1st January - Receipt of dividend of Shs.0.50 on each Shs.10 share in K Ltd.

b. 31st January - Maintenance payments: Abel Shs.3,000; Beatrice Shs.2,000

On 31st March 20X4 the trustees revalued all the investments and discharged their ability to Abel by the transfer
to him of:

a. One-half of each of the investments held on capital account;

b. Three fifths of each of the investments held on accumulation accounts, and
c. Cash for the balance of the amount due to him.

You are required to write up the following accounts in the books of the Trust for the three months ended 31st
March 20X4:
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FINANCIAL ACCOUNTING III
 Lesson Seven 401

1. Estate capital account;

2. Accumulation accounts (in columnar form),and
3. Distribution account - Laertes

Ignore taxation. (Total: 25 Marks)

QUESTION TWO
Abincha died on 31st March 20X5 and by his will he left the residue of his estate to his three sons, Bruce, Chris
and Dan, in equal shares, contingent upon attaining the age of 18 years.

The trustees' powers of investment were restricted to "those investments authorised by law as suitable for
trustees" except that the trustees could hold a plot of short leasehold land until a suitable time for its sale arose.

The will provided that the trustees could maintain the children out of the income of the trust and that on
attaining the age of 18 years each son was to receive his share of the capital of the trust and the accumulated
income due to him.

The trustees had divided the trust funds into equal, fixed interest and wider ranges under the terms of the
Trustee Act. On 31st March 20X8 the statement of financial position of the trust was:

Capital accounts Shs Shs

Fixed Interest 250,000
Wider range 250,000
Special range 60,000
Accumulation accounts
Bruce 8,000
Chris 12,000
Dan 12,000
Investments
Fixed Interest at cost
Sh.250,000 6% Government stock 20Y5 210,000
Sh.40,000 4% National stock 20X8 39,000
Wider range at cost
10,000 Sh.10 Ordinary shares in G Ltd 219,000
1,000 Sh.10 Ordinary shares in S Ltd 30,000
Special range at cost
Plot of land 60,000
Accumulations at cost
Sh.30,000 6% National stock 20Y5 24,360
Bank balances
Fixed Interest 1,000
Wider range 1,000
Accumulations 7,640
592,000 592,000

Bruce, the eldest son, attained the age of 18 years on 31st July 20X8 and the transactions of the trustees for the
four months to that date were:

30th April 20X8 received a dividend of 5% on the shares in S Ltd. and half a year's interest on
the holding of 6% Government stock 20Y5.

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STRATHMORE UNIVERSITY● STUDYPACK
 402 Trust Law and Accounts

31st May 20X8 received Shs.120,000 being the net proceeds of the sale of the plot of land and
Shs.35,000 being the net proceeds of the sale of the whole of the holding of
shares in S Ltd.

10th June 20X8 purchased and paid for sufficient Ordinary shares of Shs.10 each in Z Ltd. at
Shs.25 a wider range investment, and such an amount of 5% Government
stock 20Y4 at 80, a narrower range investment, both prices including all costs,
so that all the cash available for investment on capital funds was invested.

30th June 20X8 paid the following cheques for maintenance:

Bruce Shs.1,500, Chris Shs.900 and Dan Shs.850; received a half year's interest
on the holding of 4% National stock 20X8 on its conversion into 8%
Government stock 20Y8 at par.

31st July 20X8 the trustees revalued the trust funds and appropriated Sh.230,000 of the
holding of 6% Government stock 20Y5 and sufficient Ordinary Shs.10 shares
in Z Ltd. to satisfy Bruce's share of the capital and paid him a cheque for the
balance of accumulations due to him. Bruce had agreed to have transferred to
himself, at a later date, the shares and stock appropriated in satisfaction of his
share of the capital of the trust fund.
You ascertain that:

the mid-market values of the investments at 31st July 20X8 were:

Ordinary shares G Ltd. Shs28

6% Government stock 20Y5 95
6% National stock 20Y5 94
Ordinary shares Z Ltd Shs27.50
5% Government stock 20Y4 94
8% Government stock 20Y8 97 3/4

All necessary advice has been taken.

You are required to prepare for the 4 months ended 31st July 20X8:

a. Cash account
b. Estate Capital accounts (in columnar form)
c. Accumulation accounts (in columnar form) and
d. Statement of financial position of the trustees as at 31st July 20X8 (Total:30
Marks)

QUESTION THREE
Kamau died on 30 June 20X4, leaving a net estate of Shs.3,600,000 (after all legacies, duties, debts and other
outgoings had been paid). By his will Kamau bequeathed the residue of his estate to his three sons, Maina,
Njoroge and Karanja in equal shares; the will also contained a wide investment clause so that the provisions of
the Trustee Act were not to be applied by the trustees of the estate.

At the date of Kamau's death all three residuary legatees were under 18 years of age, but Karanja (the eldest)
became 18 on 31st March 20X6, when the trustees of Kamau's estate arranged to transfer to him his due share
of the estate.

The following transactions affecting Kamau's estate, and the interests of his sons therein, occurred between 30
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FINANCIAL ACCOUNTING III
 Lesson Seven 403

June 20X4 and 31 March 20X6:

Assets held in trust on capital account on 31 March 20X6:

Shs
Shs.1,000,000 M Ltd 9% Debenture Stock at cost 830,000
Shs.1,500,000 N Ltd 10% Loan Stock at cost 1,480,000
Shs.1,800,000 O Ltd 6% Stock (as valued at 30 June 20X4) 1,100,000
Shs.300,000 P Ltd 6% Debenture Stock (as valued at
30 June 20X4) 190,000
3,600,000

Income received from investments:

On general fund: Year to 30 June 20X5 300,000
9 months to 31 March 20X6 270,000
On accumulations: Year to 30 June 20X5 Nil
9 months to 31 March 20X6 25,200

Payments made for infants' maintenance:

Maina Njoroge Karanja
Shs. Shs. Shs.

31 December 20X4 15,000 5,000 10,000

30 June 20X5 15,000 25,000 30,000
31 December 20X5 20,000 40,000 50,000

On 1 July 20X5 the trustees purchased the following stocks out of accumulated income:
Cost
Shs.
Shs.70,000 M Ltd 9% Debenture Stock 61,000
Shs.150,000 N Ltd 10% Loan Stock 149,000

It was agreed that Karanja's entitlement would be satisfied as follows:

From General Fund

a. One-third share of nominal values of N Ltd and O Ltd stocks.

b. Sufficient M Ltd stock to cover balance due.

From Accumulations Fund

a. All M Ltd stock held on fund.

b. Sufficient cash to cover balance due.

On 31 March 20X6 the prices of the stocks held in trust were as follows:

M Ltd 9% Debenture stock 86-88

N Ltd 10% Loan Stock 94-96
O Ltd 6% Stock 58-60
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STRATHMORE UNIVERSITY● STUDYPACK
 404 Trust Law and Accounts

P Ltd 6% Debenture Stock 56-58

From the above information prepare:

a. The accumulations accounts (in columnar form) for the period from Kamau's death to 31 March 20X6
(which you may assume to be the date when the relevant distributions were made to Karanja); (6 Marks)
b. Statements of distribution for:

1. The general fund; and

2. The accumulations fund;

Showing the items transferred to Karanja and the balances remaining in trust for Maina and Njoroge;
(10 marks)
c. The trust statement of financial position showing the position immediately after the distribution to Karanja.
(4 Marks)
(20 Marks)

CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY PACK

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FINANCIAL ACCOUNTING III
 Lesson Eight 405

LESSON EIGHT

PENSION FUND

OBJECTIVES

At the end of this lesson, you should:

 Know the purpose of pension funds;

 Know how to prepare pension fund accounts.

CONTENTS

 Read the study text below.

 Attempt reinforcing questions at the end of the lesson.
 Compare your solutions with those given in Lesson 9.

STUDY TEXT

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STRATHMORE UNIVERSITY● STUDYPACK
 406 Pension Fund

INTRODUCTION
Pension funds are normally set up to provide pension benefits to employees who have retired. The pension
funds receive contributions mainly from employers and employees and the contributionsd are invested.
Pension benefits are paid out of the contributions and investment income received.

FINAL ACCOUNTS
As pension funds are set up for a specific purpose, and not for trading, we do not prepare the normal income
statement or the statement of financial position. The presentation for the final accounts are as per the
requirements of IAS 26 ( please see the appendix for other important definition) whereby instead of a trading
profit and loss accountwe have the statement of changes in net assets. We also prepare the statement of net
assets in the place of a statement of financial position.

The major emphasis in the past papers has been on the formats so please pay carefull attention to the
description.

FORMAT FOR FINAL ACCOUNTS

STATEMENT OF CHANGES IN NET ASSETS

ABC Pension Fund

Statement of Changes in Net assets for the year ended 31 December

Sh. ‗000‘ Sh. ‗000‘

Contributions Received:
- From employers: Normal X
- From employers: Additional _X
X
- From employees: Normal X
- From employees: Additional voluntary _X
X
Transfers in:
- Group transfers in from other schemes X
- Individual transfers from other schemes _X
X
Investment income:
- Income from fixed investment securities X
- Dividends from equities X
- Income from unit trusts X
- Net rents from properties X
- Interest on cash deposits X
- Share of profit/loss of trading subsidiary and joint venture _X
X
Other income:
- Claims on term insurance policies X
- Sundry income _X
_X
X
Benefits payable:
- Pensions (X)
- Commutation of pensions and lumpsum retirement benefits (X)
- Death benefits (X)
- Payments to and on a/c of leavers:
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FINANCIAL ACCOUNTING III
 Lesson Eight 407
- Refund of contributions (X)
- Group transfers out to other schemes (X)
- Individual transfers to other schemes _(X)
_(X)
X
Profit on disposal of investments X
Losses on disposal of investments (X)
X
Changes in values of investments _X
X
Payments:
- Premiums on term insurance policies (X)
- Other payments (X)
- Admin. Expenses (X)
(X)
X
Taxation on income (X)
Net change for the year X

STATEMENT OF NET ASSETS

ABC Pension fund

Statement of Net assets as at 31December

Sh. ‗000‘ Sh. ‗000‘
Investment Assets
- Fixed interest securities: Government X
: Other X
X
- Equity investments X
- Unit trust investments X
- Property: Freehold X
: Leasehold X
X

- Cash deposits X
- Trading subsidiary cost & joint ventures X
- Insurance policies X
- Other investments X
- Debtors on investment transactions X
- Creditors for investment transactions (X)
X
X
Fixed Assets
- All assets held primarily for reasons other
than investment potential X
X
Long term borrowings
(Normally to enhance fund‘s returns) (X)
X
Current Assets
Contributions due from employer X
Other current assets X
X
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STRATHMORE UNIVERSITY● STUDYPACK
 408 Pension Fund
Current liabilities
Unpaid benefits (X)
Other current liabilities (X)
(X)
X
Net Assets XX

Accumulated fund as at beginning of year X

Net new money invested as per revenue a/c (including
changes in market value of interests) X
Accumulated fund as at year end XX

Example
The following is the trial balance of Civil Servants Pension Fund as at 31 March 2005:

Sh 000 Sh 000
Accumulated fund as at 1 April 2004 3,245
Land and buildings in the Central business district 2,000
Pensions 390
Income from fixed return securities 580
11% Treasury Stock 400
Freehold Property (Developed with rental income housing units) 2,200
Employers normal contribution 980
Employees additional voluntary contributions 200
Administration expenses 150
Claims received on tem insurance policies 21
Premiums paid on term insurance policies 49
Term insurance policies 400
Employers additional contributions 25
Employers normal contributions 300
Unpaid benefits 30
Group transfers in from other schemes 75
Individual transfers out to other schemes 5
Debtors on investment transactions 16
Commutation of pensions and lump sum retirement benefits 15
Dividends received from equity investments 400
20,000 ordinary shares in Flamingo Airways 200
Individual transfers in from other schemes 14
Income from unit trusts 70
Rental income from property 45
Group transfers out to other schemes 40
Cash and demand deposits 35
Tax paid on fund income 460
Ksh.250, 000 loan stock in KVM 200
Death benefits paid 15
Creditors for investment transactions 22
Refund of contributions 28
Investment in unit trusts 350
Loan from HFCK to develop Property 1,000
Contributions due within 30 days 56
Shares in Moyalematt Ltd 2.00 2
7,009 7,009

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FINANCIAL ACCOUNTING III
 Lesson Eight 409
Notes:
The fund owned 12,000 shares in Moyalematt, which were initially purchased for Shs.14, 000. These have been
disposed of during the year. The only entries made in the books were in a debtor account and investment
account since the shares are yet to be paid for.
The trustees felt the need to reflect the following market prices in the financial statements:
Loan stock in KVM – Market price index – 84.00
Shares in Flamingo Airways -Sh.9.75 per share.

Required:
(a) Statement of changes in net assets for the year to 31 October 2005.
(b) Statement of net assets as at 31 October 2005.
(20 Marks)

Note: This should be in compliance with IAS 26 – Accounting and reporting by retirement benefit plans.

Solution
Civil Servants Pension Fund
Statement of changes in net assets for the year to 31 October 2005
Sh. ‗000‘ Sh. ‗000‘
Contributions received:
From employees: Normal 980
From employers: Additional 25
1005
From employees: Normal 300
From employers: Additional voluntary 200 500

Transfers in:
Group transfers in from other schemes 75
Individual transfers in from other
Schemes 14 89

Investment income:
Income from fixed interest securities 580
Dividends from equities 400
Income from unit trusts 70
Rents from properties 45 1095

Other income: Claim on term insurance policies 21

2710
Benefits payable:
Pensions (390)
Commutation of pensions and lump sum
retirement benefits (15)
Death benefits (15)
Payments to and on a/c of leavers:
Refund of contributions (28)
Group transfers out to other schemes (40)
Individual transfers out to other schemes (5)
(493)
2217
Profit on investment disposals 2
Changes in market values of investments:
Loan stock in KVM 10
Shares in Flamingo Airways (5)
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STRATHMORE UNIVERSITY● STUDYPACK
 410 Pension Fund

Payments: Premiums on term insurance policies (49)

: Admin expenses (150)
(199)
2025
Taxation on income (460)
Net change for the year 1565

Civil Servants Pension Fund

Statement of Net Assets as at 31 October 2005

Sh. ‗000‘ Sh. ‗000‘

Investment Assets
Fixed interest securities: 11% T.Stock 400
: KVM loan stock 210
610
Equity investments: Flamingo Airways shares 195
Unit trust investments 350
Property: Freehold 2200
Cash and demand deposits 35
Insurance policies 400
Debtors on investment transactions 16
Creditors for investment transactions ( 22)
(6)
3784

Fixed Assets
Leasehold property in Nairobi CBD 2000
5784

Long term borrowings

HFCK Loan (1000)
4784

Current Assets:
Contributions due within 30 days 56
Current Liabilities
Unpaid benefits (30)
26
Net Assets 4810

Accumulated Fund at 1 Nov.2000 3245

Net new money invested per revenue a/c
including changes in market value of
investments 1565
Accumulated Fund at 31 October 2001 4810

Example

(a) What meetings of creditors must be held and for what purpose in the course of a creditors‘ voluntary
winding up? (7 marks)
(b) The following trial balance was extracted from the accounting records of the XYZ Retirement Benefits
Scheme for the year ended 30 September 2000.

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FINANCIAL ACCOUNTING III
 Lesson Eight 411
Sh. ‗000‘ Sh. ‗000‘
Accumulated fund as at 1 October 1999 461,560
Accrued expensed 240
Administrative expenses 2,840
Cash and demand deposits 23,460
Change in market value of investments 22,640
Commutation and lump sum retirement benefits 4,820
Contributions due within 30 days 4,940
Employer normal contributions 36,480
Individual transfers in from other schemes 3,150
Individual transfers out to other schemes 1,860
Investment income 47,400
Immovable property 132,320
Kenya Government securities 263,605
Members‘ nominal contributions 18,240
Members‘ additional voluntary contributions 4,560
Pensions 7,640
Quoted equity investments 87,835
Unpaid benefits 320
Unquoted equity investments 19,990
571,950 571,950

Required:
The statement of Changes in Net Assets (the Fund Account) for the year ended 30 September 2000 and a
statement of Net Assets as at 30 September 2000, in accordance with International Accounting Standard 26
(Accounting and reporting by Retired Benefit Plans)

Hints:
The XYZ Retirement Benefits Scheme‘s accounting policies state that the reconciliation of the accumulated fund
for the year is included in Statement of Net Assets and administrative expenses are included as the final item in
the Statement of Charges in Net Assets. In all other respects, the format used is in conformity with that laid down
in the Retirement Benefits Regulations in Retirement Benefits Act. (11 marks)
(Total: 18 marks)
Solution

(a) The first meeting of creditors‘ voluntary winding up should be held on the same day when the
members have passed a resolution to wind up the company or on the day after. In this meeting the
creditors shall:

- Appoint amongst them a chairman

- Join the members to appoint a liquidator
- Join the members to appoint a committee of inspection of up to 5 people.

The directors must present to the members the statement of affairs and the list of creditors. The
creditor may also terminate the liquidator earlier appointed by the members

 When the liquidation commenced the creditors shall meet one year after commencement to
review the progress and attend to any pending matters. Such meetings are called by the
liquidator.
 If the liquidation is not complete after one year the creditors shall meet after lapse of one
year for all years in which the liquidation is incomplete.

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STRATHMORE UNIVERSITY● STUDYPACK
 412 Pension Fund
 When the liquidation is complete the liquidator must call a final meeting and lay before the
company and creditors the accounts of winding up.

(b) XYZ Retirements benefit scheme.

Statement of changes in net assets as at 30 Sept. 2000
Sh. ‗000‘ Sh. ‗000‘
Contributions received:
- From employers: Normal 36,480
- From employees: Normal 18,240
- From employees: Additional voluntary 4,560
22,800
Transfers in:
- Individual transfers in from other schemes 3,150
Investment income:
- Sundry investment income 47,400
109,830
Benefits payable:
- Pensions (7,640)
- Commutations and lumpsum retirement benefits (4,820)
Payments to and a/c of leavers:
- Individual transfers out to other schemes (1,860)
(14,320)
95,510
Changes in market values of investments (22,640)
72,870
Payments:
- Admin expenses (2,840)
Net change for the year 70,030

XYZ Retirements benefit scheme

Statement of financial position (statement of Net Assets) as at 30 Sept. 2000
Sh. ‗000‘ Sh. ‗000‘
Investment Assets:
Fixed interest securities: Kenya Govt 263,605
Equity investments: quoted 87,835
: unquoted 19,990
107,825
Cash and demand deposits 23,460
394,890
Fixed assets
Immovable property 132,320
527,210
Current Assets
Contributions due within 30 days 4,940
Current liabilities
Accrued expenses (240)
Unpaid benefits (320)
(560)
4,380
Net Assets 531,590
Accumulated fund at 1 October 1999 461,560
Net new money invested as per statement of cha. In NA 70,030
Accumulated fund at 30 Sept. 2000 531,590
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FINANCIAL ACCOUNTING III
 Lesson Eight 413

REINFORCING QUESTIONS
(a) Explain the following terms as used in bankruptcy acts:

(i) Voluntary transfers (2 marks)

(ii) Doctrine of reputed ownership (3 marks)

(b) Wafanyakazi Retirement Benefit Scheme has provided you with the following extract of the trial
balance for the year ended 31 October 2002:

Sh.‘000‘ Sh.‘000‘
Accumulated fund as at 1 November 2001 461,560
Accrued expenses 240
Administration expenses 2,840
Cash and demand deposits 23,460
Change in market value of investments 22,640
Lumpsum retirement benefits 4,820
Contributions due in 30 days 4,940
Normal contributions by: 36,480
Employer 18,240
Employees 3,150
Transfer in from other schemes
Individual transfers out to other schemes 1,860
Investment income 47,400
Immovable property 132,320
Government securities (long-term) 263,605
Members‘ voluntary contributions 4,560
Pension 7,640
Equity investments: Quoted 87,835
Unquoted 19,900
Unpaid benefits ______ 320
571,950 571,950

Required:

(i) Statement of changes in net assets for the year ended 31 October 2002.
(8 marks)
(ii) Statement of net assets as at 31 October 2002. (7 marks)
(Total: 20 marks)

CHECK YOUR ANSWERS WITH THOSE PROVIDED IN LESSON 9 OF THE STUDY PACK

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STRATHMORE UNIVERSITY● STUDYPACK
 414 Pension Fund

COMPREHENSIVE ASSIGNMENT NO. 4

TO BE SUBMITTED AFTER LESSON 8
To be carried out under examination conditions and sent to the Distance Learning Administrator for
marking by the University.

TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS

QUESTION ONE
With reference to the provisions of the law of succession:
Define a will;
Give two short explanation of failure of legacies. (5 marks)

Mr Ruare dies intestate, leaving his two wives Luky and chity whom he married under a
system of law which permits polygamy. A third wife Beaty had predeceased him. Luky has three children
Peter, Lowe and Ricci.
Beaty had two children Short and Tall. Chity has no children.

All the children are alive at the time of Mr. Ruare‘s death. The value of his personal and household effects
was Sh.350,000 and the value of the net intestate estate was Sh.3,150,000.

Required:

A clear statement to show how Mr. Ruare‘s property would devolve. (15 marks)

QUESTION TWO
Lawi Kiprop‘s will stated that the residue of his estate, after legacies to his sons and daughters, should be held
in trust. The trustees were authorized to retain any asset which was included in his estate but was not an
authorized investment under the Trustee Act (Cap. 167 of the Law of Kenya). The residue of his estate
handed over to the trustee on 1 May 2000 comprised the following:

Probate value
Sh. ‗000‘
3,000 Ordinary shares in E.A Breweries Ltd. (quoted) 330
6,000 Ordinary shares in BAT (K) Ltd 540
Collection of medals won in athletics: gold, silver and bronze 130
Sh. 500,000 6% Nairobi City Council Stock 300
Leasehold house in Kileleshwa (21 years remaining on lease) 3,750

Probate value
Sh. ‗000‘
Leasehold house in Peponi (20 years remaining on lease) 4,250
1,500 Ordinary shares in Laki Ltd. (a private company) 450
2,500 ordinary shares in Wiro Ltd. (a private company) 600
Shares in Fidelity Building Society 300
Sh. 500,000 12% Kenya Stock 2005 1,020
Sh. 1,000,000 10% Kenya Stock 2002 274
Cash at bank 12,534

Additional information:

1. The market values of the assets above were the same as the probate values except for the shares in E.A
Breweries and in BAT (K) which were quoted at Sh. 118 – 122 and Sh. 94 – 98 respectively, the 6%
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FINANCIAL ACCOUNTING III
 Lesson Eight 415
Nairobi City Council Stock which was quoted at Sh. 54 – 58 and the 12% Kenya Stock and 10% Kenya
Stock which were quoted at Sh. 108 – 112 and Sh. 98 – 102 respectively.

2. On 1 May 2000, the trustees decided to divide the trust into the Special Range, Fixed Interest and Wider
Range parts; any necessary balancing adjustments between the funds should be made firstly in cash and
then in 10% Kenya Stock 2005.

3. On 15 June 2000, the trustees sold the medals Kiprop had won in athletics for Sh. 200,000.

4. On 30 September 2000, the tenants of the house in Kileleshwa moved out of the house. It was sold for
Sh. 3,9000,000 on 31 October 2005.
5. On 31 December 2000, the tenant of the house in Peponi purchased the house, after he obtained an
extension of the lease for 50 years from the commissioner of Lands. The agreed sale price was Sh.
6,000,000. The tenant paid Sh. 3,000,000 to the Trustees. The remainder of the purchase price was a
mortgage loan to the tenant repayable over 6 years. Interest being charged at 15% per annum.

6. The trustees purchased 45,700 ordinary shares in the Nation media Group at Sh. 120 per share on 31
December 2000, on which date the market values of all the other investments were the same as on 1 May
2000. In addition, the trustees used the balance of the cash available to purchase Kenya Government
Treasury Bills. When matured, they would be rolled over.

7. On 28 February 2001, the trustees decided to liquidate the building society share account to use the
proceeds to pay the University fees of one on the beneficiaries of the trust. This transaction was
completed on 1 March 2001, with no capital profit or loss being made.

8. On 30 April 2001, the purchaser of the Peponi house repaid Sh. 500,000 of the mortgage loan. This
amount was immediately invested in Treasury Bills.
Required:
(a). Prepare a schedule to show the division of the assets on 1 May 2000. (5 marks)

(b). Write up the Trust Capital Account in columnar form for the year ended 30 April 2001. Commencing
with the probate value balance. (10 marks)

(c). Write up the Trust Cash Book for the year ended 30 April, commencing with the balance of cash after
the division on 1 May 2000. (5 marks)
(d). Prepare the Trust Statement of financial position as at 30 April 2001. (5 marks)
(Total: 25 marks)

QUESTION THREE
Philip Muniu, a widower, died on 1 March 1991. He will left the residue of his estate to his three children,
Abel, Beatrice and Cain. Since the children were infants when he died, the residue was to be held in trust;
each child would obtain an absolute interest in one-third of the property at age eighteen. Philip‘s brother
Stephen, was appointed trustee with unrestricted powers of investment: payments out of income were to be
made for the children‘s maintenance.

The balances in the books of trust as 1 March 1993 were as follows:

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STRATHMORE UNIVERSITY● STUDYPACK
 416 Pension Fund

Sh. Sh.
Capital investments:
6,000 shares in Nairobi Printers Ltd. 492,000
3,000 shares in Kenbreweries Ltd. 741,000
Sh.450,000 nominal 8% Kenya stock 1998 387,000
Accumulation Investments:
Sh.126,000 nominal 8% Kenya stock 1998 112,560
Cash at bank 7,440
Capital account 1,620,000
Accumulation account: Abel 60,000
Beatrice 30,000
Cain ________ 30,000
1,740,000 1,740,000

The trust investment are to be revalued as at 31 October 1994. Abel would be given an appropriate
investment to be decided upon.

In the 20 months period to 31 October 1994, the following occurred:

1. Interest on the holdings of 8% Kenya stock was received on the due dates 30 March and 30 September.

2. Dividend income was received as follows:

Year to 1 March 1994 Sh.51,840
8 months to 31 October 1994 Sh.17,100

3. Maintenance payments in respect of the 3 beneficiaries were made as follows:

Abel Beatrice Cain

Sh. Sh. Sh.
Year to 1 March 1994 22,320 19,800 36,000
8 months to 31 October 1994 20,562 16,036 19,130

4. On 1 March 1994, the trustees invested all available cash in 8% Kenya stock 1998 at Sh.90 cum interest.

Required:
Write up the beneficiaries Accumulation Accounts (in columnar form), the Income Account (using one
column for accumulations income and another for capital income and the Capital Account for 20 months
period. Balance the accounts at 1 March 1994 and show clearly any balance brought down at 2 March 1994.
(15 marks)

The Trust statement of financial position immediately prior to the distribution of assets to Abel,
showing the total liability to Abel in a Distribution Account.

QUESTION FOUR
The parents of Huyu, wale and Hao died in March 1998. Friends and well wishers organized a fund-raising in
May 1998 which raised Sh. 3,960,000. This money was to cater for the welfare of the three orphans. Mr.
Kilimo, who was appointed the trustee, invested this amount as follows.

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FINANCIAL ACCOUNTING III
 Lesson Eight 417

Sh
9,600 ordinary shares of Sh. 10 per value in Fimbo Ltd. 864,000
12,600 ordinary shares of Sh. 10 per value in Lima Ltd. 1,512,000
13,200 ordinary shares of Sh. 10 per value in Pewa Ltd. 1,584,000
3,960,000

Mr Kilimo also established an accumulation and maintenance trust to hold these investments on behalf of the
children. The trust had a wide investment clause. The accounts were to be made to 30 April each year. When
a beneficiary reached the age of 21 years, Mr. Kilimo would transfer the share of the fund due to him/her.
Huyu turned 21 years on 30 April 2002.

The balances on the accumulation fund for Huyu, Wale and Hao and Hao as at 1 March 2001 were SH.
414,000, Sh. 207,900 and Sh. 69,300 respectively. To that date, Mr. Kilimo had used accumulated income to
purchase 5,775 ordinary shares of Sh. 10 per value in Pewa Ltd.

In the year to 30 April 2002, Sh. 445,500 was received from capital investments and Sh. 124,740 from
accumulation investments. Maintenance payments were made as follows:

Huyu Sh. 154,000

Wale Sh. 162,000
Hao Sh. 188,000

On 30 April 2002, the market value of the shares in the companies, all listed at Nyumbani stock Exchange
(NSE) were as follows:

Fimbo Sh. 120 per share

Lima Sh. 160 per share
Pewa Sh. 140 per share

Huyu was to receive 10,000 shares of Sh. 10 per value in Lima Ltd. and the balance due to him on capital
would be made up of the shares in Fimbo Ltd. Out of the accumulation assets, Huyu was to receive Sh.
64,444 in cash and the balance in shares in the Pewa Ltd.

Required:
(a). The beneficiaries and accumulation accounts for the period ended 30 April 2002.(10 marks)

(b). The distribution statements for the capital and accumulation assets as at 30 April 2002.
(10 marks)
(Total: 20 marks)

QUESTION FIVE
(a) Briefly explain the meaning of the tem ―abatement‖ (2 marks)

(b) Identify and explain the four classifications of legacies. (8 marks)

(c) The following trial balance was extracted from the books of ABC Retirement Benefits Scheme for the
year ended 30 September 2003:

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STRATHMORE UNIVERSITY● STUDYPACK
 418 Pension Fund
Sh. Sh.
Accumulated fund – 1 October 2002 461,560
Accrued expenses 240
General administrative expenses 2,840
Cash and demand deposits 23,460
Change in market value of investments 22,640
Commutations and lumpsum retirement benefits 4,820
Contributions due within 30 days 4,940
Employer‘s normal contributions 36,480
Individual transfers in from other schemes 3,150
Individual transfers out of other schemes 1,860
Investment income 47,400
Immovable property 132,320
Government securities 263,605
Members‘ normal contributions 18,240
Members‘ additional voluntary contributions 4,560
Pensions 7,640
Equity investments – quoted 87,835
Unpaid benefits 320
Equity investments – unquoted 19,990 ______
571,950 571,950

Required:
(i) Statement of changes in net assets as at 30 September 2003. (6 marks)

(ii) Statement of net assets as at 30 September 2003. (4 marks)

[(i) and (ii) above should be in conformity with the requirements of IAS 26 – Accounting and
Reporting by Retirement Benefit Plans]

END OF COMPREHENSIVE ASSIGNMENT No.4

NOW SEND YOUR ANSWERS TO DISTANCE LEARNING FOR MARKING

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FINANCIAL ACCOUNTING III
 Lesson Nine 419

LESSON NINE

REVISION AID

CONTENTS
KASNEB SYLLABUS
SUMMARY OF RELEVANT STANDARDS
MODEL ANSWERS TO REINFORCING QUESTIONS

 LESSON 1
 LESSON 2
 LESSON 3
 LESSON 4
 LESSON 5
 LESSON 6
 LESSON 7
 LESSON 8

MOCK EXAMINATION

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STRATHMORE UNIVERSITY● STUDYPACK
 420 Revision Aid

KASNEB SYLLABUS
OBJECTIVE
To examine candidates' understanding of various institutional group accounts and their ability to apply the law
and accounting standards to published accounts of such entities; receiverships, bankruptcies and liquidation
accounts; executorship and trust accounts.

CONTENT
Legal and Institutional Framework of Financial Accounting

- The preparation of financial statements in accordance with the provisions of the Companies Act, and
legislation relating to other accounting entities. International and otherr relevant Accounting standards.
- Sources and authority of such standards.

Partnership Accounts
The more complex aspects of partnership accounting concerned with realignment and dissolutions. Conversion
of partnership to a limited liability company. The provision of the Partnership Acts. Branch and departmental
accounts.

Group Accounts
The legal and institutional requirements, the consolidated profit and loss account, statement of financial
position, and statement of sources and application of Funds; Accounting for associated companies. Published
group accounts.
Accounting for business combinations: the acquisition (Purchase) method versus merger (Pooling of
interests)method.

Bankruptcy, Receivership and Liquidation

Acts of Bankruptcy; the petition: the receiving order, powers and duties of the official receiver; scheme of
composition; deeds of arrangement; the adjudication for debtors.
The trustee; appointment, rights to the property of the bankrupt; duties, powers and privileges and removal.
Transactions voidable by the trustee. Provable and non-provable debts; priority debts; dividends, small
bankruptcy offenses; discharge; cost and appeals. Bankruptcy accounts: Statements of affairs and deficiency
accounts.

Executorship and Trust Accounts

The provisions of the law of Succession Act; Wills and probate; validity of wills; testamentary capacity.
Distribution of the estate payments of debts; solvent and insolvent estates; priority of creditors and beneficiaries;
Ademption and satisfaction; marshalling; abatement; time for distribution and future legacies. Accounts for the
executor; expenses and distribution statements. The law of trusts; classification of trusts, creation; essentials;
secret, protective and charitable trusts; appointment and capacity of trustees. Duties of trustees; investment of
trust funds, maintenance and advancement. Control of trustees, liabilities and remedies for breach of trust.

Trustee's accounts; Appreciation of Trustees Investment Act.

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FINANCIAL ACCOUNTING III
 Lesson Nine 421

SUMMARIES OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs)/

INTERNATIONAL ACCOUNTING STANDARDS (IASs)

Statements of International Accounting Standards issued by the Board of the International Accounting
Standards Committee (IASC) between 1973 and 2001 are designated "International Accounting Standards" (IAS).

The International Accounting Standards Board (IASB) announced in April 2001 that its accounting
standards would be designated "International Financial Reporting Standards" (IFRS). Also in April 2001, the IASB
announced that it would adopt all of the International Accounting Standards issued by the IASC.

IFRS 3: Business Combinations (Replaced IAS 22 Business Combinations)

Introduction:
IFRS 3 Business Combinations was issued in March 2004 and is applicable for business combinations for which
the agreement date is on or after 31 March 2004.

IFRS 3 prescribes the financial reporting by an entity when it undertakes a business combination. A
business combination is the bringing together of separate entities or businesses into one reporting entity.
IFRS 3 does not apply to:

 business combinations in which separate entities or businesses are brought together to form a joint
venture;
 business combinations involving entities or businesses under common control;
 business combinations involving two or more mutual entities; and
 business combinations in which separate entities or businesses are brought together to form a
reporting entity by contract alone without the obtaining of an ownership interest.

Summary of IFRS 3:
Scope

Definition of business combination. A business combination is the bringing together of separate entities
or businesses into one reporting entity. [IFRS 3.4]

Scope exclusions. IFRS 3 applies to all business combinations except combinations of entities under
common control, combinations of mutual entities, combinations by contract without exchange of ownership
interest, and formations of joint ventures. [IFRS 3.3]

Method of Accounting for Business Combinations

Purchase method. All business combinations within the scope of IFRS 3 must be accounted for using the
purchase method. [IFRS 3.14] The pooling of interests method is prohibited.

Acquirer must be identified. The old IAS 22 had required the pooling method if an acquirer could not be
identified. Under IFRS 3, an acquirer must be identified for all business combinations. [IFRS 3.17]

Identification of an Acquirer

Control. The acquirer is the combining entity that obtains control of the other combining entities or
businesses. [IFRS 3.17] IFRS 3 provides considerable guidance for identifying the acquirer. [IFRS 3.19-23]

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Cost of a Business Combination

Fair value of consideration given plus costs. The acquirer measures the cost of a business combination at
the sum of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity
instruments issued by the acquirer, in exchange for control of the acquiree; plus any costs directly attributable
to the combination. [IFRS 3.24] If equity instruments are issued as consideration for the acquisition, the
market price of those equity instruments at the date of exchange is considered to provide the best evidence of
fair value. If a market price does not exist, or is not considered reliable, other valuation techniques are used to
measure fair value. [IFRS 3.27]

Cost adjustments contingent on future events. If the cost is subject to adjustment contingent on future
events, the acquirer includes the amount of that adjustment in the cost of the combination at the acquisition
date if the adjustment is probable and can be measured reliably. [IFRS 3.32] However, if the contingent
payment either is not probable or cannot be measured reliably, it is not measured as part of the initial cost of
the business combination. If that adjustment subsequently becomes probable and can be measured reliably,
the additional consideration is treated as an adjustment to the cost of the combination. [IAS 3.34]

Recognition and Measurement of Identifiable Acquired Assets and Liabilities

Recognition of acquired assets and liabilities. The acquirer recognises separately, at the acquisition date,
the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the following recognition
criteria at that date, regardless of whether they had been previously recognised in the acquiree's financial
statements: [IAS 3.37]

an asset other than an intangible asset is recognised if it is probable that any associated future
economic benefits will flow to the acquirer, and its fair value can be measured reliably;
a liability other than a contingent liability is recognised if it is probable that an outflow of resources
will be required to settle the obligation, and its fair value can be measured reliably; and
an intangible asset or a contingent liability is recognised if its fair value can be measured reliably.

Measurement of acquired assets and liabilities. The acquired identifiable assets, liabilities, and contingent
liabilities are measured initially by the acquirer at their fair values at the acquisition date, irrespective of the
extent of any minority interest. In other words, the identifiable assets acquired, and liabilities and contingent
liabilities incurred or assumed, must be initially measured at full fair value, including any minority interest's
share of the acquired item.

No restructuring provisions. In applying the purchase method, an acquirer must not recognise provisions
for future losses or restructuring costs expected to be incurred as a result of the business combination. These
must be treated as post-combination expenses. [IFRS 3.41]

Recognition of intangibles. In applying the purchase method, an intangible item acquired in a business
combination, including an in-process research and development project, must be recognised as an asset
separately from goodwill if it meets the definition of an asset (it is controlled and provides economic
benefits), is either separable or arises from contractual or other legal rights, and its fair value can be measure
reliably. [IFRS 3.45]

Recognition of contingent liabilities. In applying the purchase method, an acquirer must recognise
contingent liabilities assumed in the business combination, if their fair value is reliably measurable. [IFRS
3.47] After their initial recognition, such contingent liabilities must be remeasured at the higher of: [IFRS
3.48]
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FINANCIAL ACCOUNTING III
 Lesson Nine 423

(a) the amount that would be recognised in accordance with IAS 37, and
(b) the amount initially recognised less, when appropriate, cumulative amortisation recognised in
accordance with IAS 18 Revenue.

A contingent liability recognised under IFRS 3 continues to be recognised in subsequent periods even though
it does not qualify for recognition under IAS 37.

Step acquisitions. If a business combination involves more than one exchange transaction, each exchange
transaction shall be treated separately by the acquirer, using the cost of the transaction and fair value
information at the date of each exchange transaction, to determine the amount of any goodwill associated
with that transaction. [IFRS 3.58]

Goodwill

Recognition and measurement of goodwill. Goodwill is recognised by the acquirer as an asset from the
acquisition date and is initially measured as the excess of the cost of the business combination over the
acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities.
[IFRS 3.51]

No amortisation of goodwill. IFRS 3 prohibits the amortisation of goodwill. Instead goodwill must be
tested for impairment at least annually in accordance with IAS 36 Impairment of Assets. [IFRS 3.54]

Negative goodwill. If the acquirer's interest in the net fair value of the acquired identifiable net assets
exceeds the cost of the business combination, that excess (sometimes referred to as negative goodwill) must
be recognised immediately in the income statement as a gain. Before concluding that "negative goodwill" has
arisen, however, IFRS 3 requires that the acquirer reassess the identification and measurement of the
acquiree's identifiable assets, liabilities, and contingent liabilities and the measurement of the cost of the
combination. [IFRS 3.56]

Disclosure

For each business combination (or in the aggregate for immaterial combinations), required disclosures by the
acquirer include: [IFRS 3.67]

Names and descriptions of the combining entities or businesses.

Acquisition date.
Percentage of voting equity instruments acquired.
Cost of the combination (with separate disclosure of the number and fair values of equity
instruments issued and how fair values were determined)
Amounts recognised at the acquisition date for each class of the acquiree's assets, liabilities, and
contingent liabilities, and, unless impracticable, the carrying amounts of each of those classes,
determined in accordance with IFRSs, immediately before the combination.
Amount of any negative goodwill recognised in profit or loss
Details about the factors that contributed to recognition of goodwill
Amount of the acquiree's profit or loss since the acquisition date included in the acquirer's profit or
loss for the period, unless impracticable.

The following must also be disclosed unless impracticable: [IFRS 3.70]

Revenue of the combined entity for the period as though the acquisition date for all business
combinations effected during the period had been the beginning of that period.

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Profit or loss of the combined entity for the period as though the acquisition date for all business
combinations effected during the period had been the beginning of the period

IAS 1 Presentation of Financial Statements (revised 2003)

Objective of IAS 1

The objective of IAS 1 (revised 1997) is to prescribe the basis for presentation of general purpose financial
statements, to ensure comparability both with the entity's financial statements of previous periods and with
the financial statements of other entities. IAS 1 sets out the overall framework and responsibilities for the
presentation of financial statements, guidelines for their structure and minimum requirements for the content
of the financial statements. Standards for recognising, measuring, and disclosing specific transactions are
addressed in other Standards and Interpretations.

Scope
Applies to all general purpose financial statements based on International Financial Reporting Standards. [IAS
1.2]

General purpose financial statements are those intended to serve users who do not have the authority to
demand financial reports tailored for their own needs. [IAS 1.3]

Objective of Financial Statements

The objective of general purpose financial statements is to provide information about the financial position,
financial performance, and cash flows of an entity that is useful to a wide range of users in making economic
decisions. To meet that objective, financial statements provide information about an entity's: [IAS 1.7]

Assets.
Liabilities.
Equity.
Income and expenses, including gains and losses.
Other changes in equity.
Cash flows.

That information, along with other information in the notes, assists users of financial statements in predicting
the entity's future cash flows and, in particular, their timing and certainty.
Components of Financial Statements

A complete set of financial statements should include: [IAS 1.8]

a statement of financial position,

income statement,
a statement of changes in equity showing either:
all changes in equity, or
changes in equity other than those arising from transactions with equity holders acting in
their capacity as equity holders;
cash flow statement, and
notes, comprising a summary of accounting policies and other explanatory notes.

Reports that are presented outside of the financial statements -- including financial reviews by management,
environmental reports, and value added statements -- are outside the scope of IFRSs. [IAS 1.9-10]

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FINANCIAL ACCOUNTING III
 Lesson Nine 425

Fair Presentation and Compliance with IFRSs

The financial statements must "present fairly" the financial position, financial performance and cash flows of
an entity. Fair presentation requires the faithful representation of the effects of transactions, other events, and
conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and
expenses set out in the Framework. The application of IFRSs, with additional disclosure when necessary, is
presumed to result in financial statements that achieve a fair presentation. [IAS 1.13]

IAS 1 requires that an entity whose financial statements comply with IFRSs make an explicit and unreserved
statement of such compliance in the notes. Financial statements shall not be described as complying with
IFRSs unless they comply with all the requirements of IFRSs. [IAS 1.14]

Inappropriate accounting policies are not rectified either by disclosure of the accounting policies used or by
notes or explanatory material. [IAS 1.16]

IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that compliance with
an IFRS requirement would be so misleading that it would conflict with the objective of financial statements
set out in the Framework. In such a case, the entity is required to depart from the IFRS requirement, with
detailed disclosure of the nature, reasons, and impact of the departure. [IAS 1.17-18]

Going Concern

An entity preparing IFRS financial statements is presumed to be a going concern. If management has
significant concerns about the entity's ability to continue as a going concern, the uncertainties must be
disclosed. If management concludes that the entity is not a going concern, the financial statements should not
be prepared on a going concern basis, in which case IAS 1 requires a series of disclosures. [IAS 1.23]

Accrual Basis of Accounting

IAS 1 requires that an entity prepare its financial statements, except for cash flow information, using the
accrual basis of accounting. [IAS 1.25]

Consistency of Presentation

The presentation and classification of items in the financial statements shall be retained from one period to
the next unless a change is justified either by a change in circumstances or a requirement of a new IFRS. [IAS
1.27]

Materiality and Aggregation

Each material class of similar items must be presented separately in the financial statements. Dissimilar items
may be aggregated only if the are individually immaterial. [IAS 1.29]

Offsetting> Assets and liabilities, and income and expenses, may not be offset unless required or permitted
by a Standard or an Interpretation. [IAS 1.32]

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Comparative Information

IAS 1 requires that comparative information shall be disclosed in respect of the previous period for all
amounts reported in the financial statements, both face of financial statements and notes, unless another
Standard requires otherwise. [IAS 1.36]

If comparative amounts are changed or reclassified, various disclosures are required. [IAS 1.38]

Structure and Content of Financial Statements in General

Clearly identify: [IAS 1.46]

the financial statements

the reporting enterprise
whether the statements are for the enterprise or for a group
the date or period covered
the presentation currency
the level of precision (thousands, millions, etc.)

Reporting Period

There is a presumption that financial statements will be prepared at least annually. If the annual reporting
period changes and financial statements are prepared for a different period, the enterprise must disclose the
reason for the change and a warning about problems of comparability. [IAS 1.49]

Statement of financial position

An entity must normally present a classified statement of financial position, separating current and
noncurrent assets and liabilities. Only if a presentation based on liquidity provides information that is reliable
and more relevant may the current/noncurrent split be omitted. [IAS 1.51] In either case, if an asset (liability)
category commingles amounts that will be received (settled) after 12 months with assets (liabilities) that will
be received (settled) within 12 months, note disclosure is required that separates the longer-term amounts
from the 12-month amounts. [IAS 1.52]

Current assets are cash; cash equivalent; assets held for collection, sale, or consumption within the enterprise's
normal operating cycle; or assets held for trading within the next 12 months. All other assets are noncurrent.
[IAS 1.57]

Current liabilities are those to be settled within the enterprise's normal operating cycle or due within 12
months, or those held for trading, or those for which the entity does not have an unconditional right to defer
payment beyond 12 months. Other liabilities are noncurrent. [IAS 1.60]

Long-term debt expected to be refinanced under an existing loan facility is noncurrent, even if due within 12
months. [IAS 1.64]

If a liability has become payable on demand because an entity has breached an undertaking under a long-term
loan agreement on or before the statement of financial position date, the liability is current, even if the lender
has agreed, after the statement of financial position date and before the authorisation of the financial
statements for issue, not to demand payment as a consequence of the breach. [IAS 1.65] However, the
liability is classified as non-current if the lender agreed by the statement of financial position date to provide a
period of grace ending at least 12 months after the statement of financial position date, within which the
entity can rectify the breach and during which the lender cannot demand immediate repayment. [IA 1.66]
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FINANCIAL ACCOUNTING III
 Lesson Nine 427

Minimum items on the face of the statement of financial position [IAS 1.68]

(a) property, plant and equipment;

(b) investment property;
(c) intangible assets;
(d) financial assets (excluding amounts shown under (e), (h) and (i));
(e) investments accounted for using the equity method;
(f) biological assets;
(g) inventories;
(h) trade and other receivables;
(i) cash and cash equivalents;
(j) trade and other payables;
(k) provisions;
(l) financial liabilities (excluding amounts shown under (j) and (k));
(m) liabilities and assets for current tax, as defined in IAS 12;
(n) deferred tax liabilities and deferred tax assets, as defined in IAS 12;
(o) minority interest, presented within equity; and
(p) issued capital and reserves attributable to equity holders of the parent.

Additional line items may be needed to fairly present the entity's financial position. [IAS 1.69]

IAS 1 does not prescribe the format of the statement of financial position. Assets can be presented current
then noncurrent, or vice versa, and liabilities and equity can be presented current then noncurrent then equity,
or vice versa. A net asset presentation (assets minus liabilities) is allowed. The long-term financing approach
used in UK and elsewhere – fixed assets + current assets - short term payables = long-term debt plus equity –
is also acceptable.

Regarding issued share capital and reserves, the following disclosures are required: [IAS 1.76]

numbers of shares authorised, issued and fully paid, and issued but not fully paid
par value
reconciliation of shares outstanding at the beginning and the end of the period
description of rights, preferences, and restrictions
treasury shares, including shares held by subsidiaries and associates
shares reserved for issuance under options and contracts
a description of the nature and purpose of each reserve within owners' equity

Income Statement

In the 2003 revision to IAS 1, the IASB is now using "profit or loss" rather than "net profit or loss" as the
descriptive term for the bottom line of the income statement.

All items of income and expense recognised in a period must be included in profit or loss unless a Standard
or an Interpretation requires otherwise. [IAS 1.78]

Minimum items on the face of the income statement should include: [IAS 1.81]

(a) revenue;
(b) finance costs;
(c) share of the profit or loss of associates and joint ventures accounted for using the equity method;
(d) a single amount comprising the total of (i) the post-tax profit or loss of discontinued operations
and (ii) the post-tax gain or loss recognised on the disposal of the assets or disposal group(s)
constituting the discontinued operation; and;
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(e) tax expense; and

(f) profit or loss.

The following items must also be disclosed on the face of the income statement as allocations of profit or
loss for the period: [IAS 1.82]

(a) profit or loss attributable to minority interest; and

(b) profit or loss attributable to equity holders of the parent.

Additional line items may be needed to fairly present the enterprise's results of operations.

No items may be presented on the face of the income statement or in the notes as "extraordinary items".
[IAS 1.85]

Certain items must be disclosed either on the face of the income statement or in the notes, if material,
including: [IAS 1.87]

(a) write-downs of inventories to net realisable value or of property, plant and equipment to
recoverable amount, as well as reversals of such write-downs;
(b) restructurings of the activities of an entity and reversals of any provisions for the costs of
restructuring;
(c) disposals of items of property, plant and equipment;
(d) disposals of investments;
(e) discontinuing operations;
(f) litigation settlements; and
(g) other reversals of provisions.

Expenses should be analysed either by nature (raw materials, staffing costs, depreciation, etc.) or by function
(cost of sales, selling, administrative, etc.) either on the face of the income statement or in the notes. [IAS
1.88] If an enterprise categorises by function, additional information on the nature of expenses -- at a
minimum depreciation, amortisation, and staff costs -- must be disclosed. [IAS 1.93]

Cash Flow Statement

Rather than setting out separate standards for presenting the cash flow statement, IAS 1.102 refers to IAS 7,
Cash Flow Statements

Statement of Changes in Equity

IAS 1 requires an entity to present a statement of changes in equity as a separate component of the financial
statements. The statement must show: [IAS 1.96]

(a) profit or loss for the period;

(b) each item of income and expense for the period that is recognised directly in equity, and the total
of those items;
(c) total income and expense for the period (calculated as the sum of (a) and (b)), showing separately
the total amounts attributable to equity holders of the parent and to minority interest; and
(d) for each component of equity, the effects of changes in accounting policies and corrections of
errors recognised in accordance with IAS 8.

The following amounts may also be presented on the face of the statement of changes in equity, or they may
be presented in the notes: [IAS 1.97]
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FINANCIAL ACCOUNTING III
 Lesson Nine 429

(a) capital transactions with owners;

(b) the balance of accumulated profits at the beginning and at the end of the period, and the
movements for the period; and
(c) a reconciliation between the carrying amount of each class of equity capital, share premium and
each reserve at the beginning and at the end of the period, disclosing each movement.

Notes to the Financial Statements

The notes must: [IAS 1.103]

present information about the basis of preparation of the financial statements and the specific
accounting policies used;
disclose any information required by IFRSs that is not presented on the face of the statement of
financial position, income statement, statement of changes in equity, or cash flow statement; and
provide additional information that is not presented on the face of the statement of financial
position, income statement, statement of changes in equity, or cash flow statement that is deemed
relevant to an understanding of any of them.

Notes should be cross-referenced from the face of the financial statements to the relevant note. [IAS 1.104]

IAS 1.105 suggests that the notes should normally be presented in the following order:

a statement of compliance with IFRSs;

a summary of significant accounting policies applied, including: [IAS 1.108]
the measurement basis (or bases) used in preparing the financial statements; and
the other accounting policies used that are relevant to an understanding of the financial
statements.
supporting information for items presented on the face of the statement of financial position, income
statement, statement of changes in equity, and cash flow statement, in the order in which each
statement and each line item is presented; and
other disclosures, including:
contingent liabilities (see IAS 37) and unrecognised contractual commitments; and
non-financial disclosures, such as the entity's financial risk management objectives and
policies (see IAS 32).

Disclosure of judgements. New in the 2003 revision to IAS 1, an entity must disclose, in the summary of
significant accounting policies or other notes, the judgements, apart from those involving estimations, that
management has made in the process of applying the entity's accounting policies that have the most
significant effect on the amounts recognised in the financial statements. [IAS 1.113]

Examples cited in IAS 1.114 include management's judgements in determining:

whether financial assets are held-to-maturity investments;

when substantially all the significant risks and rewards of ownership of financial assets and lease
assets are transferred to other entities;
whether, in substance, particular sales of goods are financing arrangements and therefore do not give
rise to revenue; and
whether the substance of the relationship between the entity and a special purpose entity indicates
that the special purpose entity is controlled by the entity.

Disclosure of key sources of estimation uncertainty. Also new in the 2003 revision to IAS 1, an entity must
disclose, in the notes, information about the key assumptions concerning the future, and other key sources of
estimation uncertainty at the statement of financial position date, that have a significant risk of causing a
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material adjustment to the carrying amounts of assets and liabilities within the next financial year. [IAS 1.116]
These disclosures do not involve disclosing budgets or forecasts.

The following other note disclosures are required by IAS 1.126 if not disclosed elsewhere in information
published with the financial statements:

domicile of the enterprise;

country of incorporation;
address of registered office or principal place of business;
description of the enterprise's operations and principal activities;
name of its parent and the ultimate parent if it is part of a group.

Disclosures about Dividends

The following must be disclosed either on the face of the income statement or the statement of changes in
equity or in the notes: [IAS 1.95]

the amount of dividends recognised as distributions to equity holders during the period, and
the related amount per share.

The following must be disclosed in the notes: {IAS 1.125]

the amount of dividends proposed or declared before the financial statements were authorised for
issue but not recognised as a distribution to equity holders during the period, and the related amount
per share; and
the amount of any cumulative preference dividends not recognised.

August 2005 Amendments re Capital Disclosures

As part of its project to develop IFRS 7 Financial Instruments: Disclosures, the IASB concluded also to amend
IAS 1 to add requirements for disclosures of:

the entity's objectives, policies and processes for managing capital;

quantitative data about what the entity regards as capital;
whether the entity has complied with any capital requirements; and
if it has not complied, the consequences of such non-compliance.

These disclosure requirements apply to all entities, effective for annual periods beginning on or after 1
January 2007, with earlier application encouraged. Illustrative examples are provided as guidance.

IAS 2 Inventories (revised 2003)

Effective Date: Annual periods beginning on or after 1 January 2005.

Objective To prescribe the accounting treatment for inventories, including cost determination and
expense recognition.

Summary • Inventories are required to be stated at the lower of cost and net realisable value.
• Costs include purchase cost, conversion cost (materials, labour, and overhead), and other costs to bring
inventory to its present location and condition, but not foreign exchange differences.
• For inventory items that are not interchangeable, specific costs are attributed to the specific individual items
of inventory.
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FINANCIAL ACCOUNTING III
 Lesson Nine 431

• For interchangeable items, cost is determined on either a FIFO or weighted average basis. LIFO is not
permitted.
• When inventories are sold, the carrying amount should be recognised as an expense in the period in which
the related revenue is recognised.

Interpretations None.

IAS 7 Cash Flow Statements (revised 1992)

Objective of IAS 7

The objective of IAS 7 is to require the presentation of information about the historical changes in cash and
cash equivalents of an enterprise by means of a cash flow statement which classifies cash flows during the
period according to operating, investing and financing activities.

Fundamental Principle in IAS 7

All enterprises that prepare financial statements in conformity with IAS are required to present a cash flow
statement. [IAS 7.1]

The cash flow statement analyses changes in cash and cash equivalents during a period. Cash and cash
equivalents comprise cash on hand and demand deposits, together with short-term, highly liquid investments
that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes
in value. Guidance notes indicate that an investment normally meets the definition of a cash equivalent when
it has a maturity of three months or less from the date of acquisition. Equity investments are normally
excluded, unless they are in substance a cash equivalent (e.g. preferred shares acquired within three months of
their specified redemption date). Bank overdrafts which are repayable on demand and which form an integral
part of an enterprise's cash management are also included as a component of cash and cash equivalents. [IAS
7.7-8]
Presentation of the Cash Flow Statement

Cash flows must be analysed between operating, investing and financing activities. [IAS 7.10]

Key principles specified by IAS 7 for the preparation of a cash flow statement are as follows:

operating activities are the main revenue-producing activities of the enterprise that are not
investing or financing activities, so operating cash flows include cash received from customers and
cash paid to suppliers and employees [IAS 7.14]
investing activities are the acquisition and disposal of long-term assets and other investments that
are not considered to be cash equivalents [IAS 7.6]
financing activities are activities that alter the equity capital and borrowing structure of the
enterprise [IAS 7.6]
interest and dividends received and paid may be classified as operating, investing, or financing cash
flows, provided that they are classified consistently from period to period [IAS 7.31]
cash flows arising from taxes on income are normally classified as operating, unless they can be
specifically identified with financing or investing activities [IAS 7.35]
for operating cash flows, the direct method of presentation is encouraged, but the indirect method is
acceptable [IAS 7.18]

The direct method shows each major class of gross cash receipts and gross cash payments. The
operating cash flows section of the cash flow statement under the direct method would appear
something like this:

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Cash receipts from customers xx,xxx

Cash paid to suppliers xx,xxx
Cash paid to employees xx,xxx
Cash paid for other operating expenses xx,xxx
Interest paid xx,xxx
Income taxes paid xx,xxx
Net cash from operating activities xx,xxx

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions.
The operating cash flows section of the cash flow statement under the indirect method would appear
something like this:

Profit before interest and income taxes xx,xxx

Add back depreciation xx,xxx
Add back amortisation of goodwill xx,xxx
Increase in receivables xx,xxx
Decrease in inventories xx,xxx
Increase in trade payables xx,xxx
Interest expense xx,xxx
Less Interest accrued but not yet paid xx,xxx
Interest paid xx,xxx
Income taxes paid xx,xxx
Net cash from operating activities xx,xxx

cash flows relating to extraordinary items should be classified as operating, investing or financing as
appropriate and should be separately disclosed [IAS 7.29]
the exchange rate used for translation of transactions denominated in a foreign currency and the cash
flows of a foreign subsidiary should be the rate in effect at the date of the cash flows [IAS 7.25]
cash flows of foreign subsidiaries should be translated at the exchange rates prevailing when the cash
flows took place [IAS 7.26]
as regards the cash flows of associates and joint ventures, where the equity method is used, the cash
flow statement should report only cash flows between the investor and the investee; where
proportionate consolidation is used, the cash flow statement should include the venturer's share of
the cash flows of the investee [IAS 7.37-38]
aggregate cash flows relating to acquisitions and disposals of subsidiaries and other business units
should be presented separately and classified as investing activities, with specified additional
disclosures. The aggregate cash paid or received as consideration should be reported net of cash and
cash equivalents acquired or disposed of [IAS 7.39]
cash flows from investing and financing activities should be reported gross by major class of cash
receipts and major class of cash payments except for the following cases, which may be reported on a
net basis: [IAS 7.22-24]
cash receipts and payments on behalf of customers (for example, receipt and repayment of
demand deposits by banks, and receipts collected on behalf of and paid over to the owner of
a property)
cash receipts and payments for items in which the turnover is quick, the amounts are large,
and the maturities are short, generally less than three months (for example, charges and
collections from credit card customers, and purchase and sale of investments)
cash receipts and payments relating to fixed maturity deposits
cash advances and loans made to customers and repayments thereof
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FINANCIAL ACCOUNTING III
 Lesson Nine 433

investing and financing transactions which do not require the use of cash should be excluded from
the cash flow statement, but they should be separately disclosed elsewhere in the financial statements
[IAS 7.43]
the components of cash and cash equivalents should be disclosed, and a reconciliation presented to
amounts reported in the statement of financial position [IAS 7.45]
the amount of cash and cash equivalents held by the enterprise that is not available for use by the
group should be disclosed, together with a commentary by management [IAS 7.48]

IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors (revised 2003)

Key Definitions [IAS 8.5]

Accounting policies are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements.
A change in accounting estimate is an adjustment of the carrying amount of an asset or liability,
or related expense, resulting from reassessing the expected future benefits and obligations associated
with that asset or liability.
International Financial Reporting Standards are standards and interpretations adopted by the
International Accounting Standards Board (IASB). They comprise:
International Financial Reporting Standards (IFRSs);
International Accounting Standards (IASs); and
Interpretations developed by the International Financial Reporting Interpretations
Committee (IFRIC) or the former Standing Interpretations Committee (SIC) and approved
by the IASB.
Materiality. Omissions or misstatements of items are material if they could, by their size or nature,
individually or collectively, influence the economic decisions of users taken on the basis of the
financial statements.
Prior period errors are omissions from, and misstatements in, an entity's financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable information that was
available and could reasonably be expected to have been obtained and taken into account in
preparing those statements. Such errors result from mathematical mistakes, mistakes in applying
accounting policies, oversights or misinterpretations of facts, and fraud.

Selection and Application of Accounting Policies

When a Standard or an Interpretation specifically applies to a transaction, other event or condition, the
accounting policy or policies applied to that item must be determined by applying the Standard or
Interpretation and considering any relevant Implementation Guidance issued by the IASB for the Standard or
Interpretation. [IAS 8.7]

In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or
condition, management must use its judgement in developing and applying an accounting policy that results
in information that is relevant and reliable. [IAS 8.10]. In making that judgement, management must refer to,
and consider the applicability of, the following sources in descending order:

the requirements and guidance in IASB standards and interpretations dealing with similar and related
issues; and
the definitions, recognition criteria and measurement concepts for assets, liabilities, income and
expenses in the Framework. [IAS 8.11]

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Management may also consider the most recent pronouncements of other standard-setting bodies that use a
similar conceptual framework to develop accounting standards, other accounting literature and accepted
industry practices, to the extent that these do not conflict with the sources in paragraph 11. [IAS 8.12]

Consistency of Accounting Policies

An entity shall select and apply its accounting policies consistently for similar transactions, other events and
conditions, unless a Standard or an Interpretation specifically requires or permits categorisation of items for
which different policies may be appropriate. If a Standard or an Interpretation requires or permits such
categorisation, an appropriate accounting policy shall be selected and applied consistently to each category.
[IAS 8.13]

Changes in Accounting Policies

An entity is permitted to change an accounting policy only if the change:

is required by a standard or interpretation; or

results in the financial statements providing reliable and more relevant information about the effects
of transactions, other events or conditions on the entity's financial position, financial performance, or
cash flows. [IAS 8.14]

Note that changes in accounting policies do not include applying an accounting policy to a kind of transaction
or event that did not exist in the past. [IAS 8.16]

If a change in accounting policy is required by a new IASB standard or interpretation, the change is
accounted for as required by that new pronouncement or, if the new pronouncement does not include
specific transition provisions, then the change in accounting policy is applied retrospectively. [IAS 8.19]

Retrospective application means adjusting the opening balance of each affected component of equity for the
earliest prior period presented and the other comparative amounts disclosed for each prior period presented
as if the new accounting policy had always been applied. [IAS 8.22]

However, if it is impracticable to determine either the period-specific effects or the cumulative effect
of the change for one or more prior periods presented, the entity shall apply the new accounting
policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for
which retrospective application is practicable, which may be the current period, and shall make a
corresponding adjustment to the opening balance of each affected component of equity for that
period. [IAS 8.24]
Also, if it is impracticable to determine the cumulative effect, at the beginning of the current period,
of applying a new accounting policy to all prior periods, the entity shall adjust the comparative
information to apply the new accounting policy prospectively from the earliest date practicable. [IAS
8.25]

Disclosures Relating to Changes in Accounting Policies

Disclosures relating to changes in accounting policy caused by a new standard or interpretation include: [IAS
8.28]

the title of the standard or interpretation causing the change;

the nature of the change in accounting policy;
a description of the transitional provisions, including those that might have an effect on future
periods;
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FINANCIAL ACCOUNTING III
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for the current period and each prior period presented, to the extent practicable, the amount of the
adjustment:
for each financial statement line item affected; and
for basic and diluted earnings per share (only if the entity is applying IAS 33);
the amount of the adjustment relating to periods before those presented, to the extent practicable;
and
if retrospective application is impracticable, an explanation and description of how the change in
accounting policy was applied.

Financial statements of subsequent periods need not repeat these disclosures.

Disclosures relating to voluntary changes in accounting policy include: [IAS 8.29]

the nature of the change in accounting policy;

the reasons why applying the new accounting policy provides reliable and more relevant information;
for the current period and each prior period presented, to the extent practicable, the amount of the
adjustment:
for each financial statement line item affected; and
for basic and diluted earnings per share (only if the entity is applying IAS 33);
the amount of the adjustment relating to periods before those presented, to the extent practicable;
and
if retrospective application is impracticable, an explanation and description of how the change in
accounting policy was applied.

Financial statements of subsequent periods need not repeat these disclosures.

If an entity has not applied a new standard or interpretation that has been issued but is not yet effective, the
entity must disclose that fact and any and known or reasonably estimable information relevant to assessing
the possible impact that the new pronouncement will have in the year it is applied. [IAS 8.30]

Changes in Accounting Estimate

The effect of a change in an accounting estimate shall be recognised prospectively by including it in profit or
loss in: [IAS 8.36]

the period of the change, if the change affects that period only; or
the period of the change and future periods, if the change affects both.

However, to the extent that a change in an accounting estimate gives rise to changes in assets and liabilities,
or relates to an item of equity, it is recognised by adjusting the carrying amount of the related asset, liability,
or equity item in the period of the change. [IAS 8.37]

Disclosures Relating to Changes in Accounting Estimate

Disclose:

the nature and amount of a change in an accounting estimate that has an effect in the current period
or is expected to have an effect in future periods
if the amount of the effect in future periods is not disclosed because estimating it is impracticable, an
entity shall disclose that fact. [IAS 8.39-40]

Errors
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The general principle in IAS 8 is that an entity must correct all material prior period errors retrospectively in
the first set of financial statements authorised for issue after their discovery by: [IAS 8.42]

restating the comparative amounts for the prior period(s) presented in which the error occurred; or
if the error occurred before the earliest prior period presented, restating the opening balances of
assets, liabilities and equity for the earliest prior period presented.

However, if it is impracticable to determine the period-specific effects of an error on comparative

information for one or more prior periods presented, the entity must restate the opening balances of assets,
liabilities, and equity for the earliest period for which retrospective restatement is practicable (which may be
the current period). [IAS 8.44]

Further, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of an
error on all prior periods, the entity must restate the comparative information to correct the error
prospectively from the earliest date practicable. [IAS 8.45]

Disclosures Relating to Prior Period Errors

Disclosures relating to prior period errors include: [IAS 8.49]

the nature of the prior period error;

for each prior period presented, to the extent practicable, the amount of the correction:
for each financial statement line item affected; and
for basic and diluted earnings per share (only if the entity is applying IAS 33);
the amount of the correction at the beginning of the earliest prior period presented; and
if retrospective restatement is impracticable, an explanation and description of how the error has
been corrected.

Financial statements of subsequent periods need not repeat these disclosures.

IAS 10 Events After the Statement of financial position Date (revised 2003)

Event after the statement of financial position date: An event, which could be favourable or unfavourable,
that occurs between the statement of financial position date and the date that the financial statements are
authorised for issue. [IAS 10.3]

Adjusting event: An event after the statement of financial position date that provides further evidence of
conditions that existed at the statement of financial position, including an event that indicates that the going
concern assumption in relation to the whole or part of the enterprise is not appropriate. [IAS 10.3]

Non-adjusting event: An event after the statement of financial position date that is indicative of a condition
that arose after the statement of financial position date. [IAS 10.3]

Accounting

Adjust financial statements for adjusting events – events after the statement of financial position date
that provide further evidence of conditions that existed at the statement of financial position,
including events that indicate that the going concern assumption in relation to the whole or part of
the enterprise is not appropriate. [IAS 10.8]

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FINANCIAL ACCOUNTING III
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Do not adjust for non-adjusting events – events or conditions that arose after the statement of
financial position date. [IAS 10.10]
If an entity declares dividends after the statement of financial position date, the entity shall not
recognise those dividends as a liability at the statement of financial position date. That is a non-
adjusting event. [IAS 10.12]

Going Concern Issues Arising After Statement of financial position Date

An entity shall not prepare its financial statements on a going concern basis if management determines after
the statement of financial position date either that it intends to liquidate the entity or to cease trading, or that
it has no realistic alternative but to do so. [IAS 10.14]

Disclosure

Non-adjusting events should be disclosed if they are of such importance that non-disclosure would affect the
ability of users to make proper evaluations and decisions. The required disclosure is (a) the nature of the
event and (b) an estimate of its financial effect or a statement that a reasonable estimate of the effect cannot
be made. [IAS 10.21]

A company should update disclosures that relate to conditions that existed at the statement of financial
position date to reflect any new information that it receives after the statement of financial position date
about those conditions. [IAS 10.19]

Companies must disclose the date when the financial statements were authorised for issue and who gave that
authorisation. If the enterprise's owners or others have the power to amend the financial statements after
issuance, the enterprise must disclose that fact. [IAS 10.17]

IAS 12 Income Taxes (revised 2000)

Effective Date Periods beginning on or after 1 January 1998. Certain revisions effective for periods
beginning on or after 1 January 2001.
Objective To prescribe the accounting treatment for income taxes. To establish the principles and provide
guidance in accounting for the current and future income tax consequences related to:
- the future recovery (settlement) of carrying amounts of assets (liabilities) in an entity‘s
statement of financial position, and
- current period transactions recognised in the income statement or directly through equity.
Summary • Current tax liabilities and assets should be recognised for current and prior period
taxes, measured at the rates applicable for the period.
• A temporary difference is a difference between the carrying amount of an asset or liability and its tax base.
• Deferred tax liabilities must be recognized for the future tax consequences of all taxable temporary
differences with three exceptions:
- liabilities arising from the initial recognition of goodwill;
- liabilities arising from the initial recognition of an asset/liability other than in a business combination which,
at the time of the transaction, does not affect either the accounting or the taxable profit; and
- liabilities arising from undistributed profits from investments where the enterprise is able to control the
timing of the reversal of the difference and it is probable that the reversal will not occur in the
foreseeable future.
• A deferred tax asset must be recognized for deductible temporary differences, unused
tax losses, and unused tax credits to the extent that it is probable that taxable profit
will be available against which the deductible temporary differences can be utilized, with this exception:
- the deferred tax asset arises from the initial recognition of an asset/liability, other than in a business
combination, which at the time of the transaction, does not affect the accounting or the taxable
profit.
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• Deferred tax liabilities (assets) should be measured at the tax rates expected to apply when the liability is
settled or asset is realised, based on tax rates/laws that have been enacted or substantively enacted by the
statement of financial position date.
• Discounting of deferred tax assets and liabilities is prohibited.
• Deferred taxes must be presented as non current items in the statement of financial position.
• IAS 12 specifies detailed disclosure requirements for income taxes.

IAS 21 The Effects of Changes in Foreign Exchange Rates (revised 2003)

Effective Date Annual periods beginning on or after 1 January 2005.

Objective To prescribe the accounting treatment for an entity‘s foreign currency transactions and foreign
operations.
Summary • First, determine reporting entity‘s functional currency.
• Then translate all foreign currency items into the functional currency:
- At date of transaction, record using the transaction-date exchange rate for initial recognition and
measurement.
- At subsequent statement of financial position dates: use closing rate for monetary items; use transaction-
date exchange rates for non-monetary items carried at historical cost; and use valuation-date exchange rates
for non-monetary items that are carried at fair value.
- Exchange differences arising on settlement of monetary items and on translation of monetary items at a rate
different than when initially recognised are included in net profit or loss, with one exception: exchange
differences arising on monetary items that form part of the reporting entity‘s net investment in a foreign
operation are recognised in the consolidated financial statements that
include the foreign operation in a separate component of equity; they will be recognised in profit or loss on
disposal of the net investment.
• The results and financial position of an entity whose functional currency is not the currency of a
hyperinflationary economy are translated into a different presentation currency using the following
procedures:
- assets and liabilities for each statement of financial position presented (including comparatives) are
translated at the closing rate at the date of that statement of financial position;
- income and expenses for each income statement (including comparatives) are translated at exchange rates at
the datesof the transactions; and
- all resulting exchange differences are recognised as a separate component of equity.
• Special rules for translating into a presentation currency the results and
financial position of an entity whose functional currency is hyperinflationary.

Summary of IAS 26 Accounting and Reporting by Retirement Benefit Plans and important
definitions

Objective of IAS 26

The objective of IAS 26 is to specify measurement and disclosure principles for the reports of retirement
benefit plans. All plans should include in their reports a statement of changes in net assets available for
benefits, a summary of significant accounting policies and a description of the plan and the effect of any
changes in the plan during the period.

Key Definitions

Retirement benefit plan: An arrangement by which an enterprise provides benefits (annual income or lump
sum) to employees after they terminate from service.

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FINANCIAL ACCOUNTING III
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Defined Contribution Plan: A retirement benefit plan by which benefits to employees are based on the
amount of funds contributed to the plan by the employer plus earnings thereon.

Defined Benefit Plan: A retirement benefit plan by which employees receive benefits based on a formula
usually linked to employee earnings.

Defined Contribution Plans

The report of a defined contribution plan should contain a statement of net assets available for benefits and a
description of the funding policy.

Defined Benefit Plans

The report of a defined benefit plan should contain either:

a statement that shows the net assets available for benefits, the actuarial present value of promised
retirement benefits (distinguishing between vested benefits and non-vested benefits) and the resulting
excess or deficit; or
a statement of net assets available for benefits, including either a note disclosing the actuarial present
value of promised retirement benefits (distinguishing between vested benefits and non-vested
benefits) or a reference to this information in an accompanying actuarial report.

If an actuarial valuation has not been prepared at the date of the report of a defined benefit plan, the most
recent valuation should be used as a base and the date of the valuation disclosed. The actuarial present value
of promised retirement benefits should be based on the benefits promised under the terms of the plan on
service rendered to date, using either current salary levels or projected salary levels, with disclosure of the
basis used. The effect of any changes in actuarial assumptions that have had a significant effect on the
actuarial present value of promised retirement benefits should also be disclosed.

The report should explain the relationship between the actuarial present value of promised retirement
benefits and the net assets available for benefits, and the policy for the funding of promised benefits.

Retirement benefit plan investments should be carried at fair value. For marketable securities, fair value
means market value. If fair values cannot be estimated for certain retirement benefit plan investments,
disclosure should be made of the reason why fair value is not used.

Disclosure

Statement of net assets available for benefit, showing:

assets at the end of the period
basis of valuation
details of any single investment exceeding 5% of net assets or 5% of any category of
investment
details of investment in the employer
liabilities other than the actuarial present value of plan benefits
Statement of changes in net assets available for benefits, showing:
employer contributions
employee contributions
investment income
other income
benefits paid
administrative expenses
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other expenses
income taxes
profit or loss on disposal of investments
changes in fair value of investments
transfers to/from other plans
Description of funding policy
Other details about the plan
Summary of significant accounting policies
Description of the plan and of the effect of any changes in the plan during the period
Disclosures for defined benefit plans:
actuarial present value of promised benefit obligations
description of actuarial assumptions
description of the method used to calculate the actuarial present value of promised benefit
obligations

IAS 27 Consolidated and Separate Financial Statements (revised 2003)

IAS 27 has the twin objectives of setting standards to be applied:

in the preparation and presentation of consolidated financial statements for a group of entities under
the control of a parent; and
in accounting for investments in subsidiaries, jointly controlled entities, and associates when an entity
elects, or is required by local regulations, to present separate (non-consolidated) financial statements.

Key Definitions [IAS 27.4]

Consolidated financial statements: The financial statements of a group presented as those of a single
economic entity.

Subsidiary: An entity, including an unincorporated entity such as a partnership, that is controlled by another
entity (known as the parent).

Parent: An entity that has one or more subsidiaries.

Control: The power to govern the financial and operating policies of an enterprise so as to obtain benefits
from its activities.

Identification of Subsidiaries

Control is presumed when the parent acquires more than half of the voting rights of the enterprise. Even
when more than one half of the voting rights is not acquired, control may be evidenced by power: [IAS 27.13]

over more than one half of the voting rights by virtue of an agreement with other investors; or
to govern the financial and operating policies of the other enterprise under a statute or an agreement;
or
to appoint or remove the majority of the members of the board of directors; or
to cast the majority of votes at a meeting of the board of directors.

Presentation of Consolidated Accounts

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A parent is required to present consolidated financial statements in which it consolidates its investments in
subsidiaries [IAS 27.9] – except in one circumstance: A parent is not required to (but may) present
consolidated financial statements if and only if all of the following four conditions are met: [IAS 27.10]

1. the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity

and its other owners, including those not otherwise entitled to vote, have been informed about, and
do not object to, the parent not presenting consolidated financial statements;
2. the parent's debt or equity instruments are not traded in a public market;
3. the parent did not file, nor is it in the process of filing, its financial statements with a securities
commission or other regulatory organisation for the purpose of issuing any class of instruments in a
public market; and
4. the ultimate or any intermediate parent of the parent produces consolidated financial statements
available for public use that comply with International Financial Reporting Standards.

The consolidated accounts should include all of the parent's subsidiaries, both domestic and foreign: [IAS
27.12]

There is no exemption for a subsidiary whose business is of a different nature from the parent's.
There is no exemption for a subsidiary that operates under severe long-term restrictions impairing
the subsidiary's ability to transfer funds to the parent. Such an exemption was included in earlier
versions of IAS 27, but in revising IAS 27 in December 2003 the IASB concluded that these
restrictions, in themselves, do not preclude control.
There is no exemption for a subsidiary that had previously been consolidated and that is now being
held for sale. The parent must continue to consolidate such a subsidiary until it is actually disposed
of. However, as a result of an amendment of IAS 27 by IFRS 5 in March 2004, there is an exemption
for a subsidiary for which control is intended to be temporary because the subsidiary was acquired
and is held exclusively with a view to its subsequent disposal in the near future. For such a subsidiary,
if it is highly probable that the sale will be completed within 12 months then the parent should
account for its investment in the subsidiary under IFRS 5 as an asset held for sale, rather than
consolidate it under IAS 27.

Special purpose entities (SPEs) should be consolidated where the substance of the relationship indicates that
the SPE is controlled by the reporting enterprise. This may arise even where the activities of the SPE are
predetermined or where the majority of voting or equity are not held by the reporting enterprise. [SIC 12]

Once an investment ceases to fall within the definition of a subsidiary, it should be accounted for as an
associate under IAS 28, as a joint venture under IAS 31, or as an investment under IAS 39, as appropriate.
[IAS 27.31]

Consolidation Procedures

Intragroup balances, transactions, income, and expenses should be eliminated in full. Intragroup losses may
indicate that an impairment loss on the related asset should be recognised. [IAS 27.24-25]

The financial statements of the parent and its subsidiaries used in preparing the consolidated financial
statements should all be prepared as of the same reporting date, unless it is impracticable to do so. [IAS
27.26] If it is impracticable a particular subsidiary to prepare its financial statements as of the same date as its
parent, adjustments must be made for the effects of significant transactions or events that occur between the
dates of the subsidiary's and the parent's financial statements. And in no case may the difference be more
than three months. [IAS 27.27]

Consolidated financial statements must be prepared using uniform accounting policies for like transactions
and other events in similar circumstances. [IAS 27.28]
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Minority interests should be presented in the consolidated statement of financial position within equity, but
separate from the parent's shareholders' equity. Minority interests in the profit or loss of the group should
also be separately presented. [IAS 27.33]

Where losses applicable to the minority exceed the minority interest in the equity of the relevant subsidiary,
the excess, and any further losses attributable to the minority, are charged to the group unless the minority
has a binding obligation to, and is able to, make good the losses. Where excess losses have been taken up by
the group, if the subsidiary in question subsequently reports profits, all such profits are attributed to the
group until the minority's share of losses previously absorbed by the group has been recovered. [IAS 27.35]

Separate Financial Statements of the Parent or Investor in an Associate or Jointly Controlled Entity

In the parent's/investor's individual financial statements, investments in subsidiaries, associates, and jointly
controlled entities should be accounted for either: [IAS 27.37]

at cost; or
in accordance with IAS 39.

Such investments may not be accounted for by the equity method in the parent's/investor's separate
statements.

Disclosure

Disclosures required in consolidated financial statements: [IAS 27.40]

the nature of the relationship between the parent and a subsidiary when the parent does not own,
directly or indirectly through subsidiaries, more than half of the voting power;
the reasons why the ownership, directly or indirectly through subsidiaries, of more than half of the
voting or potential voting power of an investee does not constitute control;
the reporting date of the financial statements of a subsidiary when such financial statements are used
to prepare consolidated financial statements and are as of a reporting date or for a period that is
different from that of the parent, and the reason for using a different reporting date or period; and
the nature and extent of any significant restrictions on the ability of subsidiaries to transfer funds to
the parent in the form of cash dividends or to repay loans or advances.

Disclosures required in separate financial statements that are prepared for a parent that is permitted not to
prepare consolidated financial statements: [IAS 27.41]

the fact that the financial statements are separate financial statements; that the exemption from
consolidation has been used; the name and country of incorporation or residence of the entity whose
consolidated financial statements that comply with IFRS have been produced for public use; and the
address where those consolidated financial statements are obtainable;
a list of significant investments in subsidiaries, jointly controlled entities, and associates, including the
name, country of incorporation or residence, proportion of ownership interest and, if different,
proportion of voting power held; and
a description of the method used to account for the foregoing investments.

Disclosures required in the separate financial statements of a parent, investor in a jointly controlled entity, or
investor in an associate: [IAS 27.42]

the fact that the statements are separate financial statements and the reasons why those statements
are prepared if not required by law;
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FINANCIAL ACCOUNTING III
 Lesson Nine 443

a list of significant investments in subsidiaries, jointly controlled entities, and associates, including the
name, country of incorporation or residence, proportion of ownership interest and, if different,
proportion of voting power held; and
a description of the method used to account for the foregoing investments.

IAS 28 Investments in Associates (revised 2003)

IAS 28 applies to all investments in which an investor has significant influence but not control or joint
control except for investments held by a venture capital organisation, mutual fund, unit trust, and similar
entity that (by election or requirement) are accounted for as under IAS 39 at fair value with fair value changes
recognised in profit or loss. [IAS 28.1]
Key Definitions [IAS 28.2]
Associate: An enterprise in which an investor has significant influence but not control or joint control.
Significant influence: Power to participate in the financial and operating policy decisions but not control
them.
Equity method: A method of accounting by which an equity investment is initially recorded at cost and
subsequently adjusted to reflect the investor's share of the net profit or loss of the associate (investee).
Identification of Associates
A holding of 20% or more of the voting power (directly or through subsidiaries) will indicate significant
influence unless it can be clearly demonstrated otherwise. If the holding is less than 20%, the investor will be
presumed not to have significant influence unless such influence can be clearly demonstrated. [IAS 28.6]
The existence of significant influence by an investor is usually evidenced in one or more of the following
ways: [IAS 28.7]
representation on the board of directors or equivalent governing body of the investee;
participation in the policy-making process;
material transactions between the investor and the investee;
interchange of managerial personnel; or
provision of essential technical information.
Potential voting rights are a factor to be considered in deciding whether significant influence exists. [IAS 28.9]
Accounting for Associates
In its consolidated financial statements, an investor should use the equity method of accounting for
investments in associates, other than in the following three exceptional circumstances:
An investment in an associate that is acquired and held exclusively with a view to its disposal within
12 months from acquisition should be accounted for as held for trading under IAS 39. Under IAS 39,
those investments are measured at fair value with fair value changes recognised in profit or loss. [IAS
28.13(a)]
A parent that is exempted from preparing consolidated financial statements by paragraph 10 of IAS
27 may prepare separate financial statements as its primary financial statements. In those separate
statements, the investment in the associate may be accounted for by the cost method or under IAS
39. [IAS 28.13(b)]
An investor need not use the equity method if all of the following four conditions are met: [IAS
28.13(c)]
1. the investor is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of
another entity and its other owners, including those not otherwise entitled to vote, have been
informed about, and do not object to, the investor not applying the equity method;
2. the investor's debt or equity instruments are not traded in a public market;
3. the investor did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organisation for the purpose of issuing any class of
instruments in a public market; and
4. the ultimate or any intermediate parent of the investor produces consolidated financial
statements available for public use that comply with International Financial Reporting
Standards.

Applying the Equity Method of Accounting

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Basic principle. Under the equity method of accounting, an equity investment is initially recorded at cost
and is subsequently adjusted to reflect the investor's share of the net profit or loss of the associate. [IAS
28.11]

Distributions and other adjustments to carrying amount. Distributions received from the investee
reduce the carrying amount of the investment. Adjustments to the carrying amount may also be required
arising from changes in the investee's equity that have not been included in the income statement (for
example, revaluations). [IAS 28.11]

Potential voting rights. Although potential voting rights are considered in deciding whether significant
influence exists, the investor's share of profit or loss of the investee and of changes in the investee's equity is
determined on the basis of present ownership interests. It should not reflect the possible exercise or
conversion of potential voting rights. [IAS 28.12]

Implicit goodwill and fair value adjustments. On acquisition of the investment in an associate, any
difference (whether positive or negative) between the cost of acquisition and the investor's share of the fair
values of the net identifiable assets of the associate is accounted for like goodwill in accordance with IFRS 3,
Business Combinations. Appropriate adjustments to the investor's share of the profits or losses after
acquisition are made to account for additional depreciation or amortisation of the associate's depreciable or
amortisable assets based on the excess of their fair values over their carrying amounts at the time the
investment was acquired. Any goodwill shown as part of the carrying amount of the investment in the
associate is no longer amortised but instead tested annually for impairment in accordance with IFRS 3. [IAS
28.23]

Discontinuing the equity method. Use of the equity method should cease from the date that significant
influence ceases. The carrying amount of the investment at that date should be regarded as a new cost basis.
[IAS 28.18-19]

Transactions with associates. If an associate is accounted for using the equity method, unrealised profits
and losses resulting from upstream (associate to investor) and downstream (investor to associate) transactions
should be eliminated to the extent of the investor's interest in the associate. However, unrealised losses
should not be eliminated to the extent that the transaction provides evidence of an impairment of the asset
transferred. [IAS 28.22]

Date of associate's financial statements. In applying the equity method, the investor should use the
financial statements of the associate as of the same date as the financial statements of the investor unless it is
impracticable to do so. [IAS 28.24] If it impracticable, the most recent available financial statements of the
associate should be used, with adjustments made for the effects of any significant transactions or events
occurring between the accounting period ends. However, the difference between the reporting date of the
associate and that of the investor cannot be longer than three months. [IAS 28.25]

Associate's accounting policies. If the associate uses accounting policies that differ from those of the
investor, the associate's financial statements should be adjusted to reflect the investor's accounting policies for
the purpose of applying the equity method. [IAS 28.27]

Losses in excess of investment. If an investor's share of losses of an associate equals or exceeds its
"interest in the associate", the investor discontinues recognising its share of further losses. The "interest in an
associate" is the carrying amount of the investment in the associate under the equity method together with
any long-term interests that, in substance, form part of the investor's net investment in the associate. [IAS
28.29] After the investor's interest is reduced to zero, additional losses are recognised by a provision (liability)
only to the extent that the investor has incurred legal or constructive obligations or made payments on behalf
of the associate. If the associate subsequently reports profits, the investor resumes recognising its share of
those profits only after its share of the profits equals the share of losses not recognised. [IAS 28.30]
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FINANCIAL ACCOUNTING III
 Lesson Nine 445

Impairment. The impairment indicators in IAS 39, Financial Instruments: Recognition and Measurement,
apply to investments in associates. [IAS 28.31] If impairment is indicated, the amount is calculated by
reference to IAS 36, Impairment of Assets. [IAS 28.33] The recoverable amount of an investment in an
associate is assessed for each individual associate, unless the associate does not generate cash flows
independently. [IAS 28.34]

Separate Financial Statements of the Investor

Equity accounting is required in the separate financial statements of the investor even if consolidated
accounts are not required, for example, because the investor has no subsidiaries. But equity accounting is not
required where the investor would be exempt from preparing consolidated financial statements under IAS 27.
In that circumstance, instead of equity accounting, the parent would account for the investment either (a) at
cost or (b) in accordance with IAS 39.

Disclosure

The following disclosures are required: [IAS 28.37]

fair value of investments in associates for which there are published price quotations;
summarised financial information of associates, including the aggregated amounts of assets, liabilities,
revenues, and profit or loss;
explanations when investments of less than 20% are accounted for by the equity method or when
investments of more than 20% are not accounted for by the equity method;
use of a reporting date of the financial statements of an associate that is different from that of the
investor;
nature and extent of any significant restrictions on the ability of associates to transfer funds to the
investor in the form of cash dividends, or repayment of loans or advances;
unrecognised share of losses of an associate, both for the period and cumulatively, if an investor has
discontinued recognition of its share of losses of an associate;
explanation of any associate is not accounted for using the equity method; and
summarised financial information of associates, either individually or in groups, that are not
accounted for using the equity method, including the amounts of total assets, total liabilities,
revenues, and profit or loss.

The following disclosures relating to contingent liabilities are also required: [IAS 28.40]

Investor's share of the contingent liabilities of an associate incurred jointly with other investors; and
Contingent liabilities that arise because the investor is severally liable for all or part of the liabilities of
the associate.

Presentation

Equity method investments must be classified as non-current assets. [IAS 28.38]

The investor's share of the profit or loss of equity method investments, and the carrying amount of
those investments, must be separately disclosed. [IAS 28.38]
The investor's share of any discontinuing operations of such associates is also separately disclosed.
[IAS 28.38]
The investor's share of changes recognised directly in the associate's equity are also recognised
directly in equity by the investor, with disclosure in the statement of changes in equity as required by
IAS 1 Presentation of Financial Statements. [IAS 28.39]

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STRATHMORE UNIVERSITY● STUDYPACK
 446 Revision Aid

MODEL ANSWERS TO REINFORCING QUESTIONS

LESSON 1

QUESTION ONE

CAPITAL ACCOUNT
Abincha Chumba Bichage Abincha Bichage Chumba
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
1996/1997 1997/1998
Drawings 1,075 870 1,080 Bal b/d 1,500 1,200 1,300
Interest on capital 225 180 195
Salaries 600 600 800
Bal c/d 1,800 1600 1,600 Profit:: 1st 300 240 260
2nd 250 250 125
2,875 2470 2,680 2,875 2,470 2,680
1997/1998 1997/1998
Goodwill - 2,000 1,000 Bal b/d 1,800 1,600 1,600
Drawings 1,222 856 976 Interest on capital 270 240 240
Cash 3096 - - Salaries 600 600 800
Profit: 1st 288 256 256
2nd 160 160 80
Goodwill 1,200 1,200 600
Bal c/d - 3,000 3,400 Cash - 1,800 1,800
4,318 5,856 5,376 4,318 5,856 5,376
1998/1999
Bal b/d - 3,00 3,400
Interest on capital - 450 510
Salaries - 600 800
Profit: 1st - 120 60
2nd - 375 425
Bal c/d - 4,545 5,195 - 4,545 5,195
1999/2000 1999/2000
CB - 400 2,800 Bal c/d - 3,600 4,400
CB - 3,000 1,500
Loss on
Realization - 200 100
- 3,600 4,400 - 3,600 4,400

DISTRIIBUTION OF CASH STATEMENT

(1) MAXIMUM POSSIBLE LOSS METHOD:

Total Bichage Chomba
Sh. ‗000‘ Sh.‘000‘ Sh.‘000‘
Capital balance 8,000 3,600 4,400
Cash available 15.11.99 (3,200)
Maximum possible loss 4,800 (3,200) (1,600)
Cash distributed 3,200 400 2,800
Capital balance 4,800 3,200 1,600
Cash available 30.11.99 (4,500)
Maximum possible loss 300 (200) (100)
Cash distributed 4,500 3,000 1,500
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FINANCIAL ACCOUNTING III
 Lesson Nine 447

(2) SURPLUS CAPITAL METHOD

Bichage Chomba Total
Sh.‘000‘ Sh.‘000‘ Sh. ‗000‘
Capital Cash available 3,600 4,400 8,000
Profit sharing ratio 2 1 3
Capital per unit of profit 1,800 4,40 N/A
Capitals in PSR 3,600 1,800 5,400
- 2,600 2,600
Statement of actual
distributions 15.11.99: - 2,600 2,600
Part 400 200 600
Balance 3,000 2,800 3,200
30.11.99: Total 3,400 1,500 4,500
4,300 7,700

ABINCHA, BICHAGE AND CHOMBA

P& L APPROPRIATION ACCOUNTS
1997 1998 1999
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Profit for year 4,025 3,950 3,340
Interest on capital A 225 270 -
B 180 240 450
C 195 600 240 750 510 960
3,425 3,200 2,380
Salaries A 600 600 -
B 600 600 600
C 800 1,200 800 2,000 800 1,400
1,425 1,200 980
Profit 1st A 300 288 -
B 240 256 375
C 260 800 256 800 425 800
625 400 180
2nd A 250 160 -
B 250 160 120
C 125 625 80 400 60 180
- - -

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STRATHMORE UNIVERSITY● STUDYPACK
 448 Revision Aid

QUESTION TWO

(a) Kioko, Licha and Mengo

Partnership Realisation Account
Sh.‘000‘ Sh.‘000‘
Land account 2,000 Depreciation accounts:
Buildings account 3,000 Buildings 990
Plant & machinery account 12,000 Plant and machinery 4,500
Motor vehicles account 4,000 Motor vehicles 3,500
Inventory account 5,200 Trade payables 5,100
Trade Receivables 4,100 Partners capital accounts
Cash account 1,280 Kioko 400
Additional cash 3,220 Licha 260
Profit on realization: Mengo 205 865
Kioko 3,665 Kioko‘s account:
Licha 3,665 Debtor 840
Mengo 3,665 10,995 Purchaser (Kiligo Ltd) a/c 30,000
45,795 45,795

(b) Partnership Capital Accounts

Kioko Licha Mengo Kioko Licha Mengo
2003 Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ 2002 Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
March 31 drawings 1,440 960 1,200 April 1 Balance b/f 3,000 2,000 4,000
March 31 Realisation April 1 Current A/cs 3,190 2,000 1,500
A/c: Cars 400 260 205 2003
March 31 Realisation March 31 P & L
A/c: debtor 840 Appropriation A/c:
Purchaser A/c 10,200 8,400 11,400 Interest on capital 1,800 600 400 800
Share of profit 3,600 1,200 1,200 1,200
5,400
March 31 Realisation 3,665 3,665 3,665
A/c Profit
Cash book 3,220 1,225 355 1,640
12,880 9,620 12,805 12,880 9,620 12,805

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FINANCIAL ACCOUNTING III
 Lesson Nine 449

(c) Kiligo Limited

Balance Shet as at 1 April 2003
Sh.‘000‘ Sh.‘000‘
Non-current assets
Property, plant and equipment at cost:
Freehold land 5,000
Buildings 4,000
Plant and machinery 10,000
19,000
Intangible asset: Goodwill cost 2,400
21,400
Current assets:
Inventory 5,700
Trade receivables 2,900
Cash at bank 4,500
13,100
Total assets 34500
EQUITY AND LIABILITIES
Share capital: authorized, issued and fully paid:
Sh.2 million share sof Sh.10 20,000
Share premium 10,000
30,000
Current liabilities:
Trade payables 4,500 4,500
TOTAL EQUITY AND LIABILITIES 34500

Purchaser Account
Sh. Sh.
Realisation account 30,000 Partners capital accounts: Shares
Kioko 10,200 680,000
Licha 8,400 560,000
____ Mengo 11,400
760,000
30,000 30,000 2,000,000

Partnership Statement of financial position at 31 March 2003 before cash introduced

Sh.‘000‘ Sh.‘000‘
PPM: 21,000 – 8,990 12,010
Current assets:
Inventory 5,200
Trade receivables 4,100
CB (4.5 – 3.22) 1,280
10,580
Current liabilities: Trade payables (5,100) 5,480
17,490
Capital: Closing 17,490
Opening 15,690 1,800
Add drawings 3,600
Net profit for the year 5,400

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STRATHMORE UNIVERSITY● STUDYPACK
 450 Revision Aid

QUESTION THREE
STATEMENT OF DISTRIBUTION
USING MAXIMUM POSSIBLE LOSS METHOD
Total Emojong Barmoi Kimani
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Capital a/c 25,000 12,500 7,500 5,000
Current a/c 8,750 5,000 3,750 -
33,250 17,500 11,250 5,000
Cash available (W1) (12,925)
Maximum possible loss 20,825 (8,330) (8,330) (4,165)
1st Distribution 12,925 9,170 2,920 835
capital balance 20,825 8,330 8,330 4,165
cash available (8,500)
maximum possible loss 12,325 (4,930) (4,930) (2,465)
2nd Distribution 6,500 3,400 3,400 1,700
capital balance 12,325 4,930 4,930 2,465
cash available (9,800)
maximum possible loss 2,125 (1,010) (1,010) (505)
3rd Distribution (W2) 9,800 3,920 3,920 1,960
Total distribution 31,225 16,490 10,240 4,495

(b) Realisation A/c

Sh. Sh.
Goodwill 12,500 CB: June 7,500
Buildings 18,750 July 31,250
Plant & Machinery 9,650 August 8,500
Fixtures 2,125 October 9,750
Motor vehicles 1,000 Discount received 125
Stock 8,000 Capital: E 1,010
Debtors 7,375 B 1,010
Dissolution expenses 250 K 505 2,525
59,650 59,650

CASH & BANK A/C

Sh. Sh.
Bal b/d 20 Bal b/d 16,045
Realisation: Creditors 7,000
June 7,520 Dissolution expenses 250
July 31,250 Loan 2,500
August 8,500 Capital: E 1,010
October 9,750 B 1,010
K 505 31,225
57,020 57,020

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FINANCIAL ACCOUNTING III
 Lesson Nine 451

(c) CAPITAL A/CS

E B K E B K
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Realisation 1,010 1,010 505 Bal b/d 12,500 7,500 5,000
CB 16,490 10,240 4,495 Current a/c 5,000 3,750 -
17,500 11,250 5,000 17,500 11,250 5,000

W1:
Sh. Sh.
Bal b/d 20
June Realisation 7,500
July Realisation 31,250
38,770
Creditors 7,125
Discount received (125)
Bank overdraft 16,045
Loan 2,500 25,545
12,925
W2

Sh.
Given 9,750
50
9,800

QUESTION FOUR
Apopo & Guserwa Kandie Apopo & Guserwa & Kandie
Co & Co Co Co
Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘
Office Equip. 450 420 150 New firm
Goodwill 1,500 1,065 240 Office Equip 300 420 150
WIP 1,800 1,050 240 Goodwill 1,800 1,050 150
Debtors 5,250 2,625 225 WIP 1,800 1,050 240
Debtors 4,200 2,100 180
Capital:
Apopo 300 - -
Cheloti 300 - -
Chuma 300 - -
Guserwa - 140 -
Kurgat - 240 -
___ Ochieng - 60 -
855 Kandie - - 135
9,000 5,160 9,000 5,160 855

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STRATHMORE UNIVERSITY● STUDYPACK
 452 Revision Aid

CAPITAL A/C (APOPO CHELOTI & COMPANY)

Apopo Cheloti Chuma Apopo Cheloti Chuma
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Realization 300 300 300 Balance.b/d 2,850 2,850 2,850
Cash 2,820 - - Current 270 360 120
Bal to new firm - 4,500 4,500 Cash - 1,590 1,830
3,120 4,800 4,800 3,120 4,800 4,800

CAPITAL A/C (GUSERWA & COMPANY)

Apopo Cheloti Chuma Apopo Cheloti Chuma
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Realization loss 240 240 60 Balance B/d 1,800 1,800 450
Contra 600 - - Current 600 390 60
Bal to new firm 2,250 2,250 750 Contra - 300 300
____ ____ ____ Cash 690 - -
3,090 2,490 800 3,090 2,490 800
CAPITAL A/C (Kandie)
Sh.‘000‘ Sh.‘000‘
Realization 135 B/d 900
Cash 15
Bal to new firm 750 ____
900 900
CASHBOOKS (Old Firms)
Apopo & Guserwa Kandie Apopo & Guserwa & Kandie
Co & Co Co Co
Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘
Bal. B/d 750 300 165 Capital
Capital: Apopo 2,820 - -
Cheloti 1,590 - - Kandie - - 15
Chuma 1,830 - - Creditors 450 360 120
Guserwa - 690 - Bal. to New firm 900 630 30
4,170 990 165 4,170 990 165

Dr Cr

Journal Entries
Office Equipment 300
Goodwill 1,800
WIP 1,800
Debtors 4,200
Cash 900
Capitals: Cheloti 4,500
Chuma 4,500
To record takeover of assets and capital from Apopo, Cheloti and Company.

Office Equipment 420

Goodwill 1,050
WIP 1,050
Debtors 2,100
Cash 630
Capitals: Guserwa 2,250
Kurgat 2,250
Ochieng 750

To record takeover of assets and capital from Guserwa & Company.

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FINANCIAL ACCOUNTING III
 Lesson Nine 453

Dr Cr
Office Equipment 150
Goodwill 150
WIP 240
Debtors 180
Cash 30
Capitals: Kandie 750
To record takeover of assets and capital from Kandie.
(b)
1st Six Months 2nd Six Months Full Year
Sh‘000‘ Sh‘000‘ Sh‘000‘
Profit after salaries 2,400 2,400 4,800
Add back salaries 300 x 6 300 x 7
1,800 2,100 3,900
Profit before salaries 4,200 4,500 8,700

PROFIT & LOSS APPROPRIATION A/C

6 Months to 30.09.99 Six Months to 31.03.00 TOTAL
Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘ Sh‘000‘
Net profit 4,200 4,500 8,700
Salaries: Cheloti
Chuma 300 300 600
Guserwa 300 300 600
Kurgat 300 300 600
Ochieng 300 300 600
Kandie 300 300 600
Maina - (1,800) 300 (2,100) 300 (3,900)
2,400 2,400 4,800
Profit share: Cheloti 720 540 1,260
Chuma 720 540 1,260
Guserwa 360 480 840
Kurgat 360 480 840
Ochieng 120 120 240
Kandie 120 180 300
Maina - 2,400 60 2,400 60 4,800
- - -

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 454

CURRENT A/C
Cheloti Chuma Guserwa Kurgat Ochieng Kandie Maina Cheloti Chuma Guserwa Kurgat Ochieng Kandie Maina
Drawings 270 270 270 270 270 270 - Salaries 300 300 300 300 300 300 -
Drawings 360 360 180 180 60 60 - Profit 720 720 360 360 120 120 -
Bal c/d 390 390 210 210 90 90 - share

1,020 1,020 660 660 420 420 - 1,020 1,020 660 660 420 420 -
Bal 390 390 210 210 90 90 -
b/d 300 300 300 300 300 300 300
Salary 530 540 480 480 120 180 60
Profit 125 125 - - - - -
share - - - - - - 65
Capital
a/c
Bal c/d
1,355 1,355 990 990 510 570 425 1,355 1,355 990 990 510 570 425

CAPITAL A/C
Cheloti Chuma Guserwa Kurgat Ochieng Kandie Maina Cheloti Chuma Guserwa Kurgat Ochieng Kandie Maina
Cash 1,000 1,000 - - - - - Bal b/f 4,500 4,500 2,250 2,250 750 750 -
book 125 125 - - - - - Cash - - 750 750 - 250 250
Current 3,375 3,375 3,000 3,000 750 1,125 375 book - - - - - - 125
a/c Current
Bal c/d A/c

4,500 4,500 3,000 3,000 750 1,125 375 4,500 4,500 3,000 3,000 750 1,125 375
Bal c/d 3,375 3,375 3,000 3,000 750 1,125 375 Bal b/d 3,375 3,375 3,000 3,000 750 1,125 375

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FINANCIAL ACCOUNTING III
455 Revision Aid

LESSON 2

QUESTION ONE
Income statement for the year ended 31 March 2003
Sh. Million
Turnover (net of VAT) 884
Cost of sales (601)
Gross profit 283
Other incomes 6
289
Distribution costs 109
Administrative expenses 99
Other expenses 3
Finance costs 27 (238)
Profit before taxation 51
Income tax expense (17)
Profit for the period 34

Statement of changes in Equity for the year ended 31 March 2003

Share Share Premium Revaluation Retained Total
Capital Sh. Million Reserve Earnings
Sh. Million Sh. Million Sh. Sh. Million
Million
At 1 April 2002 450 188 110 95 843
Net profit 34 34
Excess depreciation (4) 4 -
At 31 March 2003 450 188 106 133 877

Athi River Cement Limited

Statement of financial position as at 31 March 2003

Total
Sh.Million
Sh.Million
Non current assets
Property, plant and equipment (4 and 9) 848
Prepaid operating lease rentals: 60
Deferred expenditure: 15
923
Current assets:
Inventories: 186
Trade and other receivables 194
Cash and bank balances 5 385
Total Assets 1,308

Equity and liabilities

Capital and reserves 450

Share capital 188
Share premium 106
Revaluation reserve 133
Retained earnings 877

Non current liabilities:

Borrowings 50
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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 456

Finance leases payable 5

Deferred taxation 151 206

Current liabilities:
Trade and other payables 160
Finance leases payable 2
Borrowings: Bank overdraft 53
Unclaimed dividends 2
Compensating tax payable 8 225
Total equity and liabilities 1,308

Notes to the accounts

Note 1 Accounting policies

These financial statements have been prepared under the historical cost basis of accounting which is
modified to accommodate the revaluation of certain properties and in accordance with the applicable
IFRSs.

Property plant and equipment is shown at cost or revalued amount less the total accumultaed depreciation
which is based on the estimated useful life of the assets.

Inventory has been stated at the lower of cost and net relisable value.

Note 2 Profit before tax

The profit before tax has been arrived at after charging the following expenses

Sh m Sh.m
Depreciation of PPE 58
Amorisation of Intangibles 7
Directors emoluments - Fees 2
- Others 12 14
Other staff costs - Wages and salaries 81
- Social security costs 2
- Terminal benefits 3 86
Auditors remunaeration 2
Loss on dsposal of motor vehicles 3

Note 3 Taxation
Corporation tax is based on the adjusted profits for tax purpose at a corporation tax rate of 30%

Note 4 Inventories
Inventoires comprise of the following items
Sh m
Raw materials 48
Work in progress 29
Finished goods 51
Stores and spares 58
186

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FINANCIAL ACCOUNTING III
457 Revision Aid

QUESTION TWO
REALISATION A/C

Sh.‘000‘ Sh.‘000‘
Net assets taken over (W1) 2,595 Loss on realization 60
Goodwill (Balancing figures) 315 Purchase consideration 2,850
2,910 2,910

1. Assets – Liabilities (Net assets) = Capital + profits - drawings

= 1,350 + 750 + 495 – 0
= 2,595

(b) Maoja Ltd

Income Statement for the year ended 30.04.01

Sh.‘000‘ Sh.‘000‘
Sales 10,080
Cost of sales (6,720)
Gross profit 3,360
Distribution expenses 1,092
Administrative expenses (W2) 651
Finance costs 90 (1,833)
Profit before tax 1,527
Income tax expense 470
Profit after tax 1,057
Dividends: Interim 300
Final 210 (510
547

Note that final proposed dividends have been included in the income statement because the examiner
rquires so. Currently IAS 10 requires proposed dividends if declared after the year end to be given
as notes to the accounts.

Maoja Ltd
Statement of financial position as at 30.04.01
Sh.‘000‘ Sh.‘000‘
Non current Assets 2,085
Property Plant, and equipment (Note 4) 252
Goodwill 2,337

Current Assets
Inventory 1,140
Receivables 1,515
Cash and bank 405
Total current Assets 3,060
Total Assets 5397
Financed by:
Issued and fully paid share capital
210,000 ordinary shares of Sh.10 each 2,100

Retained profits 547

Shareholders funds 2,647

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 458

Long term liabilities

20% debentures 450
3,097
Current liabilities
Payables 1,530
Accruals (debenture interest) 90
Current tax 470
Proposed dividends 210 2,300

TOTAL EQUITY AND LIABILITIES 5397

W2: Administrative expenses Sh.‘000‘

Given 588
Add goodwill amortised (315/5) 63
651

Notes to the financial statements:

1. The above financial statements have been prepared under the historical basis of
accounting applicable IFRSs.
2. The net profit has been arrived at after charging:
Sh.‘000‘
Director‘s remuneration 60
Depreciation 255
Amortisation of goodwill 63
Staff costs 402

3. The tax expense for the year has been arrived at after charging tax at a corporate rate of
tax of 30% applicable in Kenya.

4. Plant, property and equipment

Land & Plant & Vehicles

Buildings Machinery Total
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Cost/valuation
Bal as at 01.05.00 - - - -
Additions 900 900 540 2,340
Bal as at 30.04.01 900 900 540 2,340
Depreciation
Bal as at 01.05.00 - - - -
Charge for the year 30 90 135 255
Bal as at 30.04.01 30 90 135 255
NBV as at 30.04.01 870 810 4050 2,0850

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FINANCIAL ACCOUNTING III
459 Revision Aid

LESSON 3
QUESTION ONE
B LIMITED
In Mombasa Books

Malindi Branch Stock A/C

20X6 Shs 20X7 Shs
July 1 Bal b/d 308,000 Jun 30 Debtors A/C 1,470,000
20X7 Jun 30 Cashbook 168,000
Jun 30 Sundry A/Cs 1,736,000 Jun 30 Sundry A/C: Returns 70,000
Jun 30 Branch Mark-up A/C Gds stolen 10,500
Jun 30 P & L A/C: Gds stolen 31,500
Jun 30 Branch Mark up A/C: Normal loss 7,000
Jun 30 Branch P&L: cash loss 10,640
Jun 30 Bal c/d 276,360
2,044,000 2,044,000
20X7
July 1 Bal b/d 276,360

Malindi Branch Mark-Up (Adjustment) Account

20X7 Shs 20X6 Shs
Jun 30 Branch Stock A/C: Returns 17,500 July 1 Balance b/d 77,000
Jun 30 Branch Stock A/C: Gds Stolen 10,500 20X7
Jun 30 Branch Stock A/C: Normal loss 7,000 Jun 30 Branch Stock A/C 434,000
Jun 30 P & L A/C: Profit 406,910
Jun 30 Bal c/d 69,090
511,000 511,000
20X7
July 1 Balance b/d 69,090

Malindi Branch Debtors Account

20X6 Shs 20X7 Shs
July 1 Balance b/d 276,220 Jun 30 P&L A/C: Bad debts 10,360
20X7 Jun 30 Cashbook 1,568,000
Jun 30 Branch Stock 1,470,000 Jun 30 P&L A/C: Discount 29,960
________ Jun 30 Balance c/d 137,900
1,746,220 1,746,220
20X7
July 1 Balance b/d 137,900

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 460

QUESTION TWO
D LIMITED

Branch Stock Accounts

20X5 20X6 (a) (b) (c)
Shs 000 Shs 000 Shs 000 Shs 000
Apr 1 Bal b/d 750 Mar 31 CB 1,200 1,200 1,200
20X6
Mar 31 Sundry A/cs 6,000 Mar 31 Branch Debtors A/c 4,370 4,370 4,370
Mar 31 Branch Debtors: Mar 31 Sundry A/c 300 300 300
Goods Returned 80 Mar 31 Branch Stock Adj 60 20 —
Mar 31 P&L A/c — 40 60
Mar 31 Bal c/d 900 900 900
6,830 6,830 6,830 6,830
20X6
Apr 1 Balance b/d 900

Branch Stock Adjustment Account

(a) (b) (c)
20X6 Shs 000 Shs 000 Shs 000 20X5 Shs 000
Mar 31 Branch Stock A/c 100 100 100 Apr 1 Bal b/d 250
Mar 31 Branch Stock A/c 60 20 — 20X6
Mar 31 P&L A/c 1,790 1,830 1,850 Mar31 Branch Stock A/c 2,000
Mar 31 Bal c/d 300 300 300
2,250 2,250 2,250 2,250
20X6
Apr 1 Bal b/d 300

Branch Bank Account

20X5 Shs 000 20X6 Shs 000
Apr 1 Balance b/f 30 Mar 31 P&L: Branch G. Expenses 420
20X6
Mar 31 Branch Debtors A/c 3,900 Mar 31 HO: CB 4,590
Branch Stock: Cash Sales 1,200 Mar 31 Balance c/d 120
5,130 5,130
20X6
Apr 1 Balance b/d 120

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FINANCIAL ACCOUNTING III
461 Revision Aid

Goods Sent To Branch Account

20X6 Shs 000 20X6 Shs 000
Mar 31 Branch Stock A/c 200 Mar 31 Branch Stock A/c 4,000
Mat 31 HO Trading A/c 3,800
4,000 4,000

Branch Debtors Account

20X5 Shs 000 20X6 Shs 000
Apr 1 Balance b/d 660 Mar 31 P&L A/c: Bad debts 150
20X6
Mar 31 Branch Stock A/c 4,370 Mar 31 CB 3,900
Mar 31 P&L A/c: Discounts Allowed 90
Mar 31 Branch Stock: Goods Returned 80
Mar 31 Balance c/d 810
5,030 5,030
20X6
Apr 1 Bal b/d 810

b. INCOME STATEMENT FOR THE YEAR TO 31ST MARCH 20X6

HO Branch Combined
(a) (b) (c) (a) (b) (c)
Shs 000 Shs 000 Shs 000 Shs 000 Shs 000 Shs 000 Shs 000
Sales 34,600 5,490 5,490 5,550 40,090 40,090 40,150
Opening Stock 1,800 500 500 500 2,300 2,300 2,300
Purchases 27,800 NIL NIL NIL 27,800 27,800 27,800
29,600 500 500 500 30,100 30,100 30,100
Goods to branch (3,800) 3,800 3,800 3,800 — — —
25,800 4,300 4,300 4,300
Goods missing — — (40) — — (40) —
Closing Stock (2,200) (600) (600) (600) (2,800) (2,800) (2,800)
23,600 3,700 3,660 3,700 27,300 27,260 27,300
Gross Profit 11,000 1,790 1,830 1,850 12,790 12,830 12,850
General Expenses 4,100 420 420 420 4,520 4,520 4,520
Bad Debts 240 150 150 150 390 390 390
Discount allowed 290 90 90 90 380 380 380
Loss of (b) Stock — — 40 — — 40 —
(c) Cash — — — 60 — — 60
4,630 660 700 720 5,290 5,330 5,350
NET PROFIT 6,370 1,130 1,130 1,130 7,500 7,500 7,500

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 462

QUESTION THREE
K LIMITED
Assumptions:

1. Non- Current Assets are shown at cost in the trial balances.

2. Taxation is ignored.
3. It is assumed that, in the HO Books, goods sent to branch are credited to purchases and debited to a
Goods Sent to Branch Account. This account will be closed off to the Branch Account.

K Limited:

Trading And Profit And Loss Accounts For The Year Ended 31st May 20X2

HO BRANCHCOMBINED
Shs 000 Shs 000 Shs 000
Sales 1,360 860 2,220
Opening Stock 260 90 350
Purchases/Goods from H.O 1,050 660 1,710
1,310 750 2,060
Deduct: Goods to Branch — — —
1,310 750 2,060
Deduct: Closing Stock 320 85 405
Cost of Sales 990 665 1,665
Gross Profit 370 195 565
Salaries and Wages 130 80 210
Staff Commission 8.67 7.68 16.35
Director's Fees 35 — 35
Rent and Rates 10 14 24
Water and Electricity 28 15 43
Advertising 13 2 15
Sundry Expenses 18 5 23
Furniture and Fittings 35 6.25 41.25
Depreciation: Motor Vehicles 63.75 8.75 72.50
Provision for Bad Debts 8.5 0.3 8.8
349.92 138.98 488.90
Net Profit 20.08 56.02 76.1

Profit And Loss Appropriation Account For The Year Ended 31st May 20X2.

Shs 000 Shs 000

Net Profit for the year 76.1
After Charging;
Depreciation 113.75
Directors' Fees 35
Deduct:
Proposed Dividend 140
Transfer to General Reserve 40
180
Retained Profit:
For the year (103.9)
Brought forward 150
Carried forward 46.1

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FINANCIAL ACCOUNTING III
 463 Revision Aid

STATEMENT OF FINANCIAL POSITIONS AS AT 31ST MAY 20X2

HEAD OFFICE (NAIROBI) BRANCH (NAKURU) COMBINED
FIXED ASSETS Shs 000 Shs000 Shs000 Shs 000 Shs 000 Shs 000 Shs 000 Shs 000 Shs 000
Furniture and Fittings 280 35 245 50 6.25 43.75 330 41.25 288.75
Motor Vehicles 255 63.75 191.25 35 8.75 26.25 290 72.50 217.50
535 98.75 436.25 85 15.00 70.00 620 113.75 506.25
Branch Current Account (69.98)
CURRENT ASSETS
Stock 320 85 405
Debtors 170 6 176
Less: Provision for Bad Debts (8.50) (0.3) (8.8)
161.50 5.7 167.2
Cash at Bank 216 — 216
Cash in Transit 50 — 50
747.50 90.7 838.2
CURRENT LIABILITIES
Bank Overdraft — 174.5 174.5
Creditors 47 48 95
Accruals 40.67 8.18 48.85
Proposed dividend 140 — 140
227.67 519.83 230.68 (139.98) 458.35 379.85
886.1 (69.98) 886.1
SHARE CAPITAL
Issued and fully paid:
35,000 Ordinary Shares of Shs 20 each 700 700
REVENUE RESERVES
General Reserve 140 140
Profit and Loss Account 46.1 46.1
186.1 186.1
886.1 886.1
Head Office Current Account (69.98)

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 464

Workings:

Branch Current Account

Balance b/d 124 C.I.T. 50
G. to Branch 350 Cashbook 550
P&L 56.02
Balance c/d 69.98
600.00 600
Balance b/d 69.98

Ho: Current Account

Remittance 600 Balance b/d 124
G from Nairobi 350
P&L A/c 56.02
Balance c/d 69.98
600 600
Balance b/d 69.98

Staff Commission Account

HO BR HO BR

Cashbook 8,000 6,000 Balance b/f 5,000 6,500

Accruals 5,670 8,180 P&L 8,670 7,680
13,670 14,180 13,670 14,180

Accruals Account
Shs 000 Shs 000
Commission
HO BR Directors Fees 35,000
Commission: HO 5,670
Branch 8,180
Gross profit 370 195 48,850
Less: Pre-commission expenses 297.75 131
P.b.d.f & Prov. 72.25 64
12% 8.67 7.68

QUESTION FOUR
MAINA
Income statement For the Year Ended 31st December 20X9
HO BRANCHCOMBINED
Shs 000 Shs 000 Shs 000
Sales 64,000 41,000 105,000
Goods Sent to Branch 46,200 —
110,200 41,000
Purchases 98,475 — 98,475
Less: Closing Stock 5,000 — 5,000
93,475 — 93,475
Cost of Processing 2,525 — 2,525
Processed Goods/HO Goods 96,000 44,000 96,000
Less: Closing stock 2,800 7,920 12,000

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FINANCIAL ACCOUNTING III
 465 Revision Aid

Cost of Sales 93,200 36,080 84,000

GROSS PROFIT 17,000 4,920 21,000
Selling and general expenses 9,450 1,060 10,510
Loss of stock — 880 800
Unrealised Pr on Stock 840 — —
10,290 1,940 11,310
NET PROFIT 6,710 2,980 9,690

STATEMENT OF FINANCIAL POSITIONS AS AT 31ST DECEMBER 20X9

HO BRANCH COMBINED
Shs 000 Shs 000 Shs 000
Branch current a/c 16,055
Less: Prov for unrealised Pr St 640
15,415
CURRENT ASSETS:
Stock 9,800 7,040 16,200
Debtors 15,480 5,680 21,160
Cash at bank and in transit 11,815 3,875 15,690
37,095 16,595 53,050
CURRENT LIABILITIES:
Creditors 30,070 540 30,610
7,025 16,055 22,440
22,440 16,055 22,440
CAPITAL:
Opening balance 15,500 — 15,500
HO a/c — 16,055 —
Add: Profit 9,690 9,690
25,190 25,190
Deduct: Drawings 2,750 2,750
22,440 16,055 22,440
Workings
Branch 41,000 X 15/125 = 4,920
HO: 46,200 X 10/110 = 4,200
64,000 X 25/125 = 12,800
Goods Shortage 1,000 X 110/125 = 880
UPS: (7,920 - 880) X 10/110 = 640 BR.
2,200 X 10/110 = 200 Goods in Transit

Ho Books: Branch Current Account

Balance b/f 19,490 Goods In Transit 2,200
P&L 2,980 Cash In Transit 4,215
c/d 16,055
22,470 22,470

Goods in Transit
Branch 2,200

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 466

Cash In Transit
Branch 4,215

Branch Books: Ho Account

Balance b/f 13,075
P&L 2,980
16,050

QUESTION FIVE
San Francisco
Trial balance as at 31 December 19X7

$ $ $ $
Dr Cr Rate Dr Cr
Leasehold premises 40,000 2.2 18,182
Amortisation of lease 8,000 2.2 5,455
Amortisation for the year: (B/S) 4,000
(P/L) 4,000 1.8 2,222
Delivery vans, at cost 10,000 2.2 4,545
Provision for depreciation on vans 5,000 2.2 3,409
Depreciaiton for the year: (B/S) 2,500
(P/L) 2,500 1.8 1,389
Opening stock 12,460 1.8 6,922
Debtors 6,293 1.6 3,933
Sales 116,308 1.8 64,616
Purchases 21,800 1.8 12,111
Goods from London 38,620 Actual 20,700
Administration expenses 3,142 1.8 2,1
Administration expenses accrued: 760
(P/L)
760 1.6 475
(B/S)
Salaries and wages 23,500 1.8 13,056
London current account (W) 49,520 Actual 24,900
Directors‘ remuneration 5,120 1.6 3,200
Selling and delivery costs 8,940 1.8 4,967
Cash at bank 13,789 1.6 8,674
Creditors 4,926 1.6 3,079
Closing stock: local (P/L) 6,060 1.8 3,367
(B/S) 6,060 1.6 3,788
London (P/L) 9,180 1.7 5,400
(B/S) 9,180 1.7 5,400 _____
111,257 110,701
Profit on exchange ______ ______ ______ ___556
206,254 206,254 111,257 111,257

b) Trading and profit and loss accounts for the year ended 31 December 19X7

London San Francisco Combined

£ £ £
Sales 78,318 64,616 142,934

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FINANCIAL ACCOUNTING III
 467 Revision Aid

Transfers to San Francisco 21,600 _____ ______

99,918 64,616 142,934
Opening stocks 8,620 6,922 15,042
Purchases 70,066 12,111 82,177
Transfers from London _____ 20,700 _____
78,686 39,733 97,219
Closing stocks 12,470 8,767 21,087
66,216 30,966 76,132
Gross profit £ 33,702 £33,650 £66,802
Administration expenses 3,186 2,168 5,354
Salaries and wages 9,420 13,056 22,476
Directors‘ remuneration 4,800 3,200 8,000
Selling and delivery costs 5,485 4,967 10,452
Amortisation of lease 1,000 2,222 3,222
Depreciation on vans 3,000 1,389 4,389
Provision for unrealized profits 550 _____ _____
27,441 27,002 53,893
Net profit 6,261 6,648 12,909
Profit on exchange _____ 556 556
£6,261 £7,204 £13,465

Statement of financial position as at 31 December 19X7

£ £ £
Non Current assets
Leasehold premises 33,182
Less: Amortisation 13,455 19,727

Motor vehicles 16,545

Less: Depreciation 12,409 4,136
23,863
Current assets
Inventory 21,508
Receivables 7,802
Cash at bank 15,597
44,907
Current liabilities
Payables 13,830
Accrued charges 1,275 15,105 29,802
£53,665
Representing:
Share capital 20,000
Profit and loss account 33,665
£53,665

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 468

Workings:
San Francisco current account
£ £
Balance b/d 22,600 Goods in transit account 900
Salaries and wages 3,200 Balance c/d 24,900
£25,800 £25,800
Balance b/d 24,900
Profit and loss account 7,204
32,104

London current account

$ $
Balance c/d 49,520 Balance b/d 44,400
Directors remuneration (at $1.60 to the £) 5,120
______
$49,520 $49,520

3. Provision for unrealized profit

£
Balance brought forward 500
Provision for the year:
On stocks at San Francisco:

$9,180 @ 1.70 = £5,400 (x 20) = 900

120
On goods in transit: £900 (x 20) = 150 1,050
120
Increase in provision £550

Closing stocks for combined trading account

£ £
London 12,470
San Francisco: from London 5,400
Less: provsion 900
4,500
Local 3,367 7,867
Goods in transit 900
Less: provision 150 750
£21,087
Closing stocks for combined statement of
financial position:
London 12,470
San Francisco: from London 5,400
Less: provision 900
4,500
Local 3,788 8,288
Goods in transit 900
Less: provision 150 750
£21,508

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FINANCIAL ACCOUNTING III
 469 Revision Aid

LESSON 4
QUESTION ONE
LOITA LTD & SUBSIDIARY
CONSOLIDATED INCOME STATEMENT FOR THE YEAR 30.09.99

Loita Leserni Group

Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Turnover 642,500 372,000 853,500
Cost of sales
Opening stock 51,250 28,240
Purchases 320,650 187,500
371,900 215,740
Less closing stock 51,300 29,740
(320,600) (186,000) (392,100)
Gross profit 321,900 186,000 461,400
Distribution costs (112,350) (64,600) (160,800)
Administration costs (94,550) (36,400) (121,850)
Goodwill amortised - - (1,500)
Operating profit 115,000 85,000 177,250
Finance costs: debenture interest (10,000) ( -) (10,000)
105,000 85,000 167,250
Investment income: dividends 18,000 - -
Profit before tax 123,500 85,000 167,250
Tax (31,000) (25,000) (49,750)
Profit after tax 92,000 60,000 117,500
Less minority interest - - (18,000)
92,000 60,000 99,500
Dividends: Interim paid (20,000) (20,000) (20,000)
Final proposed (40,000) (20,000) (40,000)
Retained profit: Year 32,000 20,000 39,500
B/f 64,950 31,800 64,950
C/f 96,950 51,800 104,450

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 470

LOITA & SUBSIDIARY

CONSOLIDATED BALANCESHEET AT 30.09.99
Loita Leserin Group
Sh.‘000‘ Sh.‗000‘ Sh.‗000‘
NON CURRENT ASSETS
Property,plant and equipment(Note 1) 141,920 62,800 204,720
Intangibles: Goodwill - - 8,500
Investments 56080 - -
198,000 62,800 213,220
CURRENT ASSETS
Inventories 51,300 29,740 81,040
Debtors 53,520 31,260 75,780
Dividend receivable 12,000 - -
Cash at bank 6,830 8,200 15,030
Cash in transit - 3,000
Total Current Assets 123,650 69,200 174,850
Total Assets 321650 132000 388070
Financed by
Ordinary share capital 100,000 40,000 100,000
Retained profit 96,950 51,800 104,450
Shareholder‘s funds 196,950 91,800 204,450

Minority Interest - - 36,720

196,950 91,800 241,170
Non Current Liabilities
20% Debenture stock 50,000 - 50,000
246,950 91,800 291,170

CURRENT LIABILITIES
Creditors 31,800 18,100 43900
Tax payable 2,900 2,100 5000
Proposed dividends 40,000 20,000 20,000
Dividend to Minority interest - - 8,000
74,700 40,200 96,900
TOTAL EQUITY AND LIABILITIES 321650 132000 388070

Workings

1. Dividends
Sh.‘000‘
Holding: Interim (paid) 20,000
Final (proposed) (40% x 100,000) 40,000
Subsidiary: Interim (paid) 60,000
Final proposed (50% x 40,000) 20,000
Preacquisition (3/12 x 60% x 40,000) 20,000
Post-acquisition (9/12 x 60 x 40,000) 40,000
6,000 To Cost of control
18,000 to Profit & Loss
8,441

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FINANCIAL ACCOUNTING III
 471 Revision Aid

2. Cost of Control
Sh.‘000‘ Sh.‘000‘
Investment in subsidiary 62,080 Pre-acquisition dividend 6,000
Ordinary share capital 24,000
Profit & Loss 22,080
Goodwill written off 1,500
- C/d 8,500 10,000
62,080 62,080

3. Profit and Loss Working

Sh.‘000‘ Sh.‘000‘
Goodwill written off 1,500 Loita 96,950
Bal c/ 104,450 Leserni 9,000
105,590 105,590

4. Minority Interest
Sh.‘000‘ Sh.‘000‘
Ordinary share capital 16,000
Bal c/d 36,720 Profit and loss 20,720
36,720 36,720

The post-acquisition reserves in Leserni is calculated as (20,000 x 9/12 x 60%)

5. Reserves (Subsidiary)
Sh.‘000‘
Reserves b/f 31,800
Pre-acquisition reserves for year (3/12 x 20,000) 5,000
Total pre-acquisition reserves 36,800
Group share (60%) to COC 22,080

6. Sales Cost of
Sh.‘000‘ sales
Sh.‘000‘
Loita 642,500 320,600
Leserni (372,000 x 9/12) 279,000 139,500 (186,000 x 9/12)
921,500 460,100

Loita Leserni
Sh.‘000‘ (9 months) Total
Sh.‘000‘ Sh.‘000‘
Distribution costs 112,350 48,450 160,800
Administrative expenses 94,550 27,300 121,850
Tax 31,000 18,750 49,750

PROPERTY,PLANT AND EQUIPMENT

LOTA LESERIN GROUP
Land and Buildings 60200 38100 98300
Motor vehicles 11270 4400 15670
Plant and Machinery 70450 20300 90750
TOTAL (NBV) 141920 62800 204720

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 472

NOTE 2
WORKINGS FOR INVESTMENTS
shs
Investment 62,080
Less: Pre acquisition dividend 6,000

QUESTION TWO

WORKINGS
1. UPOS, UPCS, UPFA

B sells to A A Sells to B Trading UPOs UPCs UPFA

% % Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Cost 75.36 100 7,008.48 406.94 542.59 2,000
Profit 24.64 20 2,291.52 133.06 177.41 400
Selling price 100 120 9,300 540 720 2,4000

ADDIS, BUNYALA & CHANIA

PROFIT & LOSS A/C FOR THE YEAR ENDED 30.11.00
Addis Bunyala Chania Group
Sh.‘000‘ Sh.‘000‘ Sh.‘000‘ Sh.‘000‘
Sales 84,000 66000 48,000 176,700
Cost of sales
Opening stock 3,824 3,757 2,822
Purchases 50,862 49,867 38,430
Depreciation - 240 -
54,686 53,864 41,252
Less closing stock (50,400) (4,124) (2,452)
( 4,286) (49,740) (38,800) (119,944.35)
Gross profit 33,600 16,260 9,200 56,77.65
Distribution costs (13,440) (8,050) (9,600)
Administration costs (8,400) (3,950) (6,400) (17,650)
Operating profit 11,760 4,260 (6,800) 10,415.65
Dividend income: Bunyala ord. 360 - - -
Pref. 1,000 - - -
Chania ord. 67.5 - - -
Profit before tax 13,187.5 4,260 6,800 10,415.65
Tax: Current (2,140) (1,050) - (3,190)
Deferred (1,420) ( 300) 2,040 (190)
(3,560) (1,350) 2,040 (3,380)
Profit after tax 9,627.5 2,910 (4,760) 7,035.65
Less MI - - - (486.87)
Profit attributable to ordinary 9,627.5 2,910 7,522.52 7,522.52
shareholders
Dividends: Pref. - 900 - -
Ord: Interim (3,000) (500) - (3,000)
Final 4,500) (750) (150) (4,500)
Retained profit: Year 2,127.5 760 (4,910) 22.52
B/f 18,300 12,650 9,200 19,965.56
C/f 20,427.5 13,410 4,290 19,988.08

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FINANCIAL ACCOUNTING III
 473 Revision Aid

RECONCILIATION OF RETAINED PROFIT

B/f Sh.‘000‘ Year Sh.‘000‘ C/f Sh.‘000‘
Addis: 18,300 2,127.5 20,247.5
UPFA (400) - (400)
Goodwill amortised (1,500) (500) (2,000)
16,400 1,627.5 18,027.5
Bunyala 12,650 760 13,410
Less pre-acquisition (8,100) - (8,100)
UPCS - (177.41) (177.41)
UPOS (133.06) 133.06 -
Depreciation adjustment 40 40 80
445,694 755.65 5,212.59
Group share 80% 3,565.56 604.52 4,170.08
Chania 9,200 (4,910) 4,290
Less pre-acquisition (9,200) 1,227.5 (7,972.5)
- (3,682.5) (3,682.5)
Group share 60% - (2,209.5) (2,209.5)
Total (A+B+C) 19,965.56 22.52 19,988.08

MINORITY INTEREST
Bunyala Chania
PAT 2,910 (4,760)
Pre-acquisition - 1,190
Depreciation adjustment 40 -
UPCS (177.41) -
UPOS 133.06 -
2,905.65 (3,570)

Pref 900 Ord 2005.65

Group 40% MI 60% Group 80% MI 20% Group 60% MI 40%

360 540 1,604.52 401.13 (2,042) (1,428)

Total MI = 540 + 401.13 + (1,428) + 486.87

Group sales = 84,000 + 66,000 + (9/12 x 48,000) – 9,300 =

Holding Subsidiary Subsidiary Intergroup

Group cost of sales = 50,400 + 49,740 + (9/12 x 38,800) – 9,300 – 40 – 133.06 + 177.41

Addis Bunyala Chania Intergroup Dep‘n adj. UPOS UPCS

QUESTION THREE

INVESTMENT IN CET BY BEM

Sh‘000‘ Sh‘000‘ Sh‘000‘
Bal b/d 4,00 Loan stock 5,000
To COC A/C 1,000 ____
5,000 5,000

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 474

LOAN STOCK CET

Sh‘000‘ Sh‘000‘ Sh‘000‘
Investment in loan stock 5,000 Balance b/d 10,000
To CBS 5,000 __ __
10,000 10,000

INVESTMENT IN BEM BY A/C

Sh‘000‘ Sh‘000‘ Sh‘000‘
Bal b/d 80,0000 Loan stock of BEM 10,000
To COC 2,000 _ ___
10,000 10,000

LOAN STOCK OF BEM

Sh‘000‘ Sh‘000‘ Sh‘000‘
Investment in loan stock 10,000 Loan stock 20,000
To CBS 10,000 __ __
20,000 20,000

Control structure BEM

% CET
%
Parent: Direct 75 -
Indirect - 60
MI Direct 25 20
Indirect - 20
100 100

COST OF CONTROL
Sh‘000‘
Sh‘000‘
A/c: Investment in BEM 70,000 OSC: BEM 22,500
BEM: Investment in CET 27,000 Profit & Loss BEM 37,500
OSC: CET 6,000
Profit & Loss CET 18,000
Inv. In BEM 2,000
Inv. In CET 1,000
Goodwill: Written off 3,600
______ C/d 6,400
97,000 97,000

PROFIT AND LOSS WORKING

Sh‘000‘
Sh‘000‘
BEM 5,250 AC 15,350
CET 4,200
Goodwill written off 3,600
CBS 2,300 _____
15,350 15,350

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FINANCIAL ACCOUNTING III
 475 Revision Aid

M. I
Sh‘000‘
Sh‘000‘
Investment in CET 9,000 OSC: BEM 7,500
CBS 22,450 Profit & Loss BEM 10,750
OSC: CET 4,000
_____ Profit & Loss CET 9,200
31,450 31,450

AC LTD & SUBSIDIARIES

STATEMENT OF FINANCIAL POSITION AS AT 31.05.2000
Sh‘000‘
NON CURRENT ASSETS
136,800
Profit, Property and Equipment
6,400
Goodwill
143,200
CURRENT ASSETS
36,800
Debtors 43,300
Cash 80,100
Total Current Assets 223300

Financed by: 100,000

Share capital 2,300
Retained earnings 102,300
Shareholders fund 22,450
Minority interest 124,750
Total shareholders funds
NON CURRENT LIABILITIES
12% loan stock: 30,000
AC 10,000
5,000 45,000
BEM
CET
CURRENT LIABILITIES
25,000
Creditors
4,500
Tax payable
9,300
Bank overdraft
4,750
Dividend to MI
10,000
Proposed dividends
53,550
223300
QUESTION FOUR
WORKINGS
1. Determination of group structure
Control in Lenga = 4,500 x 100% = 30% (Associate)
15 ,000

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 476

Control in Tera = 15,000 x 100% 75%(Subsidiary)

20 ,000

2. Unrealized profit on stock

% Sh.‘000‘
Buying price 100 32,000
Margin 25 8,000
Selling price 125 40,000
Treatment: Dr Holding co. 75% x 8,000 = 6,000
Dr MI 25% x 8,000 = 2,000
Cr group stock 8,000

3. Premium on acquisition of associate.

Sh.‘000‘ Sh.‘000‘
Cost of investment 152,000
Share of associate equity
Ordinary share capital 300,000
Share premium 24,000
Retained (218 – 102) 116,000
30% x 440,000 132,000
20,000
Amortization per annum 20,000 = 4,000
2

INVESTMENT IN ASSOCIATE

Sh.‘000‘ Sh.‘000‘
Cost of investment 152,000 Premium Amortization 4,000
Share of post acquisition profit 21,600 Balance to CBS

_____ ______
173,600 173,600

4. Analysis of Tera

COST OF CONTROL

Sh.‘000‘ Sh.‘000‘
Cost of investment 716,000 Share of Equity
OSC (75% x 400,000) 300,000
Capital reserve (75% x 56,000) 42,000
Profits 75% (288 – 128) 120,000
¼ - 1/7) 75% x 3/12 (128 – 40) 16,500
Pre-acquisition dividend (75% x 40 x ¾) 7,500
Revaluation reserve (75% x 240,000) 180,000
Goodwill 50,000
716,000 716,000
Goodwill amortization C/D = 50,000 x 9/12 = 7,500
5

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FINANCIAL ACCOUNTING III
 477 Revision Aid

5. GROUP RETAINED EARNINGS A/C

Sh.‘000‘ Sh.‘000‘
Cost of control 136,500 Balance b/d (Mega) (786 –200) 586,000
(120,000 + 16,500) Tera Ltd (288 – 10% x 400) 248,000
MI (25% x 248,000) 62,00 Associate (investment)
UPCS 6,000 Share of post acquisition 21,600
Depreciation adjustment Share of dividends: subsidiary
(180,000 x 10%) 18,000 (75% x 40,000 x 9/12) 22,500
Goodwill amortization 7,500 Associate (30% x 30,000) 9,000
Premium 400
To CBS 653,100
______ ______
887,100 887,100

6. MINORITY INTEREST

Sh.‘000‘ Sh.‘000‘
UPCS 2,000 OSC (25%x 400) 100,000
To CBS 174,000 Capital Reserves (25% x 56) 14,000
_____ Retained profit 25% (288 – 40) 62,000
176,000 176,000
7. PLANT & MACHINERY
Mega (1,375,000 – 521,800) 853,200
Tera (350,600 – 124,600) 225,600
Share of revaluation (75% x 240) 180,000
Depreciation in revaluation (18,000)
1,240,600

MEGA LTD & SUBSIDIARY

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31.03.02

Sh.‘000‘ Sh.‘000‘
Non Current Assets
Property (720 + 200) 920,000
Plant & Machinery 1,240,600
Goodwill 42,500
Investment in associate 169,600
2,372,700
Current Assets
Stock (380 +360.6 – 8)
Debtors (374.8 + 125) 732,600
Dividends Receivable 499,800
Cash in Transit 9,000
Bank 12,000
40,000 1,293,400
366,6100

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 478

Financed by:
Share capital 1,000,000
Share premium 200,000
Capital Reserve 300,000
Retained Earnings 653,100
215,3100
MI: Non current liability 174,000
2,327,100
Current liabilities
Creditors 590 + 152) 742,000
Tax (190 + 103) 293,000
Dividends proposed (Mega) (20% x 2M 200,000
MI share dividend (25% x 40,000) 10,000
Bank overdraft 94,000
1,339,000
TOTAL EQUITY AND LIABILITIES 366,6100

QUESTION FIVE
EMPIRE LTD
CONSOLIDATED CASH FLOW STATEMENT
FOR THE YEAR ENDED 30.6.1998
Sh.‘000‘ Sh.‘000‘
Operating Activities
Profit before tax 10,950
Extraordinary item 150
11,100
Adjustments for non cash items:
Depreciation of PPE 3,600
Profit of associate (450)
14,250
Adjustments for working capital items
Increase in stock (10,500)
Increase in debtors (3,150)
Increase in creditors 1,350
Cash generated from operations 1,950
Tax paid (W3) (3,000)
Net cash outflow from operating activities (1,050)
Investing Activities
Payments toa cquire fixed assets (W1) (11,550)
Proceeds on disposal of total fixed assets 2,700
Proceeds on disposal of investments (W2) 4,200
Net cash outflow from investing activities (4,650)
Financing Activities
Issue of ordinary share capital 1,500
Redemption of loan capital (7,200)
Short term borrowing obtained 15,900
Equity dividend paid (4,200)
Net cash inflow from financing activities 6000_
Increase in cash during the period

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FINANCIAL ACCOUNTING III
 479 Revision Aid

Cash and cash equivalent b/d 300

Cash and cash equivalent c/d 900
1,200

WORKINGS

1. Fixed Asset Account

Sh.‘000‘ Sh.‘000‘
Balance b.d 45,600 Disposals 2,700
Cash book: additions 11,550 Depreciation 3,600
_____ Balance c/d 50,850
57,150 57,150

2. Investment Account
Sh.‘000‘ Sh.‘000‘
Bal. B/d 37,350 Investment revaluation reserve 11,700
Investment revaluation reserve 900 Cash book: disposal 4,200
_____ Bal. C/d 22,350
38,250 38,250

3. Tax account
Sh.‘000‘ Sh.‘000‘
Cash book 3,000 Bal b/d 1,950
Bal c/d 1,200 Profit & Loss 2,250
4,200 4,200

LESSON 5
QUESTION ONE
CHEGE: STAEMENT OF AFFAIRS
AS AT 30TH JUNE 20X1

Gross Liabilities Assets

Liabilities
Shs ‗000‘ Shs ‗000‘ Shs ‗000‘
1,636 Unsecured creditors 1,636 Cash at bank 90
Creditors fully secured: Stock (Cost Shs 400,000) 300
800 Loan 800 Investment in IV Ltd. 20
Value of shop 1,400 Trade debtors 350
Surplus per contra 600 Motor car 20
50 Preferential Creditors 50 Gold watch 50
(deducted per contra) Surplus from creditors F.S 600
1,430
_(50)
1,380

Deficiency: as per
____ ____ Deficiency Account 256
2,486 1,635 1,636

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 480

Deficiency Account
Shs ‗000‘ Shs ‗000‘
Excess of Assets over liabilities Drawings: Year
As at 30 the June 20X0: Ended 30th June 20X0 180
Business 600 Estimated loss on
Personal 104 Realization:
704 Stock 100
Profit for the year Investment 980
Ended 31st Dec 1991 200 Debtors 100
Estimated profit on Realisation: 1,180
Freehold
Shop building 200
Deficiency as per Statement 256 ____
1,360 1,360

QUESTION TWO
Wanja and Juma
Statement of Affairs
As At 1st November 20X1
Gross Liabilities (as Expected Assets (as stated Estimated
Liabilities stated and to Rank and estimated by to Produce
estimated by Debtors)
debtors)
Shs. Shs. Shs. Shs. Shs.
1,300,000 Unsecured Cash in Bank
creditors 1,300,000 35,000
230,000 Creditors Partly Cash in Hand
secured 230,000 12,000
Estimated value of (Cost Shs 100,000)
security 200,000 30,000 85,000
Fixtures 10,000
Debtors: Good 140,000
Doubtful 50,000
Bad 40,000
14,000 Preferential Estimated to
Creditors 14,000 Produce 10,000 10,000
Deducted contra
292,000
Preferential
Creditors (14,000)
278,000
Deficiency as per
Deficiency Account
_______ _______ 1,052,000
1,544,000 1,330,000 1,330,000

Included in unsecured creditors is a deferred creditor Mr.Kuria in the amount of Shs.100,000. This amount
represents a loan from Mr. Kuria, the interest of which varies with the firm‘s profits.

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FINANCIAL ACCOUNTING III
 481 Revision Aid

Deficiency Account
Shs. Shs.
Excess of assets over liabilities Trading loss from carrying on
As at 1st January 20X0 216,000 Business from 1st January 20X0 784,400
Drawings by partners during this
period 298,600
1,083,000
Estimated Loss on Realisaton:
Stock 15,000
Fixtures 90,000
Debtors 80,000
Deficiency as per Statement of Affairs
1,052,000 185,000
1,268,000 1,268,000

QUESTION THREE

Rucha and Mambo

Statement of Affairs
Ruma Rucha Mambo Ruma Rucha Mambo
Sh ‗000‘ Sh Sh ‗000‘ Sh Sh Sh ‗000
‗000‘ ‗000‘ ‗000‘
Unsecured Creditors
8,500 300 1,300 Plant 400 - -
Creditors fully
secured: 2,250 1,600 Furniture etc 200 400 550
Deduct value of
freehold: (3,250) (2,35) Stock (cost Sh.3m)
Surplus 2,150 - -
below/contra: (1,000) (750) Debtors: Good
Crs partly secured 1,500 1,500 Doubtful 1,500 3,500 - -
Surplus from above/
(1,000) (850) Bad 1,000
Value of security 500 650 2,500
Preferential Creditors
Estimated to produce 900
(Deduct per contra)
250 100 50 Investments 650
Surplus from creditors
Fully secured 750
1,200
Deduct preferential
Creditors (250) (100) (50)
Surplus from Rucha‘s
estate 100
7,000 1,050 1,150
Deficiency as per
Surplus as per D A/c
surplus A/c _____ 100 _____ 2,000 ____ 150
9,000 1,050 1,300 9,000 1,050 1,300

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 482

Surplus/Deficiency Accounts
Ruma Rucha Mambo Ruma Rucha Mambo
Sh ‗000‘ Sh ‗000‘ Sh ‗000‘ Sh ‗000‘ Sh ‗000‘ Sh ‗000
Excess of Assts
Over liabilities 1,000 1,500 150

Estimate profit on Estimated loss on

Realization of
assets: Realization of assets:
Freehold property 250 350 - Plant 600 - -
Other investments - 450 350 Furniture etc. 300 200 150
Surplus from Stock 850 - -
Rucha‘s estate 100 Debtors 1,600 - -
Loss on guarantee on
overdraft - 1,500 -
Loss on partnership capital - 500 500

2,000 ____ 150 Surplus as per S.A ____ 100 ___

3,350 2,300 650 3,350 2,300 650

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FINANCIAL ACCOUNTING III
 483 Revision Aid

QUESTION FOUR
Nyamole Company Limited
Statement of Affairs
As Agt 31st July 20X1
ASSETS NOT SPECIFICALLY PLEDGED
Estimated
Realizable
Values
Shs.
Cash 115,000
Debtors 500,000
Stock - Finished Goods 500,000
- Raw Materials 300,000
1,515,000

ASSETS SPECIFICALLY PLEDGED

Estimated Due to Deficiency Surplus
Realizable Secured Ranking as Carried to
Values Creditors Unsecured Last column
Shs. Shs. Shs.
Land and buildings 1,350,000 1,020,000 330,000
Machinery 650 306,000 344,000
Debtors 400,000 300,000 100,000
Investments _109,000 200,000 (91,000) ______
2,509,000 1,826,999 (91,000) 774,000

Estimated surplus from assets specifically pledged 774,000

2,189,000
TOTAL ASSETS: To Realize
Specifically Pledged Assets 250,900
Unpledged Assets 1,415,000
3,924,000
Less: Liquidation costs (110,000)
2,079,000
Less: Preferential Creditors (305,000)
Less: Partly secured creditors 91,000 1,774,000
Less: Unsecured creditors:
Creditors 840,000
Other payables 850,000
Contingent liability 500,000 2,290,000 (2,281,000)

ESTIMATED DEFICIENCY AS REGARDS CREDITORS 507,000

Deduct:
Issued and paid up share capital 1,000,000

ESTIMATED DEFICIENCY AS REGARDS MEMBERS 1,507,000

Note:
Thus, total interest on mortgages is Shs. (24,200 + 2,000). Apportioned as follows:
a. D and Buildings 1m/1.3m x 26,000 = shs.20,000
b. Machinery 0.3m/1.3m x 26,000 = shs.6,000

Workings: Preferential Creditors:

Shs.
Accrued wages 150,000 Assumed the amount is less than Shs.4,000 for
PAYE 150,000 Any one employee for 4 months accumulated
Unrecorded PAYE 5,000
305,000

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 484

Creditors
Shs
Mort.Int. 2,000 B/d 942,000
Pref.PAYE 150,000
C/d 840,000 Audit 50,000
992,000 992,000

Other Payable
Loan 200,000 Bal b/d 1,350,000
Secured creditors 300,000
Bal c/d 850,000 ________
1,350,000 1,350,000

(B)
DEFICIENCY OR SURPLUS ACCOUNT
ITEMS CONTRIBUTING TO DEFICIENCY
Shs
Shs
Unrecorded PAYE 5,000
Loss on machinery 550,000
Unrecorded mortgage interest 24,000
Goodwill written-off 200,000
Travel expenses unrecorded 5,000
Loss on investment 91,000
Loss on stock - Finished Goods 100,000
- Raw Materials 100,000
Liquidation expenses 110,000
Audit fee unrecorded 50,000
Contingent Liability 500,000
Loss as per Profit & Loss Account 42,000
Bad debts written off 50,000
1,827,000
Items Reducing Deficiency
Surplus on Land & Buildings 320,000
320,000
Deficiency As Shown By Statement 1,507,000

QUESTION FIVE

MR. A IN BANKRUPTCY
Staement to Accompany Payment
Of Dividend to Creditors.
Shs Shs ‗000‘
‗000‘
Business Receipts, less payments 1,250 Court Fees and taxed costs 255
Proceeds of sale of assets (gross) 5,300 Auctioneer‘s fees for sale of assets 300
Trustee‘s Remuneration:
On realizations (4% x Shs.6.55m) 262.0
On dividends (8% x Shs.4.92m) 393.6 655.6
Payments to Preferential Creditors 340.0
Proposed dividend of Shs.49.2 per Shs.100
To unsecured creditors 4,920

____ Bal c/d _79.4

6,550 6,550

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FINANCIAL ACCOUNTING III
 485 Revision Aid

Assets remaining unsold are estimated to realize shs.2,760,000

(B)
SUMMARY OF TRUSTEE‘S CASH BOOK
Shs Shs ‗000‘
‗000‘
Business Receipts, less payments 1,250 Court Fees and taxed costs 255
Proceeds of sale of assets 7,750 Auctioneer‘s fees for sale of assets 300
Agents‘ fees and other outgoings 160
Trustee‘s Remuneration:
On realizations (4% x Shs.9m) = 360
On dividends (8% x Shs.7.0231m) = 561.9 921.6
Payments to Preferential creditors 340
Dividends to Unsecured Creditors:
First Dividend of Shs49 per sh.100 4,920
Second Dividend of 2,103.1
____ _79.4
9,000 9,000

LESSON 6

Types of legacy, validity, assent and circumstances of failure thereof.

a) A specific legacy of ‗my record collection‘, which lapses because George predeceased Andrew.
b) A general legacy of ‗Shs.50,000‘ conditional upon the legatee, David, marring. The condition is not
unreasonable, so the legacy must be taken subject to the condition. Thus, as David has clearly expressed
his intention not to comply with the condition, the legacy will fail.
c) A specific legacy of ‗my furniture and personal chattels not otherwise bequeathed‘ to ‗my dearest sister-
in-law‘. As Andrew had three sisters-in-law the legacy will most probably fail for uncertainty of
beneficiary unless there is clear evidence available to the court to determine which of the three sisters-in-
law was intended; for example, Andrew always referred to one of the three using this term endearment,
but never the other two.
d) A general legacy of ‗a Mini Metro‘. As the legacy is general and not specific, it is irrelevant that Andrew
has never owned such a car. The executors must assent to the legacy an in the absence of a suitable asset
forming part of Andrew‘s estate, must acquire a Mini Metro for the legatee, Peter.
e) A demonstrative legacy of Shs.200,000, payable out of my account with the Lukenya Building Society.
As the legacy is demonstrative and not specific, even though the designated fund is no longer available,
the executors must still assent to the legacy and Sandra is entitled to Shs.200,000 payable out of the
general assets of the estate.
f) A specific legacy of ‗the Shs.100,000 in my deposit account with the Trust Bank and as such will be
adeemed to the extent that the deposit account does not contain Shs.100,000. thus, Timothy will only be
entitled to receive Shs.72,000 in the deposit account at Andrew‘s death and will have no recourse to the
other assets of the estate.
g) A specific legacy of ‗my 1,000 ordinary shares in Kakuzi Ltd;. Although the asset has changed form
(from shs.20 shares to stock units of shs.5 each) since the date of the will, the substance of the asset is
unchanged; thus the gift will not adeem the executors should assent to Patrick‘s receiving the 4,000 units
of Kakuzi Ltd. Ordinary stock.
h) A general legacy of ‗Shs.100,000‘ for the refurbishment of the choir stalls at All Saints Cathedral. The
purpose of this legacy has already been fulfilled by Andrew during his lifetime; it thus fails to take effect,
being adeemded by the lifetime gift.
i) General legacies of ‗Shs.1.5m. The executors should assent to both legacies, as, although Edward
predeceases his father, the gift will be saved from lapse by the existence of Edward‘s own children, alive
at Andrew‘s death. Thus, Francis will receive Shs.1.5m and the Shs.1.5m left to Edward will pass to his
estate under the provisions of THE LAW OF SUCCESSION ACT: PARA 2 SCH2.

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 486

j) A gift of residue in two parts, a gift of a limited interest to Andrew‘s two daughters and a gift in
remainder to his grandchildren. As both daughters have married prior to Andrew‘s death, the condition
subsequent which terminates their gift of income has already been satisfied. The grandchildren thus hold
a vested interest in the residue, which will be held for them on statutory trust until they attain eighteen
years of age.

QUESTION TWO
ROBIN DECEASED, DISTRIBUTION STATEMENT
Shs ‗000‘ Shs ‗000‘ Shs ‗000‘
Specific legacies:
Wife Annie, furniture and other personal effects 1,345
Daughter Clare, freehold house (Note1) 6,500
Less mortgage, including interest thereon for 1 Jan –
31 March 1982 paid by executors (3 months) (2,060) 4,440
Friend Tony, Mercedes motor car 1,260
Secretary Betty, half of my holding of Ord. Sh.10
Share in Kenya Breweries being 5,000 shares 600
Cousin Miriam Shs.800,000 5% Kenya Stock 235
Friend Eric, 4,500 Ord. Shs.10 shares in Nation
Printers Ltd 740
plus dividend received (Note 3) 37 777
Nephew Frank, 4,000 Ord. Shs.10 shares in Kenya
Breweries Ltd 480
Cousin Hazel, debt due from William 120 1,377
9,257
Demonstrative legacy:
Niece Tracey, (Note 4) 120
General Legacies:
Son David 1,000
Estate of son Jack 1,000
Friend Gregory Gangla 100
And later in the will (Note 5) 150 250
Brother Joseph, 1,000 shared in Brooke Bond Ltd 330
Niece Tracey, balance of legacy of Shs.200,000 80 2,660
Residual legacy:
Wife Annie, balance of estate (Note 6) 7,580
19,617

List of legacies not assented to by the executors:

1. Estate of son Stuart, Sh.1 m. This legacy lapses because Stuart who predeceased his father and did not
leave issue of his own.
2. The legacy to Ben of some of my furniture fails for uncertainty.
3. The bequest to Susan of the Renoir painting is adeemed.
4. The legacy to Dennis is conditional and Dennis has indicated his refusal to accept the condition.
5. Elsie predecease her brother and the legacy of shs.6000,000 lapses.
6. The bequest to Miriam of his holding of shares in Cassava Ltd. Is adeemed.
7. The legacy to Malcolm, chauffeur lapses. Under the law of commorientes Malcolm (aged 60) is
assumed to have died before Robin reached (aged 54).
8. Jeremiah, having retired as his gardener does not receive the conditional bequest of shs.150,000.
9. Timothy is not bound to accept a legacy and can disclaim it.
10. The legacy to St. Peters Church fails as Robin provided such a stained glass window during his lifetime.

Notes:

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FINANCIAL ACCOUNTING III
 487 Revision Aid

1. Daughter Clare takes the specific legacy subject to the mortgage and the interest thereon arising after
her father‘s death. It is assumed she will pay the shs.60,000 due from her to the estate before the
executors convey the property to her.
2. Cousin Miriam receives the 5% Kenya Loan; a clerical error dies not negate a legacy.
3. A specific legacy caries with it any associated income. The dividend on the shares in Nation Printers
Limited passes with the shares to Eric.
4. A demonstrative legacy is paid from a designated fund to the extent that eh fund exists, any balance
being treated a general legacy.
5. Since the two legacies to Gerry Gangla are of different amounts, it appears that Robin intended his
friend to take both legacies.
6. The residue passing to Anne is ascertained as follows:

Shs ‗000‘ Shs ‗000

Balance of estate Bank accounts 8,500
Jaguar motor car 720
Stamp collection 850
10,070
Less: General legacies 2,660
7,410
QUESTION THREE
JACKSON DECEASED (DATE OF DEATH: 1ST APRIL 20x8)

(a) CASH BOOK

20x8 Total INCOME CAPITAL INCOME CAPITAL
Kshs. Kshs. Kshs. Kshs.
Apr 1 Bal b/f 4,735
May 1 Est.Income/capital% May 31 Est. Cap A/c 11,163
2½% SBI 300 Aug 10 Debts & Funeral
50 250 Exp. 650
Jun 15 Life Ass. Policy A/c Sept. 30 Est. in A/c
30,000 67
Jun 30 Building Soci. Dep 4,680 20X9
90 4,590
Jul 12 9% FS invest % 14,760 Jan 31 Est. Cap% - 400
Aug 1 Est. Inc/Cap. A/c 9% FS
Total 1,260 840 420
Nov 1 Est. Income A/c 300 300
20X9
Apr. 1 Est. Inc A/c
9% FS Int 450 450
Mar. 31 Bal c/d
____ _____ 1,663 42,542
1,730 54,755 1,730 54,755
20X9
Apr. 1 Bal b/f 1,663 42,542

(b) Two solutions are given to this question.

Solution (i) is based on the assumption that the 2½% Savings Bonds had gone ex-int, and the figure of
Kshs.20,020 includes the whole of the impending interest. Solution (ii) is based on the assumption that the
2½% Savings Bond had not gone ex-int and the figure of Kshs.20,020 is the cum-int. value of the stock on
1ast April 20x8.

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 488

ESTATE CAPITAL ACCOUNT

20x8 solution solution 20x8 solution solution
(i) (ii) (i) (ii)
Kshs. Kshs. Kshs. Kshs.
May 1 2½% SBA 50 -
May 31 CB (Estate Duty) 11,163 11,163 Apr.1 Bal b/f 84,795 84,795
Jul.12 9% FS In 90 90 May 1 CB - 250
Oct 2 Distion A/c Aug 4 9% FS Int 420 420
Wife‘s Household F/F 3,000 3,000

20X9
Jan 31 CB Adm. Exp. 400 400
Apr.1 Bal c/d 70,512 70,812 ____ ____
82,215 85,645 85,215 85,465
Bal b/d 70,512

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FINANCIAL ACCOUNTING III
 489 Revision Aid

JACKSON DECEASED
ESTATE STATEMENT OF FINANCIAL POSITION AS AT 1ST APRIL 20X9
SOLUTION SOLUTION
(i) (ii)
Kshs. Kshs.
CAPITAL ASSETS 8,250 8,250
Kshs.10,000 9% Funding Stock 20X6 – 20x8 19,720 20,020
Kshs.24,000 2½ Saving Bond 20X4 – 20X7 42,542 42,542
CASH AT BANK 70,512 70,812

INCOME ASSETS
CASH AT BANK 1,663 1,663
72,175 72,475

ESTATE CAPITAL ACCOUNT

ESTATE INCOME ACCOUNT (DUE TO WIDOW) 1,663 70,512 70,812
1,663 _____
72,175 72,475

2½ % SAVING BOND A/C

1998 NOMINAL INC CAPITAL 1998 NOMINAL INC CAPITAL
Kshs. Kshs. Kshs. Kshs. Kshs. Kshs. Kshs. Kshs.
(i) (ii) (i) (ii)
Apr.1 Est.Cap
A/c 24,000 19,720 20,020 May 1 CB 250
Est.Cap Est. A./c of
A/c. 300 May 1
Quoted Cum.1 50

20,020 20X9
____ ____ ____ Apr.1 Bal c/d 24,000 19,720 20.020
24,000 20,020 20,020 24,000 20,020 20,020
20X9
Apr.1 Bal b/d 24,000 19,720 20,020

Workings:
ESTATE INCOME ACCOUNT
Kshs. 1998 Kshs.
Sept. 30 CB Int. 67 Nov. 1 CB 2½ SB in 50
Jun. 30 B 5 Deposit In. 90
Nov. 1 CB 2½ SB WT 300
Aug. 1 9% ESF 840
20X9
20X9 Feb. 1 CB 9% in 450
Mar. 31 Bal c/d 1,663
1,730 1,730
20X9
Apr. 4 Bal b/d 1,663

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 490

Debts and Funeral Expenses

Kshs. Kshs.
CB 650 Est. Cap A/c 650

Building Society Interest A/C

Kshs. Kshs.
Est. Cap. A/c 90 CB 90
Inc. A/c 90 Est. Cap A/c 90
180 180

Life Policy Account

Kshs. Kshs.
20x8
Est. Cap A/c 30,000 CB 30,000

BS Deposit Account
Kshs. Kshs.
Est. Cap A/c 4,500 CB 4,500

9% FS ACCOUNT
20x8 NOM. INC CAPITAL 20x8 NOM INC CAPITAL
.
Apr. 1 Est. Cap. A/c - 23,100 Jul. 12 CB 18,000 14,760
Cap. A/c 28,000 Jul. 12 Est. Cap 90
A/c
20X9
_____ ____ Mar.31 Bal. B/f 10,000 23,100
28,000 23,100 28,000 23,100

20X9
Apr. 1
Bal. B/f 10,000 8,250

QUESTION FOUR

ESTATE CAPITAL ACCOUNT

Kshs. 20x8 Kshs.
Jun.1 CB (Estate Duty) 17,954 May 1 Bal b/d 98,734
Oct. 31 Distribution Account
Gloria: Per. Chattels 2,000 Aug. 31 Weasol p/c Dividend 40
Pecuniary Legacy 30,000 Aug. 31 CB CTT 4,140
32,000 Sep. 30 R Ltd. F Div. 367
To Beakie: Inves. In Rat 8,000 Inv in MPLC A/c
To Harold: Pecuniary Legacy 10,000 Nov. 30 (Profit on disposal: Mouse 1,600
Ltd)
Nov.30 Inv. In Fltd (loss on disposal) 1,6000
20X9
Apr.30 Estate CB Adm. Expenses 1,500 Jan. 31 CB (MPLC DIV) 140
May 1 Bal c/d 34,047 Feb. 25 CB (WEES P/C DIV) 80
105,101 105,101
20X9
May 1 Bal b/f 34,047

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FINANCIAL ACCOUNTING III
 491 Revision Aid

ESTATE INCOME ACCOUNT

20x8 Kshs. 20x8 Kshs.
Oct.31 LEGACY AT 6% P.A Jun. 30 CB MBS Int 326
FROM 1.5 x 8 TO Aug.31 CB Weasel P/c DIV 80
31.10 x 8 900 Sep.30 R. Ltd. Final Div. 133
Oct. 31 DISTR. A/c Div. TO BEAKIE 133 Oct.31 MBS Int. On Dep. 620
INT. TO HAROLD 300
20X9 20X9
Apr.30 Adm. Expenses 200 Jan.31 Rot CB 600
May 1 Bal. c/d 806 Jan.31 MPLC DIV. 420
____ Feb.28 CB (Weasel p/c Div. _160
2,339 2,339
20X9
May 1 Bal. b/d 806

ESTATE CASH ACCOUNT

TOTAL INCOME CAPITAL INCOME CAPITAL
Kshs. Kshs. Kshs. Kshs.
May1 Est.Cap.A/c 32,000 Jun.1 Est.Cap.A/c 17,954
Jun.30 Income/Tot. 980 326 654 Jun.30 D& F Exp. 4904,300
Aug.31 Inc/Cap.A/c Invest in
120 80 40 Oct.31 UPLC
Aug.31 Capital A/c Dist.A/c to 900 30,000
4,140 Oct.31 Gloria
Sep.30 Inc/Cap. Dist.A/c to 133
500 133 367 Oct.31 Beakie
Oct.31 MBS A/c Dist.A/c to 300 10,000
620 25,000 Oct.31 Harold
Nov.30 Inv.in. Frog Invest in 14,050
Ltd. 3,000 Nov Stoat
Nov.30 Inv.in MPLC
13,605
20X9 Apr.30 Admin.Exp. 200 1,500
Jan.31 Est.Inc. A/c 600 600
Jan.1 Est.Inc/Cap
Interim
MPLC
Div 560 420 140
Feb.28 Est.Inv/Cap.
A/c Final
Weasel plc
Div 240 160 80 May 1 Bal c/d 806 732
2,339 79,026 2,339 79,026
806 732
May.1 Bal b/d

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 492

DISTRIBUTION ACCOUNT
Kshs. Kshs. Kshs.
SPECIFIC
Oct.31 To Gloria - Oct. 31 Estate Capital A/c 32,000
Personal Chattel A/c
2,000 Oct. 31 Estate Income A/c 900
Capital cash to Oct. 31 Estate Capital A/c 8,000
Gloria 30,000 Oct .31 Estate Income A/c 133
Income cash 900 30,900 Oct. 31 Estate Capital A/c 10,000
Invest in Rat Ltd. A/c Estate Income A/c (Int)
Oct. 31 300
To Beakie: 8,000
Income cash 133 8,133
To Harold:
Capital cash 10,000
Income cash 3000 10,300 _____
51,333 51,333

NEVILLE DECEASED
ESTATE BALNCE SHEET AS AT 1ST MAY 20X9
CAPITAL ASSETS
Kshs.
4,000 Ordinary shares of 25p in Weasels plc 2,960
3,500 Ordinary shares of Kshs.1 in Mouse plc 12,005
5,000 Ordinary shares of Kshs.1 in Stoat plc 14,050
4,000 Ordinary shares of Kshs.1in Op/c 4,300
33,3315
Cash at bank 732
34,047
INCOME ASSETS
CASH AT BANK 806
34,853

ESTATE CAPITAL ACCOUNT 34,047

ESTATE INCOME ACCOUNT
DAVID 403
DONALD 403 806
34,853

Workings:

Final Dividend rec10eived for holding in Rat Ltd

10 months 2 months

1st July 20X7 1st May 20x8 30th June 20x8

Dividend Kshs.800

For two months (i.e. after Neville‘s death)

Dividend = 212 x 800  Kshs.133 = Income
Kshs.367 = Capital
Kshs.500 = Total

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FINANCIAL ACCOUNTING III
 493 Revision Aid

Assumption:

For general legacies, interest accrues at 6% per annum for the time period between which they were meant to
have been paid and the time they were actually paid.

Date legacies should have been paid = date of death = 1st May 20x8
Date legacies distributed = 31st October 20x8
Time interval = 6 months.

 Interest to be paid  Gloria = Kshs.30,000 x 6months x 6% = Kshs.900

12

 Harold = Kshs.10,000 x 12 months x 6% = Kshs.300

6

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 494

QUESTION FIVE
Estate Capital Account
Kshs. 20x8 Kshs.
Mar. 31 Govt. Stock loss on dsp. 1,000 Feb. 1 Bal b/d 91,600
Mar. 30 CB (Estate Duty) 2,250 Feb. 28 Walters Ltd. 700
Apr. 30 Distribution A/c 89,050 _____
92,300 92,300

Estate Cash Account

INCOME CAPITAL INCOME CAPITAL
Kshs. Kshs. Kshs. Kshs.
Feb. 1 Estate Capital 4,965 Mar.31 Cap. A/c 2,250
A/c
Feb.28 Cap. A/c Div. 700 Apr.30 Admin.exp 1,046
Mar.31 Cap. A/c 41,000
Apr.30 Build Soc A/c 5,081
Apr.30 CB 76 ______ Apr.30 Dist. A/c 76 48,450
76 51,746 76 51,746

Distribution Account
Kshs. Kshs.
SPECIFIC LEGACIES 24,000 Estate Capital A./c 89,050
To wife Jane: Freehold house 3,600
To wife Jane: Personal Chattels 10,000 Estate Income A/c 76
7,000 ordinary shares if Walters Ltd. 3,000
3,000 Ordinary shares If Chattels 40,600

GENERAL LEGACIES
GROSS ABAT NET
To wife Jane cash 15,000 5,310 9,690
Daughter CB 21,600 7,646 13,954
To son George 12,000 4,248 7,752
Harold Estate 12,000 4,248 7,752
Fredrick 12,000 4,248 7,752
To friend Charles 2,400 850 1,550
75,000 (26,550) 48,450
76 _____
Income arising to wife 89,126 89,126

LESSON 7
QUESTION ONE
Onyango Trust
(1) Estate Capital Account
20X4 Kshs. 20X4 Shs
Mar.31 Distrib. A/c 285,000 Jan.1 Bal b/f 520,000
Mar.31 K Ltd Inv. A/c 30,000
Mar.31 Bal c/d 285,000 Mar.31 K Ltd Inv. A/c 20,000
570,000 570,000
20X4
Apr. 1 Bal b/d 285,000

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FINANCIAL ACCOUNTING III
 495 Revision Aid

(2) Accumulation Accounts

Abel Beatrice Abel Beatrice
20X4 Shs Shs 20X4 Shs Shs
Jan. 31 CB 3,000 2,000 Jan.1 Bal b/f 15,000 10,000
Mar. 31 Dist. A/c 18,800 Jan.1 CB(Inc on 5,000 5,000
Acc.Inv)
Mar.31 Bal c/d 14,200 Jan.1 CB(Inc on 300 200
Acc.Inv)
Mar.31 Inv. In K Ltd 900 600
A/c
Mar.31 Inv. In K Ltd
_____ _____ A/c 600 _ 400
21,800 16,200 21,800 16,200
20X4
Apr.1 Bal b/d 14,200

Workings:
DISTRIBUTION STATEMENT
Book Market Nominal Abel Nominal Trust (for
Value Value Value Value Beatrice)
Capital Shs Shs Shs Shs Shs Shs
Investment
20,000 Shs 10
Ord. Shares in K 220,000 250,000 110,000 125,000 110,000 125,000
Ltd.
30,000 Shs10
Ord. Shares in L 280,000 300,000 150,000 150,000 150,000 150,000
Ltd.
Cash 20,000 20,000 _ 10,000 _ 10,000
520,000 570,000 285,000 285,000

Income (Accum.) Investments

1,000 Shs 10 Ord.
Shares in K Ltd
11,000 12,500 6,000 7,500 4,000 5,000
1,000 Shs 10 Ord.
Shares in L Ltd
9,000 10,000 6,000 6,000 4,000 5,000
Cash 10,500 10,500 5,300 5,200
30,500 33,000 18,800 14,200

(3) Distribution A/c - Abel

20X4 Shs 20X4 Shs
Mar.31 Capital Assets: Mar.31 Est.Cap. A/c 285,000
10,000 Shs 10 Ord. Shares in K Ltd 125,000 Mar.31 Accum. A/c 18,800
15,000 Shs 10 Ord. Shares in L Ltd 150,000
Cash Book - Cash 10,000
285,000
Mar.31 Income Assets:
600 Shs 10 Ord. Shares in K Ltd 7,500
600 Shs 10 Ord. Shares in L Ltd 6,000
5,300
Cash 18,800 ______
303,800 303,800

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 496

QUESTION TWO
Abincha Trust: Date of Death 31st March 20X5
(a) Cash Account

INCOME CAPITAL INCOME CAPITAL

Shs Shs Shs Shs 20x8 Shs Shs Shs Shs
Bal b/f 7,640 1,000 1,000 May. 31 FI/WR Cash - 120,000
Accum. A/c 500 Jun. 10 Inv. in z Ltd
Accum. A/c 7,500 (3,840 Sh.10
Land A/c 120,000 Ord.shares) 96,000
SRCB - Contra 60,000 60,000 Jun. 10 Inv in 5% Govt.
Inv.in S Ltd 35,000 St. 19Y4 (Shs
Accum. A/cs 800 (76,250 Nominal) 61,000
Jun. 30 Accum. H28A/cs:
Maintenance 3,250
Bruce Accum
Jul. 31 A/c 10,393
_____ ______ _____ _____ Jul. 31 Bal c/d 2,797 ______ _____ _____
16,440 120,000 61,000 96,000 16,440 120,000 61,000 96,000
Aug. 1 Bal c/d 2,797

(b) Capital Accounts

20x8 SRF FIF WRF 20x8 SRF FIF WRF
Shs Shs Shs Shs Shs Shs
May. 31 FIF/WRF - Contra 120,000 Apr. 1 Bal b/f 60,000 250,000 50,000
Jul. 31 Distrib. A/c May. 31 Land A/c
Bruce 218,500 26,125 (Profit on Disp.) 60,000
Jul. 31 Bal c/d 129,775 359,475 May. 31 SRF - Contra 60,000 60,000
May. 31 Inv. in S Ltd
(Profit) 5,000
Jun. 30 Inv. in 4% Nat.st 1,000
Jul. 31 Subdry Inv. A/cs
Revaluation
_____ ______ ______ Surplus ______ 37,275 70,600
120,000 348,275 385,600 120,000 348,275 385,600
Aug. 1 Bal b/d 129,775 359,475

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FINANCIAL ACCOUNTING III
 497 Revision Aid

(c) Accumulations Accounts

20x8 BRUCE CHRIS DAN 20x8 BRUCE CHRIS DAN
Shs Shs Shs Shs Shs Shs
June. 30 CB: Maintenance 1,500 900 850 Apr.1 Bal b/f 8,000 12,000 12,000
Jul.31 CB 10,393 Apr.30 CB (5% Div.
Jul.31 Bal c/d 15,474 15,523 S Ltd) 167 167 167
Apr.30 CB (6% G. St.
Int.) 2,500 2,500 2,500
Jun.30 CB (4% Nat.St.
Int.) 266 267 267
Jul.31 Inv.in 6% Nat.
_____ _____ _____ St.A/c _____ _____ _____
11,893 16,374 16,373 11,893 16,374 16,373
Aug.1 Bal c/d 15,474 15,523

(d) Trust Statement of financial position as at 31st July 20x8

Fixed Interest Assets: Shs Shs
Shs 40,000 8% Govt. Stock 19Y8 39,100
Shs 20,000 6% Govt Stock 19Y5 19,000
Shs 76,000 5% Govt Stock 19Y4 71,675
129,775
Wider Range Assets:
10,000 Shs 10 Ord. Shares in G Ltd 280,000
2,890 Shs 10 Ord. Shares in Z Ltd 79,475
359,475
Accumulation Assets:
Shs 30,000 6% National Stock 19Y5 28,200
Cash at Bank 2,797
30,997
Assets Due to Bruce:
Shs 230,000 6% Govt. Stock 19Y5 218,500
950 Shs 10 Ord. Shares in Z Ltd 26,125 244,625
764,872
Fixed Interest Fund 129,775
Wider Range Fund 359,475 489,250
Accumulations Accounts: Chris 15,474
Dan 15,523 30,997
Due to Bruce 244,625
764,872

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 498

Workings: Distribution Statement

Assets: Book MV Due To Bruce To Remain in Trust
Value 31.7.X8 Nominal MV Nominal MV
Shs Shs Shs Shs Shs Shs
Shs 40,000 8% Govt. St 19Y8 40,000 39,100 _ _ 40,000 39,100
Shs 250,000 6% Govt St 19Y5 210,000 237,500 230,000 218,500 20,000 19,000
Shs 76,250 5% Govt St 19Y4 61,000 71,675 _ _ 76,250 71,675
311,000 348,275 218,500 129,775
Wider Range
10,000 Shs 10 Ord. Shares
in G Ltd 219,000 280,000 _ _ 100,000 280,000
3,840 Shs 10 Ord. Shares
in z Ltd 96,000 105,600 9,500 26,125 28,900 79,475
315,000 385,000 26,125 359,475
TOTAL CAPITAL ASSETS 626,000 733,875 244,625 489,250
Accumulation Assets:
Shs 30,000 6% National
St. 19Y5 24,360 28,200 _ _ 30,000 28,200
Cash at Bank 13,190 13,190 10,393 2,797
37,550 41,390 10,393 30,997

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FINANCIAL ACCOUNTING III
499 Revision Aid

QUESTION THREE
KAMAU DECEASED (DATE OF DEATH 30.6.X4)
(a) Accumulations Accounts

Maina Njoroge Karanja Maina Njoroge Karanja

shs'000 shs'000 shs'000 shs'000 shs'000 shs'000
20X4 20X5
Dec.31 CB (Maintenance) 5 5 10 Jun.30 Cash
20X5 Book (Inc) 100 100 100
Jun.30 CB (Maintenance) 15 25 30
Jun.30 Bal c/d 80 70 60 ___ ___ ___
100 100 100 100 100 100
20X5 20X5
Dec.31 CB (Maintenance) 20 40 50 Jul.1 Bal b/d 80 70 60
20X6 20X6
Mar.31 Inv A/cs Mar.31 Cash Book
(Loss on Rival) 2.5 2.2 1.9 (Cap. Inc 90 90 90
Mar.31 Distribution A/c 105.3 Mar.31 CB
Balance c/f 157.1 126.2 ____ Accum. Inc.) 9.6 8.4 7.2
179.6 168.4 157.2 179.6 168.4 157.2
20X6
Apr.1 Bal b/d 157.1 126.2

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 500

(b) Statement of distribution

i. General Fund Book MV Due to Karanja To Remain in Trust
Assets Value 31.3X6 Nominal MV Nominal MV
Shs '000 Shs '000 Shs '000 Shs '000 Shs '000 Shs '000
Sh. 1m M Ltd 9% Deb.St. 830 870 399 347 471 523
Sh. 1.5m N Ltd 10% Loan St. 1,480 1,425 500 475 1,000 950
Sh. 1.8 O Ltd 6% St. 1,100 1,062 600 354 1,200 708
Sh. 0.3m P Ltd 6% St. 190 171 _ _ 300 171
3,600 3,528 1,176 2,352

ii. Accumulations Fund

Sh 70,000 M Ltd 9% Deb.St. 61 60.9 70 60.9 _ _
Sh 150,000 N Ltd 10% Loan St. 149 142.5 _ _ 149 142.5
210 203.4
Cash 185.2 185.2 44.4 140.8
395.2 388.6 105.3 283.3

(C) Trust Statement of financial position as at 31st March 20X6

Capital Assets Shs Shs
Shs 0.477m 9% Deb. St in M Ltd 523.00
Shs 1 m 10% Loan St. in N Ltd 950.00
Shs 1.2m 6% St in O Ltd 708.00
Shs 0.3m 6% St in P Ltd 171.00 2,352.00
Accumulation Assets
Shs 0.149m 10% Loan St. in N Ltd 142.50
Cash at Bank 140.80 283.30
2,635.30
Trust Capital Account 2,352.00
Accumulations Accounts:
Maina 157.10
Njoroge 126.20
283.30
2,635.30

LESSON 8
(a) See notes
(b) (i) Wafanyakazi retirement benefit Scheme
Statement of changes in net assets for the year ended 31 October 2002
Sh. Sh.
Contributions received
From employer: Normal 18,240 36,480
From members: Normal 4,560 22,800
Additional voluntary
Transfer in
From other sources (individual transfers in) 3,150
Investment income 47,400
109,830
Benefits payable
Pensions 7,640
Commutations of pensions and lumpsum benefits 4,820

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FINANCIAL ACCOUNTING III
 501 Revision Aid

Payments on accounts of leavers: individual transfer out 1,860 (14,320)

95,510
Changes in market value of investments (22,640)
72,870
Payments: Administration expenses (2,840)
70,030

Wafanyakazi retirement benefit Scheme

Statement of net assets as at 31 October 2002
Sh. Sh.
Investment assets
Fixed interest securities
Kenya Government securities 263,605
Equity investments
Quoted 87,835
Unquoted 19,990 107,825
Cash and demand deposits 23,460
394,890
Fixed Assets:
Freehold property 132,320
527,210
Current Assets
Contributions due within 30 days 4,940
Current liabilities
Unpaid benefits (320)
Accrued expenses (240)
(560) 4,380
531,590
Accumulated fund as at 01.11.01 461,560
Net change for the year 70,030
531,590

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 502

KENYA ACCOUNTANTS AND SECRETARIES NATIONAL EXAMINATION BOARD

FINANCIAL ACCOUNTING III

December 2005 Time allowed: 3 Hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the
question. Show ALL your workings.

QUESTION ONE

Soma Ltd., publishing and printing company, extracted the following trial balance as at 31 October
2005:

Sh. ‗000‘ Sh. ‗000‘

Property, plant and equipment: Cost 907,722
Accumulated depreciation 108,000
Intangible assets 120,000
Inventory 120,700
Accounts receivable 168,120
Provision for doubtful debts 620
Cash in hand 100
Accounts payable 127,450
Bank overdraft 50,754
12½% debentures 200,000
Bank loan 270,000
Corporation tax 47,500
Share capital 60,000
Retained profits 119,046
Sales 1,574,500
Cost of sales 670,396
Salaries and wages 238,720
Distribution cost 86,560
Administrative expenses 165,592
Interest charges 79,960 ________
2,555,870 2,557,870

Additional Information

1. Details of property, plant and equipment were as follows:

Values as at 1 November 2004 Cost Accumulated

depreciation
Sh. ‗000‘ Sh. ‗000‘
Freehold property (land Sh.350 million) 500,000 -
Plant and machinery 200,000 90,000
Office equipment 107,722 18,000
807.722 108,000

The company had not been providing for depreciation on freehold property which comprised land
and buildings. These were acquired on 1 November 1995, on which date the buildings were

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FINANCIAL ACCOUNTING III
 503 Revision Aid

estimated to have a useful life of 50 years. The directors have now agreed to provide depreciation
from the date of acquisition.

Depreciation on the other items of property, plant and equipment is to be provided for as
follows:

Plant and machinery - 15% on straight line basis

Office equipment - 10% on reducing balance basis

A plant which cost Sh.100 million was acquired during the year.

2. The cost of inventory as at 31 October 2005 included items valued at Sh.9.6 million that were
considered to be obsolete. The remaining inventory had a value of Sh.111.1 million.
3. Provision for doubtful debts at 5% of the accounts receivable is to be made.
4. The bank loan is repayable in ten equal annual installments of Sh.30 million.
5. The corporation tax amounting to Sh.47.5 million represents the estimated tax charge for the
previous year. This liability was agreed with the tax authority at Sh.45 million. Current year tax
is estimated to be Sh.85 million.
6. The details of salaries and wages were:

SH. ‗000‘
Factory wages 125,510
Warehouse wages 32,716
Office salaries 79,780
Directors‘ remuneration 714
238,720

The interest charges comprise:

SH. ‗000‘
Bank overdraft interest 25,460
Bank loan interest 42,000
12½% debenture interest 12,500
79,960

Intangible assets are to be amortised over 5 years. Amortisation and depreciation charges are to be
treated as part of the cost of sales.

The directors propose to pay dividend amounting to Sh.21 million in respect of the year ended 31
October 2005.

Required:
a) Income statement for the year ended 31 October 2005. (8 marks)

b) Statement of changes in equity for the year ended 31 October 2005. (show the column for
retained profits only). (2 marks)

c) Statement of financial position as at 31 October 2005. Include relevant notes, using only the
information provided, to ensure that the financial statements meet the requirements of

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 504

International Financial Reporting Standards (IFRSs).

(12 marks)
(Total:22 marks)

QUESTION TWO

The consolidated financial statements for Hipa group for the year ended 30 September 2005 together
with the comparative statement of financial position for the year 30 September 204 are shown below:

Consolidated income statement for the year ended 30 September 2005:

Sh. ‗million‘ Sh. ‗million‘
Sales 3,820
Cost of sales (2,620)
Gross profit 1,200
Operating expenses 300 -
Finance costs 30 (330)
Profit before tax 870
Share of profit after tax of associate company 20
890

Income tax expense (270)

Profit for the period 620

Attributable to holding company 580

Attributable to minority interest 40
620

Consolidated statement of financial position as at 30 September:

2005 2004
Non-Current assets: Sh. ‗million‘ Sh. ‗million‘ Sh. ‗million‘ Sh. ‗million‘
Property, plant and equipment 1,890 1,830
Intangible assets 650 300
Investment in associate company 95 80
2,635 2,210
Current Assets:
Inventory 1,420 940
Accounts receivable 990 680
Cash 70 2,480 - 1,620
5,115 3,830
Equity and liabilities:
Capital and reserves:
Ordinary shares (Sh.10 each) 750 500
Reserves:
Share premium 350 100
Revaluation reserves 140 -
Retained profits 1,570 2,060 1,380 1,480
Shareholders funds 2,810 1,980
Minority interest 135 100

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FINANCIAL ACCOUNTING III
 505 Revision Aid

Non-current liabilities:
10% debentures 300 100
Bank loan 260 300
Deferred tax 310 870 140 540

Accounts payable 875 730

Bank overdraft - 115
Accrued loan interest 15 5
Proposed dividend 280 200
Current tax 130 1,300 160 1,210
5,115 3,830

Additional Information

1. The cost of sales includes depreciation of property, plant and equipment amounting to Sh.320
million and a loss on sale of plant of Sh.50 million.

2. Intangible assets comprise:

2005 2004
Sh. ‗million Sh. ‗million‘
Goodwill 180 200
Others 470 100
650 300

Included in the amount above were tangible assets acquired during the year ended 30 September
2005 for sh.500 million.

3. During the year ended 30 September 2005, the holding company acquired a new plant which
cost Sh.250 million. The company also revalued its buildings by Sh.200 million.

4. On 1 October 2004, the holding company made a bonus issue of 1 share for every 10 shares
held. The issue was financed through the revaluation reserve.

5. The detailed analysis of the retained profits was as follows:

2005 2004
Sh. ‗million Sh. ‗million‘
Balance brought forward 1,380 1,200
Profit for the year 580 480
1,960 1,680
Transfer from revaluation reserves 10 -
Dividend paid and proposed (400) (300)
Balance carried forward 1,570 1,380

Required:
Group cash flow statement for the year ended 30 September 2005, using the indirect method in
conformity with International Accounting Standard (IAS)7. (20 marks)

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 506

QUESTION THREE

Beta East Africa Ltd. Manufactures tubeless tyres at its head office plant located in Nairobi.
It operates an overseas outlet at Kampala which maintains its own books of account.

The tyres are transferred to the branch at head office cost plus 25% mark-up. All sales are at a
uniform margin of 50%.

The trial balances extracted from the books o both the head office and the Kampala branch as at 30
June 2005 were as follows:

Head office Kampala branch

Ksh. ‗000‘ Ksh. ‗000‘ Ush. ‗000‘ Ush. ‗000‘
Cash at bank 6,000 130,000
Accounts receivable 45,000 260,000
Inventory – 30 June 2005 40,000 80,000
Plant and equipment – net book value 150,000
Accounts payable 44,000 65,000
Share capital 192,000
Motor vehicles – net book value 50,000
Branch and head office current accounts 15,000 95,000
Sales 390,000 1,600,000
Cost of goods sold 280,000 930,000
Operating expenses 70,000 360,000
Goods sent to branch ______ 30,000 _______ ________
656,000 656,000 1,760,000 1,760,000

Additional Information

1. Goods sent to Kampala branch by the head office which had cost the head office Ksh.80,000
were received by the branch on 15 July 2005. Included in the closing stock of Kampala branch
were goods received from head office valued at Ush.23,600,000. The balance of the inventory
at the Kampala branch were purchased locally in Uganda when the exchange rate was Ush.12 to
Ksh.1.

2. A customer of the head office whose operations are situated in Kampala, made a settlement of
Ush.420,000,000 to Kampala branch on 15 June 2005. This transaction was properly recorded
by the Kampala branch but the head office had not been notified by the time the trial balance
was extracted on 30 June 2005.

3. Depreciation is to be provided on plant and motor vehicles using the reducing balance method at
10% and 20% respectively per annum.

4. The head office expenses include Ksh.3,000,000 that related to Kampala branch. The head
office allocates 1/3 of the depreciation expenses on plant and equipment to the branch.

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FINANCIAL ACCOUNTING III
 507 Revision Aid

5. The rates of exchange prevailing on various dated were:

Date Rate
1 July 2004 9 Ush./Ksh.
15 June 2005 12 Ush./Ksh.
30 June 2005 13 Ush./Ksh.
Average rate for the year was 10 Ush./1Ksh. Goods transferred to Kampala branch were translated
at the rate of 10 Ush./1Ksh.

Required:
a) Branch trial balance in Kenya shillings after the necessary adjustments. (5 marks)

b) Income statement (in Kenya shillings) for the head office, branch and the combined
business, in columnar format, for the year ended 30 June 2005. (10 marks)

c) Combined statement of financial position (in Kenya Shillings) as at 30 June 2005. (5

marks)
(Total:20 marks)

QUESTION FOUR

Kuni and Moto were partners in a business of logging and saw milling sharing profits and
losses equally. The partnership statement of financial position as at 31 December 2004 was
as follows:

Sh. ‗000‘ Sh. ‗000‘

Non-current assets:
Land and building (at cost) 93,250
Furniture (at cost less accumulated depreciation) 2,500
95,750
Current assets
Cash in hand 250
Accounts receivable
Saw milling 32,000
Logging 54,000 86,000
Inventory
Saw milling 115,000
Logging 56,250 171,250
257,500
Total assets 353,250

Capital and liabilities

Capital accounts: Kuni 131,500
Moto 81,000
212,500
Non-current liability:
Loan 6,000

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 508

Current liabilities
Bank overdraft 44,750
Creditors:
Saw milling 77,000
Logging 13,000 90,000
134,750
Total capital and liabilities 353,250

Additional Information
1. The partners agreed that effective from 1 January 2005, the business would be taken over
by two separate limited companies, Kuni Ltd. And Moto Ltd. Took over the saw milling
business and Moto Ltd. Took over the logging business.

2. The providers of the loan agreed to accept 10% debentures in the new companies;
Sh.3,600,000 being applicable to Kuni Ltd. And Sh.2,400,000 to Moto Ltd.

3. Kuni Ltd. took over the land and buildings, furniture, cash and bank overdraft. The
assets and the liabilities were transferred at book values and the partners were paid
Sh.25,000,000 being goodwill for the saw milling business and Sh.20,000,000 for the
logging business

4. On 1 January 2005, the purchase consideration was satisfied by the allotment of fully
paid equity shares of Sh.10 each in the respective companies as shown below:

 Kuni – 11,875,000 shares in Kuni Ltd. and the balance in Moto Ltd.
 Moto – 7,960,000 shares in Moto Ltd. and the balance in Kuni Ltd.

5. Kuni Ltd. Also raised a 12% debenture of Sh.50,000,000 on 1 January 2005 and paid-off
the bank overdraft. The expenses incurred in raising the debenture amounted to
Sh.1,750,000.

6. Kuni Ltd. And Moto Ltd. Also issued 500,000 and 750,000 full paid ordinary shares of
Sh.10 each respectively to B Ltd. And C Ltd. on 1 January 2005.

7. The formation expenses were paid by the respective companies as follows: Kuni Ltd.
Sh.3,250,000 and Moto Ltd. Sh.2,000,000.

Required:
a) Prepare business purchase accounts, partners‘ capital accounts, vendor account and
bank accounts to record the above transactions. (12 marks)

b) Opening statement of financial position of Kuni Ltd. And Moto Ltd. (8

marks)
(Total:20 marks)

QUESTION FIVE

a) With reference in International accounting Standard (IAS) 19 on employees benefits:

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FINANCIAL ACCOUNTING III
 509 Revision Aid

i) Differentiate between the terms ―defined contribution plans‖ and ―defined benefit
plans‖.
(3 marks)

ii) Outline the two circumstances under which an enterprise should recognize
termination benefits as a liability and an expense. (3 marks)

b) Treasure Motors Ltd. Is a dealer in new and used motor vehicles. In June 1993, the
company registered a retirement benefits scheme for its 10 employees under the name
―Treasure Motors Retirement Benefits Scheme‖.

The trustees of the scheme extracted the following trial balance as at 30 June 2005.

Sh. Sh.
Pensions and commutations 209,000
Withdrawals from scheme 15,000
Management expenses 7,000
Members‘ contribution 250,200
Interest on investment 640,000
Provision for exchange losses 160,000
Investment in quoted shares 3,000,000
Investment in unquoted shares 2,500,000
Government securities 590,000
Premises 800,000
Offshore investments in shares 1,200,000
Employer‘s contributions 630,000.600
Accumulated fund balance as at 1 July 7,640,000
2004
Fixed deposits 260,000
Receivable from employer 635,600
Payable to members 8,000
Income receivable 80,000 _______
9,328,800 9,328,800

Required:

i) Statement of changes in net assets for the year ended 30 June 2005. (6
marks)

ii) Statement of net assets as at 30 June 2005. (6 marks)

(Total: 18 marks)

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 510

KENYA ACCOUNTANTS AND SECRETARIES NATIONAL EXAMINATION BOARD

FINANCIAL ACCOUNTING III

June 2005 Time allowed: 3 Hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the
question. Show ALL your workings.

QUESTION ONE
Jembe and Panga were sole traders manufacturing farm implements. On 31 March 2004, they
amalgamated and traded as partners sharing profits and losses in the ratio of 3:2 . one year later on
31 March 2005, they
converted the partnership into a limited liability company called Shamba Ltd.

No. adjustments have been made to record the amalgamation and conversion but the statement of
financial positions for the
sole traders as at 31 March 2004 and the partnership as at 31 March 2005 were as follows:

Sole Traders statement of financial Partnership statement of

position as at 31 March 2004 financial position as at 31
March2005
Jembe Panga
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Assets
Freehold property 1,500 1,000 4,000
Plant and equipment 6,800 5,600 13,000
Fixtures and fittings 1,600 1,550 3,000
Inventory 1,800 350 3,350
Accounts receivable 1,900 1,000 6,420
Balance at bank 300 150 125
13,900 9,560 29,895
Liabilities
Accounts payable (6,800) (4,000) (9,920)
Bank overdraft - - (5,625)

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FINANCIAL ACCOUNTING III
 511 Revision Aid

7,1000 5,650 14,350

Additional Information:
1. On 1 April 2004, the partners agreed to take up the assets and liabilities of the individual traders
at book values except for freehold property, plant and equipment and fixtures and fittings which
were to be revalued as follows:

Jembe Panga
Sh. ‗000‘ Sh. ‗000‘
Freehold property 2,000 1,500
Plant and equipment 6,500 5,500
Fixtures and fittings 1,500 1,500

2. During the year ended 31 March 2005, Jembe made drawings of Sh2,390,000 while Panga drew
sh.610,000.

3. The partnership was converted into a limited company on the following terms:

i) The freehold property and accounts receivable were revalued to Sh.6,00,000 and
Sh.5,670,000 respectively.

ii) Jembe and Panga were to receive 15% unsecured debentures at par so as to provide each
partner with income equivalent to a 6% return on capital employed based on capital balances
as at 31 March 2005 (that is after accounting for the profit, drawings and revaluation in note
(i) above).

iii) Shamba Ltd. Authorized share capital was made up of 150,000 ordinary shares of Sh.50
each. Out of which 130,000 shares were to be issued to the partners in their profit sharing
ratio.

iv) Any balances in the partners‘ capital accounts were to be settled in cash.

Required:
a) A computation showing the value of debentures and ordinary shares to be issued to the partners.
(12 marks)
b) Partners capital accounts as at 31 March 2005. (3 marks)

c) Statement of financial position of Shamba Ltd. As at 31 March 2005 after completing the above
transactions.
(5 marks)
(Total: 20 marks)

QUESTION TWO
Lusiola Ltd. Acquired 90% of the ordinary shares of Kacheliba Ltd. On 1 April 2003 for 30 million
when
Kacheliba Ltd‘s retained earnings were Sh.15 million.

The statement of financial position of the two companies as at 31 March 2005 were as follows:

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 512

Lusiola Ltd. Kacheliba Ltd.

Sh. ‗000‘ Sh. ‗000‘
Non-current assets:
Property, plant and equipment 26,400 16,200
Investment in Kacheliba Ltd. 30,000
Other investments 1,000 6,000
57,400 22,200
Current assets
Inventory 9,500 4,000
Accounts receivable 7,200 1,500
Bank 300 _____
17,000 5,500
Total assets 74,400 27,700
Equity and liabilities:
Ordinary share capital (Sh.10 each) 10,000 5,000
Retained earnings 48,600 6,300
58,600 11,300
Non-current liabilities
12% debentures 4,000 6,000
Current liabilities
Accounts payable 6,700 5,200
Taxation 4,100 700
Dividends 1,000 -
Overdraft - 4,500
11,800 10,400
Total equity and liabilities 74,400 27,700

Additional Information

1. The movement in Kacheliba Ltd.‘s earnings since acquisition was as follows:

Sh. ‗000‘
Balance as at 1 April 2003 15,000
Loss for the year ended 31 March 2004 (3,000)
Loss for the year ended 31 March 2005 (1,700)
Dividend paid in the year ended 31 March 2005 (1,400)
Balance as at 31 March 2005 (6,300)

2. Lusiola Ltd. Accounted for its share of Kacheliba Ltd.‘s dividend as a credit to income. The
group policy on dividend is to credit group income with dividend paid out of post acquisition
profit only.

3. On the date of acquisition, the fair values of Kacheliba Ltd.‘s assets were approximately equal to
their book values except for
i) Plant which had a net replacement value of sh.6 million in excess of its book value and
an estimated remaining useful life for 5 years.
ii) Investments with market values of sh.8 million.

4. There were no acquisitions or disposals of non-current assets since 1 April 2003.

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FINANCIAL ACCOUNTING III
 513 Revision Aid

5. The group policy in relation to goodwill arising from acquisition was to capitalise it and amortise
it over 6 years. However, in line with International Financial Reporting Standard (IFRS 3)
goodwill was tested for impairment from 1 April 2004 to 31 Mach 2005 and found to be
impaired by 16.67%. amortisation for the year ended 1 March 2004 had been provided.

6. On 27 March 2005, Lusiola Ltd. Sold goods to Kacheliba Ltd. For Sh.6,000. These goods had
not been received by 31 March 2005 and were excluded from Kacheliba Ltd. Inventory. Lusiola
Ltd. Charges goods at a standard mark-up on cost of 20%. Prior to this transaction, the agreed
purchase ledger accounts balance of Kacheliba Ltd. With Lusiola Ltd. Was Sh.1,400,000.

Required
Group statement of financial position as at 31 March 2005 (20 marks)

QUESTION THREE

Jamila traders has a head office in Nanyuki and an automation branch in Thika. The trial balances of
head office and the branch as at 30 September 2004 were as follows:

Head office Thika branch

Sh. Sh. Sh. Sh.
Buildings (at cost) 3,500,000
Goods sent to branch 6,482,205
Goods received from head office 6,387,330
Accounts receivable 764,700 535,800
Remittance from branch 7,548,750
Remittances to head office 7,620,000
Cash at bank 397,800 289,250
Stock (at cost) 2,595,000
Stock (at mark up) 1,552,500
Sales 13,000,000 9,202,200
Capital (1 October 2003) 6,040,925
Bank overdraft 250,000
Furniture and fittings 779,500 230,500
Purchases 13,626,600
Rent and rates 395,400 197,250
Salaries and wages 851,700 487,500
Current accounts 8,931,555 8,836,680
General expenses 1,887,750 1,258,950
Accounts payable 1,239,000 270,200
Drawings 783,375

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 514

Provision for unrealised profits ________ 202,500 ________ ________

34,513,380 34,513,380 18,559,080 18,559,080

Additional Information

1. Depreciation on furniture and fittings is to be provided at the rate of 10% per annum using the
reducing balance method.
2. A bonus of 10% is payable to the staff at the head office and the branch. The bonus is based on
net profits after charging these bonuses.
3. Goods sent to the branch in August 2004 and which had an invoice value of Sh.94,875 were
stolen in transit. The insurance company agreed to meet the claim to the extent of only 85% of
the cost of the goods.
4. Goods were invoiced to the branch at 15% above cost all sales were at a mark up of 331/3%
above the cost to head office.
5. No shortages of stock were reported at the head office or the branch.

Required:
Prepare in columnar form for the head office. Thika branch and the combined business. The
income statements for the year ended 30 September 2004. (12 marks)

QUESTION FOUR
Hamed and Hassan were in partnership trading under the name ‗Medsan Traders‘ and sharing profits
and losses in the ratio of 1:3 respectively. On 31 December 2004, a winding up petition was lodged
against the firm on which date the balances extracted from the books of the firm and the partners‘
separate estates were as follows:

Current value Estimated value

Sh. ‗000‘ Sh. ‗000‘
Assets
Freehold property: Medsan Traders 11,000 12,000
Hamed 7,000 10,000
Plant and machinery: Medsan Traders 3,000 1,500
Furniture and fixtures: Medsan Traders 1,000 800
Hamed 1,500 1,200
Hassan 1,800 1,500
Inventory Medsan Traders 8,000 6,500
Accounts receivable: Medsan Traders 12,000 See (note 1)
Investments: Hamed 1.500 2,400
Hassan 2,000 1,900
Liabilities
Mortgage on freehold property: Medsan Traders 6,000
Hamed 5,000
Bank overdraft: Medsan Traders 7,000
Accounts payables: Medsan Traders 19,000
Hamed 700
Hassan 2,400

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FINANCIAL ACCOUNTING III
 515 Revision Aid

Additional Information:

1. Of the accounts receivable. Sh.9 million is estimated to be good while Sh.1 million is estimated
to be bad. 50% of the remaining debts are expected to be paid.
2. The preferential accounts payables for Medsan Traders, Hamed and Hassan were Sh.1,100,000.
Sh.300,000 and Sh.500,000 respectively.
3. Medsan Traders bank overdraft was secured by a second mortgage on the partnership freehold
property and by the deposit of Hamed‘s investments together with his personal guarantee.

Required:
Using the format laid down in the Bankruptcy Act (Cap 53) and showing the legal position in relation
to the
double proof. Prepare

a) Statement of affairs as at 31 December 2004. (10 marks)

b) Deficiency or surplus accounts as at 31 December 2004 (10 marks)

(Total:20 marks)

QUESTION FIVE
a) Briefly explain the following terms as used in trust and executorship accounting:

i) Life tenant (2 marks)

ii) General legacy (2 marks)
iii) Demonstrative legacy (2 marks)

b) The will of Apollo Matalanza, who died on 23 January 2004, contains the following provisions:

I leave my house and personal effects to my wife Joan Matalanza

I leave Sh.9,000 in cash to my son Yacobo Matalanza
I leave all my investments to Chuo Kikuu
Any income earned on my investments prior to distribution, I leave to my priest Father Tony
Christopher.
I leave the remainder of my estate to Raphael Juma

Additional Information:

1. The executor, Kamau Otieno, took an inventory of the assets of the testator and determined
their fair value at the time of Apollo Matalanza‘s death to be as follows:

Sh.
Cash 40,000
Household an personal effects 310,000
Investments:
Stocks 21,000
Bonds 44,000

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 516

Land (rental property) 65,000

Antiques 19,000
Dividend receivable 1,000
Interest receivable 2,000
Rent receivable 4,000
512,000

2. The following Valid claims were made against the estate and paid by the executor:

Sh.
Funeral expenses 17,000
Executor charges 9,000
Medical expenses 11,000
Debts 5,000

3. The following cash collections were received by the estate

Sh.
Dividend 2,000
Interest 3,000
Rent 7,000
Sale of antiques 21,000

4. Prior to 25 June the date the charge and discharge statement was prepared, the executor had
made complete distribution to both Joan Matalanza and Yacobo Matalanza.

Required:
A charge and discharge statements for the estate of Apollo Matalanza. (14 marks)
(Total: 20 marks)

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FINANCIAL ACCOUNTING III
 517 Revision Aid

JUNE 2005
QUESTION ONE
(a) Computation of bond and ordinary shares to be issued to partners:

Determine the opening capital balances as 1 April 2004.

Jembe Panga Partnership

Assets less liabilities to partnerships Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Freehold property 2,000 1,500 3,500
Plant and equipment 6,500 5,500 12,000
Fixtures and fittings 1,500 1,500 3,000
Inventory 1,800 350 2,150
Accounts receivable 1,900 1,000 2,900
Balance at bank 300 150 450
14,000 10,000 24,000
Accounts payable (6,800) 4,000 10,800
Capital balances 1.4.04 7,200 6,000 13,200

Compute the capital balances as at 31 March 2005 before conversion takes place.

Jembe Panga
Shs. ‗000‘ Shs. ‗000‘
Capital balance as at 1.1.04 7,200 6,000
Profit for year
(Net assets as at 31.3.05 – Total capital b/f + Drawings)
(14,350 – 13,200 + 2,390 + 610) = Sh. 4,150
Share in PSR 3:2 2,490 1,660
9,690 7,660
Less drawings: (2,390) (610)
Capital balance at 31.3.05 7,300 7,050

Bond to be issued
Sh. ‗000‘ Sh. ‗000‘
Capital balance as at 31.5.05 7,300 7,050
Add Revaluation gain
(6,000 + 5,670 – 4,000 – 6,420)1,250
Share in PSR 3:2 750 500
Updated capital balances 8,050 7,550
6% rate of return 483 453
483
15% Bond to be issued 3,220 3,020
0.15

Revaluation a/c
Jembe Panga Jembe Panga
Plant & Equipment 300 100 Freehold property 500 500
Fixtures 100 50
Capital-surplus 100 350 __ __
500 500 500 500

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 518

Capital A/C
Jembe Panga Jembe Panga
Bal b/d 7,100 5,650
Bal c/d 7,200 6,000 Revaluation 100 350
7,200 6,000 7,200 6,000

Net profit for the year

Change in capital = profit

Capital bal as at 31/3/05 14,350

Less: opening capital 13,200
Change in capital 1,150
Add: Drawings 3,000
Profit for the year 4,150

Profit share Jembe 2,490

1,660

Jembe Panga Total

Capital employed 7,200 6,000 13,200
Bal b/d 2,490 1,660 4,150
Add: share of profit 750 500 1,250
Add: revaluation (2,390) (610) (3,000)
Less: drawings 8,050 7,550 15,600

Debentures issued 3,220 3,020 6,240

Shares 3,900 2,600 6,500

Shares to be issued:
Jembe Panga
Sh. ‗000‘ Sh. ‗000‘
Total per value
130,000 x 50 = Sh. 6,500,000
Based on PSR 3:2 3,900,000 2,600,000
(12 Marks)

(b) Partners capital account as at 31 March 2005

Capital account
J P J P
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Drawings 2,390 610 Balance b/d 7,200 6,000
Bond 3,220 3,020 Profit 2,490 1,660
Share capital 3,900 2,600 Revaluation
Bank 930 1,930 Gain 750 500
10,440 8,160 10,440 8,160
(3 marks)

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FINANCIAL ACCOUNTING III
 519 Revision Aid

(c)
Shamba Ltd
Statement of financial position as at 31 March 2005
Non current assets Sh. ‗000‘ Sh. ‗000‘
Freehold property 6,000
Plant and equipment 13,000
Fixtures and fittings 3,000
22,0000
Current assets
Inventory 3,350
Accounts receivable 5,670
Bank 125 9,145
Total assets 31,145

Share capital 6,500

Non current liabilities

15% Bond 6,240

Current liabilities
Accounts payable 9,920
Bank overdraft 8,485 18,405
31,145
(5 Marks)
(Total: 20 marks)

WORKINGS

(ii) Bank overdraft

Sh. ‗000‘
Balance as at 31 May 2005 (5,625)
Less: Jembe 930
Panga 1,930
8,485

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 520

QUESTION TWO
Lusiola Group
Consolidated Statement of financial position as at 31 March 2004
Sh. ‗000‘ Sh. ‗000‘
Non current assets:
Property 45,840
Goodwill (4,800 – 800) 800
Investments 8,800

Current assets:
Inventory (13,500 + 600 – 100) 14,000
Receivables (7,200 + 1,500 – 2,000) 6,700
Cash and Bank 300 21,000
76,440
Equity & Liabilities:
Equity shares(ord. shares) 10,000
Accumulations profits 34,510
Minority interest 1,130
Dividends 1,000
46,640
Non-current liabilities:
12% debentures 10,000

Current liabilities:
Payables (6,700 + 5,200 – 1,460) 10,500
Overdraft 4,500
Tax 4,800
19,800
76,440
(Total: 20 marks)

WORKINGS:

(1) Property Plant & Equipment

Sh. ‗000‘
Lusialo 26,400
Kacheliba 16,200
Revaluation 5,400
Depreciation additional (2 years) (2,160)
45,840

Investments
Lusialo 1,000
Kacheliba 6,000
Revaluation 90% (8,000 – 6,000) 1,800
8,800

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FINANCIAL ACCOUNTING III
 521 Revision Aid

(2) Inventory
Total 9,500 + 4,000 13,500
100
Add: Goods in transit (600 x ) 500
120
14,000

(3)
Cost of control
Sh. ‗000‘ Sh. ‗000‘
Cost 30,000 Shares 90% 4,500
Profit 13,500
Revaluation 7,200
Pre-acq div. 3,600
_____ Goodwill 1,200
30,000 P 30,000

(4) MI
Ordinary shares = 5,000 x 10% = 500
Retained earnings = 6,300 x 10% = 630
1,130

(5)
P & L (W)
Shs. Shs.
K-Post-Acq. Loss 8,700 x 90% 7,830 Lusialo bal b/d 48,600
UPCS 100
Dep. Adj 2,160
Pre-Acq. Div 3,600
Goodwill w/o 1,466 _____
48,600 48,600

QUESTION THREE
(a)
JAMILA TRADERS
Income Statements
For the year ended 30 September 2004
NANYUKI THIKA COMBINED
Shs. Shs. Shs.
Sales 13,000,000 9,202,200 22,202,200
Goods sent to branch
(Less: lost in transit) 6,387,330 - -
19,387,330 9,202,200 22,202,200
Less: Cost of sales
Opening stock 2,595,000 1,552,500 3,945,000
Purchases/Goods received 13,626,600 6,387,330 13,626,600
16,221,600 7,939,830 17,571,600
Less: Cost of goods lost 82,500 - 82,500
Closing stock 834,900 2,932.5 837,450
Cost of sales 15,304,200 7,936,897.5 16,651,650

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 522

Gross profit 4,083,130 1,265,302.5 5,550,550

Add: Realised profit 202,117.5 - -

Less: Expenses
Goods lost (not claimed) 12,375 12,375
Rent and rates 395,400 197,250 592,650
Salaries and wages 851,700 487,500 1,339,200
General expenses 1,887,750 1,258,950 3,146,700
Depreciation 77,950 23,050 101,000
Staff bonus (1,060,072.5 x 10 ) 96,370 - 96,370
100
Net profit 963,702.5 (701,447.5) 262,255
(701,447.5) 701,447.5
Net profit c/d 262,255
(12 marks)

(b)
JAMILA TRADERS
Statement of financial position
As at 30 September 2004
ASSETS COMBINED

Non Current Assets Shs.

Buildings 3,500,000
Furniture & fittings 909,000
Branch current account -
Less: prov for unrealized profit -
4,409,000
Current Assets
Stock 837,450
Accounts receivable 1,300,500
Insurance claim receivable 70,125
Cash in Transit 71,250
Cash at Bank 687,050
2,966,375
Less: Current Liabilities
Accounts payable 1,509,200
Bank overdraft 250,000
Bonus payable 96,370
1,855,570

Net Current Assets 1,110,805

5,519,805
Financed by:
Capital 6,040,925
Net profit 262,255
6,303,180
Less: Drawings 783,375
5,519,805

(8 Marks)

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FINANCIAL ACCOUNTING III
 523 Revision Aid

(Total: 20 Marks)

Provision for Unrealised Profits

Shs. Shs.
P & L (Realised) 202,117.5 Balance b/d 202,500
Balance c/d 382.5 _____
202,500.0 202,500
Balance b/d 382.5

Branch Current Account

Shs. Shs.
Balance b/d 8,931,555 Remittances 7,548,750.0
Stock lost 94,875.0
Cash in transit 71,250.0
Branch loss 701,447.5
_______ Balance c/d 515,232.5
8,931,555 8,931,555.0
Balance b/d 515,232.5

Head Office Current Account

Shs. Shs.
Remittances 7,620,000.0 Balance b/d 8,836,680.0
Branch loss 701,447.5
Bal c/d 515,232.5 ________
8,836,680.0 8,836,680.0
Balance b/d 515,232.5

SELECTED WORKINGS

1. Depreciation
Head office: 779,500 x 10% = 77,950
Branch: 230,500 x 10% = 23,050

2. Insurance claim
100
Cost of Goods = 94,875 x = 82,500
115
3. Loss: 15% x 82,500 = 12,375

4. Cost of Closing Stock::

Head office
Opening stock at cost 2,595,000
Purchases 13,626,600
Goods available for sale 16,221,600

Less: Goods to Branch:

100
(6,482,205 x ) (5,636,700)
115

Sales (13,000,000 x ¾) (9,750,000)

Closing stock at cost. 834,900

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 524

Branch:
Opening Stock 1,552,500
Goods received 6,387,330
7,939,830

Less: Cost of sales

 115 
 9,202,200x 3 4 x  (7,936,897.5)
 100 
Closing stock at mark up 2,932.5

(5) Combined stock:: Shs.

Head office 834,900
 100 
Branch:  2,932.5x  2,550
 115 
837,450

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FINANCIAL ACCOUNTING III
525 Revision Aid

QUESTION FOUR
Medsan Traders
Statement of affairs as at 31/12/04
Jani estate Hamed Hassan Jani estate Hamed Hassan
Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Unsecured creditors 17,900 400 1,900 Plant & machinery 1,500 - -
Fully secured creditors 6,000 5,000 - Furniture & fixtures 800 1,200 1,500
Less value of security 12,000 10,000 - Inventory 6,500 - -
Surplus to below/contra 6,000 5,000 - Accounts receivable 10,000 - -
Partly secured creditors 7,000 7,000 - Investments - - 1,900
Less value of security (6,000) (2,400) - Surplus from fully secured - 5,000 -
creditors
Deficiency ranking as 1,000 4,600 - Available to preferred unsecured 18,800 6,200 3,400
unsecured credit
Preferential creditors 1,100 300 500 Less: preferential creditors (1,100) (300) (1,800)
deducted as per contra deducted per contra
Surplus to partnership 300 900 Available to unsecured creditors. 17,700 5,900 2,900
Surplus as per surplus a/c 600 100 Surplus from partners – H 300
- Hasan 900
18,900 5,900 2,900 18,900 5,900 2,900

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 526

Deficiency/Surplus
Medsan Hamed Hassan Medsan Hamed Hassan
Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Estimated excess of assets over liabilities 3,000 5,050 3,650 Unrecorded liability-loss on
guarantee of overdraft - 7,000 -
Estimated gain on realization - prop 1,000 3,000 - Estimated loss on realization
- investments - 900 - - Plant & machine 1,500 - -
Surplus from partners – Hamed 300 - - - Furniture & fittings 200 300 300
- Hassan 900 - - - Inventory 1,500 - -
- Receivables (12-10) 2,000 - -
- Other investments - - 100
Loss of partnership capital - 750 2,250
Surplus and partnership - 300 900
Surplus as per SOA - 600 100
5,200 8,950 3,650 5,200 8,950 3,650

Workings:

1. Unsecured creditors Medsan Hamed Hassan

Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Accounts payable 19,000 700 2,400
Less: preferential creditors (1,100) (300) (500)
17,900 400 1,900
2. Fully secured creditors Medsan Hamed Hassan
Mortgage on freehold property 6,000 5,000 -
Less: value of security (12,000) (10,000) -
6,000 5,000 -
To partly secured To assets estimated
Creditors To realize
3. Partly secured creditors Medsan Hamed Hassan
Bank overdraft 7,000 7,000 -
Less value of security (6,000) (2,400) -
Deficiency ranking as unsecured 1,000 4,600 -

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FINANCIAL ACCOUNTING III
Lesson Two 527

4. A/C receivables
Good debtors = 9M
Bad debtors = 1M
10M

Total = 12M – 10M = 2M (doubtful) x 50 (expected to be paid)

100
= 1M
Total debtors expected = 9M + 1M = 10M

5.
Joint Hamed Hassan (Double proof)
Def (1,200) Surp 900 Surp 1,000
300 PSR (300) (900)
900 600 100
-

Excess of assets over liabilities

Partnership Hamed Hassan
Assets Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Freehold property 11,000 7,000 -
Plant and machinery 3,000 - -
Furniture and fixtures 1,000 1,500 1,800
Inventory 8,000 - -
Account receivables 12,000 - -
Investments – in partnership - 150 2,250
- Private - 1,500 2,000
35,000 10,750 6,050
LIABILITIES
Mortgage on property (6,000) (5,000) -
Bank overdraft (7,000) - -
Accounts payables (19,000) (700) (2,400)
CAPITAL 3,000 5,050 3,650

NOTE:
The excess of assets over liabilities in the partnership of Shs. 3 represents the combined capital of Hamed
and Hassan. The example does not give the breakdown of how much has been contributed by each
partner and thus we will assume that the capital has been contributed in their profit sharing ratio.

 Hamed = ¼ x 3,000 = 750

Hassan = ¾ x 3,000 = 2,250

QUESTION FIVE
(a) (i) Life tenant: the person, normally the wife, who will receive the benefits of the trust fund
until her death. (2 Marks)

(ii) A gift that does not come from a designated source is known as a general legacy. It
may also be said to be a testamentary gift, whether specific or general of property
described in general terms to be provided out of the general estate of the testator.
(2 Marks)

(iii) A conveyance of gift that is to be derived from a specified source is known as a

demonstrative legacy. It may also be said to be a testamentary gift which is in its
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STRATHMORE UNIVERSITY● STUDY PACK
 Lesson Nine 528

nature general but which manifests an intention that the gift shall be primarily satisfied
out of a specific part of the property of the testator, or upon failure of that fund or
property, be met from the general estate. (2 marks)

Estate of Apollo Matalanza

Charge and Discharge Statement
January 23, 2004 – June 25, 2004
Kamau Otieno, Executor

AS TO PRINCIPAL
Shs. Shs. Shs.
I CHARGE MYSELF WITH:
Assets per original inventory 512,000
Gain on sale of antiques 2,000
Total charges 514,000

I CREDIT MYSELF WITH

Debts of decedent:
Medical expenses 11,000
Other debts 5,000 16,000
Funeral and admin expenses 26,000

Legacies distributed:
Joan Matalanza
(house and personal effects) 310,000
Yacobo Matalanza
(Cash) 9,000 319,000
Total credits (361,000)
Estate principal 153,000

ESTATE PRINCIPAL
Cash (see working below) 23,000
Investments:
Stocks 21,000
Bonds 44,000
Land 65,000
Estate principal 153,000

CASH BALANCE
Beginning balance 46,000
Sale of antique 21,000
Collection of receivables
(dividends 1,000 interest 2,000 and rent 4,000) 7,000
(Funeral expenses 17,000, executor charges
9,000 medical expenses 11,000 and debts 5,000) (42,000)
Legacy distribution (Yacobo Matalanza) (9,000)
Cash balance 23,000

AS TO INCOME

I CHARGE MYSELF WITH:

Shs.
Dividend income
(2,000 collection less 1,000 receivable at death) 1,000
Interest income (3,000 less 2,000) 1,000
Rent income (7,000 less 4,000) 3,000
Balance as to income 5,000

Balance as to income:
Cash 5,000

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FINANCIAL ACCOUNTING III
529 Revision Aid

DECEMBER 2005
QUESTION ONE
Soma Ltd
Income Statement for the year ended 31 October 2005
Sh. ‗000‘ Sh. ‗000‘
Revenue
Cost of Sales 1,574,500
Gross Profit (886,478)
(688,022)
Expenses
Distribution costs 127,062
Administration expenses 246,086
Finance costs 92,460 (465,608)
Profit before tax 222,414
Income tax expense (85,000 – 2,500) (82,500)
Profit for the year 139,914

Soma Ltd
Statement of changes in equity (extract)
Retained
Profits
Sh. ‗000‘
Balance as at 1.1.2004 119,046
Correction of error (additional depreciation) (27,000)
Balance as restated 92,046
Profit for the period 139,014
Purposed dividend (21,000)
Balance as at 31.10.2005 210,960

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 530

Soma Ltd
Statement of financial position as at 31 October 2005
Non current assets Sh. ‗000‘ Sh. ‗000‘
Property, plant and equipment 715,750
Intangible assets 96,000
811,750
Current assets
Inventory 111,100
Accounts receivables 159,714
Cash 100 270,914
Total assets 1,082,664

Ordinary share capital 60,000

Retained profits 210,960
Shareholders funds 270,960

Non current liabilities

12½ Debentures 200,000
Bank loan 240,000 440,000

Current liabilities
Bank loans (including overdraft) 80,754
Accounts payable 139,950
Current tax 130,000
Proposed dividends 21,000 371,704
Total equity and liabilities 1,082,664

Notes to the Accounts

NOTE 1: ACCOUNTING POLICIES

(i) Financial statements have been prepared under the historical cost basis of accounting in
accordance with the applicable international financial reporting standards.
(ii) Property, Plant and equipment is stated as cost less the accumulated depreciation. Depreciation is
provided at the following rates:

Asset Rate
Land Nil
Buildings 2% on cost
Plant and equipment 15% on cost
Office equipment 10% on reducing balance

(iii) Inventory is stated in the accounts at the lower of cost and net realizable value.

NOTE 2: PROFIT FOR THE PERIOD

The profit for the period is arrived at after charging the following expenses;

Sh. ‗000‘
Depreciation 56,972
Amortisation 24,000
Director remuneration 714
Employee benefits 238,006

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FINANCIAL ACCOUNTING III
531 Revision Aid

NOTE 3: PROPERTY PLANT AND EQUIPMENT

Cost/valuation Land Buildings Plant Office Total

Equipment
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Balance at 1.11.2004 350,000 150,000 200,000 107,722 807,722
Additions - - 100,000 - 100,000
Balance at 31.10.2005 350,000 150,000 300,000 107,722 907,722

Depreciation
Balance as at 1.11.2004 - - 90,000 18,000 108,000
Provisions for previous years - 27,000 - - 27,000
Charge for the year - 3,000 45,000 8,972 56,972
Balance as at 31.10.2005 - 30,000 135,000 26,972 191,972

Net book value:

As at 31.10.2005 350,000 120,000 165,000 80,750 715,750

As at 31.10.2004 350,000 150,000 110,000 89,722 699,722

Workings:

(i) Cost of sales (ii) Distribution costs

Shs. ‗000‘ Shs. ‗000‘
Per trial balance 670,396 Per trial balance 86,560
Depr: Property 3,000 Increase in provision for debts 7,786
Plant 45,000 Warehouse 32,716
Amortisation 24,000 127,062
Office equipment 8,972
Write down of inventory 9,600
Factory wages 125,510 (iii) Administration expenses
886,478 Shs. ‗000‘
Per trial balance 165,592
(ii) Office salaries 79,780
Finance Costs Sh. ‗000‘ Directors‘ remuneration 714
Per trial balance 79,960 246,086
Debenture interest 12,500
92,460
(v) Income tax expense
(v) Sh. ‗000‘
Current tax in B/S Sh. ‗000‘ Current year estimate 85,000
Previous years (as agreed) 45,000 Previous year‘s over provision (2,500)
Current year‘s estimate 85,000 82,500
130,000

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STRATHMORE UNIVERSITY● STUDYPACK
 Lesson Nine 532

QUESTION TWO
Hipa Group

Cash Flow Statement for the year ended 30.9.2005

Cash flows from operating activities Sh. million Sh. million

Profit before tax 870

Adjustments
Amortisation of other intangibles 130
Goodwill (200 – 180) 20
Depreciation of property, plant and equipment 320
Finance costs 30
Loss on sale of plant 50
1,420

Changes in working capital

Increase in inventory (1420 – 940) (480)
Increase in receivables (990 – 780) (310)
Increase in accounts payable (875 – 730) 145
Cash generated from operations 775
Interest paid (30 – (15 + 5)) (20)
Income tax paid (130)
Net cash from operating activities 625

Cash flows from investing activities

Purchase of property, plant and equipment (250)
Additional intangible assets (500)
Proceeds on sale of plant 20
Dividends from associates (80 + 20 – 95) 5
Net cash used in investing activities (725)

Cash flows from financing activities Shm Shm

Proceeds from issue of shares at a provision 450
Issue of loan notes (300 – 100) 200
Repayment of loan (40)
Dividends: Holding Co. 2004 Final + 2005 interim) (320)
Minority Interest (100 + 40 – 135) (5)
Net cash received from financing activities 285
Net increase in cash and cash equivalent 185
Cash and cash equivalent b/f (115)
Cash and cash equivalent c/f

Cash and cash equivalent 70

B/f C/f
Shm Shm
Cash - 70
Bank overdraft (115) -
(115) 70

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FINANCIAL ACCOUNTING III
533 Revision Aid

Workings:

(i) Amortisation of intangibles (ii) Property, plant and equipment

Shm Shm
Bal B/f 100 Bal b/f 1,830
Addition 500 Revaluation surplus 200
Bal. c/d (470) Plant bought 250
Amortisation 130 Depreciation (320)
Bal c/d (1,890)
(ii) Diffence (NBV of disposal) 70
Tax paid Shm Disposal: NBV 70
Loss (50)
B/f: Current tax 160 Cash received 20
Deferred tax 140
Change to P & L 270 (iv)
Bal. c/f current tax (130) Share capital Shm
Deferred tax (310) Bal b/d (500)
Cash paid (130) Bonus issue (50)
Bal. c/d 750
Cash received 200
Plus share premium (350 – 100) 250
450

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 534

QUESTION THREE
(a) Kampala Branch Translated Trial Balance

Ush ‗000‘ Ush. ‗000‘ Rate Ksh. ‗000‘ Kshs. ‗000‘

Cash at bank 130,000 13 10,000
Accounts receivable 260,000 13 20,000
Inventory – 30 June 2005 7,160
Accounts payable 65,000 13 5,000
Head office – current 96,000 - 50,000
Sales 1,600,000 10 160,000
Cost of goods sold 930,000 10 93,000
Operating expenses 360,000 10 36,000
Exchange loss - _______ 48,840 _____
1,761,000 1,761,000 215,000 215,000

Workings

Value of closing stock Ush. ‗000‘ Rate Kshs. ‗000‘

Received from Head Office 24,600 10 Ush/Ksh. 2,460
Purchase locally 56,400 12 Ush/Ksh. 4,700
81,000 7,160
Head office current a/c
Balance per head office records 15,000
Add debtors received by branch 35,000
50,000

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FINANCIAL ACCOUNTING III
 535 Revision Aid

Unrealised profit
Goods from head office 2,460
2,460
Cost = (1,968)
1.25
UPCS 492

Beta (EA) Ltd

Trading, profit and loss account

For the year ended 30 November 2005
Head office Branch Combined
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Sales 390,000 160,000 550,000
Goods sent to branch 30,000 - -
420,000 160,000 550,000
Cost of sales 280,000 93,000 373,000
Less: goods from H/O (30,000)
_____ ____ 343,000
Gross profit 140,000 67,000 207,000

Unrealised profit (492) - (492)

139,508 67,000 206,508

Expenses
Exchange loss - 48,840 48,840
Operating expenses 67,000 39,000 106,000

Depreciation
Plant and equipment 10,000 5,000 15,000
Motor vehicles 10,000 - 10,000
Net profit 52,508 (25,840) (26,668)

Beta (EA) Ltd

Statement of financial position as at 30 November 2005
Equipment 135,000
Motor vehicles 40,000
175,000
Current assets
Inventories 46,668
Accounts receivable 30,000
Bank 16,000
267,668
Equity and liabilities
Share capital 192,000
Profit and loss 26,668

Current liabilities
Accounts payable 49,000
267,668

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 536

QUESTION FOUR
Business Purchase Account
KUNI MOTO KUNI MOTO
LTD LTD LTD LTD
Shs. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Bank overdraft 44,750 Land & Buildings 93,250 -
Creditors 77,000 13,000 Furniture 2,500 -
Loan 3,600 2,400 Cash 250 -
Purchase consideration 142,650 114,550 Debtors 32,000 54,000
Stock 115,000 56,250
_____ _____ Goodwill 25,000 20,000
268,000 130,250 268,000 130,250

Partners Capital Accounts

KUNI MOTO KUNI MOTO
LTD LTD LTD LTD
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
Shares in Kuni Ltd 118,750 23,900 Balance b/d 131,500 81,00
Shares in Moto Ltd 35,250 79,600 Goodwill 22,500 22,500
154,000 103,500 154,000 103,500

Vendors Account
Sh. ‗000‘ Shs. ‗000‘
Ord. Shares in Kuni Ltd. 142,650 Business Purchases A/C
Ord. Shares in Moto Ltd. 114,850 Kuni Ltd. 142,650
_____ Moto Ltd. 114,850
257,500 257,500

Bank Account
KUNI MOTO KUNI MOTO
LTD LTD LTD LTD
Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘ Sh. ‗000‘
12% Debentures 50,000 Balance b/d 44,750
Issue of shares B Ltd & C Ltd 5,000 7,500 Debenture expense 1,750
(Share application) Preliminary exp 3,250 2,000
_____ ____ Balance c/d _5,250 5,500
55,000 7,500 55,000 7,500

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FINANCIAL ACCOUNTING III
 537 Revision Aid

OPENING STATEMENT OF FINANCIAL POSITION

Kuni Ltd. Moto Ltd.
ASSETS Shs. Shs. Shs. Shs.
Non current assets
Land and buildings 93,250
Furniture 2,500
95,750
Intangible assets
Goodwill 25,000 20,000
Establishment costs 3,250 2,000
Debenture expenses 1,750 -
30,000 22,000
Current assets
Cash 250 -
Bank 5,250 5,500
Debtors 32,000 54,000
Stock 115,000 56,250
152,500 115,750

Less: Current liabilities

Creditors 77,000 75,500 13,000 102,750
201,250 124,750
Financed by:
Share capital
Ordinary shares of Shs. 10 each 147,650 122,350

Long term liabilities

12% Debentures 50,000
10% Debentures 3,600 2,400
201,250 124,750

QUESTION FIVE
(a) (i) Defined contribution plans – are post-employment benefits plans under which an
enterprise pays fixed contribution into a separate entity (a fund) and will have no legal or
constructive obligation to pay further contributions if the fund does not hold sufficient
assets to pay all employees benefits relating to employee services in the current and prior
periods.

(ii) Terminal benefits should be recognized as a liability and an expense when and only when the
enterprise is demonstrably committed to either:

(1) Terminate the employment of an employee or group of employees before the

normal retirement date; or
(2) Provide terminal benefits as a result of an offer made in order to encourage
voluntary redundancy.

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 538

(b) (i)
Treasure Motors Retirement Benefits Scheme
Statement of change in net assets for the year ended 30 th June 2005
Kshs. Kshs.
Members contributions 250,200
Employers contributions 630,600
Total contributions 880,800
Pensions and commutations (209,000)
Withdrawals from scheme (15,000)
Net additions by members 656,800

Return on investments:
Interest on investments 640,000 640,000

Other expenses:
Management expenses (7,000)
Net change in net assets 1,289,800
Opening accumulated fund as at (July 2004) 7,640,000
Net assets at 30 June 2005 8,929,800

Treasure Motors Retirement Benefits Scheme

Statement of change in Net Assets for the year ended 30 th June 2005

Assets Kshs.

Premises 800,000
Quoted shares 3,000,000
Unquoted shares 2,500,000
Government securities 590,000
Off-shares investments 1,040,000
Fixed deposits 260,000
Current deposits 32,200
Receivables from employers 635,600
Income receivable 80,000
Payable to members (8,000)
Net assets as at 30 June 2005 8,929,800

Funded by: -
Opening Account fund 7,640,000
Change in net assets 1,289,800
8,929,800

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FINANCIAL ACCOUNTING III
 539 Revision Aid

MOCK EXAMINATION
CPA PART II
FINANCIAL ACCOUNTING III

To be carried out under examination conditions and sent to the Distance Learning Administrator for
marking by the University.
Answer All Questions Time Allowed: 3Three Hours.

Answer all questions. Marks allocated to questions are shown at the end of questions

QUESTION ONE
Ademo Limited is a company quoted on the Nairobi Stock Exchange. It distributes a wide variety of
household machinery including sewing machines. On 1 October 1997 it purchased shares in Afro clothing
Limited. The group purchased shares in Piki Limited, a nation wide chain of retail shops dealing in casual
wear on 1 April 1998. All the companies make up their accounts to 31 March each year.

The draft final accounts for the three companies for the year ended 31 March 2000 are as follows:

Income statement for the year ended 31 March 2000.

Ademo Ltd Afro Ltd Piki Ltd
Sh.m Sh.m Sh.m
Revenue 1,368 774 685
Cost of sales (810) (407) (355)
Gross profit 558 367 330
Distribution costs (196) (64) (78)
Administration expenses (112) (73) (72)
Finance cost (50) (20) 0
Profit before tax 200 210 180
Income tax expense (60) (60) (50)
Profit after tax 140 150 130
Proposed dividends (150) (100) (100)
Retained profits for the year (10) 50 30
Retained profits brought forward 713 610 420
Retained profit carried forward 703 660 450

Statement of financial position as at 31 March Ademo Ltd Afro Ltd Piki Ltd
2000
Non current assets Sh.m Sh.m Sh.m
Property, plant and equipment 853 415 495
Investment in Afro 602
Investment in Piki 405
1455 820 495
Current assets
Inventory 368 200 190
Trade receivables 380 230 240
Cash at bank 120 115 91
Total assets 2,323 1,365 1,016

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 540

Ordinary share capital 800 200 100

Retained profits 703 660 450
Shareholders funds 1,503 860 550

Non current liabilities

10% loan stock 500 200 0

Current liabilities
Trade payables 140 175 346
Current tax 30 30 20
Proposed Dividends 150 100 100
Total equity and liabilities 2,323 1,365 1,016

The following additional information is available:

(i) On 1 October 1997 Ademo Ltd acquired 16 million sh.10 ordinary shares in Afro Clothing Ltd.
For sh. 602 million when the retained profits of Afro Ltd was sh. 490 million.
(ii) On 1 April 1998 Afro Ltd acquired 7.5 million sh.10 ordinary shares in Piki Ltd for sh.405
million when the retained profits of Piki Ltd amounted to sh. 300 million. On this date the a
leasehold property had a fair value of sh.40 million in excess of the book value and 10 years
remaining on the lease. Depreciation charge on the book value of the lease is included as part of
administration expenses.
(iii) In the year ended 31 March 2000 Piki Ltd sold goods at a price of Sh.80 million. Piki Ltd had
marked up these goods by 100% on cost. Afro Ltd held 50% of these goods in stock on 31
March 2000.
(iv) In the year ended 31 March 2000 Afro ltd sold Ademo Ltd goods at a price of sh.90 million.
Afro ltd had marked up these goods by 80% on cost. Ademo Ltd held 25% of these goods in
stock on 31 March 2000.
(v) On 1 April 1999 Ademo Ltd sold sewing machines to Afro Ltd for sh.150 million. Afro Ltd
included these machines in its PPE and charges depreciation of 20% on cost. Ademo Ltd had
marked up these items at 50% on cost. Afro ltd includes the depreciation of these machines in its
cost of sales.
(vi) On 31 March 200 all the inter company balances are in agreement with Afro Ltd owing Piki Ltd
sh. 24 million and Ademo Ltd owing Afro Ltd sh.18 million.
(vii) The group does not amortise goodwill arising on consolidation. However in the current year the
management feels that half of these goodwill has been impaired. This impairment loss is to be
charged as a separate item in the income statement.

Required
The consolidated income statement for the year ended 31 March 2000 and a consolidated statement of
financial position as at the same date. (25 marks)

QUESTION TWO
Hapa and Kule Ltd operate a head office in Nairobi and a branch in Eldoret. Goods sent to the branch are
marked up by 10% on cost. All goods sold by the branch are supplied from Head Office.

The trial balances extracted from the head –office and branch books as at 30th September 19 1, rounded to
the nearest Shs.1,000 were as follows:

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FINANCIAL ACCOUNTING III
541 Revision Aid

Nairobi Eldoret
Dr Cr Dr Cr
Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘ Shs. ‗000‘
Share Capital: Authorised, Issued and Fully Paid
Ordinary shares of Shs.10 each 5,000 - -
Share Premium account 1,250 - -
Profit and Loss account 6,194 - -
Debtors / Creditors 2,016 2,903 1,588 72
Head Office Current Account - - - 4,432
Land and buildings: cost/accumulated 4,750 475 2,150 268
Depreciation as at 1 Oct 19 0
Plant and Machinery: cost/accumulated 3,870 1,540 - -
Depreciation as at 1 Oct 19 0
Motor Vehicles: cost/accumulated 1,380 552 760 304
Depreciation as at 1 Oct 19 0 1,397
Stock at 1 Oct 19 0: cost/mark-up 2,988 47
Bank 678 19,050
Sales 23,935
Purchases/Goods from Head Office 34,834 17,061
Administration Expenses 2,672 726
Selling and Distribution Expenses 1,321 491
Provision for unrealised profit on stock 127
Branch Current Account 4,671
Goods sent to branch 17,204
_____ _____ _____ _____
59,180 59,180 24,173 24,173

The following information is relevant to the preparation of the Head Office, Branch and whole business Trading and Profit and Loss Accounts for the
year ended 30 September 19 1:

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 542

Stocks at 30 September 19 1 were as follows:

At Head Office, at cost Shs.3,034,000
At Branch, at marked up price Shs.1,694,000
In transit, at marked up price Shs. 143,000

There was cash in transit from the branch to the head office at 30 September 19 1 of Shs.96,000.

Depreciation is to be charged at the following rates:

Land and Buildings : 2% of cost
Plant and Machinery : 10% of cost
Motor Vehicle : 20% of written down value such charge being rounded down to the nearest
Shs.1,000).

Head Office administration expenses included:

Audit fees : Shs. 45,000
Director‘s fees 4 non-executive directors) : Shs.144,000
Directors‘ salaries : Shs.400,000
Head Office selling and distribution expenses included:
Sales Director‘s salary : Shs.180,000

Corporation tax for the year ended 30 th September 19 1 is to be provided in the amount of Shs.1,355,000.
A final dividend of 21% on the paid-up share capital has been proposed by the directors.

Required:
Prepare a columnar Trading and Profit Loss Account for internal use for the year ended 30th September
1991, which will show separately the results of the Head Office, the branch and the whole business.
(10 marks)
Prepare the Income statement for the year ended 30th September 19 1, and the statement of financial
position as at
30th September 19 1 in accordance with the Companies Act and IFRS (where applicable)
(10 marks)
(Total: 20 marks)

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FINANCIAL ACCOUNTING III
 543 Revision Aid

QUESTION THREE
X, Y, Z and M are in partnership sharing profits in the ratio 3:2:1:4 respectively. It is decided to dissolve
this small size partnership on 1 January 1994 on which date the statement of financial position was as
below:
Sh. Sh.
Non current assets:
Land and buildings 42,500
Plant and machinery 39,605
Goodwill 15,000
Investments 19,00^
107,105
Current Assets:
Stock 31,740
Debtors 19,205
Cash at bank 1,565
52,510
Less creditors 34.61517 895
125,000
Capital Accounts:
X 35,000
Y 20,000
Z 15,000
M 20,000
Leasehold redemption fund 10,000
General reserve 25,000
125,000
The assets are realised piecemeal as below:
Sh.
January 11 Stock (Part) 17,500
15 Debtors (Part) 14,660
29 Investments 12,100
February 4 Goodwill 10,000
22 Land and buildings 35,000
22 Debtors (Part) 2,500
22 Stock (balance) 13,750
March 16 Plant and machinery 32,800
16 Debtors (balance) 1,755
Subject to providing Sh.2,500 to meet the probable expenses of realisation, the partners decide that after
the creditors have been paid, all cash received shall be divided between them immediately.

The expenses of realisation, which are paid on 16 March amounts to Sh.2,000.

Required:
(a) Prepare a statement showing how the distributions should be made. (10
marks)
(b) Prepare a realisation Profit an Loss Account, Cash Account and the Partners Capital Accounts.
(10 marks)

QUESTION FOUR
Ted Safari has had a bankruptcy petition filed against him in the High Court. A receiving order was made on 31
October 1995. He has not kept accounts for 10 months to 31 October 1995. His financial position as at 31
December 1993 (the Official Receiver has accepted that the Deficiency Account cover the period from this date)
was as follows:-

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STRATHMORE UNIVERSITY● STUDYPACK
Lesson Nine 544

Business Statement of financial position Net Personal Assets

As at 31 Decmber 1994 As at 31 December 1994

Fixed assets
(Net Book Value) Sh.‗000‘ Sh. ‗000‘ Assets at cost: Sh.‗000‘
Plant and Machinery 4,000
House 4,000
Motor vehicles 5,000 Furniture and contents 300
9,000 Motor car 700
5,000
Current Assets:
Stock 3,000 Mortgage on house 3,000
Debtors 7,000 Car loan (secured on car) 500
10,000 3,500
Value of net estate 1,500
Current Liabilities
Bank overdraft 3,000
(secured on plant)
Creditors 5,000
8,000 2,000
11,000
Capital 7,500
Finance lease on vehicles 3,500
11,000

You establish the following facts.

Between 1 January 1995 and 31 October 1995, he had made 10 monthly payments of Sh.60, 000 each in
respect of his mortgage: mortgage interests for the period was Sh.500, 000. He had made 3 quarterly
repayments on his car loan Sh.75, 000 each and on the finance lease on his vehicles of Sh.850, 000 each;
interest for the 10 months on the car loan and finance lease were Sh.100,000 and Sh.600,000 respectively.
These payments were made out of his business bank account for the 10-month period to 31 October 1995;
sales (both for cash and on credit) totalled Sh.30 million. He collected and banked directly Sh.28 million
from debtors and sales; he used Sh.1 million collections for drawings. All creditors at 3 December 1994 were
in respect of trade purchases. In the 10 months he had paid Sh 22 million to trade creditors and Sh.5million
in respect of expenses. He had neither purchased nor sold any fixed assets, either for his business or his
personal use. He had obtained a short-term loan from his uncle on 29 October 1995 for Sh.5 million which
he had banked in his business bank account on the same day. Overdraft interest for the period had been
charged in the amount of Sh.750, 000. On 31 October 1995, stock at cost was Sh.2 million. Liabilities of Sh.6
million for purchases and Sh.1 million for expenses (including Sh.300, 000 to his 25 employees for months of
September and October – all earn in excess of Sh.3, 000 per month, and Sh.260, 000 PAYE deductions not
yet paid across to the Income Tax Department) need to be accounted for: The realisable value of assets are:
Plant Sh.1.8 million, Motor vehicles Sh.2.5 million, Stock Sh.1.6 million, Debtors Sh.5.5 million, House Sh.4.2
million, Furniture and contents Sh.0.1 million, Motor Car Sh.0.4 million. He had drawn Sh.500, 000 from his
business bank account in respect of personal expenses.

Required:
Statement of Affairs and a Deficiency Account in accordance with the format contained in the Bankruptcy
Act. Show all your workings.

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FINANCIAL ACCOUNTING III
 545 Revision Aid

QUESTION FIVE
a. State two main ways of constituting a trust.
Give appropriate examples (4 marks)

b. Five years ago Otieno bought a house in the name of his friend Odhiambo in order to conceal the
ownership of the house. Odhiambo is now claiming the house as his own.

Required:
What is the position on ownership of the house? Would the position be the same if Odhiambo was Otieno‘s
son? (6 marks)
c. An aircraft went out of control and crashed on Kimani‘s villa in Tena estate. Kimani and his members of
the family perished in the accident.. The Utopian ambassador being a kind man immediately raised a
fund for the benefit of the dependants of Kimani‘s family.
It now appears that there are no dependants and the ambassador wishes to know how he should
distribute the money he had raised for late Kimani‘s dependants. Explain to the ambassador the
alternatives opened to him. (5 marks)
(Total: 15 marks)

END OF MOCK EXAINATION

NOW SEND YOUR ANSWER S TO THE DISTANCE LEARNING CENTRE FOR MARKING.

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STRATHMORE UNIVERSITY● STUDYPACK