Accounting 621

Year 2 Semester 1
 FACULTY OF BUSINESS AND MANAGEMENT SCIENCES

STUDY GUIDE

MODULE: ACCOUNTING 621

(1ST SEMESTER)

Copyright © 2022
Richfield Graduate Institute of Technology (Pty) Ltd
Registration Number: 2000/000757/07
All rights reserved; no part of this publication may be reproduced in any form or by any means, including
photocopying machines, without the written permission of the Institution
 TABLE OF CONTENTS
Topics Page no
Preface vi
1. Welcome vii
2. Title of Modules vii
3. Purpose of Module vii
4. Learning Outcomes vii
5. Method of Study vii
6. Lectures and Tutorials vii
7. Notices viii
8. Prescribed & Recommended Material viii
9. Assessment & Key Concepts in Assignments and Examinations viii
10.Specimen Assignment Cover Sheet xii
11.Work Readiness Programme xiii
12.Work Integrated Learning xvi
ST
ACCOUNTING 611 (1 SEMESTER)
TOPIC1 : FINANCIAL REPORTING 1
1.1 Types of reports 1
1.2 Qualitative characteristics of financial statements 2
1.3 Underlying assumptions 4
1.4 Elements of financial statements 5
1.5 Recognition of elements of financial statements 7
1.6 Requirements of IFRS 7
1.7 Layout of income statements 7
1.8 Equity and liabilities 13
1.9 Steps to follow when compiling income statements and balance sheets
16
1.10 The effect of inflation on the reporting function 17
REVIEW QUESTIONS
TOPIC 2: STATEMENT OF PROFIT OR LOSS AND OTHER 23
COMPREHENSIVE INCOME (SOPL-OCI) AND RELEVANT NOTES AND STATEMENT OF
CHANGES IN EQUITY OF COMPANIES
2.1 Identification of financial statements 23

2.2 Statement of comprehensive income 23

2.3 Structure and content: Notes to the financial statements (IAS 1 par 33
.112 - .138)

2.4 Structure and content: Notes to the financial statements (IAS 1 par 34
.112 - .138)

2.5 Exercises 35
2.6 Self-assessment 43

TOPIC 3 : STATEMENT OF FINANCIAL POSITION (SOFP) AND RELEVANT NOTES OF 44

COMPANIES
3.1 Framework of statement of financial position and notes 44
3.2 Non-current assets 46
3.3 Current assets 52
3.4 Total equity 52
3.5 Non-current liabilities 54
3.6 Current liabilities 63
3.7 Examples 63
3.8 Self-assessment 85
TOPIC 4: FINANCIAL REPORTING: COMPANIES 86
4.1 The principle of disclosure 86
4.2 Disclosure and annual financial statements 87
4.3 The structure of published annual financial statements 87
4.4 The function of the directors ‘report 87
4.5The function of the auditors’ report 87
4.6 The prospectus 88
4.7 Tax position 88
4.8 Share capital 88
REVIEW QUESTIONS
TOPIC 5 : PROPERTY, PLANT AND EQUIPMENT (IAS 16) 98
5.1 Objective – IAS 16.1 98
5.2 Scope – IAS 16.2–5 98
5.3 Definitions – IAS 16.6 99
5.4 Recognition 100
5.5 Measurement at recognition – IAS 16.15–28 100
5.6 Measurement after recognition – IAS 16.29–66 104
5.6 Worked examples 104
TOPIC 6 : FINANCIAL REPORTING: MANUFACTURING ENTERPRISES 138

6.1 Manufacturing concern 138

6.2 The components of manufacturing costs 138
6.3 The income statement of a manufacturing concern 140
6.4 Unrealized profit in stock 142
REVIEW QUESTIONS 144
TOPIC 7: ADDENDUM 621 (A): REVIEW QUESTIONS 151

TOPIC 8: ADDENDUM 621 (B): TYPICAL TEST QUESTIONS 154

PREFACE 1. WELCOME

Welcome to the Faculty of Business and Management Sciences at Richfield Graduate Institute of
Technology (RGIT). We trust you will find the contents and learning outcomes of this module both
interesting and insightful as you begin your academic journey and eventually your career in the business
world.

This section of the study guide is intended to orientate you to the module before the commencement of formal
lectures.

The following lectures will focus on the common study units described:

WELCOME & ORIENTATION

Study unit 1: Orientation Programme

Lecture 1
Introducing academic staff to the learners by academic head. Introduction of
institution policies.

Study unit 2: Orientation of Learners to Library and Students Facilities

Introducing learners to physical structures Lecture 2

Study unit 3: Distribution and Orientation of Accounting 621 Learner Guides,

Textbooks and Prescribed Materials Lecture 3

Study unit 4: Discussion on the Objectives and Outcomes of Accounting 621

Lecture 4

Study unit 5: Orientation and guidelines to completing Assignments

Lecture 5
Review and Recap of Study units 1-4
2. TITLE OF MODULES, COURSE, CODE, NQF LEVEL, CREDITS & MODE OF DELIVERY

1st Semester

Title of Module: Accounting 621

Code: ACC_621
NQF Level: 6
Credits: 10
Mode of Delivery: Contact/Distance

3. PURPOSE OF MODULE

Accounting 621 (1st Semester)

The purpose of this module is to equip learners with knowledge of accounting and the skills to apply
the acquired knowledge. Learners will be taught the theoretical and conceptual approaches to
accounting as well as the
informational and reporting functions of accounting.

4. LEARNING OUTCOMES

On completion of this module, learners should have a basic / fundamental practical and theoretical
knowledge of:
• General aspects of financial reporting
• Financial reporting in trading organisations and other organisations for gain
• Financial reporting in organisations and societies not for gain
• Financial planning and evaluation

5. METHOD OF STUDY
The sections that have to be studied are indicated under each topic. These form the basis for tests,
assignments and examination. To be able to do the activities and assignments for this module, and to
achieve the learning outcomes and ultimately to be successful in the tests and examination, you will
need an in- depth understanding of the content of these sections in the learning guide and prescribed
book. In order to master the learning material, you must accept responsibility for your own studies.
Learning is not the same as memorizing. You are expected to show that you understand and are able
to apply the information. Use will also be made of lectures, tutorials, case studies and group discussions
to present this module.
6. LECTURES AND TUTORIALS

Learners must refer to the notice boards on their respective campuses for details of the lecture and
tutorial time tables. The lecturer assigned to the module will also inform you of the number of lecture
periods and tutorials allocated to a particular module. Prior preparation is required for each lecture
and tutorial. Learners are encouraged to actively participate in lectures and tutorials in order to ensure
success in tests, assignments and examinations.
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 7. NOTICES

All information pertaining to this module such as tests dates, lecture and tutorial time tables,
assignments, examinations etc. will be displayed on the notice board located on your campus. Learners
must check the notice board on a daily basis. Should you require any clarity, please consult your
lecturer, or programme manager, or administrator on your respective campus.

8. PRESCRIBED & RECOMMENDED MATERIAL

8.1Prescribed Material
Myburgh, JE. (2019). Accounting an Introduction .13 th Ed. South Africa: Lexis Nexis Publishers. ISBN:
9780639003566

8.2 Recommended Material

Scott, D. (2020). About Financial Accounting Volume 1. 8th Ed. South Africa: LexisNexis Publishers.
ISBN:9780639008646

Scott, D. (2020). About Financial Accounting Volume 2. 8th Ed. South Africa: LexisNexis Publishers.
ISBN:9780639008660

8.3 Library Infrastructure

The following services are available to you:

8.3.1 Each campus keeps a limited quantity of the recommended reading titles and a larger variety of
similar titles which you may borrow. Please note that learners are required to purchase the
prescribed materials.

8.3.2 Arrangements have been made with municipal, state and other libraries to stock our
recommended reading and similar titles. You may use these on their premises or borrow them
if available. It is your responsibilities to safe keep all library books.
8.3.3 RGIT has also allocated one library period per week as to assist you with your formal research
under professional supervision.

8.3.4 RGIT has dedicated electronic libraries for use by its learners. The computers laboratories, when
not in use for academic purposes, may also be used for research purposes. Booking is essential
for all electronic library usage.

9 ASSESSMENT

Final Assessment for this module will comprise two Continuous Assessment tests, an assignment and
an examination. Your lecturer will inform you of the dates, times and the venues for each of these. You
may also refer to the notice board on your campus or the Academic Calendar which is displayed in all
lecture rooms.
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9.1 Continuous Assessment Tests
There are two compulsory tests for each module (in each semester).

9.2 Assignment
There is one compulsory assignment for each module in each semester.
Your lecturer will inform you of the Assessment questions at the commencement of this module.

9.3 Examination
There is one two-hour examination for each module. Make sure that you diarize the correct date, time
and venue. The examinations department will notify you of your results once all administrative matters
are cleared and fees
are paid up.

The examination may consist of multiple choice questions, short questions and essay type questions.
This requires you to be thoroughly prepared as all the content matter of lectures, tutorials, all
references to the prescribed text and any other additional documentation/reference materials is
examinable in both your tests and the examinations.

The examination department will make available to you the details of the examination (date, time and
venue) in due course. You must be seated in the examination room 15 minutes before the
commencement of the examination. If you arrive late, you will not be allowed any extra time. Your
learner registration card must be in your possession at all times.

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9.4 Final Assessment
The final assessment for this module will be weighted as follows:
Continuous Assessment Test 1
Continuous Assessment Test 2 40% Assignment 1

Examination 60%
Total 100%

9.5 Key Concepts in Assignments and Examinations

In assignment and examination questions you will notice certain key concepts (i.e. words/verbs) which
tell you what is expected of you. For example, you may be asked in a question to list, describe, illustrate,
demonstrate, compare, construct, relate, criticize, recommend or design particular information /
aspects / factors /situations. To help you to know exactly what these key concepts or verbs mean so
that you will know exactly what is expected of you, we present the following taxonomy by Bloom,
explaining the concepts and stating the level of cognitive thinking that theses refer to.

Competence
Skills Demonstrated
observation and recall of information
knowledge of dates, events, places knowledge
of major ideas mastery of subject matter
Question Cues list, define, tell, describe, identify, show, label, collect, examine,
tabulate, quote, name, who, when, where, etc.

Knowledge

Comprehension understanding information grasp meaning

translate knowledge into new context interpret facts, compare, contrast, order,
group, infer causes predict consequences

Question Cues

summarize, describe, interpret, contrast, predict,

associate, distinguish, estimate, differentiate, discuss, extend

x
 use information
use methods, concepts, theories in new situations solve problems using required
Application skills or knowledge

Questions Cues

apply, demonstrate, calculate, complete, illustrate, show, solve, examine,

modify, relate, change, classify, experiment, discover

seeing patterns organization of

parts recognition of hidden
meanings identification of
components
Question Cues
analyse, separate, order, explain, connect, classify, arrange, divide, compare, select,
explain, infer
Analysis

Synthesis use old ideas to create new ones

generalize from given facts
relate knowledge from several areas
predict, draw conclusions
Question Cues combine, integrate, modify, rearrange, substitute, plan, create,
design, invent, what if?, compose, formulate, prepare, generalize, rewrite

compare and discriminate between ideas assess value of

theories, presentations make choices based on reasoned
argument
verify value of evidence recognize subjectivity
Question Cues assess, decide, rank, grade, test, measure, recommend,
convince, select, judge, explain, discriminate, support, conclude,
Evaluation compare, summarize

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 FACULTY OF BUSINESS AND MANAGEMENT SCIENCES
ASSIGNMENT COVER SHEET
1ST SEMESTER ASSIGNMENT
Name & Surname: ____________________________________________
ICAS No: _________________ Qualification: ______________________ Semester: _____
Module Name: __________________________
Specialization: _____________________ Date Submitted: ___________

QUESTION NUMBER MARK ALLOCATION EXAMINER’S MARK MODERATOR’S

MARK

TOTAL
Examiner’s Comments:

Moderator’s Comments:

Signature of Examiner: Signature of Moderator:

The purpose of an assignment is to ensure that the Student is able to:

• Demonstrate an understanding of accounting principles.
• Systematically record the financial aspects of business transactions.
• Prepare financial statements to know the result of business operations for a particular
period of time.
• To meet the financial information needs of the decision-makers and help them in rational
decision-making.
• Report the results and position of business to “Users” of financial statements.
• Presenting ‘true and fair’ view of financial transactions.
• Show accurate calculations for all transactions.

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NB: All Assignments are compulsory as they form part of continuous assessment that counts towards the
final mark

11 WORK READINESS PROGRAMME (WRP)

In order to prepare learners for the world of work, a series of interventions over and above the formal
curriculum, are concurrently implemented to prepare learners. These include:
• Soft skills
• Employment skills
• Life skills
• End –User Computing (if not included in your curriculum)

The illustration below outlines some of the key concepts for Work Readiness that will be included in your
timetable.

It is in your interest to attend these workshops, complete the Work Readiness Log Book and prepare for the
Working World.

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12 WORK INTEGRATED LEARNING (WIL)

Work Integrated Learning forms a core component of the curriculum for the completion of this
programme. All modules making this qualification will be assessed in an integrated manner towards
the end of the programme or after completion of all other modules. Prerequisites for placement with
employers will include:
• Completion of all tests & assignment
• Success in examination Payment of all arrear fees
• Return of library books, etc.
• Completion of the Work Readiness Programme.

Learners will be fully inducted on the Work Integrated Learning Module, the
Workbooks & assessment requirements before placement with employers.

The partners in Work Readiness Programme (WRP) include:

Good luck and success in your studies…

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 TOPIC1 : FINANCIAL REPORTING
1.1 Types of reports Lecture 6
1.2 Qualitative characteristics of financial statements
1.3 Underlying assumptions
1.4 Elements of financial statements Lecture 7-8
1.5 Recognition of elements of financial statements
1.6 Requirements of IFRS
1.7 Layout of income statements
1.8 Equity and liabilities Lecture 9-10
1.9 Steps to follow when compiling income statements and balance sheets

1.10 The effect of inflation on the reporting function

REVIEW QUESTIONS Lecture 11
TOPIC 2. STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME (SOPL-OCI) AND RELEVANT
NOTES AND STATEMENT OF CHANGES IN EQUITY OF COMPANIES

2.1 Identification of financial statements Lecture 12

2.2 Statement of comprehensive income
2.3 Statement of changes in equity Lecture 13
2.4 Notes Lecture 14
2.5 Exercises

2.6 Self-assessment
TOPIC 3 : STATEMENT OF FINANCIAL POSITION (SOFP) AND RELEVANT
NOTES OF COMPANIES

3.1 Framework of statement of financial position and notes Lecture 15-16

3.2 Non-current assets

3.3 Current assets Lecture 18-19
3.4 Total equity
3.5 Non-current liabilities
3.6 Current liabilities Lecture 20-22
3.7 Examples
3.8 Self-assessment

xv
 TOPIC 4: FINANCIAL REPORTING: COMPANIES
4.1 The principle of disclosure Lecture 23
4.2 Disclosure and annual financial statements
Lecture 24
4.3 The structure of published annual financial statements
4.4 The function of the directors ‘report
4.5The function of the auditors’ report
4.6 The prospectus Lecture 25-26
4.7 Tax position
4.8 Share capital Lecture 27-28
REVIEW QUESTIONS
TOPIC 5 : PROPERTY, PLANT AND EQUIPMENT (IAS 16)
5.1 Objective – IAS 16.1 Lecture 29
5.2 Scope – IAS 16.2–5
5.3 Definitions – IAS 16.6
5.4 Recognition
5.5 Measurement at recognition – IAS 16.15–28
5.6 Measurement after recognition – IAS 16.29–66 Lecture 30-31
5.6 Worked examples
TOPIC 6 : FINANCIAL REPORTING: MANUFACTURING
6.1 Manufacturing concerns Lecture 32
6.2 The components of manufacturing costs Lecture 33-34
6.3 The income statement of a manufacturing Lecture 35-36
6.4 Unrealized profit in stock Lecture 37
REVIEW QUESTIONS Lecture 38
TOPIC 7: ADDENDUM 621 (A): REVIEW QUESTIONS Lecture 39
TOPIC 8: ADDENDUM 621 (B): TYPICAL TEST QUESTIONS Lecture 40

xvi
The following are guide icons that will be used throughout this learner guide:

INTERACTIVE ICONS USED IN LEARNER GUIDES

Writing Activity
Learning Outcomes Study Read

Think Point Research Interactive

Glossary Questions

Review Questions Case Study Questions and Group work

Answers

Web Resource

Multimedia Resource

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 TOPIC 1

FINANCIAL REPORTING

LEARNING OUTCOMES

After studying this topic, you should be able to:

• demonstrate detailed knowledge of the main areas of financial
reporting, including an understanding of and the ability to apply
the International Financial Reporting Standards to unfamiliar but
relevant contexts; and knowledge of Financial Reporting and
how it relates to other fields, disciplines or practices
• demonstrate detail understanding of financial statements

For further theory and worked examples based on this topic, students
must refer to chapter 1 (The
Conceptual Framework) in the prescribed textbook.

Financial reporting is done in the financial statements of the entity. These financial statements are based
on the accounting records of the entity. It is therefore important to know that the accounting records are
materially accurate to the extent that the financial statements based thereon fairly present the financial
position of the entity.

1.1 TYPES OF REPORTS

There are two broad categories of financial reports, namely:

(i) Responsibility Reports
(ii) Information Reports
Responsibility reports are used by both external and internal users.

1
(i) Responsibility Reports
The purpose of responsibility reports is to determine the performance of specific people within their
sphere of responsibility and to communicate this information first to the person concerned and
subsequently to the party to whom he/she is accountable. Responsibility reports can also be external
responsibility reports concerning management’s responsibility towards the owner(s) of the enterprise.

Internal reporting
Internal reporting involves reporting to the person responsible for managing the business and requires
far greater detail than that required by external reporting. The management has to be very well informed
in order to manage the business efficiently and profitably.

External reporting
The annual financial statements of a business enterprise constitute the basis for external responsibility
reports concerning management’s responsibility towards the owner(s) of the enterprise.

(i) Information Reports

The purpose of information reports is to provide a decision-maker with the information necessary to make
specific decisions. The nature and contents of
this type of report is based on the information needs of the user.

There needs to be controls to ensure

• Compliance with any Act governing the entity
• Compliance with GAAP
• Compliance with management policy
• Accuracy of transactions recorded with regard to
• Validity
• Completeness
• Value
• Classification
• Timing

In some countries, income tax authorities require companies to prepare

accounts that conform to national laws for measuring taxable income. Are
those financial statements ‘general-purpose financial statements’? Why?

2
 1.2 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
Statement AC 000 identifies four principal characteristics, namely
• Understand ability
• Relevance
• Reliability
• Comparability and Consistency

1.2.1 Understand Ability

• Information provided in financial statements should be clearly understandable to the user. Generally
accepted accounting practice should however always be kept in mind when preparing information.
• The ability of users to understand the information contained in the financial statements depends
partly on the party preparing the information and partly on the level of financial sophistication of the
users. AC 000 comments on this, indicating (par 25) that users are assumed to have:

(i) A reasonable knowledge of business and economic activities, and (ii) A willingness to
study the information with reasonable diligence.

AC 000 adds that information of a complex nature should not be excluded from the financial statements
(where relevant to users’ decision-making) merely because it may be too difficult for certain users to
understand. However, the provision of information should take place against the background of a
cost/benefit constraint, i.e. information should be included only if the benefits are considered to outweigh
the costs of providing the information.

1.2.2 Relevance
• Relevance may be defined as the ability of financial information to make “a difference in a decision
by helping users form predictions about outcomes of past, present and future events or to confirm
or correct expectations” (FASB, 1980, par 47).AC 000 sees predictive and feedback (confirmatory)
value as ingredients of relevance. It notes that information need not be in the form of a specific
forecast to have predictive value (par 34); information about past performance is often used for
predictions, and consequently the manner in which information is displayed is an important practical
consideration in making information relevant.

• AC 000 comments (par 29) that the relevance of information is influenced by its nature and
materiality. Materiality means all items, which are material enough, whether in amount or nature, to
affect any decision, which, is based on the contents of those financial statements.

1.2.3 Reliability
Financial information should be reasonably free from errors and subjective judgments. The information
presented should be what it purports to be. In
order to be reliable accounting information must:

• Fairly represent transactions

• Record substance over form
• Be neutral (free from prejudice and bias)
• Be prepared with prudence
3
With regard to neutrality, AC 000 notes that financial statements will not be neutral if ‘by the selection
or presentation of information, they influence the making of a decision or judgement in order to achieve
a predetermined result or outcome’ (par 36).

Generally, in presenting accounting information, accountants face a trade-off between relevance and
reliability. In increasing the relevance of the information it frequently becomes necessary to provide the
information earlier or to give estimated rather than actual figures, or qualitative rather than quantitative
data, thus reducing reliability.
‘Timeliness’ is therefore a practical consideration affecting both relevance and reliability.

1.2.4 Comparability & Consistency

The forth quality that financial information should possess is that of comparability. This quality attempts
to introduce a common language into the presentation of financial statements so that users can compare
information about an enterprise for different time periods, or with information of other enterprises.
Statement 621 requires in par. 9 that comparative information should be disclosed in respect to the
previous period for all numerical information in the financial statements. Comparative information should
be included in narrative and descriptive information when it is relevant to an understanding of the
current period’s financial statements. Comparability is not, however, a mindless uniformity. The purpose
of such comparisons is to detect and explain similarities and differences. To make comparisons easier,
the notion of consistency of measurement methods is introduced – without such a requirement
the comparability of financial statements would be significantly affected if not destroyed altogether.
Comparability and consistency improve the usefulness of accounting information by enhancing the
characteristics of relevancy and reliability, Comparability of information can only be useful if that
information is disclosed consistently in the same form or manner. If however a deviation from the way
information was disclosed seems necessary, this fact must also be fully disclosed.

1.3 UNDERLYING ASSUMPTIONS

These assumptions reflect the scope of accounting, reporting and the expectations that set certain limits
in the way accounting information is reported.

Going concern
This concept accepts that the enterprise will continue to do business for the foreseeable future. This has
an influence on the way information is disclosed in the financial statements as these are then based on
the assumption that there is no intention or necessity to liquidate or significantly curtail the
scale of operations.

4
 An entity has incurred losses during the last four years and its current liabilities
exceed its total assets. The entity was in breach of its loan covenants and has
been negotiating with the related financial institutions in order to ensure their
continuing support. These factors raise substantial doubt that the entity will be
able to continue as a going concern.
How should management deal with this matter?

The accrual concept

This means that assets, liabilities, income and expenses should be recognised when the transaction that
causes them occurs, not necessarily when cash is received or paid. Income is recognised when earned and
expenses when incurred. Expenses are recognised in the income statement on the basis of direct
relationship between the cost incurred and the income earned (matching concept)

1.4 ELEMENTS OF FINANCIAL STATEMENTS

The financial position of an enterprise is primarily provided in the Statement of Financial Position. The
elements include:

1. Asset: An asset is a resource controlled by the enterprise as a result of past events, and from
which future economic benefits are expected to flow to the enterprise.
2. Liability: A liability is a present obligation of the enterprise arising from the past events, the
settlement of which is expected to result in an outflow from the enterprise's resources, i.e., assets.
3. Equity: Equity is the residual interest in the assets of the enterprise after deducting all the
liabilities. Equity is also known as owner's equity.
The financial performance of an enterprise is primarily provided in a Statement of Comprehensive
Income (Income Statement or Profit and Loss account). The elements of an income statement or the
elements that measure the financial performance are as follows:
4. Revenues: Increases in economic benefit during an accounting period in the form of inflows or
enhancements of assets, or decrease of liabilities that result in increases in equity. However, it does not
include the contributions made by the equity participants, i.e., proprietor, partners and shareholders.
5. Expenses: Decreases in economic benefits during an accounting period in the form of outflows,
or depletions of assets or incurrence of liabilities that result in decreases in equity.

1.5 RECOGNITION OF ELEMENTS OF FINANCIAL STATEMENTS

Recognition is the process of incorporating in the Statement of Financial Position (Balance Sheet)
or in the Income Statement an item which:
Will have a future economic benefit for an entity or when the item has a cost or value that can be measured
with reliability.

5
 (a) Give examples of resources that might be treated as assets in a balance
sheet but normally are not. How helpful is the Framework definition of assets
in making clear that they are not included?
(b) Give examples of resources that are normally treated as assets in a
balance sheet. How helpful is the Framework definition of assets in deciding
the monetary amount at which they should be recorded?

Measurement of the Elements of Financial Statements

• Measurement is the process of determining the monetary value (amounts) at which the elements
are to be recognised and carried in the balance sheet and income statement. This involves the
selection of a particular basis of measurement.
• A number of different measurement bases are employed to different degrees and in varying
combinations in financial statements. They include the following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair
value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded
at the amount of proceeds received in exchange for the obligation, or in some circumstances (for
example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the
liability in the normal course of business.

(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be
paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted
amount of cash or cash equivalents that would be required to settle the obligation currently.

(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that
could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their
settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to
satisfy the liabilities in the normal course of business.

(d) Present value. Assets are carried at the present discounted value of the future net cash inflows
that the item is expected to generate in the normal course of business. Liabilities are carried at the
present discounted value of the future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business.
The measurement basis most commonly adopted by entities in preparing their financial statements is
historical cost. This is usually combined with other measurement bases. For example, inventories
are usually carried at the lower of cost and net realisable value, marketable securities may be carried
at market value and pension liabilities are carried at their present value. Furthermore, some entities
use the current cost basis as a response to the inability of the historical cost accounting model to
deal with the effects of changing prices of non-monetary assets.

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 A company’s senior financial officer says, ‘I always follow IFRSs in preparing my
company’s financial statements. But the IASB Framework is a lot of conceptual
theory that doesn’t affect me directly. It is not an accounting standard, so I
have never read it.’ Is the IASB Framework a standard? Is it relevant to
preparing IFRS financial statements? If so, how?

1.6 REQUIREMENTS OF IFRS

In terms of the requirements of IFRS the following financial statements must be presented at the end of a
financial year (IAS1.8):
• Statement of Financial Position
• Statement of Comprehensive Income
• Statement of Changes in Equity (SOCE)
• Cash Flow Statement
• Notes, including a summary of the significant accounting policies
1.7 LAYOUT OF INCOME STATEMENTS

Statement of Comprehensive Income (Income Statement)

Information in the income statement is given in such a manner that the income and expenses fully reflect
the activities of the enterprise. At a minimum, the income statement should show the following items
separately: a) Revenue
b) The results of the operating activities
c) Finance costs
d) Tax expense
e) Profit or loss from ordinary activities f) Net profit or loss for the year

In addition, an enterprise should present, either on the face of the income statement or in the notes, an
analysis of expenses using a classification based on either the nature of expenses or their function within
the enterprise. The choice of which method to follow depends on operational factors as well as the size
and nature of the enterprise.

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FORMAT OF A STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED:
R: R:
20.2 20.1
XXX XXX
Revenue (xxx) (xxx)
Cost of Sales
Inventory (Opening balances) xx xx

Purchases xx xx

Carriage of purchases xx xx

Inventory (Closing balances) (xx) (xx)

Gross Profit XXX XXX

Other operating income xx xx

Rent income xx xx xx xx
Credit losses recovered xx xx
Provision for adjustment xx xx
Profit on disposal of assets
Distribution expenses,
Administrative expense and
Other operating expenses (XXX) (XXX)
Directors/Auditors/Acc.officer remuneration xx xx

Carriage on sales xx xx

Credit losses xx xx

Stationery consumed xx xx
Pension contributions xx xx

Medical Aid contribution xx xx xx xx xx

Bank charges xx xx xx
Discount
XXX XX XXX XX
Depreciation
(XX) (XX)
Profit from operations Investment income XX XX
XXX xx XXX
Finance Cost (XXX) XXX xx
(XX) (XXX)
Income from associates
Profit before tax XXX
Interest expense (XX)
Income tax expense
Profit after tax
Extraordinary item
Net profit for the period XXX XXX

8
STATEMENT OF CHANGES IN EQUITY
An enterprise should present, as a separate component, a statement showing:
a) The net profit or loss for the year
b) Each item of income and expense, profit or loss that is recognised directly in equity and the total of
these items.
c) Capital transactions with and distributions to owners.
d) The balance of the accumulated profit and loss at the beginning of the year and at the balance sheet
date and movements thereof.
e) Reconciliation between the carrying amount of each class of equity capital, share premium and
reserves at the beginning and end of the year and the movements thereof.

CASH FLOW STATEMENT

The cash flow statement should provide information that gives the users a basis to assess the ability of
the enterprise to generate cash and cash equivalents and the ability of the enterprise to utilize these cash
flows.

ACCOUNTING POLICY AND NOTES TO THE FINANCIAL STATEMENTS

An accounting policy contains the specific principles, bases, conventions, rules and practices adopted by
an enterprise in preparing and presenting financial statements.
This policy must be stated in the notes to the financial statements.

FORMAT OF A STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)

The Balance Sheet shows the financial position of an enterprise at a particular date. The heading of the
balance sheet is therefore, for example:

Balance Sheet as at 31 March 2002

The following elements of the financial statements are dealt with in the balance sheet:
• Equity
• Liabilities
• Assets

9
The balance sheet is divided into two sections, namely:
• The equity and liabilities section. (Equity, non-current liabilities, current liabilities)
• The assets section. (Noncurrent assets, current assets)

FORMAT OF A BALANCE SHEET NAME OF COMPANY..................... STATEMENT OF FINANCIAL

POSITION AS AT 28 XXX 20.X
ASSETS Notes 20.X

Non – current assets XXX

Fixed assets 3 XX
Financial assets ( e.g. Fixed deposit) xx
Current Assets XXX
Inventories 4 XX
Trade and other inventories 5 XX
Cash and equivalents 6 XX
Other financial assets
TOTAL ASSETS XXX

EQUITY AND LIABILITIES

Capital reserves* XXX
Ordinary share capital 7 XX
Share premium 8 X
Retained earnings 9 XX
Members ‘contributions
Non – current liabilities XX
Mortgage loan XX
Current liabilities XX
Trade and other payables 10 XX
Bank overdraft ( if any) X
Current portion of long-term borrowings
Profit distribution payable
Current tax payable
TOTAL EQUITIES AND LIABILITIES XXX

10
*Note: on the Balance Sheet, you should notice that everything is the same as it is for partnerships and
sole traders. The only difference is the equity structure of the business:
• The owners buy shares in a business – Ordinary share capital
• The shares can sometimes be sold above par value – this premium is recorded in the Share
premium account and is part of the equity of the company.
• Retained earnings are the remaining profit that has not been issued to the shareholders.

FORMAT FOR NOTES TO THE FINANCAL STATEMENTS NAME OF THE

COMPANY.............
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 28 XXX
20.X

1 Interest income XX
Interest from fixed deposit XX
Interest from current account XX
Interest from investment XX
Interest from overdue debtors X

2 Interest expense XX
Interest on overdraft XX
Interest on mortgage loan XX
XX

3 Property, Plant and Equipment

Land & Vehicles Equipment Total

Buildings
Carrying value at beginning of year XX XX XX XX

Cost at beginning of year XX XX XX XX

Accumulated depreciation (XX) (XX) (XX)

Movements:
Additions at cost xx XX XX
Disposals at carrying value (XX) (XX)
Depreciation for the year (XX) (XX) (XX)
Carrying value at the end of year (XX) (XX) (XX)
Cost at end of year XX XX XX XX
Accumulated depreciation (XX) (XX) (XX)

11
4 Inventories Xx
Trading inventory XX
Consumable stores on hand XX

5 Trade and other receivables: xxx

Trade debtors XX
Provision for Credit losses (XX)
Net trade debtors xxx
Accrued income XX
Prepaid expenses XX
SARS: Income tax XX

6 Cash and cash equivalents Xx

Fixed deposits (maturing within 12 months) Xx

Savings account X
Bank Xx
Cash float (XX) X
Petty cash (XX) X

7 Equity capital:
Authorised share capital
XxX ordinary shares at RX each XX
Issued share capital
xxx shares at RX each is issue at beginning of the year XX

xxx shares issued during the year Xx

xxx shares at RX each is issue at end of the year XX

8 Share premium:
Balance at beginning of the year XX
Shares issue during the year Xx
Balance at the end of the year XX

12
 9 Retained earnings:
Retained earnings at beginning of the year XX
Net profit(loss) for the year XX
Ordinary dividends for the year (XX)
Paid X
Recommended X
Retained earnings at end of the year XX
10 Trade and other payables: xxx
Trade creditors Xxx
Accrued expenses X
Creditors for wages XX
Pension fund XX
Medical aid fund XX
South African Revenue Services XX
PAYE XX
Income tax Xx
Shareholders for dividends XX
Income received in advance XX
Current portion of loan Xxx

1.8 EQUITY AND LIABILITIES

Equity and liabilities can be described as the ‘money’ used by the enterprise to buy the goods and
services required to carry on business. These requirements will depend on the business activities of the
entity. The money required may come from a variety of sources, for example the owners and banks. The
goods and services required are not necessarily bought for cash but may also be bought on account, in
which case they are paid for at a later stage or in instalments. The suppliers of the goods are then also
considered as providers of funds. Instead of paying its suppliers immediately, an enterprise may use the
cash for something else in the meantime.

The providers of both cash and goods on account are creditors, therefore liabilities, of the enterprise.
These liabilities can be divided into current liabilities and non-current liabilities.
The owners (or shareholders) of a company also provide funds for the activities of the company. This is
called equity. The total amount owing to the shareholders, except for dividends, will be repaid only once
the company ceases to exist. The total amount owing to the shareholders is the capital contributed plus
accumulated reserves. (Note that a shareholder that sells his shares in the company is not paid by that
company, but by the person who buys the shares from him.)

13
 Capital and reserves
The owners’ contribution to equity is twofold:
• a contribution as capital, and
• re-investment of profits earned (accumulated reserves)

Consider the following basic cycle:

Shareholders invest R200 000 cash. Equity then consists of:

Capital R200 000

And the company owes the shareholders R200.000

The company buys inventory for R200 and sells it for R300, thereby realising a profit of R100. Equity then
consists of:

Capital R200 000

Accumulated reserves R100 000
R300 000

The shareholders can now either withdraw the R100000 or leave it (re-invest it) in the company. If they
re-invest the R100 000, the company will owe them R300 000.

Liabilities
Liabilities are divided into two categories, namely non-current (or long-term) liabilities and current
liabilities.

(a) Non-current liabilities- More than 12 months Non-current liabilities can

originate:
• Through the introduction of cash, as in the case of a loan. For example, a company wishes to purchase
certain property from where it will conduct its business. The bond that it obtains from the bank to
pay for the property is an example of a non-current liability through the provision of cash funds. A
public company may also obtain a ‘loan’ from the general public, through the issue of debentures,
once certain requirements have been complied with.
• Through the supply of goods on account, as is the case where a supplier of e.g. manufacturing
equipment supplies the equipment under an instalment sale agreement to the entity.

Note that in both instances mentioned above, the portion of the debt, which is repayable within the next
12 months, is classified as a current liability. The balance which becomes payable after 12 months, is
classified as non-current.

14
(b) Current liabilities – Less than 12 Months Current liabilities can
originate:
• Through the introduction of cash, as in the case of a bank overdraft;
• Through the supply of goods on account, as is the case where a supplier supplies inventory
on account to the company. Such an account is usually payable within 30 to 60 days;
• Through amounts owing in respect of taxes;
• As a result of the short-term portion of non-current liabilities.

Assets
The goods that a company buys with the funds it employs are the assets of the entity. Assets will provide
future benefits to the enterprise that owns the assets. Some of the assets, such as machinery, are
acquired to use by the company itself, while other assets, such as inventory, are bought for resale.

But the funds of the company may also be employed in other ways, e.g. the company may also supply
goods on account to others. The company then becomes the creditor of that buyer of the goods, and the
buyer becomes the debtor of the company.

It could also be that the company does not employ all its funds in a manner described above. Surplus
funds can then either be left in the bank, in which case it can be withdrawn at any time, or at notice of
not more than twelve months.

If surplus funds will not be required in the short term, it can also be invested for a longer period by, for
example, buying shares in another company or any other investment extending beyond 12 months.

Assets can be divided into two groups:

Non-current assets, which consist of
• Tangible assets, such as property, plant and equipment;
• Intangible assets, such as goodwill, and
• Financial assets, such as investments, where funds are invested for longer than 12 months.
Note that investments in companies, over which the reporting company has a significant
influence, are dealt with under a separate heading.

Non-current assets are typically used by the enterprise for periods of longer than one year. But these
assets will not, after five years have the same value as on the day they were acquired. Some assets, like
buildings, may be worth more while
others, like motor vehicles, may be worth less than the original cost.

In order to recognise this, assets which appreciate in value (become worth more), are often re-valued at
their market value. The total value of assets would increase by the amount of the revaluation, while equity
would also increase.
Assets which depreciate over time, are also re-valued, but in terms of the company’s depreciation policy.
The original cost of the assets is written off as depreciation against profits, over the useful life of that
asset.

15
Current assets, which consist of:
• Inventories, for re-sale or consumption
• Trade and other receivables
• Prepayments (Prepaid expense)
• Cash and cash equivalents

It often happens that current assets, other than cash, will not realise in cash or cash equivalents. This is
the case, for example, where inventory becomes obsolete. Think for a moment how rapidly computer
technology has advanced over the last few years. Also, people do not always pay their debts. It happens
frequently that companies have to write off amounts owing to them by their debtors. These amounts are
written off against profits as obsolete inventory and credit losses respectively.

1.9 STEPS TO FOLLOW WHEN COMPILING INCOME STATEMENTS AND BALANCE SHEETS

The steps are as follows:

Step 1
Determine what is required. In practice however, you have to determine what is required. It is necessary
to bear these requirements in mind when reading through the given information.

Step 2
Read through the question to determine what type of information is given. You are usually given basic
information, for example, the partnership agreement and a pre-adjustment trial balance plus a number
of year-end adjustments, which have to be taken into account.
Remember that each year-end adjustment requires a double entry which usually (not always involves one
entry in an income statement account and one in a balance sheet account).

Step 3
Now you can start planning the answer:
(a) You need a page for basic calculations, which should always form part of your answer.
(b) You need a page for each of the profit and loss and appropriation sections of the income statement.
(c) Another page is needed for the summary of transactions with members in the case of close
corporations, etc.
(d) The last page is required for the balance sheet.

Step 4
Where specifically asked for, calculations should be done from the list of adjustments on the basic
calculation sheet. Calculations should be numbered to enable cross-reference to the financial statements.
If an adjustment is simple, e.g. the writing off an irrecoverable debt, which entails an addition to the
expense item: Irrecoverable debts and a reduction of the amount of debtors (asset account), this may be
done directly in the given trial balance.

16
Step 5
When you have determined and noted your year-end adjustments you must start preparing the financial
statements from the trial balance and basic calculations. Mark off the items as you enter them in the
different sections of the income statement, in the following sequence:
1. Manufacturing section where applicable.
2. Trading section where applicable.
3. Profit and loss section.
4. Appropriation section.
5. Summary of partners’ current accounts in the case of partnerships.
6. Balance sheet.

1.10 THE EFFECT OF INFLATION ON THE REPORTING FUNCTION

The effect of inflation on accounting and particularly on the reporting function has for the past number
of years been investigated by the accounting profession and other interested parties, like commerce and
industry and even government bodies throughout the world. Despite all efforts, there still exists no
agreement between the parties concerned about a method of adapting the historically cost- funded
financial statements so that the effect of inflation thereon could be accounted for.

The problem of inflation

The term inflation implies a continuous increase in the price of goods and services, that is, a continuous
decrease in the purchasing power of money. The percentage price increase is, of course, not consistent
for all goods and/or services and the effect thereof on individuals, on partnerships, on companies, etc.
will differ, depending on the types of goods and services.

During the past few years, the rate of inflation has been high and continuous. A major problem due to
inflation originated in accounting: The annual financial statements of any concern are supposed to be a
fair representation of the state of affairs and the business at the end of a particular financial year, as well
as of the profit or loss of that enterprise for the same year. If annual financial statements are compiled
according to historical cost, the question arises whether the requirements of a fair presentation can still
be complied with.

The effect of inflation on financial reporting

The results of the activities of an enterprise, reflected in historical figures, are often misleading because
of the continuous price increases. The comparisons of similar enterprise, and the comparison between
different years in the same enterprise, are, therefore, also misleading due to figures.
The effect of inflation on the annual financial statements will now briefly be discussed with regard to fixed
assets, depreciation and cost of sales.

Non-current assets
Non-current assets, which are not shown at their current value in the books, can cause the profit/loss,
ultimately realised at the sale of such assets, to be a misrepresentation of the actual position.
17
 Depreciation
Non-current assets are consumed to earn income at current prices but depreciation on such fixed assets
is generally based on historical cost. Because the historical cost of such assets often have no relation to
current replacement cost, a lesser amount is debited against income regarding depreciation, which
results in an excessive profit (on which, of course, tax has to be paid).

Cost of sales
By taking the cost of sales in a period of increasing price levels will be insufficient to replace stock sold
during the year.

Possible methods of counteracting the problem

As a result of continuous efforts on the part of various bodies and institutions in different countries of the
world, various alternative methods have been introduced in recent years for making financial statements
more meaningful by eliminating the influences of inflation.

Three adjustments have to be made:

• Adjustment of depreciation.
• Adjustment of cost of sales.
• Financial gearing adjustment.

The guideline further stipulates that if the required information is available only in respect of
depreciation and cost of sales adjustments, this information must be disclosed in the financial
statements, but no current cost income statement needs to be presented.
The guideline explains how calculations can be made and can, where appropriate, be simplified by using
indexes.
TYPES OF ENTERPRISES
The following are the basic types of enterprises:
• Sole Proprietorships
• Partnerships
• Close Corporations (cc)
• Companies

Close
Characteristic s Sole Ownership Partnership Corporation Company

18
1) Number of One – the owner Two or more, but One or more but Public company:
members not more than 20 may not exceed 10 Seven or more with
no upper limit

Private company:
One or more but
limited to 50

2) Formation Simple: Only Simple: Should Fixed requirement Strict

permits/licences, preferably have a s, but not requirements in
depending on the type of partnership complicated terms of the
business/profession agreement Founding Companies Act
statement and Needs
certificate of certificate to
incorporation commence
business

3)Legal Not a separate legal Not a Legal entity. Legal entity.

personality entity. The owner separate legal Limited Liability of
is responsible for entity. Partners liability shareholders in
the debts of the are jointly provided certain both types of
solvability
business and companies is
and liquidity
severally liable limited to the
requirement s
for debts amount invested
are complied
of the business. in shares of the
with
company

Management by Management All members Public

4) Management owner By owners participate in company has two
Responsibility and Mutual management or more
control are responsibility unless directors while a
vested in and control otherwise stated private
the same person in the company has one
association or more
agreement directors

19
5) Name of enterprise No legal requirements No legal Name must be Public company:
requirement s followed by CC Name must include
(English) and “Limited” as final
BK (Afrikaans) word

Private company:

Name must end

with
“(Proprietary)
Limited”.

6) Changes in policy Unlimited within the With common On mutual Limited –

boundaries of the consent agreement
business requires approval
by directors and
shareholders

7) Provision of capital Limited to the capital Limited to the Limited to the Public
contribution of one capital interest that company provides
person – the owner contribution of members capital by issue of
the separate contributed to the shares to its
partners corporation members
Private
company provides
capital by the issue
of shares to
founder members

20
8) Income tax Profit of enterprise is Every partner Close Company pays
taxed as the personal pays separately Corporation pays tax on its profits
income of the owner tax at company
on his share of
rates.
the profit
Members are

9) Transfer of owner’s Transferable on the Not freely transfer their Public company:
interest authority of the transferable interests with the Shares are freely
owner consent of the traded and
– requires other members. transferred
consent of the An amended
partners founding
statement is
required

10) Continuity of Theoretically the On withdrawal of Unlimited Unlimited

existence enterprise ceases to one partner the existence except existence,
exist when the owner old partnership in the case of except in the
dies, although this is dissolves and a case of
deregistration or
not always the case in new partnership liquidation
practice has to be formed liquidation
as a result of the
changes in the
original
partnership

21
 REVIEW QUESTIONS

1. Explain in full the four qualitative characteristics of accounting information.

2. Explain what is meant by equity.
3. Distinguish between non-current and current assets.
4. What is meant by the term inflation?
5. How will inflation affect the disclosure of fixed assets, depreciation and cost
of sales in the financial statements?
6. What guidelines have been laid down by the SA Institute of Chartered
Accountants regarding the disclosure of the effect of price changes on financial
results?
7. Identify internal and external users of financial statements.

22
 TOPIC 2

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (SOPL-

OCI) AND RELEVANT NOTES AND STATEMENT OF CHANGES IN EQUITY OF
COMPANIES

Learning Outcomes
After studying this study unit, you should be able to:
• Prepare the SOPL-OCI of a company according to the specific
requirements of the Companies Act 71 of 2008 and Generally
Accepted Accounting
Practice
• know all the items which have to be shown as notes to the SOPL-
OCI of a company, in terms of the provisions of the Companies Act
71 of 2008
• Prepare a statement of changes in equity for a company

For further theory and worked examples based on

SOPL-OCI, students must refer to chapter 2 (Presentation
of Financial Statements) in the prescribed textbook.

2.1 Identification of financial statements (IAS 1 par .49 - .53)

The financial statements should be clearly identified. This includes information concerning:
• the name of the reporting entity, whether the financial statements are for the individual
• entity or for a group of entities, the reporting date and currency, as well as the level of
• rounding of the figures (for example R'000).

2.2 Statement of profit or loss and other comprehensive income

The statement of profit or loss and other comprehensive income shall present, in addition
to profit or loss and other comprehensive income sections:
(a) Profit or loss;
(b) Total comprehensive income;
(c) Comprehensive income for the period, being the total of profit or loss and other
comprehensive income.

23
If an entity presents a separate statement of profit or loss it does not present, the profit or loss section
in the statement of profit or loss and other comprehensive income.
An entity shall present the following items, in addition to the profit or loss and other comprehensive
income sections, as allocation of profit or loss and other comprehensive income for the period:
(a) profit or loss for the period attributable to:
(i) non-controlling interests, and (ii) owners of the parent.
(b) comprehensive income for the period attributable to:
(i) non-controlling interests, and (ii) owners of the parent.
If an entity presents profit or loss in a separate statement it shall present in that statement.

Study example 2.2 and 2.3 in prescribed textbook.

Study

Information to be presented in the profit or loss section or the statement of profit or loss
In addition to items required by other IFRSs the profit or loss section or the statement of profit or loss
shall include line items that present the following amounts for the period:
• revenue;
• gains and losses arising from the de-recognition of financial assets measured at amortised
cost;
• finance costs;
• share of the profit or loss of associates and joint ventures accounted for using the equity
method;
if a financial asset is reclassified so that it is measured at fair value, any gain or loss arising from a
difference between the previous carrying amount and its fair value at the reclassification date;
• tax expense;
• a single amount for the total of discontinued operations

An entity shall not present any income or expense items as extraordinary items, in the statement of profit
or loss and other comprehensive income or in the notes.

Information to be presented in the other comprehensive income section The other comprehensive
income section shall present line items for amounts of other comprehensive income in the period,
classified by nature (including share of the other comprehensive income of associates and joint ventures
accounted for using the equity method) and grouped into those that, in accordance with other IFRSs:
(a) will not be reclassified subsequently to profit or loss; and
(b) will be reclassified subsequently to profit or loss when specific conditions are met.

Profit or loss for the period

An entity shall recognise all items of income and expense in a period in profit or loss unless an IFRS requires
or permits otherwise.

24
Other comprehensive income for the period (IAS 1 par .81 - .90)
An entity shall disclose the amount of income tax relating to each item of other comprehensive income,
including reclassification adjustments, either in the statement of profit or loss and other comprehensive
income or in the notes.
An entity may present items of other comprehensive income either:
• net of related tax effects, or
• before related tax effects with one amount shown for the aggregate amount of income tax
relating to those items.

Information to be presented either in the statement of profit or loss and other comprehensive income
or in the notes (IAS 1 par .97 - .105)
The nature and amount of all income and expense items shall be disclosed separately if they are
material.
The following circumstances give rise to separate disclosure of income and expense items:
• inventories written down to net realisable value and reversals of these writedowns;
property, plant and equipment written down to recoverable amount and reversals of these write-
downs;
• restructuring of an entity's activities and reversals of provisions made for the costs of
restructuring;
• disposal of property, plant and equipment;
• disposal of investments;
• discontinuing operations; litigation settlements; and other reversals of provisions.

When income and expenditure is classified in terms of the functions which give rise to them, additional
information of the nature of the expenditure should be provided in the notes to the statement of
profit or loss and other comprehensive income, including: depreciation;
• amortisation; and
• employee benefit expense.

FRAMEWORK LIMITED
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME FOR THE YEAR ENDED 31 DECEMBER 20.2
(Illustrating the classification of expenses by function)

25
Comments
In the above example the individual components of other comprehensive income are disclosed on a pre-
tax basis (i.e. before taking into account their related tax effect). The combined tax effect is then reflected
as a single line item immediately following these components. An alternative presentation would be to
disclose each of these components net of tax. On accounting 2 level the effect of tax is not dealt with. The
illustration of the tax effect is for cognisance only.

26
FRAMEWORK LTD
NOTES FOR THE YEAR ENDED..........

27
Directors' remuneration
When directors' remuneration is disclosed it is necessary to distinguish between
• Executive directors (directors who are involved in the day-to-day management of the company)
➢ emoluments
➢ loss of office
➢ pension
• Non-executive directors (directors who have no involvement in the day-to-day management of
the company)
➢ emoluments
Note: A director's remuneration from a subsidiary is analysed in the parent company under what he is
doing in the parent company. (Example: If a director is a non-executive director in the parent company but
an executive in the subsidiary his remuneration from the subsidiary will be analysed as non- executive
even though he is an executive in the subsidiary.)
Directors' remuneration includes all amounts payable or receivable from
• The company
• Subsidiaries
• Other people
Emoluments include the following:
• Paid for services rendered
• Basic salary
• Bonuses and performance related payments
28
• Sums paid by way of expense allowances (Please note expenses paid by the director for example
travelling expenses paid is not part of his remuneration but is an expense to the company.)
• The estimated monetary value of any other material benefits received
• Contributions paid under any pension scheme under the pension section, and
• Gains made in the exercise of share options, presented in tabular form.

Example
Directors' remuneration
Work through thoroughly

29
Directors' remuneration will be calculated and disclosed as follows in the financial statements of Well-fair
Ltd for the year ended 28/2/19.6. Remember that only amounts paid to directors of the parent are
disclosed.

The following steps should be followed:

• Establish who the directors of the parent are.
• Establish the executive and non-executive directors of the parent.
• Establish whether the services were rendered to the parent or the subsidiary.
Calculations:
Directors' remuneration

30
31
Comments

• Entertainment expenses of R850 represent the actual expenses of Underdog Ltd and not an
entertainment allowance, therefore they do not represent part of the directors' remuneration.
• Although Mr Woofle also received a travelling allowance of R1 500 in his capacity as director of
Underdog Ltd, this was not included in the calculations since he was not a director of Well-Fair
Ltd.

Tax
Work through thoroughly
The amount budgeted for tax for the present financial year, as well as adjustments in the provision for tax
in any previous financial year, must also be disclosed.

When the tax liability for the year is calculated, the SOPL-OCI is debited with the income tax expense and
``Tax payable'' is credited under ``Current liabilities''.

A company is obliged to make three provisional tax payments to the SA Revenue Service annually. The first
provisional payment takes place six months after the beginning of a company's financial year. The second
provisional payment takes place on the last day of the financial year and the third provisional payment
takes place seven months after the end of the financial year.

All provisional payments are debited to ``provisional tax payments'' under ``Current assets''.
After the annual liability for tax has been calculated, these provisional payments are deducted and the net
tax liability is shown under ``Tax payable''.

Once the financial statements of a company have been completed they are forwarded to the
SA Revenue Service, together with a completed tax return. The SA Revenue Service then uses the
information to calculate the tax liability and issue a tax assessment.
32
It is possible, however, that the SA Revenue Service may not permit certain expenses, which would mean
that the company's tax calculation would differ from that of the SA Revenue
Service. This tax adjustment is then shown on the SOPL-OCI under ``Tax adjustment for previous year''.
As we explained, any transfers to/from the deferred tax account have to be disclosed in the
SOPL-OCI as well.

The disclosure of tax can also take the form of a note to the SOPL-OCI. In Accounting II you will not be
expected to be able to do complicated tax calculations.

Study example 2.8 and 2.9 in prescribed textbook.

2.3 Structure and content: Statement of changes in equity (IAS 1 par .106 - .110) A statement of
changes in equity forms part of the financial statements. What is essentially required is a reconciliation
of equity at the beginning of the financial year with equity at the end of the financial year.
The statement should include the following:
• Total comprehensive income for the period, showing separately the total amounts attributable to
owners of the parent and non-controlling interest.
• The effects of retrospective application or retrospective restatement recognised in accordance
with IAS 8 for each component of equity.
• For each component of equity, a reconciliation between the carrying amount at the beginning and
the end of the period.

Dividends paid for the period and related dividend per share can be disclosed either in the
statement of changes in equity or in the notes. Study this framework thoroughly.

33
 Read section 2.4.3 on page 37 then attempt example 2.10 in prescribed textbook.

FRAMEWORK LIMITED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.2

2.4 Structure and content: Notes to the financial statements (IAS 1 par .112 - .138)
The notes to the annual financial statements should:
• present information about the basis of preparation of the financial statements;

34
 • present the specific accounting policies selected and applied for significant transactions and
events;
• disclose information required not presented elsewhere in the financial statements; and
• provide additional information not presented elsewhere in the financial statements, but that is
relevant to an understanding of any of them, for example contingent liabilities.

Notes to the annual financial statements should be:

• presented in a systematic manner; and
• each item on the statements cross-referenced to the notes.

An entity should disclose in the summary of significant accounting policies:

• the measurement basis (or bases) used in preparing the financial statements, for example,
historical costs, net realisable value, fair value; and
• the other accounting policies used that are relevant to an understanding of the financial
statements.

2.5 Exercises - Study thoroughly

The following are three comprehensive examples, which you will need to work through carefully. You will
note that you will have to do a number of calculations before you will be able to draft the SOPL-OCI
statement and the relevant notes. These are similar to questions you can expect in the assignments and
the examination.

The following information was taken from the accounting records of XYZ Ltd for the year ended 28
February 19.3.

35
During the financial year 19.3 the directors of XYZ Ltd and W Ltd each attended four board meetings
only; the alternative director attended only two board meetings. The directors of
XYZ Ltd and W Ltd receive R1 000 and R500 respectively per meeting. The chairmen of
XYZ Ltd and W Ltd receive an additional R500 and R250 respectively per meeting.

The alternative directors receive R500 per meeting. The following salaries were paid during the year:

36
REQUIRED
Prepare the SOPL-OCI, statement of changes in equity and applicable notes for XYZ Ltd for the year ended
28 February 19.3. Your answer should comply with the requirements of the Companies Act 71 of 2008 and
Generally Accepted
Accounting Practice. (Ignore notes on accounting policy and comparative figures.)

37
38
5. Depreciation at 25% per annum on the carrying amount of machinery and equipment has still to be provided
for. No machinery was purchased or sold during the year.
6. Credit losses written off during previous years never exceeded R2 000.
7. Provision must still be made for normal tax amounting to R205 240 (the rate is 28%).
8. An ordinary dividend of 20c per share was declared on 28 June 19.3. Ordinary shares were issued at R1 per
share.
9. Turnover represents net sales to third parties, excluding VAT.

REQUIRED
Prepare the SOPL-OCI, statement of changes in equity and relevant notes of X Ltd for the year ended 30
June 19.3 in accordance with the provisions of the Companies Act 71 of 2008 and Generally Accepted
Accounting Practice. Ignore comparative figures and accounting policy notes.

39
40
Comments

• F's remuneration is not included in the calculation of directors' remuneration, since F is not a
director of XYZ Ltd.
• An alternative director is a director who can deputise for another director if the latter is unable to
attend a meeting.
41
• Expenditure on air tickets and accommodation is a normal expense for the company and therefore
does not need to be shown as directors' remuneration.

42
2.6 Self-assessment
After studying this study unit:
• Are you able to prepare the SOPL-OCI of a company according to the specific requirements of the
Companies Act 71 of 2008 and Generally Accepted Accounting Practice?
• Do you know all the items which have to be shown as notes to the SOPL-OCI of a company, in
terms of the provisions of the Companies Act 71 of 2008?
• Are you able to prepare a statement of changes in equity for a company?

43
 TOPIC 3

STATEMENT OF FINANCIAL POSITION (SOFP) AND RELEVANT NOTES OF COMPANIES

Learning Outcomes
After studying this study unit you should be able to:
• Prepare a statement of financial position of a company
according to the specific requirements of the Companies Act
71 of 2008 and Generally Accepted Accounting Practice.
• Know all the items which should be shown as notes to the
statement of financial position of a company, in accordance
with the requirements of the Companies Act 71 of 2008 and
Generally Accepted Accounting Practice.

For further theory and worked examples based on SOFP, students

must refer to chapter 2 (Presentation of Financial Statements),
section 2.4.1 in the prescribed textbook.

3.1 Framework of statement of financial position and notes

To make financial statements clearer to the users, specific disclosure procedures are laid down by the
Companies Act 71 of 2008. We refer here to the narrative form of presentation of financial statements;
accordingly, this is the form of presentation we use in Accounting II. We do not accept the conventional T
accounting form. Another step aimed at improving the understand ability of the statements is to present
only the most important information from both the SOFP and the SOPL-OCI on a single page. The other
information which has to be disclosed then takes the form of notes on other pages.

The Companies Act provides that the annual financial statements of a company should consist of:
• A statement of financial position (SOFP)
• A statement of profit or loss and other comprehensive income (SOPL-OCI) A statement showing
either:
➢ all changes in equity, or
➢ changes in equity other than those arising from capital transactions with owners and distributions
to owners

44
A statement of cash flows
Accounting policies and explanatory notes A
Directors' report and an auditor's report.

Comparative figures for the immediately preceding period should be shown for all items in the financial
statements. Comparative figures are not required in the case of the first financial statements produced by
a company.

Accounting bases may be seen as methods developed for the application of underlying accounting
concepts to financial transactions such as the amounts at which items in the SOFP of a company are shown.
Since there is more than one accounting base for showing an item like inventory in financial statements, a
company would use a note to disclose its accounting policy regarding its method of valuing inventory.
Corporate reporting can only be properly analysed and interpreted if the accounting policy applied is
disclosed.
(Please note that chapter numbers must be ignored, pay attention to the format)

45
 Read through the illustration of the SOFP in example 2.1 in chapter 2
in the prescribed textbook.

3.2 Non-current assets

A company's long-term investments, in the case that the full value will not be realized within the
accounting year. Noncurrent assets are capitalized rather than expensed, meaning that the company
allocates the cost of the asset over the number of years for which the asset will be in use, instead of
allocating the entire cost to the accounting year in which the asset was purchased.

Property, plant and equipment

Overview

IAS 16 Property, Plant and Equipment outlines the accounting treatment for most types of property, plant
and equipment. Property, plant and equipment is initially measured at its cost, subsequently measured
either using a cost or revaluation model, and depreciated so that its depreciable amount is allocated on a
systematic basis over its useful life.
See Topic 5 for further reading on this section. You may also refer to
chapter 9 in the prescribed textbook.

46
IAS 16 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005.

Related Interpretations

IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine

SIC-6 Costs of Modifying Existing Software. SIC-6 was superseded by and incorporated into IAS 16 (2003).

SIC-14 Property, Plant and Equipment – Compensation for the Impairment or Loss of Items. SIC-14 was
superseded by and incorporated into IAS 16 (2003).

SIC-23 Property, Plant and Equipment - Major Inspection or Overhaul Costs. SIC-23 was superseded by and
incorporated into IAS 16 (2003).

Amendments under consideration by the IASB

none

Summary of IAS 16

Objective of IAS 16

The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The
principal issues are the recognition of assets, the determination of their carrying amounts, and the
depreciation charges and impairment losses to be recognised in relation to them.

Scope
IAS 16 applies to the accounting for property, plant and equipment, except where another standards
requires or permits differing accounting treatments, for example:

• assets classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations
• biological assets related to agricultural activity accounted for under IAS 41 Agriculture
• exploration and evaluation assets recognised in accordance with IFRS 6 Exploration for and Evaluation
of Mineral Resources
• mineral rights and mineral reserves such as oil, natural gas and similar non regenerative resources.

The standard does apply to property, plant, and equipment used to develop or maintain the last three
categories of assets. [IAS 16.3]

The cost model in IAS 16 also applies to investment property accounted for using the cost model under IAS
40 Investment Property. [IAS 16.5]

The standard does apply to bearer plants but it does not apply to the produce on bearer plants. [IAS 16.3]

47
Note: Bearer plants were brought into the scope of IAS 16 by Agriculture: Bearer Plants (Amendments to
IAS 16 and IAS 41), which applies to annual periods beginning on or after 1 January 2016.

Recognition

Items of property, plant, and equipment should be recognised as assets when it is probable that: [IAS 16.7]

• it is probable that the future economic benefits associated with the asset will flow to the entity,
and
• the cost of the asset can be measured reliably.

This recognition principle is applied to all property, plant, and equipment costs at the time they are
incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and
equipment and costs incurred subsequently to add to, replace part of, or service it.
IAS 16 does not prescribe the unit of measure for recognition – what constitutes an item of property, plant,
and equipment. [IAS 16.9] Note, however, that if the cost model is used (see below) each part of an item
of property, plant, and equipment with a cost that is significant in relation to the total cost of the item
must be depreciated separately. [IAS 16.43]

IAS 16 recognises that parts of some items of property, plant, and equipment may require replacement at
regular intervals. The carrying amount of an item of property, plant, and equipment will include the cost
of replacing the part of such an item when that cost is incurred if the recognition criteria (future benefits
and measurement reliability) are met. The carrying amount of those parts that are replaced is
derecognised in accordance with the de-recognition provisions of IAS 16.67-72. [IAS 16.13]
Also, continued operation of an item of property, plant, and equipment (for example, an aircraft) may
require regular major inspections for faults regardless of whether parts of the item are replaced. When
each major inspection is performed, its cost is recognised in the carrying amount of the item of property,
plant, and equipment as a replacement if the recognition criteria are satisfied. If necessary, the estimated
cost of a future similar inspection may be used as an indication of what the cost of the existing inspection
component was when the item was acquired or constructed. [IAS 16.14]

Initial measurement
An item of property, plant and equipment should initially be recorded at cost. [IAS 16.15] Cost includes all
costs necessary to bring the asset to working condition for its intended use. This would include not only
its original purchase price but also costs of site preparation, delivery and handling, installation, related
professional fees for architects and engineers, and the estimated cost of dismantling and removing the
asset and restoring the site (see IAS 37 Provisions, Contingent Liabilities and Contingent Assets). [IAS 16.16-
17]

If payment for an item of property, plant, and equipment is deferred, interest at a market rate must be
recognised or imputed. [IAS 16.23]

If an asset is acquired in exchange for another asset (whether similar or dissimilar in nature), the cost will
be measured at the fair value unless (a) the exchange transaction lacks commercial substance or (b) the

48
fair value of neither the asset received nor the asset given up is reliably measurable. If the acquired item
is not measured at fair value, its cost is measured at the carrying amount of the asset given up. [IAS 16.24]

Measurement subsequent to initial recognition

IAS 16 permits two accounting models:

Cost model. The asset is carried at cost less accumulated depreciation and impairment. [IAS 16.30]
Revaluation model. The asset is carried at a revalued amount, being its fair value at the date of revaluation
less subsequent depreciation and impairment, provided that fair value can be measured reliably.

The revaluation model

Under the revaluation model, revaluations should be carried out regularly, so that the carrying amount of
an asset does not differ materially from its fair value at the balance sheet date. [IAS 16.31]

If an item is revalued, the entire class of assets to which that asset belongs should be revalued. [IAS 16.36]

Revalued assets are depreciated in the same way as under the cost model (see below).

If a revaluation results in an increase in value, it should be credited to other comprehensive income and
accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a
revaluation decrease of the same asset previously recognised as an expense, in which case it should be
recognised in profit or loss. [IAS 16.39]

A decrease arising as a result of a revaluation should be recognised as an expense to the extent that it
exceeds any amount previously credited to the revaluation surplus relating to the same asset. [IAS 16.40]

When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained
earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained
earnings should not be made through profit or loss. [IAS 16.41]

Depreciation (cost and revaluation models)

For all depreciable assets:

The depreciable amount (cost less residual value) should be allocated on a systematic basis over the asset's
useful life [IAS 16.50].

The residual value and the useful life of an asset should be reviewed at least at each financial year-end
and, if expectations differ from previous estimates, any change is accounted for prospectively as a change
in estimate under IAS 8. [IAS 16.51]

The depreciation method used should reflect the pattern in which the asset's economic benefits are
consumed by the entity [IAS 16.60]; a depreciation method that is based on revenue that is generated by
an activity that includes the use of an asset is not appropriate. [IAS 16.62A]

49
Note: The clarification regarding the revenue-based depreciation method was introduced by Clarification
of Acceptable Methods of Depreciation and Amortisation, which applies to annual periods beginning on
or after 1 January 2016.

The depreciation method should be reviewed at least annually and, if the pattern of consumption of
benefits has changed, the depreciation method should be changed prospectively as a change in estimate
under IAS 8. [IAS 16.61] Expected future reductions in selling prices could be indicative of a higher rate of
consumption of the future economic benefits embodied in an asset. [IAS 16.56]

Note: The guidance on expected future reductions in selling prices was introduced by Clarification of
Acceptable Methods of Depreciation and Amortisation, which applies to annual periods beginning on or
after 1 January 2016.

Depreciation should be charged to profit or loss, unless it is included in the carrying amount of another
asset [IAS 16.48].
Depreciation begins when the asset is available for use and continues until the asset is derecognised, even
if it is idle. [IAS 16.55]

Recoverability of the carrying amount

IAS 16 Property, Plant and Equipment requires impairment testing and, if necessary, recognition for
property, plant, and equipment. An item of property, plant, or equipment shall not be carried at more
than recoverable amount. Recoverable amount is the higher of an asset's fair value less costs to sell and
its value in use.

Any claim for compensation from third parties for impairment is included in profit or loss when the claim
becomes receivable. [IAS 16.65]

De-recognition (retirements and disposals)

An asset should be removed from the statement of financial position on disposal or when it is withdrawn
from use and no future economic benefits are expected from its disposal. The gain or loss on disposal is
the difference between the proceeds and the carrying amount and should be recognised in profit and loss.
[IAS 16.67-71]

If an entity rents some assets and then ceases to rent them, the assets should be transferred to inventories
at their carrying amounts as they become held for sale in the ordinary course of business. [IAS 16.68A]

Disclosure

For each class of property, plant, and equipment, disclose: [IAS 16.73]

• basis for measuring carrying amount

• depreciation method(s) used
• useful lives or depreciation rates
• gross carrying amount and accumulated depreciation and impairment losses

50
 • reconciliation of the carrying amount at the beginning and the end of the period, showing:
1. additions
2. disposals
3. acquisitions through business combinations
4. revaluation
5. increases or decreases
6. impairment losses
7. reversals of impairment losses
8. depreciation
9. net foreign exchange differences on translation
10. other movements

Additional disclosures
The following disclosures are also required: [IAS 16.74]
• restrictions on title and items pledged as security for liabilities
• expenditures to construct property, plant, and equipment during the period
• contractual commitments to acquire property, plant, and equipment
• compensation from third parties for items of property, plant, and equipment that were impaired,
lost or given up that is included in profit or loss.
IAS 16 also encourages, but does not require, a number of additional disclosures.
[IAS 16.79]

Revalued property, plant and equipment

If property, plant, and equipment is stated at revalued amounts, certain additional disclosures are
required: [IAS 16.77] the effective date of the revaluation
• whether an independent valuer was involved
• for each revalued class of property, the carrying amount that would have been recognised had the
assets been carried under the cost model
• the revaluation surplus, including changes during the period and any restrictions on the distribution of
the balance to shareholders.

Financial assets
Financial asset: any asset that is:
• cash
• an equity instrument of another entity
• a contractual right to receive cash or another financial asset from another entity; or o to exchange
financial assets or financial liabilities with another entity under conditions that are potentially
favourable to the entity; or

51
• a contract that will or may be settled in the entity's own equity instruments and is: a non-derivative
for which the entity is or may be obliged to receive a variable number of the entity's own equity
instruments
• a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another
financial asset for a fixed number of the entity's own equity instruments. For this purpose, the entity's
own equity instruments do not include instruments that are themselves contracts for the future
receipt or delivery of the entity's own equity instruments
• puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32
as equity instruments

3.3 Current assets

Current assets are assets that are: [IAS 1.66]
• expected to be realised in the entity's normal operating cycle
• held primarily for the purpose of trading
• expected to be realised within 12 months after the reporting period
• cash and cash equivalents (unless restricted).

All other assets are non-current. [IAS 1.66]

3.4 Total equity

Equity is what the owners of an entity have invested in an enterprise. It represents what the business owes
to its owners. It is also a reflection of the capital left in the business after assets of the entity are used to
pay off any outstanding liabilities. Equity therefore includes share capital contributed by the shareholders
along with any profits or surpluses retained in the entity. This is what the owners take home in the event
of liquidation of the entity. The Accounting Equation may further explain the meaning of equity: Assets -
Liabilities = Equity

Share capital and other components of equity

Invested money that, in contrast to debt capital, is not repaid to the investors in the normal course of
business. It represents the risk capital staked by the owners through purchase of a company’s common
stock (ordinary shares).

The value of equity capital is computed by estimating the current market value of everything owned by
the company from which the total of all liabilities is subtracted. On the balance sheet of the company,
equity capital is listed as stockholders' equity or owners' equity. Also called equity financing or share
capital.

Retained earnings
Profits generated by a company that are not distributed to stockholders (shareholders) as dividends but
are either reinvested in the business or kept as a reserve for specific objectives (such as to pay off a debt
or purchase a capital asset).

52
A balance sheet figure shown under the heading retained earnings is the sum of all profits retained since
the company’s inception. Retained earnings are reduced by losses, and are also called accumulated
earnings, accumulated profit, accumulated income, accumulated surplus, earned surplus, undistributed
earnings, or undivided profits.

Share capital

53
Reserves
Reserves should be classified under two main headings, namely:
• non-distributable reserves
54
• distributable reserves
The movement on each reserve during the current year must be disclosed in the statement of changes in
equity. The nature and purpose of reserves need to be disclosed.

Example

Comment
A company comes into being on the day on which the Registrar of Companies issues the certificate of
incorporation. Any profits which may arise before this date are classified as pre-incorporation profits.

3.5 Non-current liabilities

The liabilities of a company should be included in the information needed to disclose the general nature
of the company and should be classified under suitable headings.

Loans may be either secured by an encumbrance on the assets or unsecured.

The following information must be disclosed in respect of convertible instruments and debentures:
• The amount and classes issued
• The conditions of conversion and the dates of redemption
• Particulars of convertible instruments and debentures which may be issued by the company again

55
 • That portion which is payable within 12 months of SOFP date (to be classified as a current liability)

The following must be disclosed in respect of loans:

• The amount of the obligation
• The interest rate applicable
• The repayment conditions
• That portion which is payable within 12 months of SOFP date (to be classified as a current liability)

Deferred taxation
Accounting for income taxes
• Applies the ‘balance sheet’ method—recognition of assets and liabilities in the balance sheet based
on the differences between accounting and tax values of assets and liabilities
• Focuses on comparing the carrying value of an entity’s assets and liabilities (determined by
accounting rules) with the tax base for those assets and liabilities

– effectively involves comparing the balance sheet derived using accounting rules with balance
sheet that would be derived from taxation rules

Carrying amount vs tax base of asset or liability

• Carrying amount is the amount the asset or liability is recorded at in the accounting records
56
• Tax base is defined as the amount that is attributed to an asset or liability for tax purposes—tax base
represents the amount an asset or liability would be recorded at if the balance sheet were prepared
applying taxation rules
• Where the carrying amount of an asset or liability is different from the tax base a ‘temporary
difference’ can arise

Temporary differences can be of two types A taxable

temporary difference

– will result in an increase (decrease) in income tax payable (recoverable) in future periods when
the carrying amount of the asset or liability is recovered or settled
▪ Creates a liability—deferred tax liability A deductible
temporary difference

– will result in a decrease (increase) in income tax payable (recoverable) in future periods when
the carrying amount of the asset or liability is recovered or settled
▪ Creates an asset—deferred tax asset

• Deferred tax liability

– the carrying amount of the asset exceeds the tax base

– taxation payments have effectively been deferred to future periods

– tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later
Example of deferred tax liability
• Carrying amount of a non-current depreciable asset exceeds the tax base in early years, as
depreciation allowable as a deduction for tax purposes is greater than depreciation for accounting
purposes
• This will be reversed in later years when no depreciation is allowable for tax purposes

57
 It is inherent in the recognition of an asset that its carrying amount will be
recovered in the form of economic benefits that flow to the entity in
future periods. When the carrying amount of the asset exceeds its tax
base, the amount of taxable economic benefits will exceed the amount
that will be allowed as a deduction for tax purposes. This difference is a
taxable temporary difference and the obligation to pay the resulting
income taxes in future periods is a deferred tax liability. As the entity
recovers the carrying amount of the asset, the taxable temporary
difference will reverse and the entity will have taxable profit. This makes
it probable that economic benefits will flow from the entity in the form
of tax payments.

Deferred tax asset

– the carrying amount of an asset is less than the tax base

Example of deferred tax asset

• Tax base of a depreciable asset exceeds the carrying amount in early years, as depreciation allowable
as a deduction for tax purposes is less than depreciation for accounting purposes
• This will be reversed in later years when the asset is fully depreciated for accounting purposes, but
depreciation is still allowable as a deduction for tax purposes

Income tax expense

• Represents the sum of the tax attributable to taxable income, plus or minus any adjustments relating
to temporary differences Defined as

– the aggregate amount included in the determination of profit or loss for the period in respect of
current tax and deferred tax

Income tax payable

• The amount of tax generally expected to be paid to the Tax Office, as a result of the year’s operations,
within the next financial period
• Under the ‘taxes payable method’ would be same as tax expense, i.e. the amount payable to the Tax
Office is also treated as the tax expense by the organisation
• Under balance sheet method income tax payable does not necessarily equate to tax expense – tax
expense affected by temporary differences

Calculation of income tax payable

• Income tax payable is based on taxable income, not accounting profit

58
• Necessary to make adjustments to accounting profit to determine tax profit, e.g.

– add back accounting depreciation

– deduct depreciation for taxation purposes Calculation of income tax payable

– Tax rate multiplied by tax profit

Journal entry if temporary differences result in deferred tax asset

– to recognise tax expense that relates to the temporary difference

Dr Deferred tax asset (temp. difference x tax rate)
Cr Tax expense

– to recognise tax expense that relates to the entity’s taxable profit

Dr Taxation expense
Cr Income tax payable

Journal entry if temporary differences result in deferred tax liability

– to recognise tax expense that relates to the temporary difference

Dr Tax expense
Cr Deferred tax liability (temp. difference x tax rate)

– to recognise tax expense that relates to the entity’s taxable profit

Dr Taxation expense
Cr Income tax payable

Reversal in future periods

• In future periods, timing differences will reverse

– deferred tax asset will be credited – deferred tax liability will be debited

Calculation of tax base for assets

• Carrying amount + future deductible amount—future assessable amount
• Although an asset might be expected to give rise to future assessable amounts that exceed the asset’s
carrying amount, IAS 12 focuses on the tax
consequences of recovering an asset to the extent of its carrying amount only
• Where carrying amount of asset exceeds tax base there is a deferred tax liability
• If the carrying amount of the asset is less than the tax base there is will be a deferred tax asset
• Consideration of doubtful debts when examining accounts receivable

59
 – amounts provided for doubtful debts are not deductible for tax purposes
▪ deductible only when the account receivable is actually written off

– any provision for doubtful debts will result in a difference between carrying amount and tax base
▪ this will result in a deferred tax asset

Calculation of tax base for liabilities

• Carrying amount – future deductible amount + future assessable amount Exception to the rule

– tax base of a liability that is in the nature of ‘revenue received in advance’ must be calculated as
the liability’s carrying amount less any amount of the revenue received in advance that has been
included in assessable amounts in the current or a previous reporting period

– this will result in a deferred tax asset

• Tax base of a liability for ‘revenue received in advance’

– tax base of the liability is equal to the carrying amount of the liability where the ‘revenue received
in advance’ is taxed in a reporting period subsequent to the reporting period in which received

– the tax base of the liability is equal to zero where ‘revenue received in advance’ is taxed in the
reporting period when received

– carrying amount – amount of revenue received in advance that will not be subject to tax in future
periods = tax base

Deferred tax assets and deferred tax liabilities

• Assets

– deferred tax liability arises when carrying amount > tax base – deferred tax asset arises when
carrying amount < tax base
• Liabilities

– deferred tax liability arises when

carrying amount < tax base

– deferred tax asset arises when

carrying amount > tax base

Summary
• Carrying amount of assets or liabilities – tax bases of assets or liabilities = taxable or deductible
temporary differences

60
• Taxable or deductible temporary differences x tax rate = deferred tax liabilities or deferred tax assets

– assessable temporary difference results in increase in tax payable in future years – deductible
temporary difference results in decrease in tax payable in future years

Deferred tax asset—Recognition criteria A number

of assumptions are made

– the entity will remain in business (going concern)

– taxable income will be derived in future years

– recognition of deferred tax asset same as applied to other assets—reliance on ‘probability’ test

▪ A deferred tax asset must be recognised for all deductible temporary differences that reflect
the future tax consequences of transactions and other events to the extent that it is probable
that future taxable amounts within the entity will be available, against which the deductible
temporary differences can be utilised
• The ‘probable’ test will always be met in relation to deferred tax liabilities Unused tax losses
• Deferred tax assets can arise as a result of tax losses

– losses incurred in previous years can generally be carried forward to offset taxable income
derived in future years
• Tax losses can generate subsequent benefits in the form of tax payments saved in future profitable
periods

– for example, if we make a tax loss of R300 000 this year, but next year we make a taxable profit
of R300 000 then we will be able to carry forward the loss and not have to pay tax in the next
year. The prior loss has created an economic benefit in the form of tax that has been saved
• Consistent with the test for deferred tax assets generated by temporary differences, deferred tax
assets generated as a result of unused tax losses must also be able to satisfy the ‘probable’ test before
they are recognised as assets
• A deferred tax asset shall be recognised arising from the carry-forward of unused tax losses and unused
tax credits to the extent that it is probable that future taxable profit will be available against which the
unused tax losses and unused tax credits can be utilised
• As a general principle applicable to all deferred tax assets it is a requirement that they be reviewed at
each reporting date to ensure that the assets are not overstated

Change of tax rates

• Tax rates will change across time
• Will have implications for value to be attributed to pre-existing deferred tax assets and deferred tax
liabilities
• An increase in tax rates will create an expense (which will be of the nature of income tax expense)
when an entity has deferred tax liabilities, and will create income in the presence of deferred tax assets

61
• Conversely, a decrease in tax rates will create income when an entity has deferred tax liabilities,
whereas a decrease will create an expense in the presence of deferred tax assets

Because the income taxes statement will only be discussed in detail in Accounting III, in this course we will
do no more than familiarise you with the basic principle of deferred taxation, namely the distinction
between permanent and temporary differences.
Temporary differences arise where the same transactions are recognised in different periods for
accounting and taxation purposes. These are the differences which have their origin in one accounting
period and are then reversed in the course of one or more subsequent accounting periods.
In order to comply with the matching concept, deferred taxation must be provided on temporary
differences.

Deferred taxation arises as a result of a book entry to make provision for the difference between
accounting profit and taxable profit. This difference could arise, for example, where the company provides
for depreciation at 25% according to the straight-line method but the
South African Revenue Service (henceforth SA Revenue Service) only allows wear and-tear at 20%
according to the straight-line method. The company would therefore write off the total cost price of the
asset over four years (25% 6 4 = 100%) but the SA Revenue Service would write it off over a period of five
years. In both cases the full cost price is written off Ð all that differs is the period over which it is written
off.

Example
An Ltd buys a machine on 1 June 19.1 the cost price of which is R1 000 000. A Ltd provides for depreciation
on machinery at 20% per annum according to the straight-line method. The SA Revenue Service allows a
wear-and-tear allowance of 25% per annum according to the straight-line method. The year-end of A Ltd
is 31 May. Assume a taxation rate of 40%. The profit before provision for depreciation is R500 000.

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The company therefore has to pay R100 000 to the SA Revenue Service for the current year and the R20
000 is seen as an obligation which it will only be possible to write back in the long term.
As you will have realised by now, this is a book entry the purpose of which is to make provision for tax
which will be payable in future.

For the purposes of Accounting II, all you need to know is where deferred tax should be disclosed on the
SOFP and SOPL-OCI.

3.6 Current liabilities

Current liabilities are those: [IAS 1.69]
• expected to be settled within the entity's normal operating cycle
• held for purpose of trading
• due to be settled within 12 months
• for which the entity does not have an unconditional right to defer settlement beyond 12 months
(settlement by the issue of equity instruments does not impact classification).
Other liabilities are non-current.

When a long-term debt is expected to be refinanced under an existing loan facility, and the entity has the
discretion to do so, the debt is classified as noncurrent, even if the liability would otherwise be due within
12 months. [IAS 1.73]

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 reporting date, the liability is current, even if the lender has agreed,
after the reporting date and before the authorisation of the financial statements for issue, not to demand
payment as a consequence of the breach. [IAS 1.74] However, the liability is classified as non-current if the
lender agreed by the reporting date to provide a period of grace ending at least 12 months after the end
of the reporting period, within which the entity can rectify the breach and during which the lender cannot
demand immediate repayment. [IAS 1.75]

3.7 Examples

The following balances were taken from the ledger of ABC Ltd on 30 June 19.5:

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 Additional information
1. Authorized share capital consists of the following:
o 500 000 Ordinary shares o 50 000 12%
Preference shares
All shares were issued at R1 each. At the end of the financial year the directors had authorization to
issue the unissued ordinary shares.

2. The loan from Money Bank is unsecured, bears interest at 18% per annum and is repayable on 31
December 19.8.
3. On 25 June 19.5 it was decided to issue capitalization shares at R1 each to the ordinary shareholders
in the proportion of 1 to every 20 already held.

4. The long-term loan was secured by a first bond over land and buildings and is repayable in annual
instalments of R5 000 each. The first instalment is payable on 31 December 19.5.

5. Investments consist of the following:

(a) An investment of 1 000 ordinary shares in AEF (Pty) Ltd at a cost price of R2 500. The issued share
capital of AEF (Pty) Ltd consists of 25 000 ordinary shares. The directors value the shares at R5 000.
Each share carries one vote. This investment is designated as not held for trading.
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 (b) An investment of 7 500 ordinary shares in XYZ (Pty) Ltd at a cost price of R30 000. The issued share
capital of XYZ (Pty) Ltd consists of 10 000 ordinary shares. Each share carries one vote.

(c) An investment of 10 000 ordinary shares in BCD Ltd at a cost price of R20 000. The issued share
capital of BCD Ltd consists of 90 000 ordinary shares (each of which carries one vote). The shares of
BCD Ltd are traded on the stock exchange and ABC Ltd bought some shares in BCD Ltd for speculative
purposes. On 30 June 19.5 the market value amounted to R4, 00 per share.

6. The land consist of erf 1114, Monument, Pretoria. On 1 June 19.4 Mr Lomu valued the property at
replacement value.

Furniture and fittings with a carrying amount of R40 000 (original cost price R60 000) were sold during
the year and replaced with new furniture at a cost price of R65 000. Depreciation on furniture and
fittings for the current year amounted to R29 000.

7. A loan was granted to the parent, PQR Ltd, on 1 June 19.3 at an interest rate of 10% per annum. PQR
Ltd provided security. Over the year the amount of the loan varied from R18 000 to R50 000. No
agreement was entered into regarding repayments.

8. Inventory consists of raw materials (R10 000), unfinished work (R8 000) and finished products (R14
000).

9. ABC Ltd guaranteed XYZ (Pty) Ltd.’s bank overdraft to the amount of R15 000.

REQUIRED
Prepare the statement of financial position and relevant notes of ABC Ltd at 30 June 19.5 to comply with
the requirements of the Companies Act 71 of 2008 and Generally Accepted. Accounting Practice.
(Comparative figures and notes on accounting policy are not required.)

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9. Rainbow Limited only owned one delivery motor cycle which was sold on 1 March 19.3. The
transaction was entered correctly in the books of Rainbow Limited. The original cost price of this asset
was R20 000 and the carrying amount at date of sale was R2 000.

10. It is Rainbow Limited's policy to write off depreciation on machinery and equipment at 20% per annum
according to the diminishing balance method. No purchase or sale of machinery took place during the
year.

11. Revenue for the year amounted to R4 500 000 and represents net sales to third parties of goods
purchased for resale. Rainbow Limited maintained a 40% gross profit percentage throughout the year.

12. Debentures are redeemable before 1 March 19.10 at par.

13. The authorised share capital of Rainbow Limited on 1 March 19.3 was as follows:
700 000 Ordinary shares 250 000 8%
Preference shares.

14. Buildings are depreciated at 2% per annum on the straight line basis.

15. Included in profit before tax are distribution expenses amounting to R26 800.

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REQUIRED
Prepare the statement of financial position, the statement of profit or loss and other comprehensive
income, the statement of changes in equity and the relevant notes thereto of Rainbow Limited for the year
ended 28 February 19.4 according to the requirements of the Companies Act, 71 of 2008 and Generally
Accepted Accounting Practice. (Ignore accounting policy notes and comparative figures. Show all
calculations.)

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These expenses will be financed from...

8. Contingent liability
The company signed a surety ship for a bank overdraft of a subsidiary company.

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3.8 Self-assessment

After studying this topic:

• Are you able to draw up a statement of financial position of a company according to the specific
requirements of the Companies Act 71 of 2008 and Generally Accepted Accounting Practice?

• Do you know all the items which should be shown as notes to the statement of financial position of a
company, in accordance with the requirements of the Companies Act 71 of 2008 and Generally
Accepted Accounting Practice?

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 TOPIC 4

FINANCIAL REPORTING: COMPANIES

LEARNING OUTCOMES
After studying this topic, you should be able to:
• demonstrate detailed knowledge of the main areas of financial
reporting for companies, including an understanding of and the
ability to apply the key terms, concepts, facts, principles, rules and
theories of financial reporting to unfamiliar but relevant contexts;
and knowledge of the principle of disclosure.
• demonstrate detailed understand the function of the auditor’s and
director’s report.
• prepare the company financial statements so as to comply with the
specific requirements of the Companies Act 2008.

To refresh your memory on this topic, read through chapter six (6)
(Introduction to companies) from the recommended textbook (Berry
P.R, Klerk E.S, Doussy F., Botha S.M., Jansen J.S. and Ngcobo R.N. 2017.
About Financial Accounting, 6th edition. Vol. 2. South Africa: LexisNexis.).

4.1 THE PRINCIPLE OF DISCLOSURE

The principle of disclosure is fundamental to South African Company legislation. In terms of this principle,
the Companies Act demands the disclosure of specified information for the benefit of interested parties.
The same result is achieved by instituting broad disclosure guidelines in respect of companies, as with
detailed legislation in this regard. There is a functional connection between requiring disclosure and
dispensing with regulatory legislation.
The company in the process of formation is granted its incorporated status by the registration of
constitutive documents, the Memorandum and the Articles of Association, with the Registrar of
Companies where they will then be available for public inspection.

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The disclosure requirements of the Act extend throughout the life of the company. At its incorporation, its
constitutive documents are made available to public scrutiny. On its dissolution, the Registrar of
Companies publishes notice thereof in the Government Gazette. Whenever the company offers shares to
the public, certain prescribed information must be included in the prospectus. The financial position of a
public company is also disclosed. A copy of the latest annual financial statements is available for inspection
at the registrar of Companies.

4.2 DISCLOSURE AND ANNUAL FINANCIAL STATEMENTS

Disclosure remains the principal safeguard on which the Companies Act pins its faith. Schedule 4 of the
Companies Act 1973 regulates the contents of annual financial statements in detail. The requirements of
continuous disclosure of the latest financial information of companies by publication of annual financial
statements (and interim annual financial statements) and interim reports serves to round off the
disclosure requirements of the Act. This “publication” takes place by dispatching copies of the annual
financial statements to shareholders and holders of debentures, and the submission of copies to the
Registrar and the presentation of annual statements to the annual general meeting.

4.3 THE STRUCTURE OF PUBLISHED ANNUAL FINANCIAL STATEMENTS

An important factor in improving the comprehensibility of annual financial statements, viz. for
shareholders (whom mostly have no accounting knowledge) is in the form of presentation. In this regard
the narrative form fulfils an important requirement, since it is easier to understand than the conventional
T- account form of presentation.

4.4 TH E FUNCTION OF THE DIRECTORS’REPORT

4.4.1 In terms of the requirements of the Companies Act annual statements, which have to comply with
generally accepted accounting practice, must fairly reflect the state of affairs of the company as at the
end of a particular financial period.

4.4.2 Such a fair representation has to be brought about by means of (a) figures and (b)a narrative
report to supplement and where necessary, explain figures in the Financial statements. The prescribed
narrative report is the directors’ report.

4.4.3 Section 299 of the Companies Act stipulates that every company has to present a directors’ report
to its annual general meeting as part of its annual financial statements.

4.5 THE FUNCTION OF THE AUDITORS’ REPORT

4.5.1 Section 282 describes the statutory duties of the auditor of a company and stipulates that he has to
report to the members of a company in the manner and on the matters required by the Act (these
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requirements are set out in section 300 of the Act) and perform all other duties imposed upon him by the
Companies Act or any other Act.

4.5.2 When the auditor has complied with the requirements of and satisfied himself as to the matters
stated in Section 300, he shall make a report to the members of the company that he has examined
the annual financial statements and that in his opinion they fairly present the financial position of
the company and the results of its operations in the manner required by the Act.

4.5.3 In the event of the auditor being unable to make such a report or to make it without qualification,
he shall include a statement in his report to that effect, and set forth the facts or circumstances,
which prevent him from making his report or making it without qualifications.

4.6 THE PROSPECTUS

A public company normally obtains most of its capital by inviting the public to become members or to
buy one or more shares (usually in multiples of hundred) in a document of advertisement, which is called
a prospectus. The Companies Act prescribes the information that must be set out in a prospectus. On
the basis of this information, the potential investor is able to decide on the merits of the offered shares
or debentures as an investment.
A public company, which does not offer shares or debentures to the public, must issue a statement in
lieu of a prospectus. A private company by the very nature of its limited private ownership, can never
issue a prospectus, and is in fact prohibited from inviting public subscription.

4.7 TAX POSITION

Companies in South Africa pay many different taxes, such as normal tax and secondary tax on companies
(STC). The size and nature of their operations make it compulsory for companies to register for VAT.

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 4.8 SHARE CAPITAL

The capital which shareholders invest in a company is known as share capital. Pay special attention
to the following:
• Issued share capital
• Value of shares
• Share premium
• Classes of shares
• Reserves

ACTIVITY
The objective of financial statements is to provide information about the
financial position, performance and changes in financial position of an
enterprise that is useful to a wide range of users in making economic
decisions (IASB Framework). International Accounting Standards (IAS)
prescribed the set of these financial statements. Identify a complete set
of financial statements as outline in IAS 1.10.

Form and general contents of published annual financial statements

Annual financial statements are the statements which are presented to the annual general meeting and
must include the following:
• Statement of Comprehensive Income (Income Statement)
• Statement of Financial Position (Balance Sheet)
• Statement of Changes in Equity
• Cash flow statement
• Notes to the annual financial statements
• Directors’ Report
• Auditors’ Report

Detailed requirements with regard to the contents of annual financial statements

Schedule 4
In the interest of fairly presenting the state of affairs of a company at its accounting date (the end of the
financial year), the Companies Act and especially Schedule 4 contain detailed provisions regarding:

(1) What items of shareholders’ interest, liabilities and assets must be specifically shown in the Balance
Sheet, and (2) What information must be disclosed concerning such items?

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The Act further prescribes what information must be disclosed in the income statement to comply with
the fair presentation of profit or loss of the company for the financial year.

Prescribed information

For the purpose of this module, you do not need to be familiar with details of the prescribed information.
You only need to be informed about the following
items:

Part 1 – Statement of Financial Position (The Balance Sheet): Assets Non-current assets Property, Plant and
Equipment
Clearly show the cost price, accumulated depreciation, and carrying amount of every main class of non-
current assets. This is done in the form of a note to the Balance Sheet. On the face of the Balance Sheet
only the carrying amount of property, plant and equipment are disclosed.

Investments
Investments must be shown at cost. Distinguish between listed and unlisted investments. If available, show
the name of the company, the number, class, and nominal value of shares held.

The market value in the case of listed and the directors’ valuation in the case of unlisted investments
must also be shown. (All the information about investments is usually given in a note to the
balance sheet, though it can be on the face. In this module we will give the information on investments
on the face of the balance sheet).

Current assets
The following must be disclosed:
Inventories (this includes merchandise and consumables such as stationery, packing and cleaning
materials)

• Trade and other receivables, which can be shown separately or as one amount, includes debtors less
provision for credit losses, bills receivable and income arrears

• Prepayments

• Cash and cash equivalents (i.e. favourable bank, petty cash, cash float)

Deferred expenses
The following expenses are included:
• Preliminary expenses
• Share issue expenses
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Part 2 – The balance sheet: Equity and liabilities

1. Authorized share capital

• Par value shares
Distinguish between the various classes as follows: Ordinary shares: number, par value and total
amount Preference shares: number, par, value and total amount.

NB: These totals do not form part of the total of the balance sheet.

• No par value shares

Distinguish between the various classes as follows: Ordinary share: number Preference shares:
number
• Any particular class of share can consist only of either par value or no par value shares, never both.
For example, the ordinary shares of a company cannot consist partly of shares with a par value
and partly of shares without par value.

2. Issued share capital

The disclosure for each class of share must be as follows:
• Par value shares: the number, the par value and the total amount of the issued share capital
• No par value shares: the number and the total amount of the stated share capital account.
• The total amount of the issued shares forms part of the total of the balance sheet.

3. Reserves
• Non-distributable reserves
Only the capital redemption reserve appears in problems in this course. You do not need to know
the origin thereof.

• Distributable reserves
Only the general reserve is of importance in this course

4. Accumulated profits/ (losses) Liabilities

Non-current liabilities
An interest bearing borrowing is a long-term liability with a repayment date of more than 12 months
after the date of the balance sheet concerned.

The following information in respect of each non-current liability must be disclosed:

• How it is secured (mortgage or otherwise)
• Interest rate
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 • Repayment conditions (dates and instalments)

Instalments payable within the next 12 months must be shown as a current liability.

5. Current liabilities
• Trade and other payables. These can be shown as one amount or separately and include trade
creditors, bills payable, accrued expenses and income received in advance
• Bank overdraft
• Short-term borrowings
• Current portion of interest bearing borrowings (i.e. instalments that are payable during the
following 12 months)
• Income tax payable (provision minus provisional tax paid)
• Dividends payable
Part 3 – The income statement

1. The revenue for the year must be disclosed.

2. The net profit or loss for the year.
• Income from investments, distinguishing between
• Listed investments and
• Unlisted investments
• Profits on the disposal of property, plant and equipment
• Losses on the disposal of property, plant and equipment
• Depreciation of property, plant and equipment
• Finance costs
• Directors’ remuneration (no details)
• Auditor’s remuneration (no details)
• Income tax expense (no details)

Part 4 – The Statement of Changes in Equity

This statement is required in terms of the revised October 1998 Statement of Generally Accepted
Accounting Practice AC621.

Notes on taxation in financial statements

When the tax liability (if any) for the year has been estimated, the income tax expense account is debited
with the provision for the income tax, while the taxation payable account is credited. The taxation expense
account is then closed off to the profit and loss account and is shown in the balance sheet under the
heading “Current Liabilities”.

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Three provisional tax payments are made in respect of each financial year. When these payments are
made, the bank account is credited and the taxation payable account is debited, thereby reducing the
amount owed to the SA Revenue Service. This treatment is the same as the treatment of an ordinary
creditor.

REVIEW QUESTIONS

QUESTION 1
1.1 What is meant by the term “published” annual financial statements?
1.2 What is the function of notes to annual financial statements?
1.3 What are the functions of the directors’ and auditors’ reports
respectively?

QUESTION 2

The following information relates to Happy Traders Limited:

TRIAL BALANCE AS AT 28 FEBRUARY 20.8

DR CR
R R
Ordinary share capital issued 200 000
Preference share capital issued General reserve 50 000
General reserves 10 000
Accumulated profits (28 February 20.7) 5 000

15% R10 debentures (secured by a first mortgage bond over land 50 000
and buildings)

16% long-term loan (secured by a second mortgage bond over land 30 000
and buildings)

Trade creditors 80 000

Trade debtors 150 000
Inventory 1 March 20.7 90 000
Provisional tax paid 15 000
Sales 975 000

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 Purchases 700 000
Salaries and wages 95 450

Interest on bank overdraft 2 000

Bank overdraft 15 000
Interest on mortgage loan 4 800
Interest on debentures 3 750
Investment in:
Listed company at cost 25 000
Unlisted company at cost 20 000

Land and buildings at cost 158 000

Vehicles at costs 60 000

Furniture and equipment at cost 52 000
Stationery and postage 3 000
Dividends earned from:
Listed investments 2 000
Unlisted investments
3 000
Provision for credit losses 28 February 20.7 5 000
Freight on purchases 6 000
Freight on sales 4 000
Discount received 4 000
Discount allowed 3 000

Commission paid to salesman 9 000

Auditor’s remuneration 6 000

Directors’ remuneration 15 000
Insurance 6 000
Sundry expenses 18 000
Sales returns 5 000
A Accumulated depreciation on: Vehicles
Furniture and equipment 10 000
12 000

1 451 000 1 451

ii. iii.
000
iv.

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 a Additional Information
Happy Traders Ltd was registered on 1 March 20.1 with an authorized share capital of
R600 000 ordinary shares of 50c each and 50 000 12% preference shares of R1 each.
Closing inventory at 28 February 20.8 amounts to R95 000. An amount of R5 000 must be transferred
to the general reserve.

The provision for bad debts must be adjusted to 5% of the outstanding trade debtors at 28 February 20.8

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v. The interest on debentures is payable half-yearly on 1 September and 1 March.
vi. The investments consist of:
• 20 000 R1 ordinary shares in Milty Trade Ltd. On 28 February 20.8 the shares were traded at
150c per share on the Johannesburg Stock Exchange.
• 25 000 no par value ordinary shares in Tiny (PTY) Ltd. According to the directors the value of the
shares was 70c per share on 28 February
20.8
vii. On 31 August 20.8 an instalment of R5 000 is payable on the long-term loan.
viii. Included in sundry expenses is an amount of R2 000 representing a loss on the sale of redundant
equipment.
ix. Provision must be made for depreciation as follows:
• Motor vehicles: 20% per annum in cost price
• Furniture and equipment: 10% per annum on the diminished balance
x. Dividend on preference shares and a dividend of 5c per share on the ordinary shares
xi. An amount of R500 for auditor’s remuneration. xii. An amount of R40 000 for income tax for
the current year.

REQUIRED:
1. Complete the Trial Balance.

2. Prepare the following financial statements so as to comply with the specific requirements of the
Companies Act 2008. Use the available Information only and pay particular attention to headings,
classifications and terminology:
• The Statement of Comprehensive Income for the year ended 28 February
20.8
• The Statement of Changes in Equity for the year 28 February 20.8
• The Statement of Financial Position as at 28 February 20.8
• Notes to the financial statements for the year ended 28 February 20.8

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 QUESTION 3

The following information is in respect of Lager Limited for the financial year ended 31 December 2001:
1. Lager Limited was registered with an authorised share capital of:
• 150 000 10% redeemable preference shares of R2 each
• 300 000 ordinary shares of R1 each
The following shares were issued on 1/01/2001:
80 000 10% redeemable preference shares issued at R2,20 each 100 000 ordinary
shares issued at R1 each.

On 2 January 2001, 20 000 10% redeemable preference shares were redeemed at par value. The
redemption was performed as follows:
5 000 shares were redeemed out of profits, and the rest were financed by an issue of ordinary shares
at R1, 50 each.
2. Summarised provisional income statement:
R
Net profit before taxation 200 000
Taxation (50%) 100 000
Net profit 100 000
Accumulated profit at the beginning of the year 225 000

3. Included in the net profit before taxation are the following items:
Depreciation: Machinery 20 100
Truck 2 500
Interest expense on long-term loan 1 900
Interest income on fixed deposit 1 110
Interest expense on overdrawn bank account 2 215
Rates and taxes 800
Bank charges 340
Advertising 4 600
Credit losses 200
Net sales 300 000
Cost of sales 60 000

4. The following items have not yet been taken into account:
Profit on the expropriation of land and buildings 53 000
Profit on sale of machinery (taxable) 14 000

A dividend of 10 cents per ordinary share was declared on 31 December 2001. No entry has been made yet.

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 TOPIC 5

PROPERTY, PLANT AND EQUIPMENT (IAS 16)

LEARNING OUTCOMES

Once you have studied and completed this course material, you should be able
to:
• Account for property, plant and equipment, and depreciation in the
financial statements of an entity in terms of the requirements of
Generally Accepted Accounting Practice.
• Account for revaluations of property, plant and equipment in the
financial statements of an entity in terms of the requirements of
Generally Accepted Accounting Practice.

Study this topic in conjunction with chapter 9 (Property Plant and Equipment)
in the prescribed textbook (Pretorius, D., Badenhorst, W. M. and Kotze, L.J.
2018. GAAP Handbook 2018 Volume 1 & 2: Financial Accounting and
Reporting Practice. South Africa: LexisNexis.).

5.1 OBJECTIVE – IAS 16.1

IAS 16 contains prescriptions for the accounting treatment for property, plant and equipment (PPE) so that
users of the financial statements can discern information about an entity's investment in its PPE and the
changes in such investment. The principal issues in accounting for PPE are the following: the recognition
of PPE as assets, and
• the determination of their carrying amounts, and
• the related depreciation charges and impairment losses.

5.2 SCOPE – IAS 16.2–5

The standard shall be applied to PPE except when another standard requires or permits a different
accounting treatment.
The standard does not apply to:
(a) PPE-items classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations;
(b) biological assets related to agricultural activity (IAS 41 Agriculture); or
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(c) the recognition and measurement of exploration and evaluation assets (see
IFRS 6 Exploration for and Evaluation of Mineral Resources); or
(d) mineral rights and mineral reserves such as oil, natural gas and similar nonregenerative resources.
However, the standard applies to PPE used to develop or maintain the assets described in (a) and (b). The
standard also applies to the following:
• where other standards may require recognition of an PPE-item based on an approach different from
that in the standard (e.g. Leases under IAS 17), other aspects of the accounting treatment for these
assets, including depreciation, are prescribed by this standard;
• investment property that is being accounted for in accordance with the cost model (see learning unit
2 for investment properties).

5.3 DEFINITIONS – IAS 16.6

The following terms are used in the standard with the meanings specified:

Carrying amount
The carrying amount is the amount at which an asset is recognised in the statement of financial position
after deducting any accumulated depreciation and accumulated impairment losses.

Cost
Cost is the amount of cash or cash equivalents paid and the fair value of the other consideration given to
acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed
to that asset when initially recognized in accordance with the specific requirements of other IFRSs, e.g.
IFRS 2 Share-based Payment.

Depreciable amount
The cost of an asset, or other amount substituted for cost, less its residual value.

Depreciation
The systematic allocation of the depreciable amount of an asset over its useful life.
Entity-specific value
The present value of the cash flows an entity expects to arise from the continuing use of an asset and from
its disposal at the end of its useful life or expects to incur when settling a liability.

Fair value
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

Impairment loss
The amount by which the carrying amount of an asset exceeds its recoverable amount.

Property, plant and equipment PPE are

tangible assets that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
(b) are expected to be used during more than one period.
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Recoverable amount
It is the higher of an asset's net selling price (fair value less costs to sell) and its value in use.

Residual value
The estimated amount that an entity would currently obtain from disposal of an asset, after deducting the
estimated costs of disposal, if the asset were already of the age and in the condition expected at the end
of its useful life.

Useful life
It is either:
(a) the period over which an asset is expected to be available for use by an entity; or
(b) the number of production or similar units expected to be obtained from the asset by an entity.

5.4 Recognition
The first step to take in accounting for an item of expenditure, is to decide whether the item should be
recognised and accounted for as an asset or as an expense, based on the recognition criteria set out in the
Framework for the Preparation and Presentation of Financial Statements. These criteria also apply to
subsequent recognition.
The cost of an PPE-item shall be recognised as an asset if, and only if:
• it is probable that future economic benefits associated with the item will flow to the entity (this will
usually be the case where the risks and rewards of ownership have passed to the entity); and
• the cost of the item can be measured reliably.

An entity evaluates under this recognition principle all its PPE-costs at the time they are incurred. These
costs include costs incurred initially to acquire or construct a PPE-item and costs incurred subsequently to
add to, replace part of, or service it (under certain circumstances).
Spare parts and servicing equipment do not normally meet the definition of PPE as they are used in one
accounting period. They are normally carried in inventory and recognised in profit and loss as and when it
is used. However, major spare parts and stand-by equipment qualify as PPE when an entity expects to use
them during more than one period. Similarly, if the spare parts and servicing equipment can be used only
in connection with a certain PPE-item, they are accounted for as PPE.

5.5 MEASUREMENT AT RECOGNITION – IAS 16.15–28

A PPE-item that qualifies for recognition as an asset shall be measured at its cost.

Elements of cost
The cost of an PPE-item comprises:
(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting
trade discounts and rebates.
(b) any costs directly attributable to bringing the asset to the location and condition necessary for it
to be capable of operating in the manner intended by management.
(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on
which it is located. This obligation can arise either when the item is acquired or as a consequence of having
used the item during a particular period for purposes other than to produce inventories during that period.

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Examples of directly attributable costs are:
(a) costs of employee benefits arising directly from the construction or acquisition of the PPE-item;
(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;
(e) costs of testing whether the asset is functioning properly, after deducting the net proceeds from
selling any items produced while bringing the asset to that location and condition (such as samples
produced when testing equipment); and
(f) professional fees.

An entity applies IAS 2 Inventory to the costs of obligations for dismantling, removing and restoring the
site on which an item is located that are incurred during a particular period as a consequence of having
used the asset to produce inventories during that period. (This implies that these costs will be capitalised
to inventory and not to the PPE-item.)
Examples of costs that are not costs of a PPE-item are:
(a) costs of opening a new facility;
(b) costs of introducing a new product or service (including costs of advertising and promotional
activities);
(c) costs of conducting business in a new location or with a new class of customer
(including costs of staff training); and
(d) administration and other general overhead costs.

Recognition of costs in the carrying amount of a PPE-item ceases when the item is in the location and
condition necessary for it to be capable of operating in the manner intended by management. Therefore,
costs incurred in using or redeploying an item are not included in the carrying amount of that item. For
example:
(a) costs incurred while an item capable of operating in the manner intended by management has yet to
be brought into use or is operated at less than full capacity;
(b) initial operating losses, such as those incurred while demand for the item's output builds up; and
(c) costs of relocating or reorganizing part or all of an entity's operations.

Some operations occur in connection with the construction or development of a PPE-item, but are not
necessary to bring the item to the location and condition necessary for it to be capable of operating in the
manner intended by management. For example, income may be earned through using a building site as a
car park until construction starts. Income and related expenses of such incidental operations are not
included in the carrying amount of that item, but are recognised in profit or loss and included in their
respective classifications.
The cost of a self-constructed asset is determined using the same principles as for an acquired asset. Any
internal profits are eliminated in arriving at such costs. Similarly, the cost of abnormal amounts of wasted
material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the
asset.

MEASUREMENT OF COST
Abnormal credit terms
The cost of an PPE-item is the cash price equivalent at the recognition date. If payment is deferred beyond
normal credit terms, the difference between the cash price equivalent and the total payment is recognised
as interest over the period of credit (unless such interest is recognised in the carrying amount of the item
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in accordance with the allowed alternative treatment in IAS 23 – however, capitalisation of finance costs
do not form part of this module).

Exchange (swap) of PPE-items (IAS 16.24)

One or more PPE-items may be acquired in exchange for monetary or nonmonetary asset(s) or a
combination of both. The cost of the acquired item is measured at fair value unless (a) the exchange
transaction lacks commercial substance or (b) the fair value of neither the asset received nor the asset
given up is reliably measurable. In both cases the asset that is acquired, is measured at the carrying value
of the asset given up.
An entity determines whether an exchange transaction has commercial substance by considering the
extent to which its future cash flows (after tax) are expected to change as a result of the transaction. An
exchange transaction has commercial substance if:
(a) the configuration (risk, timing and amount) of the cash flows of the asset received differs from the
configuration of the cash flows of the asset transferred; or
(b) the entity-specific value of the portion of the entity's operations affected by the transaction (after
tax cash flows) changes as a result of the exchange; and (c) the difference in (a) or (b) is significant relative
to the fair value of the assets exchanged.
When the fair values of both the acquired asset and the asset given up can be measured reliably, then the
fair value of the asset given up is used to measure the cost of the asset received unless the fair value of
the asset received is more evident, in which case it can be used.

EXAMPLE
Bob Ltd entered into the following exchange transactions during the year ended 30 June 20.10:
Transaction 1
A motor vehicle with a carrying amount of R100 000 in the records of Bob Ltd and a fair value of R120 000
was exchanged for a light delivery vehicle of Zaz Ltd with a fair value of R125 000. The fair values of both
vehicles can readily be determined since there is an active market for used vehicles.
Transaction 2
A machine of Bob Ltd with a carrying amount of R90 000 was exchanged for a machine of Yk Ltd which is
carried in Yk's records at R80 000. The fair values of neither of the machines could be readily determined.
Transaction 3
A computer network system of Bob Ltd with a carrying amount of R160 000 was exchanged for furniture with
a carrying amount of R170 000 in the records of Xi! Ltd. The fair value of the network system cannot be
determined readily as this item is seldom sold in its entirety, but based on probabilities the fair value is
estimated at R150 000. The fair value of the furniture is R165 000 and is readily determinable because an
active market exists for these used assets.
Transaction 4
Bob Ltd exchanged a truck with a carrying value of R200 000 for a similar truck with the same age and
condition of WOW Ltd. The truck of Bob Ltd has blue stripes painted on the sides and the other truck has
silver stripes which is more to the liking of the managing director of Bob Ltd. The fair value of the blue striped
truck is R210 000 and that of the silver striped truck is R220 000, which indicates that the silver striped truck
is more popular.
EQUIRED
Calculate for each transaction the amount at which the new asset acquired from the exchange should be
measured in the financial statements of Bob Ltd according to the requirements of International Financial
Reporting Standards. Motivate your answer by reference to IAS 16.

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SOLUTION
Transaction 1
The delivery vehicle will be measured at R120 000. (IAS 16.26) Transaction 2
The acquired machine will be measured at R90 000, the carrying amount of the machine given up. (IAS
16.24)
Transaction 3

The furniture will be measured at R165 000, its fair value, since it is more readily determinable than the
fair value of the asset given up. (IAS 16.26 (last part).)
Transaction 4
The silver stripe truck will be measured at R200 000. This transaction is without commercial substance
and the carrying amount of the blue stripe truck given up is used as the cost of the acquired truck. (IAS
16.24, 25)

You may now study example 9.1, 9.2, 9.4 and 9.4 from chapter 9 in the
prescribed textbook (Pretorius, D., Badenhorst, W. M. and Kotze, L.J.
2018. GAAP Handbook 2018 Volume 1 & 2: Financial Accounting and
Reporting Practice. South Africa: LexisNexis.).

5.6 MEASUREMENT AFTER RECOGNITION – IAS 16.29–66

An entity shall choose, after the initial recognition of a PPE-item, either the cost model or the revaluation
model as its accounting policy and shall apply that policy to an entire class of property, plant and
equipment.

Cost model
After recognition as an asset, a PPE-item shall be carried at its cost less any accumulated depreciation and
any accumulated impairment losses.

Revaluation model – IAS 16.31–42

Depreciation – IAS 16.43–62

Traditionally there are different points of departure regarding the nature of depreciation within the
context of historical cost. The three most important views regard depreciation as a process of:
• valuation, or
• capital maintenance, or
• cost allocation.

IAS 16 follows the point of view that depreciation is a process of cost allocation. IAS 16.6 and 50 states
that depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The
standard also allows a revaluation amount to be the depreciable amount.

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Depreciable items of property, plant and equipment
Each part of a PPE-item with a cost that is significant in relation to the total cost of the item shall be
depreciated separately.
An entity allocates the amount initially recognised in respect of a PPE-item to its significant parts and
depreciates separately each such part. For example, it may be appropriate to depreciate separately the
airframe and engines of an aircraft. A significant part of a PPE-item may have a useful life and a
depreciation method that are the same as the useful life and the depreciation method of another
significant part of that same item. Such parts may be grouped in determining the depreciation charge.
To the extent that an entity depreciates separately some parts of a PPE-item, it also depreciates separately
the remainder of the item. The remainder consists of the parts of the item that are individually not
significant. If an entity has varying expectations for these parts, approximation techniques may be
necessary to depreciate the remainder in a manner that faithfully represents the consumption pattern
and/or useful life of its parts.
An entity may choose to depreciate separately the parts of an item that do not have a cost that is significant
in relation to the total cost of the item.

Where is depreciation recorded?

The depreciation charge for each period shall be recognised in profit or loss unless it is included in the
carrying amount of another asset.
The depreciation charge for a period is usually recognised in profit or loss. However, sometimes, the future
economic benefits embodied in an asset are absorbed in producing other assets. In this case, the
depreciation charge constitutes part of the cost of the other asset and is included in its carrying amount.
For example, the depreciation of manufacturing plant and equipment is included in the costs of conversion
of inventories. Similarly, depreciation of PPE for development activities may be included in the cost of an
intangible asset.

Depreciable amount
The depreciable amount of an asset shall be allocated on a systematic basis over its useful life.
The residual value and the useful life of an asset shall be reviewed at least at each financial year-end and,
if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an
accounting estimate in accordance with IAS 8.
Depreciation is recognised even if the fair value of the asset exceeds its carrying amount, as long as the
asset's residual value does not exceed its carrying amount.
Repair and maintenance of an asset do not negate the need to depreciate it.
The depreciable amount of an asset is determined after deducting its residual value. In practice, the
residual value of an asset is often insignificant and therefore immaterial in the calculation of the
depreciable amount.
The residual value of an asset may increase to an amount equal to or greater than the asset's carrying
amount. If it does, the asset's depreciation charge is zero unless and until its residual value subsequently
decreases to an amount below the asset's carrying amount.

Period of depreciation
Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition
necessary for it to be capable of operating in the manner intended by management. Depreciation of an
asset ceases at the earlier of the date that the asset is classified as held for sale and the date that the asset
is derecognised. Therefore, depreciation does not cease when the asset becomes idle or is retired from

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active use unless the asset is fully depreciated. However, under usage methods of depreciation the
depreciation charge can be zero while there is no production.

Useful life
The future economic benefits embodied in an asset are consumed by an entity principally through its use.
However, other factors, such as technical or commercial obsolescence and tax allowance while an asset
remains idle, often result in the diminution of the economic benefits that might have been obtained from
the asset. Consequently, all the following factors are considered in determining the useful life of an asset:
(a) expected usage of the asset. Usage is assessed by reference to the asset's expected capacity or
physical output.
(b) expected physical tax allowance. This depends on (i) operational factors such as the number of
shifts for which the asset is to be used and the repair and maintenance program, and (ii) the care and
maintenance of the asset while idle.
(c) technical or commercial obsolescence. This arises (i) from changes or improvements in production,
(ii) or from a change in the market demand for the product or service output of the asset.
(d) legal or similar limits on the use of the asset, such as the expiry dates of related leases.

The useful life of an asset is defined in terms of the asset's expected utility to the entity. The asset
management policy of the entity may involve the disposal of assets after a specified time or after
consumption of a specified portion of the future economic benefits embodied in the asset. Therefore, the
useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset
is a matter of judgement based on the experience of the entity with similar assets.

Useful life of land and buildings

Land and buildings are separable assets and are accounted for separately, even when they are acquired
together. With some exceptions, such as quarries and sites used for landfill, land has an unlimited useful
life and therefore is not depreciated. Buildings have a limited useful life and therefore are depreciable
assets. An increase in the value of the land on which a building stands does not affect the determination
of the depreciable amount of the building.

If the cost of land includes the costs of site dismantlement, removal and restoration, the restoration cost
portion of the land asset is depreciated over the period of benefits obtained by incurring those costs. In
some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that
reflects the benefits to be derived from it.

Depreciation methods and their recognition – IAS 16.60–62

The depreciation method used shall reflect the pattern in which the asset's future economic benefits are
expected to be consumed by the entity.
The depreciation method applied to an asset shall be reviewed at least at each financial year-end and, if
there has been a significant change in the expected pattern of consumption of the future economic
benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change
shall be accounted for as a change in an accounting estimate in accordance with IAS 8. A variety of
depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis
over its useful life, namely:
The straight-line method: depreciation results in a constant charge over the useful life if the asset's residual
value does not change. This allocation of depreciation in fixed instalments is usually adopted where the
income produced by the asset or part of it is a function of time rather than usage and where the repair
and maintenance charges are fairly constant.
106
The diminishing balance method: depreciation results in a decreasing charge over the useful life of the
asset. The allocated amount of depreciation declines on an annual basis. The method is usually used where
there is uncertainty as to the amount of income that will be derived from the asset, especially in
subsequent years, and where the effectiveness of the asset is expected to gradually decline.
The repair and maintenance costs will usually increase as an asset ages. The total debit for the cost of the
asset will therefore remain fairly constant.
The units of production method (or: sum of the units method): depreciation is a charge based on the
expected use or output of the asset.

The entity selects the method that most closely reflects the expected pattern of consumption of the future
economic benefits embodied in the asset. That method is applied consistently from period to period unless
there is a change in the expected pattern of consumption of those future economic benefits.

Revaluation surplus
A revaluation surplus should be realised either immediately through disposal, or gradually through usage
in line with depreciation.

In this module we will assume that it is not the policy of the company to realise the revaluation surplus
through use and therefore the full amount of the revaluation surplus will be transferred to retained
earnings on the date of recognition.

Refer to the following illustrative examples for accounting for property, plant and equipment.

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 TOPIC 6

FINANCIAL REPORTING: MANUFACTURING ENTERPRISES

LEARNING OUTCOMES

After studying this topic, you should be able to:

• demonstrate detailed knowledge of the main areas of
financial reporting for manufacturing concern, including an
understanding of and the ability to apply the key terms,
concepts, facts, principles, rules and theories of financial
reporting for manufacturing entities to unfamiliar but relevant
contexts; and knowledge of the principle of disclosure.
• prepare the financial statements for manufacturing entities.

There is no prescribed material for this topic. However, for further

reading, you may refer to the chapter 27 in the following textbook:
Flynn, D.K., Koornhof, C., Kleynhans, J.E., Meyer, L.A., Posthumus, L.
Arendse, R. and Muriro, E. 2014.
Fundamental Accounting. 6th ed. Cape Town: Juta & Co
Ltd.

6.1 MANUFACTURING CONCERNS

A trading concern buys and sells manufactured goods. In contrast, a manufacturing

enterprise buys raw materials, processes it and then sells the manufactured products. Thus,
a furniture factory buys timber, etc. which it then uses to manufacture furniture, which is
then sold to furniture stores (trading concerns) who in turn will sell the furniture to
customers.

6.2 THE COMPONENTS OF MANUFACTURING COSTS

The three most important components of manufacturing costs are material, labour, and
manufacturing overheads.

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Direct material
Raw material (material) is one of the primary components of manufacturing costs. The raw
material is that material which is used in the manufacturing process and which is readily
identifiable and measurable as an integral part of the finished product. For example, in the
manufacturing of wooden tables, the wood would be the direct material required. If the feet
of the tables are made from steel and the top from wood, then steel and wood are the direct
materials used.

Direct Labour
Direct labour refers to the labour costs of factory personnel directly involved in the
manufacturing of the product. For example, in the manufacturing of the tables they would
be the workers who measure, saw, plane and assemble the wood.

Primary costs
The total of the monetary value of direct value material (raw material) used and direct labour
incurred is called primary costs because these two components (material and labour) make
up the bulk of production costs.

Manufacturing overheads
Manufacturing overheads include all the other expenses incurred in the manufacturing
process. To make it easier to understand manufacturing
overheads we will discuss this topic under the following headings:

Indirect material
This is the portion of material used in the production process which cannot readily be
identified as a basic component of the finished product. It also refers to those materials used
in such small quantities that it is not worth the effort to calculate its cot per unit of
manufactured product. In our example of the manufacture of tables the glue, sanding paper,
screws, nails, etc. would be treated as indirect materials.

Indirect Labour
Indirect labour includes the remuneration of employees not directly involved in the
manufacturing process. Examples of indirect labour costs are the wages paid to factory
cleaners, security personnel and the salary of the factory foreman.

Other overhead costs

In addition to indirect material and indirect labour costs all other costs incurred in the
manufacturing process and not identified as direct material or direct labour must be included
under manufacturing overhead costs. Examples of the overhead costs are the depreciation
on factory, plant and equipment, rent paid for the factory building, water and electricity
consumed and insurance paid. Selling and administration expenses do not fall under the

140
 manufacturing overheads. These costs are in no way connected to the manufacturing
process.

Fixed costs
A cost that does not vary depending on production or sales levels, such as rent, insurance or
interest expense. Fixed costs are made up of two components namely direct and indirect
costs.

Variable costs
These are expenses that change in preparation to the activity of a business. This is the sum
of marginal costs over all unit produced.

6.3 THE INCOME STATEMENT OF A MANUFACTURING CONCERN

There is a small difference between the income statement prepared by manufacturing

companies and income statement prepared by merchandising companies. Manufacturing
companies also calculate cost of goods manufactured in their income statement. This
calculation is not required by merchandising companies.

Following is an example of the statement of profit or loss and other comprehensive income
of a manufacturing company:

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Sales 24750000
Direct Materials
Materials Inventory 1 January 2015 1572400
Purchases 8420000
Less: Purchases returns and allowances 42000 8378000
Materials available for use 9950400
Less: Materials Inventory 31 Dec 2015 1270600
Direct Materials Consumed 8679800
Direct Labour 7346400
Indirect Labour 1329300
Salaries 972000
Payroll Taxes 489000
Power 112000
Heat 69200
Light 44300
Factory Supplies 50000
Depreciation: Factory Building 68300
Depreciation Machinery 403000
Repairs and Maintenance 145800
Patent Amortization 33200
Tools and Dies Used 178600
Insurance on Building and machinery 21200 3915900
Total Manufacturing Cost 19942100
Add Work in process
Inventory 1 Jan 2015 2338000
Cost of Goods Manufactured 20976900
Add Finished goods Inventory1 Jan 2015 966100
Cost of Goods Available for Sale 21943000
Less Finished Goods Inventory31 Dec2015 -658000
-
Cost of goods sold
21285000
Gross Profit 3465000
Less Commercial Expenses:
Marketing Expenses 580000
Administrative Expenses 533750 -1113750
Income From Operation 2351250
Other Income and Expenses:
Royalties and Dividends 167000
Gain from sales of Plant 12000
179000
Interest and Debt Expenses -129500
Net Addition 49500
Income before Income tax 2400750
Less Income Tax -1064250
1336500

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6.4 UNREALISED PROFIT IN STOCK
It often happens that completed goods are transferred to the sales department at cost plus
a certain percentage profit. The purpose of adding a percentage profit on cost is to equalize
the production price with the wholesale price normally applicable to the purchasing of
similar products.

The profit calculated in the manufacturing account is actually an unrealized profit on the
unsold portion of the finished products at the end of the period. The manufacturing profit is
realised only when all the products have been sold. It is therefore essential to provide for
this unrealized profit on unsold products.

FINANCIAL STATEMENTS OF A MANUFACTURING ENTERPRISE

Manufacturing concerns prepare the following statements:

• Production cost statement: It is a vertical representation of the raw materials stock
account and the work in progress stock account from the General ledger and shows the
cost of production of finished goods over the financial period.
• Trading statement: is used to calculate the gross profit.
• Profit and loss statement: is used to calculate the net profit.
The Statement of Financial Position (Balance sheet) is similar to the Balance Sheet of a sole
trader, with only slight differences to the Notes

NB: The Trading Statement and Profit and Loss Statement are sometimes replaced with the
Statement of Comprehensive Income
(Income statement)

FORMAT OF THE PRODUCTION COST STATEMENT

Notes Amount
Direct cost:
Direct material costs
Direct labour costs 1 xx xx
Manufacturing costs 2 xx xxx
Total manufacturing overhead costs 3 xx
Add: Work-in progress at beginning of year
(xx) xxxx
Less: Work-in progress at end of year
Cost of production of finished goods

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NOTES TO THE FINANCIAL STATEMENT OF XYZ FOR THE YEAR ENDED 28 FEBRUARY 2009

1 Direct material costs xxx Opening raw materials inventory xxx

Add: Purchases of raw materials(less: returns) xxx
Add: Carriage/railage/freight on purchases of raw materials/custom
duties/import tariffs. xxx
Less: Closing raw material used in production. xxx
2
Direct labour costs xxx
Factory wages xxx
Add: Pension fund contribution: factory xxx
Medical Aid contribution: factory workers xxx
UIF contribution: factory workers xxx
3
Manufacturing overhead costs: xxx
Indirect material. xxx
Indirect labour xxx
Depreciation: factory equipment xxx
Maintenance: factory equipment xxx
Rent of factory buildings xxx
Water and electricity: factory xxx
Insurance: factory xxx

ANALYSIS AND INTERPRETATION OF THE PRODUCTION COST STATEMENT CALCULATIONS USED BY

MANUFACTURERS

1. Direct material cost per unit = Direct material costs Total units produced
2. Direct labour cost per unit = Direct labour cost
Total units produced
3. Total direct cost per unit (i.e. Prime cost per unit) =Total direct cost
Total units produced
4. Manufacturing overhead costs per unit = Manufacturing overhead costs
Total units produced
5. Total production cost per unit = Cost of production of finished goods Total units produced

The interpretation of the results of each of the calculations is

valid if the results of the same calculations for the previous years
are available, or if the budgeted costing figures are available.

Comprehensive example – Financial statements of a manufacturing company

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 The following information was obtained from the financial records Peninsula Manufacturing LTD for the
year ended 30 June 2017:

Inventories 1 July 2016 30 June 2017

R R
Finished product 1 600 1 800
Work-in-progress 600 950
Raw materials (direct) 3 000 3 500

Provision for unrealized profit in inventory of finished products (1 July 2016) R

Raw materials purchased (direct) 400
direct wages Factory 25 000
rental 12 000
Freight on raw material purchased 3000
Depreciation on factory equipment 300
Delivery expenses on sale 150
Depreciation on delivery 250
vehicle
50
Electricity (factory 75% and administration 25%) Sales
1 200

Additional information:
1. Products are transferred to the sales department at cost 33⅓%.
2. During the year 300 units were completed.
3. The SA normal income tax for the financial year amounted to R8 700

REQUIRED:
a) Prepare the manufacturing cost statement of Peninsula Manufacturers BP LTD for the year ended
30 July 2017.
b) Prepare the statement of profit or loss and other comprehensive income of Peninsula
Manufacturers LTD for the year ended 30 June 2017.
c) Calculate the cost price per unit manufactured during the year.

NB: show all calculations.

SUGGESTED SOLUTION:
Comprehensive example – Financial statements of a manufacturing company

PENINSULA MANUFACTURERS LTD

MANUFACTIRING COST STATEMENT FOR THE YEAR ENDED 30 JUNE 2017
R
Direct materials used 24 800
Inventory: Raw materials (1 July 2016) 3 000

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 Purchase 25 000
Freight on purchase 300
Inventory: Raw materials (30 June 2017) 28 300 (3500)
Direct labour 12 000
Primary costs 36 800
Manufacturing overheads 4 050
Factory rental 3 000
Depreciation (factory equipment) 150
Electricity (75% × R1 200) 900

Total manufacturing costs 40 850

Inventory: work-in-progress (1 July 2016) 600

Inventory: work-in-progress (30 July 2017) 41 450

(950)
Cost of finished product manufactured 40 500 Manufacturing profit (33⅓% × R40 500) 13 500
Cost of finished products manufactured transferred to sales department 54 000

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 PENINSULA MANUFACTURERS LTD
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 30
JUNE 20.1
R
Revenue 70 000
Cost of sales (53 800)
Inventory: finished product (1 July 2016) 1 600
Cost of finished product transferred 54 000
55 600
Inventory: finished product (30 June 2017) (1 800)
Gross profit 16 200
Manufacturing profit 13 500
29 700
Distribution, administrative and other expenses (650)
Delivery expenses on sale 250
Depreciation (delivery vehicle) 50
Electricity (25% × R1 200) 300
Unrealized profit in inventory of finished products 50
Profit before tax 29 050
Income tax expense (8 700)
Profit for the year 20 350
DETERMINATION OF UNIT COST OFF GOODS MANUFACTURED
Cost of finished goods manufactured ÷ Total number of units manufactured
R 40 500 / 300 units
= R 135 per unit

Calculations
Adjustment of provision for unrealized profit in inventory of finished products
33⅓ = 1/4 × R1 800 R
133 1 = 450
(400)
Existing provision 50

REVIEW QUESTIONS

You may now attempt question 1 – 3 below.

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QUESTION 1

California Beach Manufacturers produces beach umbrellas. The information below relates to the
manufacturing activities for the year ending 30 June 2017.
30/06/2016 30/06/2017
R R
Manufacturing machinery at carrying value 580 000 ?
Raw material inventory 35 000 44 000
Work-in-progress 28 000 39 000
Finished umbrellas 14 000 18 000
Purchases: Raw materials 230 000
Carriage on raw materials 12 000
Labour:
Direct 141 000
Indirect 77 000

Rent of building (80% manufacturing) 50 000

Maintenance of machinery 9 000
Insurance (R1 000 administrative) 13 000
Municipal services (90% manufacturing) 38 000
Sundry selling and administrative expenses 186 000
Sales of umbrellas 900 000

Additional information
4. Depreciation on the manufacturing machinery should be provided at 15% per annum on the
carrying amount.
5. Direct wages of R8 000 and municipal services of the factory of R1 800 should be provided.
6. During the year 20 000 beach umbrellas were completed.

REQUIRED:

Prepare the Production Cost Statement for the year ended 30 June 2017.

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QUESTION 2
The following information relates to BIGTIME MANUFACTURERS for the year ended 31 March 2011:
R
Capital: B Bently 190 700
Factory buildings 79 307
Factory plant and machinery 40 000
Accumulated depreciation: Plant and machinery 8 500
Vehicles 30 000
Vehicles 50 000
Inventory (1/04/2010): Raw
materials 17 810
Finished goods 22 770
Debtors 41 700
Provision for credit losses 4 000
Petty cash 350
Bank (favourable) 36 000
Creditors 51 100
Raw materials purchased 46 010
Raw materials returned 2 010
Carriage on purchases 5 500
Repairs:
Factory plant and machinery 2 800
Vehicle of sales representative 1 500

Salaries 48 463
Direct labour 40 000
General sundry expenses 20 500
Insurance 6 000
Water and electricity 5 000
Fuel and oil 2 600
Sales 185 000

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Additional information
1. Inventories at 31 March 2011:

Raw materials R22 200

Finished goods R84 440

2. Salaries consist of:

Administrative personnel R15 463

Production shop steward R33 000.

3. Direct labour pertains to the factory with the exception of R1 150 paid to the cleaner.

4. General sundry expenses were allocated as follows:

• 75% factory
• 25% administrative

5. Depreciation should be provided as follows:

• Plant and equipment at 15% on the diminishing balance Vehicles at 20% on the
diminishing balance.
(Vehicles with a cost price of R15 000 and accumulated depreciation of R5000 are used exclusively
in the manufacturing process for the transport of raw materials.)

6. Insurance included an amount of R3500 in respect of the administrative section. Included in the
factory insurance is an amount of R1 200 paid on 1 February 2011 for the following 12 months.

7. Fuel and oil are allocated to the manufacturing section according to the carrying amount of vehicles
used in the factory. (Carrying amount at 31 March 2011)

8. Water and electricity account not yet paid on 31 March 2011 amounted to R700.

REQUIRED:
1. Prepare the Production Cost Statement for the year ended 31 March 2011.
2. Prepare the Statement of Comprehensive Income for the year ended 31
March 2011.

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 QUESTION 3

The following information pertains to Globe Manufacture LTD.

Statement of financial position as at 28 February 2011

R Purchases of direct raw materials

115 500Transport costs on the purchase of direct raw materials

8 400
Purchases returns of direct raw materials 21 000
Inventories: 1 March 2010
Raw materials (direct) 63 000
Work-in-progress 42 000
Finished products 31 500
Direct labour 52 500
Indirect labour 21 000
Salary-factory foreman 35 700
Maintenance-factory 7 875
Electricity consumed (75% relates to the factory) 6 300
Rental expenses (80% relates to the factory) 18 900
Depreciation: Manufacturing equipment 31 300
Office furniture 2 250
Salaries-administrative personnel 37 800
Sales 525 000
Selling expenses 4 000
Interest on bank loan overdraft 21 000

Additional information
R
1. Inventories: 28 February 2011
Raw materials 60 000
Work-in-progress 73 200
Finished products 73 500
2. Salaries and wage due at 28 February 2011 R

Direct labour 1 500

Indirect labour 6 000

Administrative personnel 1 200
3. SA normal income tax the year ended 28 February 2011 amounts to R 73 433

REQUIRED
a) Prepare the manufacturing cost of Globe Manufacturers for the year ended 28 February 2011.
b) Prepare the statement of profit or loss and other comprehensive income of Globe Manufacturers
for the year ended 28 February 2011.

NB show all the calculations

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 TOPIC 7

ADDENDUM 621 (A): REVIEW QUESTIONS

QUESTION ONE (60 MARKS)

Part A

Ernst Young and Cash Gates were discussing basic accounting concepts one Friday evening, after
attending lectures in the afternoon in March 2003.

Ernst: My father has a motor repair business and he has asked me whether the following are assets of his
business for purposes of reporting in the statement of financial position at the end of the financial year,
which is 31 December 2002:

• A spanner purchased in 2001 for R250 (estimated useful life 4 years)

• Equipment hired on a weekly basis from ‘The Weekly Hire Company’, and
• The good reputation (goodwill) of the business with its customers.”
You are required to:

Explain whether you regard each of the above as an asset. Justify your answer with specific reference to
the IAS framework. (20)

Part B

A company uses specialized machinery in the process of manufacture. The company sends an invoice
which transfers the ownership of one of these machines to a purchaser. The purchaser, however, is
building new premises and will be unable to use the machine until the new premises are completed.
The seller will therefore continue to use the machine until the premises are completed.

You are required to:

Explain briefly the treatment of the machine in the financial statements of the seller company if the
statements are prepared BEFORE the purchaser’s premises are completed. Specific reference should be
made to the qualitative characteristics of financial information in the conceptual framework, especially
substance over form. (5)

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Part C

Ignore VAT.

Round up to nearest rand.

Beta Foil Manufacturers is a firm specialising in the manufacturing of foil chocolate wrappers and chip
packets. The accounting department personnel of Beta Foil Manufacturers provided the following
financial information on 31 December 2011:

1.
Type of asset Cost Date of purchase Residual value Depreciation Rate of
method depreciation
Machine A R1 200 000 1 January 2008 R50 000 Straight-line 20% per annum

2. On 1 January 2011, without disruption operations, Machine A was improved. After the
improvements had been made the firm decided to re-estimate the depreciation rate for Machine A as
follows:
Type of asset Improvement New useful life Residual value Depreciation Rate of
cost from 1 Jan 2011 method depreciation
Machine A R490 000 5 years R80 000 Straight-line 20% per
annum

3. On 1 October 2011, machine A broke down and was damaged beyond repair. The insurance
company was prepared to pay only R550 000.

You are required to:

Prepare the asset disposal account, as it would appear in the general ledger after the necessary general
journal entries have been recorded and posted. (The account must be properly closed off.) (19)

Part D

Delux Traders reported the following information in its 2012 annual financial statements:
2012 2011
R R
Statement of financial position
Inventory 187 600 173 500
Trade payables 67 450 73 900

Statement of comprehensive income

Cost of sales 763 500 691 890

153
Assume that Delux Traders uses the perpetual method of recording inventory and 80% of all its inventory
purchases are on credit.

You are required to:

1. Calculate the total purchases for the year 2012 (8)

2. Calculate the amount of cash paid to creditors during 2012 (8)
QUESTION TWO (40 MARKS)

Malright, a limited liability company, has an accounting year end of 31 October. The accountant is
preparing the financial statements as at 31 October 20X7 and requires your assistance. The
following trial balance has been extracted from the general ledger

ACCOUNT Dr Cr
R’000 R’000
Buildings at cost 740

Buildings accumulated depreciation, 1 November 20X6 60

Plant at cost 220

Plant accumulated depreciation, 1 November 20X6 110

Bank balance 70
Revenue 1 800
Net purchases 1 140

Inventory at 1 November 20X6 160

Cash 20

Trade payables 250

Trade receivables 320

Administrative expenses 325

Allowance for receivables at 1 November 20X6 10

Retained earnings at 1 November 20X6 130
Equity shares, R1 415
Share premium account 80
–––––– ––––––
2 925 2 925
–––––– ––––––
The following additional information is also available:
– The allowance for receivables is to be increased to 5% of trade receivables. The allowance for
receivables is treated as an administrative expense.
– Plant is depreciated at 20% per annum using the reducing balance method and buildings are
depreciated at 5% per annum on their original cost. Depreciation is treated as a cost of sales expense.
– Closing inventory has been counted and is valued at R75 000.
– An invoice of R15 000 for energy costs relating to the quarter ended 30 November 20X7 was received
on 2 December 20X7. Energy costs are included in administrative expenses.

REQUIRED:
Prepare the statement of profit or loss and the statement of financial position of Malright Co as at 31
October 20X7.
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 TOPIC 8

ADDENDUM 621 (B): TYPICAL TEST QUESTIONS

THEORY BASED QUESTIONS:

QUESTION ONE (10 MARKS)

Definition and recognition criteria for an asset

Chemco Ltd. is engaged in the production of chemical products and selling them locally. The company
wishes to extend its market and export some of its products. It has come to the attention of the financial
director that compliance with international environmental requirements is a significant precondition if it
wishes to sell products overseas. Although Chemco Ltd. has during the past put in place a series of
environmental policies, it is clear that it is also common practice to have an environmental audit done
from time to time, which will cost approximately EUR 120,000. The audit will encompass the following:
• a full review of all environmental policy directives;
• a detailed analysis of compliance with these directives;
• a report containing in-depth recommendations of those physical and policy changes that would be
necessary to meet international requirements.
The financial director of Chemco Ltd has suggested that the amount be capitalised as an asset and then
written off against the revenues generated from export activities so that the matching of income and
expense will occur. Do you agree with the financial director? Explain why.

APPLICATION TYPE QUESTIONS

QUESTION ONE (20 MARKS)

SME A incurred (and paid) the following expenditures in acquiring an administration building and the
land on which it is built:

Date Amount Additional Information

01 January 2011 200 000 000 20 per cent of the price is attributable to the land
01 January 2011 20 000 000 Non Refundable transfer taxes (Not Included in the
200 000 000 purchase price
01 January 2011 1 000 000 Legal Costs directly attributed to the acquisition
01 January 2011 10 000 Reimbursing the previous owner for prepaying the non-
refundable local government property taxes for the 6
month period ending 30 June 2011
30 June 2011 20 000 Non-refundable annual local government property taxes
for the year ending 30June 2012

Throughout 2011 120 000 Day-to-day repairs and maintenance, including the salary and other costs
of the administration and maintenance staff. These costs are attributable equally to each of the
10 units.

155
 At 31 December 2011 SME A made the following assessments: Useful
life of the building: 50 years from the date of acquisition
Residual value of the building: R20 000 000
The entity will consume the building’s future economic benefits evenly over 50 years from the
date of acquisition
Fair value less costs to sell of the land and building: R250 000 000.

REQUIRED:
Prepare accounting entries to record the effects of the property, plant and equipment in the accounting
records of SME A for the year ended 31 December 2011.

156