ACCOUNTING

MY NOTES
st
1 EDITION

1
About this book
This booklet is just a combination of different sources that were accessible to the compiler of
these notes. Everyone who will be able to get this copy, it is advisable to use it as your extra
notes ONLY IF approved by your teacher or helper or whoever you trust when it comes to
your studies. Some notes consisted in this book were based on my understanding of this
subject. I urge users of this book to love accounting, pay attention in class, discuss in groups
and research more on every aspect they do not understand. I hope this book would be of help
and someone will benefit from it. It is my wish to improve on the next edition of this book. If
any need to contact and want a soft copy you can email at [email protected]

Acknowledgements
- Internet sources

Textbooks
1. Turn-up college – “A” Level Accounting
2. H. Randall – A Level Accounting 3rd edition
3. Frank Wood’s Business Accounting (Tenth edition)

Dedicated to:

Mr N.Z who taught me that it is in vain if you have acquired knowledge and
you have not imparted it to others. One love my brother as you always say
“sharing knowledge is easy only if one is willing to share what they know”.

God bless.

July 2016

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ACCOUNTING CONCEPTS / ACCOUNTING PRINCIPLES
Generally, a principle is a fundamental truth that is always accepted. However in accounting,
principles relate to an accepted guidance or method.
These principals include:
Accruals concept
-business transactions are recorded when they occur and not when the related payments are
received or made.
Going concern concept
-financial statements are prepared assuming that the company is a going concern which
means that the company intends to continue its business and is able to do so.
Business entity concept
-in accounting we treat a business or organisation and its owners as two separately
identifiable parties.
-it means that personal transactions of owners are treated separately from those of the
business, thus personal transactions of the owners are not mixed up with the transactions and
accounts of the business.
Monetary unit assumption
-n accounting we can communicate only those business transactions and other events which
can be expressed in monetary units.
Historical cost concept
-accounting is concerned with past events and it requires consistency and comparability that
is why it requires the accounting transactions to be recorded at their historical costs.
-the concept of historical cost is important because market values change so often that
allowing reporting of assets and liabilities at current values would distort the whole fabric of
accounting, impair comparability and makes accounting information unreliable.
Matching principle
-in order to reach accurate net income (profit) figure, the expenses incurred to earn the
revenues recognised during the accounting period should be recognised in that time period
and not in the next or previous.
-this goes with the accruals principle
Substance over form
-while accounting for business transactions and other events, we measure the economic
impact of an event instead of its legal form.
Example

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A lease might not transfer ownership to the leasee but the lease has to record the leased items
as an asset if it intends to use it for major portion of its useful life or where the present value
of lease payment is fairly equal to the fair value of the asset. Although legally the leasee is
not the owner, so the leased item is not his asset, but from the perspective of the underlying
economics the leasee is entitled to the benefits embedded in the use of item and hence
recorded as an asset.
Consistency concept
-the concept of consistency means that methods once adopted must be applied consistently in
future.
-also same methods and techniques must refrain from changing its accounting policy unless
on reasonable grounds.
-consistency concept is important because of the need for comparability, that is, it enables
investors and users of financial statements to easily and correctly compare the financial
statements of a company.
Prudence concept
-this accounting principle states that assets and income are not overstated and liabilities and
expenses are not understated.

Users of financial statements



Owners / Shareholders


Potential investors


Management


Providers of finance e.g. banks or other financial institutions


Trade relations


Employees


Government and its agencies


Financial analysts, Stock brokers, Financial journalists
Tax authorities
Task-find the information needs of each of these users.

Research on manual accounting systems and computerised accounting systems

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ERRORS AND SUPENSE ACCOUNTS
Errors where a trial balance still balances:


Error of omission


Error of commission


Error of principle


Compensating error


Error of original entry


Reversal of entries
Transposition error
-these errors do not affect the suspense account.
Errors where a trial balance does not balance:
 Single sided entry – a debit entry has been made but no corresponding credit entry


made or vice versa
Miscasting – an incorrect addition in any individual account


Debit and credit entries have been made but at different values
Extraction error – the balance in the trial balance is different from the balance in the


relevant account


Opening balance has not been brought down
Two entries have been made on the same side
-correction to any of these errors will affect the suspense account
-if there is difference on the trial balance, a suspense account is used to make the total debits
equal the total credits.
-above all, errors that affect net profit should be adjusted in the income statement and those
affecting assets, liabilities and part of the equity must be adjusted in the statement of financial
position (Balance sheet)
Suspense accounts
-a suspense account is an account in which debits or credits are held temporarily until
sufficient information is available for them to be posted to the correct accounts.
-suspense accounts must be dealt with according to the usual rules of double entry book-
keeping.

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BANK RECONCILIATION
-objective of a bank reconciliation is to reconcile the difference between two balances, thus
the cash book balance and the bank statement balance.
-cash book is the business’ record of their bank account, while bank statement is for bank’s
records of the bank account.
-the debits and credits are reversed in the bank statements because the bank will be recording
the transactions from its point of view in accordance with the business entity concept.
- a debit balance in the bank statement represent a negative balance ( a credit balance in the
cash book), while a credit balance represent a positive balance (a debit balance in cash book)
*keep this in mind because it is important especial in your paper one question
Differences between the bank statement and the cashbook
(1) Unrecorded items
-these include:


Interest


Bank charges
Dishonoured cheques
-they are not recorded in the cashbook simply because the business does not know that
these items have arisen until they see the bank statement
-the cash book must be adjusted to reflect these items
Cash book account
Bank interest X Bank charges X
Direct credits X Direct debits X
Standing order X
Dishonoured cheques X

(2) Timing difference

-these items have been recorded in the cash book, but due to the bank clearing process
have not yet been recorded in the bank statement:


Outstanding/ Unpresented cheques
Outstanding/ Uncleared lodgements
The bank statement balance needs to be adjusted for these items.
Bank reconciliation statement
Balance as per bank statement X
Less: unpresented cheques (X)
Add: uncleared lodgements X
Balance as per cash book X

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Errors in the cash book and bank statement
-a client may make mistake in their cash book and also bank may make a mistake on the
bank statement.
-such errors must be adjusted in both books
Cash book account
Balance b/d X Balance b/d X
Adjustments X Adjustments X
Revised balance c/d X Revised balance c/d X
X X

Bank reconciliation statement

Balance as per bank statement X
Unpresented cheques (X)
Uncleared lodgements X
Other adjustments to the bank statement X/(X)
Revised balance per cash book X

J2013 P2 Q1 ZIMSEC
A sole trader provides the following information:
Misnomer Enterprises
Trial Balance as at 31 December 2012
Machinery at cost 26 700
Provision for depreciation of machinery 4 220
Debtors (Receivables) 6 000
Creditors (Payables) 4 300
Motor vehicles at cost 12 400
Capital 42 480
Inventory (Stock) 5 200
Wages accrued 250
Bank 4 210
Drawings 4 000
Net profit 6 220
Suspense 6 460 -
61 220 61 220

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The following errors were discovered:
(i) Lynn a customer and a supplier, had settled her account of $300 by purchases
ledger contra, but this had not been recorded in the books.

(ii) The motor vehicle was purchased on the 1 October 2012. It is expected to have a
residual value of $400 at the end of its five year useful life. The straight line
method of depreciation is used on all fixed assets, with a proportionate charge in
the year of acquisition.

(iii) A receipt of $500 from Didmore, a debtor, had been posted to his account as $300.

(iv) A refund of $350 from Barbara, a creditor, had been made in the creditor’s
account.

(v) Wages accrued of $520 had been entered in the trial balance as $250.

(vi) The bank balance according to the cash book was $4 120 on 31 December 2012.
A bank statement received on 2 January 2013 showed a balance of $4 100 on 31
December 2012. Scrutiny of the cash book revealed the following:

1. unpresented cheques amounting to $460,

2. deposits of $480 not yet appearing on the bank statement.

(vii) Discounts received of $130 had been omitted from the Profit and Loss Account.
Required
(a) Prepare a bank reconciliation statement as at 31 December 2012
(b) A suspense account showing the correction of the above errors.
(c) A statement to adjust the net profit
(d) Mismomer’s trial balance after the correction of the above.

Solution
(a)Bank reconciliation statement as at 31 December 2012
$
Balance as per bank statement 4 100
Less unpresented cheques 460
3 640
Add bank lodgements 480
Balance as per cash book 4 120

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Journal entries
$ $
Payables 300
Receivables 300

− 600
Profit and loss ( �
600
Provision for depreciation
Suspense (500 – 300) 200
Receivables: Didmore 200
Suspense 350
Payables 350
Suspense 770
Wages accrued 770
Suspense 90
Bank (4 210 – 4 100) 90
Drawings 8 000
Suspense 8 000
Suspense 130
Profit and loss 130

(b) Suspense account

Trial balance difference 6 460
Receivables 200
Payables 350
Wages accrued 770
Profit and loss 130
Bank 90 Drawings 8 000
8 000 8 000

(c) Statement to correct profit

Net profit as per draft a/cc 6 220
Less depreciation (600)
Add omitted discount received 130
Corrected net profit 5 750

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(d)Corrected Trial balance
Machinery at cost 26 700
Provision for depreciation of machinery 4 220
Receivables (6 000 – 300 – 200) 5 500
Payables (4 300 – 300 + 350) 4 350
Motor vehicles 12 400
Provision for depreciation of machinery 600
Capital 42 480
Inventory 5 200
Wages accrued (770 – 250) 520
Bank 4 120
Drawings (8 000 – 4 000) 4 000
Net profit - 5 750
57 920 57 920

N2007 P1 ZIMSEC
The following information was provided by a business on 30 June 2006
$
Balance as per bank statement 121 000
Cheques received from customers not yet deposited 49 500
Cheques not yet presented to the bank by creditors 50 000
Bank charges 11 500
Customers’ dishonoured cheques 7 500
Credit transfer dividend 64 000
What is the cash book balance?
A. $75 500
B. $76 500
C. $120 500
D. $128 000
Solution
Bank reconciliation statement
$
Balance as per bank statement 121 000
Less cheques not yet presented 50 000
71 000
Add cheques not yet deposited 49 500
Balance as per cash book 120 500

Answer: $120 500 (C)

10
N2007 P1 ZIMSEC
The table shows extracts from a business’ bank reconciliation statement
$
Cash book balance 5 074 Cr
Outstanding cheques not presented 12 444
Cheques deposited not credited 20 160

What is the balance as per bank statement?

Solution
$
Balance as per cash book (5 074)
Less cheques deposited not credited (20 160)
(25 234)
Add outstanding cheques not presented 12 444
Balance as per bank statement (12 790)

Answer: $12 790 Dr

J2009 P1 ZIMSEC
The table shows information taken from the records of sole trader at 31 December 2006
$
Balance as per bank statement 720 000 Dr
Uncredited cheques 4 200 000
Unpresented cheques 1 750 000

What is the balance in the cash book at 31 December 2006?

A. $1 730 000 Cr
B. $1 730 000 Dr
C. $3 170 000 Cr
D. $3 170 000 Dr
Solution
$
Balance as per bank statement (720 000)
Less unpresented cheques (1 750 000)
(2 470 000)
Add uncredited cheques 4 200 000
Balance as per cash book 1 730 000

Answer: $1 730 000 Dr

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Books of prime (Books of original entry)
-these are books in which we record transactions before posting is done in the ledger.
-this is done so as to capture as much detail as possible when transaction take place.
When transaction occurs it is recorded in the books of prime entry then used to update
ledger accounts.
Accounting records
 Data sources
 Books of prime entry
 Ledger accounts
 Trial balance
 Financial statements

Books of prime entry Transaction type

Sales day book Credit sales
Purchases day book Credit purchases
Sales return day book Returns of goods sold on credit
Purchases return day book Returns of goods bought on credit
Cash book All bank transactions
The Journal All transactions not recorded elsewhere

Ledger accounts
-these are books containing the individual accounts.
General ledger contains all accounts or a summary of all accounts necessary to produce the
trial balance and financial statements e.g. control accounts are contained in the general ledger
Receivables ledger account contains an account for each credit customer to show how much
each one owes. The receivables control account summarise this information.
Payables ledger account contains an account for ach credit supplier to shoe how much they
are owed. The payables control account summarise this information.
Control accounts
-these are ledger accounts that summarise a large number of transactions
-control accounts do form part of the double entry system
-there is receivable/sales ledger control account and payables/purchases ledger control
account.
Purposes of control accounts
-provide totals of receivables and payables quickly when a trial balance is being prepared.
-to identify the ledger or ledgers in which errors have been made when there is a difference
on a trial balance

12
-act as independent checks on arithmetical accuracy of the aggregates of the balances in the
sales and purchase ledger.

Receivables ledger control account

Balance b/d X Balance b/d X
Credit sales SDB X Sales return SRDB X
Bank –dishonoured cheques CB X Bank(receipts from customers) CB X
Bank-refunds of credit balances X Irrecoverable debts J X
Discount allowed X
Contra (set off) X
Balance c/d X Balance c/d X
X X
Balance b/d X Balance b/d X

Payables ledger control account

Balance b/d X Balance b/d X
Bank (payment to suppliers) CB X Credit purchases PDB X
Purchases returns PRDB X Bank –refunds of debit balances CB X
Discount received X
Contra (set off) X
Balance c/d X Balance c/d X
X X
Balance b/d X Balance b/d X

Transactions used to prepare control accounts would have been extracted from books of
prime entry
SDB – sales day book
CB – cash book
SRDB – sales return day book
PDB – purchases day book
PRDB – purchases return day book
J- The Journal
N.B. any entries to the control accounts must also be reflected in the individual accounts
within the receivable and payable ledgers.
Control account reconciliation
-control accounts are prepared with information from the totals of books of prime entry.
-control accounts prove the accuracy of the ledger accounts, such as receivables and payables
-in checking the accuracy of the receivables ledger accounts we can use following ways:

13
  Getting the information from different sources i.e. the sales from sales day book
 To compare the sum of the total of the individual receivables ledger accounts with
the balance on the receivables ledger control account.

-the ledger accounts and control accounts are prepared using the same sources and therefore
should agree.
-if there are differences between the control account and the ledger accounts, they must
identified and reconciled.
Differences may arise due to:
 Errors in the receivables or payables ledger
 Errors in the receivables or payables control accounts
 Errors in both the control account and ledger account

Receivable ledger reconciliation compares the total of the accounts in the receivable ledger
with the balance on the receivable ledger control account.
Payable ledger reconciliation compares the total of the accounts in the payables ledger with
the balance on the payables ledger control account.
Control account reconciliation extracts
Receivable ledger control account
Balance b/d (given in the question) X Adjustments for errors X
Adjustments of errors X Revised balance c/d X
X X

Reconciliation of individual receivables balances with control balance

Balance as extracted from list of receivables X
Adjustments for errors (of individual accounts) X/(X)
Revised total agreeing with balance on control account XX

-care must be taken when identifying transactions that affect individual ledger accounts and
control accounts or affecting both accounts.

THE JOURNAL
-is a book of prime entry which records transactions which are not routine (and not recorded
in any other books of prime entry) for example:
- end of year adjustments i.e. closing inventory ,depreciation charge for the year ,accruals and
prepayments ,record of movement in allowances for receivables
-acquisition and disposal of non-current assets.

14
-correction of errors
-opening balances for statement of financial position
Presentation of journal
Journal entry DR CR
Non- current asset XXX
Cash XXX

Purchase of non-current asset using cash

DR: non-current asset X
CR: cash X
N2006 P3 Q2 ZIMSEC
In an attempt to ascertain the debtors at 30 June 2004, Soko Mukanya prepared the sales
ledger control account shown below
Sales Ledger Control Account
$ $
Balance b/d 262 500 Credit sales 752 800
Credit sales returns 29 875 Dishonoured cheques 4 100
Cash and cheques received 500 000 Discount allowed 42 300
Cash sales 21 000 Bad debts 14 605
Set off 10 800
Provision for bad debts 6 000 Balance c/d 20 470
830 175 830 175

Mukanya’s total sales ledger balances amount to $389 720 which does not agree with the
closing balance in the sales ledger control account. Subsequently, you discover the following
additional errors:
(i) A balance due of $24 600 by J. Jones had been omitted from the list of debtors.

(ii) A receipt of $31 300 was correctly entered in the bank account. However, no entry
was made in the debtor’s account.

(iii) A debit balance for $18 500 in the sales ledger had been transferred to the
purchases ledger but no entry had been made in the control account.

(iv) A sales invoice for $11 200 had not been entered in the sales journal.

(v) A debtor’s account had been understated by $15 000.

15
 (vi) A payment of $18 450 by a debtor, C. Ncube had been posted to the debit side of
her account

(vii) The disposal of a motor vehicle for $55 000 had been credited to the sales
account.

(viii) The discount allowed account had been undercast by $4 900.

(ix) Bad debts of $2 300 had been written off in the control account but no entry had
been made in the debtor’s account to cancel the debt.

(x) Goods returned by a debtor, which had been invoiced to him at $6 800, had been
correctly entered in the sales returns account but debited to the debtor’s account as
$8 600.

Required
(a) Prepare a corrected sales ledger control account
(b) Draw up a statement amending the total of the sales ledger balance so that it agrees
with the corrected control account balance.

Solution
Notes – recognise carefully the transactions which affect individual debtors/sales ledger
balances or sales ledger control account or both.
(a) Corrected Sales Ledger Control Account
Balance b/d 262 500 Credit sales returns 29 875
Credit sales (752 800+11 200) 764 000 Discount allowed (42 300+4 900) 47 200
Bad debts 14 605
Cash and cheques received 500 000
Set off (10 800+18 500) 29 300
Motor vehicle disposal 55 000
Dishonoured cheques 4 100 Balance c/d 354 620
1 030 600 1 030 600
Balance b/d 354 620

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(b) Reconciliation of sales ledger balance with control balance
$
Balance as extracted from list of debtors 389 720
Omitted balance: J. Jones 24 600
Receipt from a debtor (31 300)
Sales invoice 11 200
Understated balance 15 000
Payment (18 450 X 2) (36 900)
Bad debts (2 300)
Returns inwards (8 600 + 6 800) (15 400)
Revised total agreeing with balance on control a/cc 354 620

IAS 2: INVENTORIES
-this standard deals with inventories (stock).
-it covers the following types of inventories:
(i)work in progress
(ii)raw materials
(iii)finished goods
(iv)components
Basis of inventory valuation
Inventory is valued at the lower of cost and net realisable value in accordance with the
prudence concept which prohibits the overstatement of profits and assets, while recognising
losses immediately.

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Definitions
Cost refers to the purchase price of inventory plus all other costs incurred in bringing the
inventory to its present location and condition e.g. carriage inwards, customs duty, etc.
Cost of purchase is the purchase price paid less discounts and rebates.
Cost of conversion refers to the cost incurred in the process of converting inventories.
Net realisable value (NRV) is the expected selling price less costs incurred to sell.
Simple illustrations
Example 1
Naison had the following items and inventory
Product Costs Selling price
A 24 29
B 28 21
C 46 53
Calculate the value of inventory.
Solution
$
Product: A 24
B 21
C 46
Inventory value 91
Example 2
N.Z limited purchased inventory worth $6 000.From these goods, goods costing $2 000 were
damaged and can now be sold for $2 100 after repairs worth $400.
Calculate the value of inventory.
Solution
Cost Net realisable value (NRV)
Damaged goods $2 000 2 000 – 400 =1 700
Normal goods 4 000
Inventory value = $1 700 - $4 000 = $5 700
Example 3
The following information was extracted from the books of Brian

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 Product Cost of raw Production cost Selling price Advertising
materials
X 19 16 54 8
Y 30 22 49 14
Z 29 15 70 17
Calculate the value of inventory
Solution
Product Cost NRV
X 19+16=35 54-8=46
Y 30+22=52 49-14=35
Z 29+15=44 70-17=53
Value of inventory = 35+35=44
=$114
***from the above example you can observe that inventory is valued at the lower of cost and
net realisable value , you take the value which is smaller by comparing cost and NRV .The
definitions of the terms makes the calculations done above easy to understand.
Methods of valuing inventory
1.First in first out (FIFO)
2.Last in first out (LIFO)
3.Weighted average cost method (AVCO)
4.Periodic inventory system
5.Perpetual inventory system
FIFO
-it is a method (of valuing inventory) which values inventory on the most recent prices hence
overstates profits and assets.
-it assumes that inventories received early are to be first to be issued out. (Queue approach)
LIFO
-it values inventory based on the earlier prices hence it understates both profit and assets.
-it assumes that latest inventory received is the one to be issued first. (Pile approach)
AVCO
-it values inventory by averaging costs i.e. a new average cost of inventory is calculated each
time purchases are received.
Periodic inventory system
-it is when inventory take (stock take) is done at regular basis.

19
Perpetual inventory system
-inventory is updated every time goods are received or issued using bin cards.

Stock take (inventory take) done after the financial year end
The procedure is to reverse or re-instate transactions so as to determine inventory value at the
end of the year.
N.B. Apply the principle of lower cost and NRV.

Statement of correcting inventory

$
Inventory balance as per count date XXX
Sales XXX
Purchases (XX)
Returns inwards (XX)
Returns outwards XXX
Drawings XXX
Overstated inventory balance (need to be adjusted) (XX)
Sale or return goods XXX
Corrected inventory balance XXX

**calculation of sales figure includes profit, we must deduct the profit to get to the cost price,
this is also true for returns inwards.
*remember inventory is valued at the lower of cost and net realisable value.
Question
Jerry, a retailer whose financial year ends on 31 May, failed to check his stock at cost was
valued at $72 200. Jerry’s mark-up is 30% on cost.
During the first 8 days of June, the following transactions took place:
$
i. Purchases of goods for resale 21 200
ii. Purchases returns 510
iii. Sales 25 740
iv. Sales returns (at selling price) 273
v. Goods taken for personal use, at cost 700

After taking stock, Jerry discovered that the following items had been included in the
valuation at 8 June:
vi. A parcel of stock which had been water-damaged. This had been on sale for $390 but
was now worthless

20
vii. Stock which had a cost of $1 200 but was now out of fashion and would have to be
sold for $400 less than cost.
viii. Goods costing $950 which Jerry had acquired on a sale or return basis. He had not
decided whether or not to keep them.
ix. Goods sold during May for $1 560, which were awaiting collection by a customer.

Required
a) Explain the difference between mark-up and margin
b) Prepare a statement to calculate the correct value of stock at cost at 31 May

Solution
a) Mark-up is the percentage added to cost to find selling price whilst margin is the
percentage deducted from the selling price to find the cost price.

b) Statement to correct stock as at 31 May 2009

$
Stock at 8 June 2009 72 200
Purchases (21 200)
Purchases returns 510
Sales (25 740 X 10/13) 19 800
Sales returns (273 X 10/13) (210)
Drawings 700
Water damaged (390 X 10/13) (300)
Out of fashion (400)
Sale or return (950)
For collection (1 560 X 10/13) (1 200)
Correct valuation as at 31 May 2009 68 950

N2012 P3 Q1 ZIMSEC
Nyaradzo, who retails office desks, commenced trading on 1 January 2008 with a
capital of $100 000 which she deposited in a bank account for the business. On the
same day, she wrote a cheque to buy two trucks at $20 000 each.
Table 1 shows transactions in office desks for the year 2008.

Table 1
Purchases Sales
Jan 11 10 desks at $200 each Feb 3 6 desks at $340 each
Mar 16 20 desks at $220 each Apr 19 15 desks at $380 each
May 12 14 desks at $230 each Jun 8 17 desks at $400 each
July 10 9 desks at $250 each Aug 13 10 desks at $430 each
Sept 17 15 desks at $270 each Oct 14 12 desks at $460 each
Nov 20 19 desks at $280 each Dec 16 17 desks at $480 each

Additional information
1. All transactions have been on a cash basis.
2. Nyaradzo’s office expenses amounted to $150 per month.
3. She took drawings of $280 during the year.

21
 4. Depreciate delivery trucks by 20%.
5. She is deciding whether to use the first in first out (FIFO) or the last in first
out (LIFO) method of inventory (stock) valuation.

Question 1
(a) Prepare an income statement (trading and profit and loss account) for the year
assuming that stocks were valued on a:
(i) FIFO basis,
(ii) LIFO basis.
(b) State the basis for inventory valuation.

Solution
a) FIFO
Date Jan 11 Mar 16 May 12 July 10 Sept 17 Nov 20
Unit price 200 220 230 250 270 280
Quantity 10 20 14 9 15 19
Issues
Feb 3 (6)
4
Apr 19 (4)
- (11)
9
Jun 8 (9)
- (8)
6
Aug 13 (6)
- (4)
5
Oct 14 (5)
- (7)
8
Dec 16 (8)
- (9)
10

Valuation of closing inventory = $280 X 10 =$2 800

Sales value = (6 X 340) + (15 X 380) + (17 X 400) + (10 X 430) + (12 X 460) + (17 X 480)
= $32 520
Purchases value = (10 X 200) + (20 X 220) + (230 X 14) + (9 X 250) + (15 X 270) + (19 X
280) = $21 240

22
LIFO
Date Jan 11 Mar 16 May 12 July 10 Sept 17 Nov 20
Unit price 200 220 230 250 270 280
Quantity 10 20 14 9 15 19
Issues
Feb 3 (6)
4
Apr 9 (15)
5
Jun 8 (14)
(3) -
2
Aug 13 (9)
(1) -
1
Oct 14 (12)
3
Dec 16 (17)
2

Valuation of closing inventory = (4 X $200) + (1 X $220) + (3 X $270) + (2 X $280)

= $800 + $220 +$810 +$560
= $2 390

Income statement
(i)FIFO basis (ii)LIFO basis
$ $ $ $
Sales 32 520 32 520
Less cost of sales
Purchases 21 240 21 240
Less closing inventory 2 800 18 440 2 390 18 850
14 080 13 670
Less Expenses
Office expenses 1 800 1 800
DPN: delivery trucks 8 000 (9 800) 8000 (9 800)
Net profit 4 280 3 870

(b)Inventory is valued at the lower of cost and net realisable value in accordance with the
prudence concept which prohibits the overstatement of profits and assets, while recognising
losses immediately.

23
IAS 16: PROPERTY, PLANT AND EQUIPMENT (PPE)
An asset is a resource owned or controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
Cost is the purchase price paid plus any other cost incurred in bringing the asset to its present
location and condition. E.g. customs duty, carriage inwards, installation costs
Depreciation is the allocation of depreciable amount of an asset over its useful life.
Residual value is the value which the entity expects to realise from disposal of the asset at
the end of its useful life.
Useful life is the period over which the asset is expected to be available for any entity’s
use.
It is denoted in number of years, it may also be denoted in terms of number of units
expected to be produced by the asset.
Depreciable amount is the cost of an asset, or any other amount substituted for cost less its
residual value.

Causes of depreciation
-wear and tear
-rust and decay
-obsolescence (due to changes in technology)
-inadequacy
-depletion
Factors to consider when determining the amount of depreciation
-cost
-residual value or scrap value
-useful life
-expected life of usage
-expected revenue
Methods of depreciation
(i) straight line method
(ii) reducing or diminishing balance method
(iii) machine hour or production method
(iv) sum of digits

Straight line method

-this method charges a constant amount of depreciation each year over the useful life of the
asset.

24
-it is based on the assumption that an asset will generate constant amount of revenue over its
useful life.

Formula

1. cost X depreciation rate

−
2.

Disadvantage -it is not realistic

Reducing balancing method

-it charges different amount of depreciation each year, higher amounts in early years which
gradually declines in subsequent years.

-under this method, depreciation is charged as a percentage of the written down or book value
of the asset i.e. cost minus accumulated depreciation.

-this method result in a decreasing charge over the useful life of the asset.

Depreciation = (cost – accumulated depreciation ) X depreciation rate

Advantage

-it provides a better matching of expenses and revenue in that it equalises depreciation and
repair costs.

Disadvantage

-its calculation is complex.

Machine hour method

-this method charges depreciation according to usage.

Illustration

A machine cost $30 000 and will be scraped for $5 000 after 4 years.

The machine was used as follows:

Year 1: 7 000 hours

Year 2: 4 000 hours

Year 3: 6 000 hours

Year 4: 3 000 hours

25
Calculate depreciation for each of the 4 years.

Solution

Step I: calculation of depreciable amount

Depreciable amount = cost - scrap value

= $30 000 - $5 000

= $25 000

Step II: calculation of depreciation per hour

Depreciation per hour =

$
=

=$1,25 per hour

Step III: depreciation charges

Year 1 – 7 000 X $1,25 = $8 750

Year 2 – 4 000 X $1,25 = $5 000

Year 3 – 6 000 X $1,25 = $7 500

Year 4 – 3 000 X $1,25 = $3 750

Sum of digits method

-this method charges different amount of depreciation each year, higher amounts in early
years which gradually decline in subsequent years.

Illustration

Machine cost $30 000, a scrap value of $5 000 after useful life of 4 years.

Calculate depreciation using sum of digits.

Solution

Step I

Depreciable amount =$30 000 - $5 000

=$25 000

26
Step II

Sum of digits = 1 + 2 + 3 + 4

= 10

Step III

Year 1 – X $25 000 = $10 000

Year 2 - X $25 000 = $7 500

Year 3 - X $25 000 = $5 000

Year 4 - X $25 000 = $2 500

Double entry of depreciation

(i) Asset account

(ii) Provision for depreciation account

(iii) Disposal account

Asset account

-it records assets at cost in the beginning of the year plus additions during the year less
disposals at cost to obtain closing balance.

N.B. Pay special attention to dates and details.

27
 Asset account

Date Details $ Date Details $

Balance b/d xxx

Bank/cash (additions) xxx

Name of supplier

(credit purchase) xxx Balance c/d xxx

xxx xxx

Balance b/d xxx Disposal xxx

Additions xxx Disposal xxx

Trade-in(disposal) xxx Balance c/d xxx

xxx xxx

Balance b/d xxx

*closing balance for one period is carried forward to be the opening balance for the next
period.

Provision for depreciation account

Date Details $ Date Details $

Balance c/d xxx Profit and loss xxx

xxx xxx

Disposal xxx Balance b/d xxx

Balance c/d xxx Income statement(p&l) xxx

xxx xxx

Balance b/d xxx

28
 Disposal account

Date Details $ Date Details $

Asset @ cost xxx Prov. For depreciation xxx

Trade-in xxx

Proceeds of sale xxx

Income statement(profit) xxx Income statement(loss) xxx

xxx xxx

Depreciation methods

-the method used is decided to be reviewed at the end of each financial year.

-if there is a change in the consumption pattern, the method may be changed.

-the impact of such change shall be accounted for as a change in accounting estimates in
accordance with IAS 8: (accounting policies, changes in accounting estimates).

*change in accounting estimates i.e. change in rates or useful life

-no changes to earlier periods are required.

-it is applied prospectively i.e. from the date of change onwards

N2010 P2 ZIMSEC

The following information was extracted from Tangisha Ltd’s fixed asset register on 1
January 2006:

Vehicle number Date of purchase Cost Useful life Residual value

$ (Years) $

AAA 0473 1 January 2004 30 000 4 Nil

AAI 8600 1 September 2004 40 000 6 4 000

29
During the year ended 31 December 2006 the following events occurred:

January 1: The estimated useful life of AAA 0473 was revised from 4 years to 5 years, with

no residual value

June 30: Vehicle number AAK 9530 with an expected useful life of 6 years and a residual

value $2 000 was purchased on credit from Fuzzy and Wayne for $50 000 to replace

AAI 8600. A trade-in price of $30 000 was agreed for AAI 8600.

Required

(a) Motor vehicles Account

(b) Provision for depreciation account
(c) Disposal account (for vehicle number AAI 8600)

Solution

(a) Motor vehicles account

Date Details $ Date Details $

2006 2006

Jan 1 Balance b/d 70 000 Jun 30 Disposal – AAI 8600 40 000

Jun 30 Disposal – trade in 30 000

Fuzzy and Wayne 20 000 Balance c/d 80 000

120 000 120 000

2007

Jan 1 Balance b/d 80 000

30
(b) Provision for depreciation account

Date Details $ Date Details $

2004 2004

Dec 31 Balance c/d 9 500 Dec 31 Profit and loss 9 500

2005 2005

Jan 1 Balance b/d 9 500

Dec 31 Balance c/d 23 000 Dec 31 Profit and loss 13 500

23 000 23 000

2006 2006

Jun 30 Disposal 11 000 Jan 1 Balance b/d 23 000

Dec 31 Balance c/d 24 000 Dec 31 Profit and loss 12 000

35 000 35 000

2007

Jan 1 Balance b/d 24 000

(c) Disposal account

Date Details $ Date Details $

2006 2006

Jun 30 Vehicle AAI 8600 40 000 Jun 30 Trade-in 30 000

Dec 31 Profit and loss 1 000 Depreciation 11 000

41 000 41 000

Total depreciation of the disposed vehicle AAI 8600 up to 30 June 2006

2 000 + 6 000 + 3 000 = $11 000

There was profit on disposal of $1 000

31
Calculations of depreciation - charge for the year

� − �
Straight line method used =
�

31 Dec 2004 31 Dec 2006

AAA 0473 ( 7 500 AAA 0473 ( 5 000

− −
AAI 8600 ( � 2 000 AAI 8600 ( )X 3 000

Profit and loss 9 500 −

AAK 9530 ( X 4 000
31 Dec 2005
Profit and loss 12 000
AAA 0475 ( 7 500 Note- since the estimated useful life of
vehicle AAA 0473 has changed from 4 to 5
−
AAI 8600 ( 6 000 years in 1 January 2006, that means the
remaining life now is 3 years because 2004
Profit and loss 13 500 and 2005 (2 years) have been accounted for
using the previous useful life. After the
change in the useful life the book value of
the vehicle at date has to be calculated to
carry on with remaining useful years.

NOTE: to disclose fixed assets (non-current assets)

It shows assets at cost at the beginning of the year plus additions during the year plus
revaluation less disposal to obtain closing balance at cost.

Accumulated depreciation at the beginning of the year plus charge for the year less disposal
to obtain accumulated depreciation at the end of the year.

Balance of assets at cost at the end of the year less accumulated depreciation at the end of the
year to obtain net book value.

32
NON-CURRENT ASSET SCHEDULE

Details Land and Plant and equipment Motor vehicle

buildings
COST

At the beginning(year) XXX XXX

XXX
Additions XXX XXX
XXX
Revaluation - -
XXX
Disposal (XXX) (XXX)
XXX
Cost at the end XXX XXX
XXX
ACC DEPRICIATION

At the beginning(year) XXX XXX

-
Charge for the year XXX XXX
-
Disposal (XXX) (XXX)
-
At the end of the year XXX XXX
-
Net book value XXX XXX
XXX

NBV = cost at the end of the year – accumulated depreciation at the end the year

JUNE 2011 P2 Q3 (b) ZIMSEC

The following information is extracted from the trial balance of Sigogo Ltd as at 31
December 2006

Premises at cost 2 400 000

Office equipment at cost 310 000

Delivery vehicles at cost 159 000

33
Provision for depreciation- Premises 480 000

- Office equipment 170 000

- Delivery vehicles

Loss on sale of delivery vehicle

(i) Depreciation is provided on cost at the following annual rates:

 Premises 2½%
 Office equipment 10 %
 Delivery vehicles 20 %

It is a company policy to charge a full year’s depreciation on all assets held at the end of
the year.

(ii) Office equipment costing $30 000 was bought during the year

(iii) A delivery vehicle bought during the year ended 31 December 2004 for $35 00
was sold on 1 August 2006 for $17 500

(iv) Items (ii) and (iii) have already been correctly dealt with in the accounts.

Required – a schedule of fixed assets as at 31 December 2006

Solution: Workings

Calculation for depreciation – charge for the year

Premises – 2 ½ % X 2 400 000 = 60 000

Equipment – 10% X 310 000 = 31 000

Vehicles – 20% X 159 000 = 31 800

Calculation for depreciation of the disposed delivery vehicle

Disposal account

Cash / Bank 17 500

Profit and loss 3 500

Vehicle (cost) 35 000 Depreciation ( bal. fig ) 14 000

35 000 35 000

34
Schedule of fixed assets as at 31 December 2006

Premises Equipment Delivery vehicle

$ $ $

Cost

At the beginning of the year 2 400 000 280 000 194 000

Additions 30 000

Disposals - - (35 000)

At the end of the year 2 400 000 310 000 159 000

Depreciation

At the beginning of the year 480 000 170 000 60 000

Charge for the year 60 000 31 000 31 800

On disposal - - (14 000)

At the end of the year 540 000 201 000 77 800

Net Book Values at year end 1 860 000 109 000 81 200

35
INCOMPLETE RECORDS
-single entry refers to a situation where only one aspect of the transaction was recorded
instead of the use of double entry.
-various techniques can be used to obtain missing information:
 Accounting equation(identification of profit figure)
 Ledger accounts(total receivables ,total payables ,cash ,bank ,expense)
 Ratios (gross profit margin ,mark-up)

-when preparing a set of accounts, it is likely that all information may not be available to
complete set of financial statements.
-you have to make best use of information given to calculate missing figures.
Calculation of missing figures
Margin is the gross profit expressed as a percentage of net sales.

Gross profit margin = �

Mark-up is gross profit expressed as a percentage of cost of sales.

Mark-up = �

Relationship between margin and mark-up

Given that margin is , then the mark-up is

−

Given that mark-up is , then margin is

+

Example
Given that margin is 20%.Find mark-up.
� �
Margin =20%= , then mark-up is =
−�
�
= =25%

Calculation of opening capital

Prepare a statement of affairs using opening balances

36
Statement of affairs as at 1 January 19X6
$ $
Assets
Non-current assets X
Current assets X
Total assets X
Less liabilities
Current liabilities X
Non-current liabilities X
Total liabilities ( X)
CAPITAL X

Calculation of net profit

Net profit = capital at the end – capital at the beginning –capital introduced + drawings

-when using balancing figure (bal. fig) approach ledger account must be prepared to find
certain missing figure
Ledger account Missing figure
Receivables credit sales, money received from receivables
Payables credit purchases, money paid to payables
Cash at bank drawings, money stolen
Cash in hand cash sales, cash stolen

Receivables control account

$ $
Balance b/d XX
Credit sales XX Receipts from receivables XX
Discount allowed XX
Bad debts XX
Set-off XX
XX Balance c/d XX
XX
Balance b/d XX
Total sales = credit sales + cash sales

37
 Payables control account
$ $
Returns outwards XX Balance b/d XX
Payment to suppliers XX Credit purchases XX
Balance c/d XX XX
XX Balance b/d XX
Total purchases = credit purchases + cash purchases
Expense account
Prepayment b/d X Accrual b/d X
Bank /Cash X Income statement(bal.fig) X
Accrual c/d X Prepayment c/d X
X X
Prepayment b/d X Accrual b/d X

Cash at bank account

$ $
Payment to suppliers X
Balance b/d X Payment of expenses X
Receipts from receivables X Drawings X
Bankings from cash in hand X Money stolen X
X Balance c/d X
X

Cash in hand account

$ $
Cash purchases X
Balance b/d X Sundry expenses X
Cash sales X Bankings X
All receipts X Money stolen X
Balance c/d X
X X

*if money stolen can be compensated by an insurance company then that amount must be
recorded in the statement of financial position under current assets.
Cost of inventory lost
-in incomplete record questions, inventory may have been lost probably due fire or flood.
-to calculate cost of lost inventory ,complete the trading account from the information given
and then balancing figure will be lost inventory.

38
-lost inventory is subtracted from the cost of sales.
-lost inventory may either be insured or not insured.
Accounting treatment
If insured DR: insurance company (current asset)
CR: income statement (cost of sales)
If not insured DR: income statement (expense)
CR: income statement (cost of sales)
Other calculations
Non-current account (@ net book value)
$ $
Balance b/d X Disposal X
Additions X Depreciation (bal. fig) X
Balance c/d X

-preparation of provision for depreciation, disposal account and non-current account has been
covered in IAS 16(PPE).

39
NON PROFIT ORGANISATIONS
-these are organisations which seek to provide social services to members instead of making
profit ,they include burial societies ,social clubs ,football clubs ,public schools. etc.
Terminology
Profit making Non profit making
Capital Accumulated fund
Profit and loss Income and expenditure
Net profit Surplus
Net loss Deficit
Cash and bank Receipts and payments
Expenses Expenditure

Sources of funds
1. Subscriptions – these are payments by members at regular intervals to maintain
membership
2. Sale of refreshments
3. Sale of dinner dance tickets
4. Takings from pool tables

Ancillary activities
-these are trading like activities but at a smaller scale e.g. operating a bar tuck shop

Set of accounts
i. Bar trading account
ii. Income and expenditure account
iii. Balance sheet (statement of financial position)

Bar trading account extract

$ $
Bar sales X
Less bar cost of sales
Bar opening inventory X
Add bar purchases X
X
Less closing inventory (X)
Cost of goods sold (X)
Bar gross profit X
Less barman wages (X)
Bar net profit XX

40
Income and expenditure account extract
Income $ $
Subscriptions X
Donations (general) X
Bar net profit X
Takings from pool tables X
Sale of refreshments X
Less cost of refreshments X X
Sale of dinner tickets X
Less dinner expenses X X
Sale of raffle tickets X
Less raffle expenses X X
X
Less expenditure
Rent X
Depreciation of non-current assets X
Travelling expenses X
Loss on disposal of non-current assets X (X)
Surplus / (deficit) XX

Accumulated fund
-calculated by using opening balances i.e. total assets – liabilities
-prepare statement of affairs
Statement of affairs
Assets $ $
Non-current assets X
Subscriptions accrued X
Expenses prepayments X
Receivables X
Bank X
X
Less liabilities
Subscriptions in advance X
Expenses accruals X
Payables X
Total liabilities X
Accumulated fund X

Subscriptions account

accruals b/d X Advance b/d X

*income and expenditure X Bank X
Advance c/d X Accruals c/d X
X X

41
Statement of financial position extract
Financed by
Surplus / deficit XX
Accumulated fund XX
Legacy XX

N.B. T-accounts may be opened to calculate missing figures

Notes
Life subscriptions and entry fees
-these are lump sums paid by members and should be dealt with in accordance with the
matching concept.
-they must be credited to income and expenditure account in equal annual instalments
over a determined period by a committee.
Donations made to the club
-the treatment of the donations , legacies etc made to a club will depend upon the purpose for
which they are made.
-if the donation is simply intended to add the club funds , it may be credited to the income
and expenditure account.
-if the donation is given for a special purpose the wishes of the donor must be respected
,thereby should be recognised by crediting the donation to a special fund and shown in
the statement of financial position under the financed by section.

Question N2013 P3 (ZIMSEC)

Togara, James and Kombo run a sports and social club. The following is the receipts and
payments account of the club for the year ended 31 October 2009.

42
 $ $
Clubhouse 130 000
Balance b/d 11 900 Equipment 14 800
Wages 46 800
Equipment repairs 8 640
Subscriptions 35 200 Restaurant supplies 71 000
Restaurant sales 124 200 Annual dance 7 500
Loan from members 100 000 General expenses 10 840
Annual dance 30 000 Balance c/d 11 720
301 300 301 300

Additional information
Assets and liabilities at 31/10/2008 31/10/2009
$ $
Subscriptions in arrears 1 100 1 300
Subscriptions in advance 200 900
Restaurant stock 12 780 15 040
Restaurant creditors 8 470 9 570
Annual dance costs owing 100 250
Clubhouse at cost 130 000
Equipment at cost 16 000 30 800
Loan from members 100 000

2. The original equipment was purchased on 1 November 2007, the date the club opened.
Included in the new equipment is equipment which cost $2 200 for use in the restaurant.
Depreciation is charged at 2% per annum straight line on the clubhouse and 25% per annum
reducing balance on equipment. Depreciation is charged for the whole year in the year of
purchase.
3. Interest on the loan from members is payable at the rate of 5% per annum. The loan was
received on 1 November 2008.
4. The general expenses include $2 100 which should be charged to the restaurant. One third
of the wages are paid to restaurant staff.
Required
a) Prepare the restaurant income statement for the year ended 31 October
b) Prepare the club’s income and expenditure account for the year ended 31 October
2009
c) Draw the statement of financial position as at 31 October 2009

Solution

43
(a) Restaurant income statement for the year ended 31 October
$ $
Sales 124 200
Less cost of sales
Opening stock 12 780
Add purchases (71 00+9 570 - 8 470) 72 100
84 880
Less closing stock 15 040 69 840
Gross profit 54 360
Less expenses
Depreciation: equipment(25% X 2200) 550
General expenses 2 100
Wages (1/3 X 46 800) 15 600 18 250
Net profit 36 110

(b) Income and expenditure account for the year ended 31 October 2009
Income $ $
Restaurant profit 36 110
Subscriptions(200+35 200+ 1 300 – 1 100- 900) 34 700
Annual dance proceeds (30 000+250-7 500-100) 22 650
93 460
Less expenditure
General expenses (10 840 – 2 100) 8 740
Equipment repairs 8 640
Depreciation: equipment 6 150
clubhouse 2 600
Wages (2/3 X 46 800) 31 200
Loan interest (100 000 X 5%) 5 000 62 330
Surplus 31 130

Workings
Depreciation
Old equipment: 31/10/2008 = 16 000 X 25%=4000
31/10/2009=(16 000-4 000) X 25% =3 000
New equipment: Restaurant (2 200 X 25%) = 550
Club (14 800 – 2 200) X 25% =3 150
Clubhouse = 2% X 130 000=2 600
-you can calculate other missing figures using t-accounts or just do your workings in
brackets if you can.

44
Accumulated fund = assets – liabilities (using opening balances)
=11 900+1 100+12 780+100+16 00 – (200+8 470)
= 33 210
(c) Statement of financial position as at 31 October 2009
$ $ $
Non-current assets Cost DPN NBV
Clubhouse 130 000 2 600 127 400
Equipment 30 800 6 700 24 100
160 800 9 300 151 500
Current assets
Subscriptions in arrears 1 300
Restaurant stock 15 040
Annual dance costs owing 250
Bank 11 720 28 310
179 810
Equity and liabilities
Accumulated fund 33 210
Surplus 31 130
64 340
Current liabilities
Subscriptions in advance 900
Restaurant creditors 9 570
Loan interest owing 5 000
15 470
Non-current liabilities
Loan from members 100 000 115 470
179 810

J2013 P2 Q2 ZIMSEC
The treasurer of Sharma Snooker Club provided the following information:
1. Assets and liabilities at 1 Jan 2012 31 Dec 2012
$ $
Non- current assets 25 000 26 700
Bar inventory 2 600 3 700
Subscriptions in advance 210 25
Subscriptions in arrears 150 -
Bar payables 1 750 2 050
Prepaid rent - 200
Accrued rent 100 -

45
2. Receipts and Payments Account for the year ended 31 December 2012.
$ $
Balance b/d 1 200 Bar purchases 6 600
Subscriptions received 4 965 Bar expenses 200
Municipality grant 1 500 General expenses 3 700
Bar takings 7 000 Purchase of non-current assets 13 500
Sale of non- current assets 9 000
Balance c/d 1 535 Rent 1 200
25 200 25 200
Balance b/d 1 535
3. The non- current assets sold had a book value of $9 400.
4. The club receives an annual grant of $2 000 from municipality.

(a) Explain three differences between an Income and Expenditure Account and Receipt
and Payments Account.
(b) Prepare the Bar trading account for the year ended 31 December 2012.
(c) Prepare the Club’s Income and Expenditure Account for the year ended 31 December
2012.
(d) Prepare the Statement of financial position as at 31 December 2012.

Solution
(a)
Income and Expenditure account Receipts and Payments account
-prepared on accrual basis -prepared on cash basis
-records revenue expenditure only -records both capital and revenue
expenditure
-balance is surplus or deficit -balance is cash at bank or overdraft

(b)Bar trading account for the year ended 31 December 2012

$ $
Bar takings 7 000
Less Cost of sales
Opening inventory 2 600
Add Purchases (2 050 + 6 600 – 1 750) 6 900
9 500
Less closing inventory 3 700 5 800
Gross profit 1 200
Less bar expenses 200
Bar profit 1 000

46
(c)Income and Expenditure Account for the year ended 31 December 2012
Incomes $ $
Subscriptions (210 + 4 965 – 25 – 150) 5 000
Bar profit 1 000
Municipality grant 2 000
8 000
Less Expenditure
Loss on disposal (9 400 – 9 000) 400
Depreciation 2 400
General expenses 3 700
Rent 900 7 400
Surplus 600

Non-current account @ NBV

Balance b/d 25 000 Depreciation (bal. fig) 2 400
Disposal 9 400
Bank 13 500 Balance c/d 26 700
38 500 38 500

(c)Statement of financial position as at 31 December 2012

Cost DPN NBV
Non-current assets 29 100 2 400 26 700

Current assets
Inventory 3 700
Prepaid rent 200
Municipality grant owing 500 4 400
31 100
Equity and liabilities
Accumulated fund 26 890
Surplus 600
27 490
Current liabilities
Bar payables 2 050
Subscriptions prepaid 25
Bank overdraft 1 535 3 610
31 100

Accumulated fund = Assets – Liabilities

= (1 200+25 000+2 600+150) – (210+1 750+1000)
= $26 890

47
IAS 10: Events after the balance sheet date (events after the reporting period)
-it refers to transactions which occur between the financial year end of the business and the
date at which accounts are approved by directors.
-event give rise to (i) adjusting events
(ii) non-adjusting events
Adjusting events
-are those transactions which give evidence that they existed at the balance sheet date but the
entity was not aware of their final position.
For example, inventory becoming obsolete, a debtor becoming bankrupt leading to be
written-off.
-these events require alterations to be made in the balance sheet.
Non-adjusting events
-these are events which occur after balance sheet date but did not exist at the preparation of
final accounts.
For example premises which were later destroyed by fire or lightning.
-these events are not adjusted in the balance sheet but are disclosed by a way of a note.

IAS 37 deals with accounting for contingencies. A contingency is a condition, which exists at
the balance sheet date whose outcome will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events.
-if the probability of the event occurring is remote ignore the event.
A contingent asset is an event which may or may not occur whose outcome would be
confirmed by a third party such as a court of law which may result in the inflow of cash to the
entity e.g. an entity is suing another entity
-disclosed by a way of a note.
A contingent liability is an event which may or may not occur whose outcome would be
confirmed by a third party such as court of law which may result in the outflow of cash.
-disclosed by a way of a note.

48
STATEMENT OF CASHFLOWS (IAS 7)
Statement of cash flows are included as a component of financial statements under IAS
1(Presentation of financial statements).
-the standard deals with the preparation of cash flow statement.
-the statement of cash flows shows the movement of cash and cash equivalents under 3
distinct sections of the cash flow cycle and allows users to assess the cash flows and their
sources.
1 .Cash flow from operating activity
2. Cash flow from investing activity
3. Cash flow from financing activity
Definition of terms according to the standard
-Cash: it comprises of cash in hand
-Cash equivalents: these are balances at the bank and other short term highly liquid
investments.
These are readily convertible to known amounts of cash and which are subject to insignificant
risk of changes in value.
I.Cash flow from operating activity
Operating activities are principal revenue-producing activities of the entity.
-records of the business main transactions as contained in its object clause.
-The disclosure of the cash flows from operating activities will enable users to judge whether
the entity is fulfilling the main purpose for which it exists ,i.e. to earn sufficient money from
principal revenue-producing activities so as to maintain operating capability ,pay dividends
,repay loans and make new investments.
II. Cash flow from investing activity
Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
-records the purchase and sale of plant, property and equipment (PPE) and investments.
-this group of activities indicates the extent to which the entity is investing in the activities
which will bring benefits in the future.
III. Cash flow from financing activity

49
Financing activities are activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.
-records the cash inflows and outflows from the business main sources of finance.
-the information under this group of activities helps the readers to know how the entity has
raised or repaid financial resources. These details help in predicting claims on future cash
flows by providers of capital to the entity.
Statement of cash flows are presented under two standard formats
(i) direct method ,whereby major classes of gross cash receipts and gross cash payments are
disclosed.
-the standard recommends this method because it provides information which may be useful
in estimating future cash flows.
(ii)indirect method ,whereby profit or loss is adjusted for the effects of transactions of a non
cash nature ,any deferrals or accruals of past or future operating cash receipts or payments
,and items income or expense associated with investing or financing cash flows.
-operating profit from income statement is taken as a starting figure, it reconciles net profit to
cash flow generated by operations by adjusting for the effects of the non-cash items.
-this method is easier, faster, cheaper and therefore preferred by many companies.
**the difference between the two methods is only in the calculation of cash flows from
operating activities.

Extract of the statement of cash flows (direct method)

Cash flows from operating activities
Cash sales xxx
Receipts from trade receivables, royalties, commissions etc. xxx
Cash purchases xxx
Payment to suppliers xxx
Payments to employees xxx
Cash generated from operations xxx
Less tax paid xxx
Interest paid xxx

50
 Drawings (current year ) xxx
Net cash flow from operating activities xxx

Extract of the statement of cash flows (indirect method)

Cash flows from operating activities $ $
Profit before interest and tax(operating profit) x
Adjustments for non –cash items
Depriciation /Amortisation of non-current assets x
Loss(profit) on sale of non- current assets x/(x)
Increase(decrease) in provisions x/(x)
Operating profit before working capital adjustments x
Changes in working capital
(Increase)/decrease in inventories ( x)/x
(Increase)/decrease in receivables (x)/x
Increase/(decrease) in payables x/(x)
(Increase)/decrease in prepayments (x)/x
Increase/(decrease) in accruals x/(x)
Cash generated from operations x
Less interest paid x
Tax paid x
Net cash flows from operating activities x
Cash flows from investing activities
Purchase of non-current assets (tangible or intangible) (xx)
Sale of non-current assets (xx)
Dividends received xx
Net cash flow from investing activities xx
Cash flows from financing activities

51
Issue of shares/debentures xx
Redemption of shares/debentures (xx)
Borrowing of loan xx
Repayment of loan ( xx)
Interest paid (xx)
Net cash flow from financing activities xx
Increase /(decrease) in cash and cash equivalents x/(x)
Opening balance of cash and cash equivalents xx
Closing balance of cash and cash equivalents xx

NB – other two headings cash flows from investing and financing activities are presented the
same way in direct and indirect methods.
In case when operating profit is not given, profit and loss appropriation account may be
prepared as follows:
$ $
Transfer to general reserve X Retained earnings b/d X
Tax(current year) X Profit (balancing figure) X
Interim dividends X Dividends received X
Final dividends X
Redemption reserve X
Retained earnings c/d X

N.B.workings for other items in the statement of cash flows must be done through T-accounts
.
Classification of certain specific items
IAS 7 gives guidance on the classification of certain items. Consider the following example
to understand the impact of each classification:
Classification of interest paid and interest and dividends received
For all institutions other than financial institutions:
(a) Either interest paid and interest and dividends received are classified under operating
activities as it can be argued that a company should be able to pay all these from their
operating activities;

52
(b) or interest paid is classified under financing activities (because it is the cost of obtaining
financial resources ) and interest and dividends received are classified under investing
activities (being the returns on investments)
Classification of dividends paid
These may be classified:
(a)Either as financing activities because they are a cost of obtaining financial resources
(dividends need to be paid to shareholders, otherwise shareholders would not keep their
shares –it is their return on investment);
(b)or as a component of cash flows from operating activities ,so that users can assess whether
the entity is able to pay dividends out of operating cash flows.
**The IAS allows entities the flexibility to decide how to classify interest and dividends,
depending on circumstances and the judgement of management (and now yours as a
student).
Benefits to management of preparing cash flow statement
-enables an evaluation of change in net assets of the entity.
-assessing ability of a firm to generate cash and cash equivalents.
-enhances comparability of reporting performance of different firms.
-shows liquidity and solvency
-helps in assessing profitability and liquidity
-aid in preparation of cash budgets
-comparing the cash generated or utilised against the cash budget.
Benefits of preparing cash flow statements in addition to statement of comprehensive income
(income statement) and statement of financial position (balance sheet)
A cash flow statement used in conjunction with a balance sheet provides information on the
liquidity, viability and financial adaptability of a business.
Statement of cash flow used in conjunction with income statement can be useful for making
assessments of future cash flows.
Statement of cash flows give an indication of the relationship between profitability and cash
generating ability and thus, of the quality of the profit earned.
Information contained in cash flow statements enable users to assess the capability of the
business to generate cash and cash equivalents.
Statement of cash flow can be useful when negotiating loans with banks and other lenders.

53
Worked example
Statement of financial position of Gore at 31 December
2012 2011
$000 $000
Non-current assets 1,048 750
Accumulated depreciation (190) (120)
––––– –––––
858 630
Current assets
Inventory 98 105
Trade receivables 102 86
Dividend receivable 57 50
Cash 42 18
––––– –––––
299 259
––––– –––––
Total assets 1,157 889

Capital and reserves

Share capital 200 120
Share premium 106 80
Revaluation reserve 212 12
Accumulated profits 283 226
––––––– –––––––
801 438
Non-current liabilities
Loan 200 300
Current liabilities
Trade payables 47 52
Dividend payable 30 27
Interest accrual 3 5
Tax 76 67
––––– –––––

54
 156 151
––––– –––––
Total equity &liabilities 1,157 889

Income Statement of Gore at 31 December 2012

$000
Sales revenue 1,100
Cost of sales (678)
–––––
Gross profit 422
Operating expenses (309)
–––––
Operating profit 113
Investment income – interest 15
-dividends 57
Finance charge (22)
Income tax (71)
–––––
Net profit for year 92

Operating expenses include a loss on disposal of non-current assets of $5,000.

 During the year plant which originally cost $80,000 and with depreciation of $15,000
was disposed of.
Required
The Statement of Cash Flows for Gore.

Solution

55
Statement of cash flow for Gore
Cash flows from operating activities $000 $000
Operating profit 113
Adjustments for non-cash items
Depreciation 85
Loss on disposal 5 90
Net profit before working capital adjustments 203
Changes in working capital
Decrease in inventory 7
Increase in trade receivables (16)
Decrease in trade payables (5) (14)
Cash generated from operations 189
Less :interest paid (24)
tax paid (62)
Net cash flows from operating activities 103
Cash flows from investing activities
Dividend received 50
Interest received 15
Proceeds from disposal 60
Purchase of plant (178)
Net cash flows from investing activities (53)
Cash flows from financing activities
Issue of shares 80
Increase in share premium 26
Repayment of loan (100)
Dividends paid (32)
Net cash flows from financing activities (26)
Increase in cash and cash equivalents 24
Add opening cash balance 18
Closing cash balance 42

N.B. amount of issue of shares and increase in share premium may be summed together to get
a total amount which is proceeds in issue of shares.

56
-you must not account for bonus issue as there is no cash movement.
Workings (missing figures represented by *)
Appropriation acc
*dividends 35 Bal b/d 226
Bal c/d 283 Net profit 92
318 318
Dividends payable acc PPE acc
*bank 32 Bal b/d 27 Bal b/d 750 Disposal 80
Bal c/d 30 P&L 35 Revaluation 200
62 62 *bank 178 Bal c/d 1048
Tax payable acc 1128 1128
*bank 62 Bal b/d 67 PPE Dpn acc
Bal c/d 76 P&L 71 Disposal 15 Bal b/d 120
138 138 Bal c/d 190 *P & L 85
205 205
Dividends receivable acc PPE Disposal acc
Bal b/d 50 *bank 50 Dpn 15
P&L 57 Bal c/d 57 P&L 5
107 107 PPE(cost) 80 *cash 60
Interest payable acc 80 80
*bank 24 Bal b/d 5
Bal c/d 3 P&L 22
27 27

-any other alternatives for working out missing figures can be used other T – accounts

57
PARTNERSHIP ACCOUNTING
A partnership is a business entity carried by two to twenty people with the objective of
making profit and share it using pre-determined profit and loss sharing ratio.
- The number of partners is limited to 20 except for certain professions like chartered
accountants, solicitors, etc.
- Every partnership should be based upon an agreement which should be in writing to
reduce possibility of disputes about their rights and duties as partners.
- Therefore partners prepare what is called partnership deed.

Partnership Deed
-this is a verbal or documented agreement made by partners before entering into a partnership
Following are the common provisions of the deed:
 Capital to be contributed by each partner
 Ratio in which profit and losses are to be shared between the partners
 Salary allowable to partner(s), if any
 Interest charged to partners’ drawings
 Interest allowable on partners’ capital and loan
 Provisions with regards to the dissolution of the partnership
 The division of power and obligation among partners and procedures to be followed
in settling disputes amongst partners

Partnership act 1890

-in the absence of the partnership deed, we apply the provisions of this act which states that:
a) Capital contributions should be equal
b) Profit and losses to be shared equal
c) No partner entitled to a salary and interest on capital
d) No interest charged on drawings
e) 5% interest allowed to partner’s loan or additional capital

If a question is silent on an provision of the partnership deed or agreement

Accounting entries
1. Profit and loss appropriation account
2. Partners current account ( or drawings account)
3. Partner’s capital accounts
4. Balance sheet (Statement of financial position)

Capital accounts
-represent the contribution made by the partners in the partnership

58
-shows each partner’s permanent investment in the partnership
-contributions made need not to be of the same nature
-they can be in any of the following forms:
 Cash
 Assets
 Expenses paid by a partner on behalf of the partnership

-capital accounts must not be combined with current accounts, must be prepared separately in
columnar form.
Current accounts
-this account record all income accruing to a partner and drawings made against that income.
Some of the transactions recorded in the current accounts on both debit and credit side

 Share of loss  Share of profit

Debit side Credit side

 Drawings  Interest on loan

 Interest on drawings  Interest on capital
 Salary paid

Where a partner(s) guarantee the other partner a minimum share of profit

If partners agree that one of theirs should not receive a share of profit less than a certain
figure, after sharing in the normal way if it amounts to less than the amount agreed, the short
fall should be shared by the other partners in their profit sharing ratio excluding the
guaranteed partner’s ratio.

Partnership changes
-refers to a situation which requires alterations to be made in the partnership deed.
For instance, this may happen when there is:
a) Introduction of a new partner
b) Retirement of a partner
c) Change in the profit sharing ratio
d) Amalgamation of partnerships

Accounting entries
1) Revaluation account
2) Adjustment for goodwill

59
 3) Capital account
4) Balance sheet after the partnership change

Revaluation account
-it records changes in assets i.e. increase or decrease in the value of assets to determine profit
or loss on revaluation
Revaluation account
Decrease in assets X Increase in assets X
Increase in liabilities X Decrease in liabilities X
Increase in provision for bad debts X
Capital: A X Capital: A X
B X B X
X X

-the difference or the balancing figure on the debit side is profit on revaluation, while that on
the credit side will be loss on revaluation.
-therefore that difference is apportioned to the partners in the profit sharing ratio
-if a new partner is admitted, the difference is apportioned to the old partners using their
previous ratio.
Goodwill adjustment
Partner Old sharing ratio New sharing ratio Gain or Loss Action required
A 10 20 gain DR capital a/cc 10
B 20 10 loss CR capital a/cc 10

Capital accounts
A B A B
Asset taken over X X Balance b/d X X
Goodwill X X Liabilities taken over X X
Loss on revaluation X X Goodwill X X
Balance c/d X X Profit on revaluation X X
X X X X

Admission of a partner during the year

-when a partner is admitted partway through the year, income and expenses should be
apportioned as per question
-in the absence of a specific policy, they should be apportioned on a time basis

60
Partnership dissolution
-refers to winding up of a partnership business
-assets are sold, debtors collected and liabilities settled, so as to close partnership books.
Reasons for dissolution
 The death of one of the partners
 Attainment of set objectives
 A decline in the market for product – low demand of a product
 Insolvency of the partnership or one of the partners
 Compulsory dissolution by law
 Retirement of old partners
 Disputes

Accounting entries
1) Realisation account
2) Capital account
3) Bank account

Realisation account
-when a partnership is dissolved for whatever reasons a realisation account is opened
-it is debited with the net book value of assets except bank and cash and credited with
liabilities, as well as amounts realised from the dissolution.
Realisation account
Assets at net book value X Assets sold – Bank X
Dissolution expenses-Bank X Discount received X
Discount allowed (debtors – debtors paid) X
Profit on realisation (Bal. figure) X Loss on realisation (Bal. figure) X
X X

Capital account
A B A B
Balance b/d X X
Loss on realisation X X Current account X X
Assets taken over X X Realisation profit X X
Liabilities taken over X X
Bank (bal. figure) X X Bank (bal. figure) X X
X X X X

61
 Bank account
Balance b/d X Balance b/d (overdraft) X
Assets sold X Creditors paid X
Debtors (collected by firm) X Dissolution expenses X
Capital : A X Capital: A X
B X B X
X X

COMPANY ACCOUNTS
-these are accounts prepared by limited liability companies.
-a company is a business entity with a separate legal entity. i.e. it can sue or be sued in its
own name ,it can also own assets and owe liabilities in its own name.
-a share is a unit of capital i.e. companies sell shares to raise capital.
Types of shares
(a) Ordinary shares
(b) Preference shares
Ordinary shares
-receive a variable rate of dividends
-can vote at the annual general meeting
-receive dividends after preference dividends have been paid
-they are risk form of investment
Preference shares
-receive fixed rate of dividends
-do not vote at the annual general meeting
-receive dividends first before ordinary shares have been paid
-they are a safe form of investment
Further classes of preference shares
Participative preference shares –these are entitled to a fixed rate of dividend plus a further
share of company profits after ordinary dividends have been paid.
Cumulative preference shares –any unpaid dividends due to insufficient profits are carried
forward to future years and would be paid first before current dividends.
Non-cumulative preference shares –any unpaid dividends due to insufficient profits are lost
for good to the shareholder.

62
Dividends
-it is a share of company profits paid to shareholders as a return to their investment.
-dividends on ordinary shares are expressed as an amount per share. e.g. 5c per share or 5%
of nominal value
Interim dividends –are dividends paid in the first half of the year.
Final dividends –are dividends paid in the last half of the year.
Debenture
-it is a loan to the company and it receives a fixed rate of interest.
General reserve
-it is money set aside from profits for future profits.

Set of accounts
1).Income statement (trading and profit and loss account)
2).Statement of changes in equity/ (appropriation account)
3).Statement of financial position
4).Statement of cash flows
5).Notes to accounts

63
Statement of financial position extract
Assets $ $
Non-current assets
Property, plant and equipment XXX
Other intangible assets XXX XXX
Current assets
Inventories XXX
Trade receivables XXX
Prepayments XXX
Other current assets XXX
Cash/Bank XXX XXX
Total assets XXX

Equity and liabilities

Share capital (ordinary and preference) XXX
Retained earnings XXX
Share premium account XXX
Reserves XXX
Other components of equity XXX
Total equity XXX
Non-current liabilities
Loan notes XXX
Debentures XXX
Other long term borrowings XXX
Current liabilities
Trade and other payables XXX
Short borrowings XXX
Current tax payable XXX
Proposed dividends XXX
Total liabilities XXX
Total equity and liabilities XXX

64
Income statement extract
$ $
Sales revenue XXX
Cost of sales (XX)
Gross profit XXX
Other income XXX
Distribution costs (XX)
Administrative expenses (XX)
Other expenses (XX)
Operating profit XXX
Finance costs (XX)
Profit before tax XXX
Tax expense (XX)
Profit for the period XXX

Less appropriations
Transfer to general reserve XXX
Proposed ordinary dividends XXX
Interim dividends paid :Preference XXX
:Ordinary XXX (XX)
Retained profit for the year XXX
Add profit and loss b/d (previous year profit) XXX
Retained profit carried forward XXX

According to IAS 1: Presentation of financial statements the part of appropriations is now

represented in the statement of changes in equity, so thus the income statement ends in the
profit for the period.
Statement of changes in equity extract
Details Share Share General Revaluation Accumulated Total
capital premium reserve reserve profits equity

Balance b/d XXX XXX XXX --- XXX XXX

Issue of
new shares XXX XXX - --- - XXX
Revaluation
Surplus - - - XXX - XXX
Dividends - - - --- (XX) XXX
Transfer - - XXX --- (XX) XXX
Net profit - - - --- XXX XXX
Balance c/d XXX XXX XXX XXX XXX XXX

65
Issue and redemption of shares
Issue of shares
-companies raise capital through the following ways:
(i).Public offer
(ii).Rights issue
(iii).Bonus issue
Public offer
-it is the issue if shares to the general members of the public through the stock exchange at
the prevailing market price per share.
Rights issue
-it is the issue of shares to existing shareholders in proportion to their current shareholding at
a price below the ruling market price.
Bonus issue
-it is the issue of shares to existing shareholders in proportion to their current shareholding
for free by capitalising reserves.
Par value / Nominal value / Face value
-it is the registered price of each share e.g. $1 shares
Share premium
-it is a reserve which arises when shares are issued at more than their par value e.g. $1
ordinary shares were issued at $1,50 ,this $1 is credited to the share capital account whilst the
$0,50 is credited to the share premium account.
It is a capital reserve and may be used as follows:
-to pay unissued shares as fully paid bonus shares
-to write off preliminary expenses on formation of the company
-to write off expenses incurred in share issues
-to provide any premium payable on redemption of shares or debentures
Capital reserves
-these are reserves which are not created by setting aside profits but arise due to different
circumstances.
-required by law in certain circumstances.
-cannot be used to pay out dividends

66
Examples
(i).share premium
(ii).revaluation reserve – arises when assets are revalued upwards
(iii).capital redemption reserve (CRR) – arises when shares are redeemed from internal
resources.
If the company redeems the preference share capital, the assets of the company will be
reduced due to repayment of capital. This may hurt the interests of payables, therefore a
company may create a capital redemption reserve to protect payables (creditors).
Revenue reserves
-these are created by setting aside profits of the business.
-can be used to pay cash dividends
Examples
(i).general reserve – this is a general purpose voluntary reserve.
(ii).asset replacement reserve (e.g. plant and machinery replacement reserve) – the company
create this reserve and invest an equivalent amount outside the business. When the life of an
asset is over, it is expected that funds for replacement will be generated by selling the
investments.
(iii) Foreign currency exchange reserve
(iv) Retained profits
Issue of bonus shares leaving reserves in the most flexible form or usable form it implies that
the bonus issue must be first made out of capital reserves and then revenue reserves in the
following order:
 revaluation reserve
 capital redemption reserve
 share premium
 general reserve
 retained profits

Redemption of shares

67
-it is the purchase by a company of its own shares which were issued as redeemable.-
redemption of shares is outlined in the companies act chapter 24:03. It can be financed as
follows:
1).Financed by a fresh issue of another class of shares. In this case ensure that the fresh issue
raises just enough funds for redemption i.e. to get the number of shares issued –divide the
required amount by the issue price of new shares.
2).Financed from internal resources i.e. profits. In this case transfer an amount equivalent to
the par value of shares being redeemed from profit and loss account to capital redemption
reserve and then proceed to redeem.
3).Redemption can be financed partly from fresh issue and partly from internal resources.
N.B. share premium on redemption
Premium paid on redemption can be financed by the share premium account up to the extent
of the share premium which was raised on the original issue of these shares being redeemed
now. The excess premium paid should come from profit and loss account.
Capital reconstruction / reduction / re-organisation
-it is a scheme which is undertaken when a company has been experiencing successive losses
or declining profits.
-the scheme seek to protect shareholders and creditors, and to steer the company back to
profitable ways.
Features of capital reduction
1).reduction of par value of shares
2).elimination of intangible assets such as goodwill
3).settlement of liabilities other than by cash
4).elimination of debit balance of profit and loss etc
Reasons for reorganisation
i. when some assets are overvalued
ii. when there is a persistent overdraft in the bank
iii. the assets no longer fully represent the capital employed
iv. when substantial trading losses have accumulated
v. when there is existence of fictitious assets

Accounting entries
(i).Journal entries
(ii).Profit and loss account
(iii).Capital reduction /reorganisation account
(iv).Statement of financial position after the scheme

68
N2009 P3 Q2 ZIMSEC
The summarised Balance Sheet of Magadlela as at 31 March 2004 is as follows:
$000
Land and Buildings 3 000
Other assets 1 180
4 180
Equity and liabilities
Ordinary shares of $1 each 8 000
6% Redeemable Preference shares of $1 each 1 000
Profit and loss (7 000)
2 000
9% loan stock 2 000
Preference dividend due 180
4 180
The directors propose the following scheme of reconstruction:
(i) The existing 9% loan stock is to be cancelled and the loan stockholders are to be
issued with $1 300 000 10% loan stock and the balance in ordinary shares of $0,20
each fully paid.
(ii) The existing ordinary shares are to be cancelled and the ordinary shareholders are
to be issued with 8 million ordinary shares of $0,20 each fully paid.
(iii) A preference share dividend due to be settled through an ordinary share issue.
(iv) Land and buildings to be revalued to $3 600 000
(v) Redeemable preference shares with normal value of $350 000 are to be redeemed
at par. The necessary funding is to be through an issue of 1 500 000 Ordinary shares
of $0,28 each

Required
Prepare the summarised Balance Sheet as at 1 April 2004 assuming the scheme was
implemented

69
 Solution
Journal entries
$000 $000
9% loan stock 2 000
10% loan stock 1 300
Ordinary shares (of $0,20 each) 700
Ordinary shares of $1 each 8 000
Ordinary shares of $0,20 each 1 600
Capital reconstruction 6 400

Preference dividend 180

Ordinary shares 180
Land and buildings 600
Capital reconstruction 600
Bank ($0,28 X 1 500) 420
Ordinary shares ($0,20 X 1 500) 300
Share premium ($0,08 X 1 500) 120

Redeemable preference shares 350

Bank 350

Capital reconstruction 7 000

Profit and loss 7 000

Capital reconstruction account

$000 $000
Ordinary shares 6 400
Profit and loss 7 000 Land and buildings 600
7 000 7 000

N.B –the capital reduction/reconstruction account either balance itself off or have a difference
which can be goodwill if it is on credit and capital reserve if it is on the debit side.
Convertible loan stock is the loan which upon maturity can be converted into ordinary shares
in future.
Capital reconstruction is changing capital structure of a business
-it is a process of revaluing assets and other liabilities of a business to reduce losses, start paying
dividends, to come up with an improved business.

70
Balance sheet as at 1 April 2004 after implementation of scheme
$000
Land and Buildings 3 600
Other assets (1 180 + 420 – 350) 1 250
4 850
Equity and liabilities
Ordinary shares (180 + 700 + 1 600 + 300) 2 780
Redeemable preference share (1 000 – 350) 650
Share premium 120
3 550
10% loan stock 1 300
4 850

The Directors report

-a copy of the directors’ report along with the income statement and the balance sheet
(statement of financial position) must be received by the shareholders.
Task: get a copy of the directors’ report from the press.
Following are some of the issues which should be included
a) a fair view of the business
b) the dividends proposed
c) the amounts transferred to reserves
d) post balance events
e) the principal activities of the company
f) name of all persons who are directors of the company

Auditors report
-this is an independent report which is prepared by an independent external auditor.
-purpose of this report is to express an opinion whether the financial statements show a true
and fair view of the company.
-the independent auditors’ report should include the following:
a) title
b) date
c) name of the auditor or the audit firm
d) the opinion paragraph
e) the scope of work undertaken
f) signature of the auditor

71
PARTNERSHIP TAKEN OVER BY LIMITED COMPANIES
Accounting entries
Partnership books
1. Realisation account
2. Partners’ capital account
3. Bank account

Company books
1. Limited company account
2. Business purchase account
3. Company balance sheet (statement of financial position )

Formats
Realisation account
X limited (purchase price) XX
Payables XX
Capital : A XX
Assets at net book value XX B XX
XX XX

Capital account
A B A B
Realisation acc(loss) X X
Ordinary shares X X Balance b/d X X
Share premium X X Current account X X
Debentures in X ltd X X Loan X X
Bank (bal. figure) X X Realisation acc(profit) X X
X X X X

Calculation of debentures
loan �n�e�e�� �n �he pa��ne��h�p
�� � � =
deben�u�e %
Bank account
Balance b/d XX Capital : A XX
X ltd XX B XX
XX XX

72
 X limited account
Ordinary shares XX
Debentures XX
Realisation acc XX Share premium XX
XX XX

Business purchase account

X ltd (purchase price) X Assets taken over @NBV X
Payables X
Capital reserve(bal. fig) X Goodwill(bal. fig) X
X X

N2012 P2 Q4 ZIMSEC
Exx and Wye are partners sharing profits and losses in the ratio 3:2 respectively. On 30
September 2012, the partners sold their business to Pea Ltd.
The balance sheet of the partnership was as follows:
$ $
Sundry assets 40 000
Bank 1 000
Current account – Exx 2 000
43 000
Capitals - Exx 15 000
-Wye 12 000 27 000
3 000
8 000
5 000
43 000

Pea Ltd took over all the assets except bank.

The purchase consideration of $46 000 was settled as follows:
(i) Exx received sufficient 8% debentures in Pea Ltd to earn him the same amount of
interest he was getting from his loan.
(ii) Pea Ltd paid $11 000 into the partnership bank account.

73
 (iii) The balance of the purchase price was settled in ordinary shares of $1 each in Pea
Ltd at a premium of 25 cents per share.

The shares were distributed between the partners in the profit and loss sharing ratio and
any remaining balances on their capital accounts were settled in cash.`
(a) Prepare
(i) Realisation account
(ii) Bank account
(iii) Capital accounts (in columnar form)
(b) Calculate the number of shares that Exx gets in Pea Ltd.
(c) Give two reasons why partners may have decided to sell their business to Pea Ltd.

Solution
a (i) Realisation account
Sundry assets 40 000
Capital: Exx 6 600 Capital: Exx 4 600
Wye 4 400 Wye 7 400
51 000 51 000

a (iii) Capital accounts

Exx Wye Exx Wye
Current account 2 000 Balance b/d 15 000 12 000
8% debentures 5 000 Realisation profit 6 600 4 400
Ordinary shares 18 000 12 000 Loan 8 000
Bank 4 600 7 400 Current account - 3 000
29 600 19 460 29 600 19 400

(ii) Bank account

Balance b/d 1 000 Capital: Exx 4 600
Pea Ltd 11 000 Wye 7 400
12 000 12 000

�
8% debentures =
%
%�
=
%

= $5 000

74
Purchase consideration
8% debentures $5 000
Bank 11 000
Ord. shares @ $1,25 (bal. fig.) 30 000
Purchase price 46 000

Ordinary shares (with share premium): Exx ( � 3 = $18 000

Wye ( � 3 = $12 000

$
(b) = 14 400 shares
$ ,

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS

-in order to review the performance and status of the business and make decisions each
business enterprise prepares certain statements ,known as financial statements.
-sometimes information provided in the financial statements is not adequate to take certain
critical decisions (for exampl , expansion or investment in another entity ,etc ).
-in order to arrive at a meaningful conclusion, an effective analysis and interpretation of
financial statements is necessary.
-financial statements are analysed by various stakeholders of the entity in order to take
various decisions.
Ratio analysis
-accounting ratios and ratio analysis is the key to analysing and interpreting financial
statements.
-they add life to a set of numbers in such a way that numbers reveal those details which even
words would find difficult to reveal.
-accounting ratios and ratio analysis help unearth problems and provide solutions.
Ratios can be compared with similar ratios of:
-a different reporting period of the entity
-another similar entity for the same reporting period
-industry average ratios
 The user needs to analyse them and interpret the results
 Analysis of ratios is not an exact science ; there can be no hard and fast rules

75
 The analysis and interpretation will depend upon the circumstances of each entity

Factors on which analysis and interpretation of financial ratios

-the size of the business
-the state of the economy
-the policies of management
-the company norms
-government rules and regulations
Purpose of interpretation of financial statements
1. To measure the profitability of the business
2. To analyse the past trend
3. To evaluate the growth potential of the business
4. To do comparative study of firm’s position in relation to other firms in the industry
5. To assess overall financial strength of business
6. To examine solvency of the business

Shortcomings and Dangers of ratio analysis

 Requires a basis of comparison – one ratio on its own has no use ; must compare to ,
e.g. last year’s figures , other companies’ figures etc
 Ratios need to be analysed for successful conclusion
 Outside influences can affect ratios –e.g. national / world economy , trade cycles
 Care must be taken to compare like with like , as definitions of terminology may vary
 Easy for the inexpert to arrive at false conclusion
 Different accounting policies between companies may render ratios incompatible
 Prepared using historical costs , so can be outdated
 Need more than ratios to get an accurate view of the company

Financial ratios
-generally ratios are divided into 4 areas of classification that provide different kinds of
information.
 Profitability ratios
 Liquidity ratios
 Utilisation of resources (Efficiency ratios)
 Investment ratios

Profitability ratios
-profitability ratios help to analyse the profitability of a company
-the best way to start an analysis of the profitability of a company is by examining the
revenue it earns.

76
Gross profit margin = X 100

Net profit margin = X 100

Return on capital employed (ROCE)

-this is the most important ratio as it measures the overall performance of the company.

ROCE = X 100

Return on assets
-this reflects the relationship between the profits earned by a company and its total assets.
���� � ��
(ROA) = �

Liquidity ratios
-liquidity ratios help to assess the liquidity and cash position of the company.
-it is an indicator of whether the business has the capacity to pay its trade payables , expenses
, loans as well as other current liabilities at the correct point of time.
Current ratio (working capital ratio)
-this ratio helps decide whether the current assets will be able to generate sufficient cash to
pay off the current liabilities as and when they fall due.

Current ratio = X 100

Quick ratio (acid test ratio)

-this is another ratio used to test the liquidity position of a company
−
Quick ratio = �

Current assets minus inventory may be referred as quick assets.

-this ratio helps decide whether the quick assets of a company will generate sufficient cash to
pay off the current liabilities as and when they fall due.

Efficiency ratios
-this set of ratios help us analyse how efficiently the assets of a company are being used in
generating revenue.

77
Asset turnover
-it shows how much revenue is generated by a $ worth of assets

Asset turnover =

Utilisation of capital employed

-it shows how effectively the capital employed has been used to generate sales.

Utilisation of capital employed =

Inventory turnover
-this ratio indicates how many times the inventory is being turned over in a year.

Inventory turnover =

+
Where average inventory =

Receivable days
-this reflects the number of days it takes for a customer to pay.

Receivable days = X 365 days

Payable days
-this reflects the number of days it takes for a company to settle its bills.

Payable days = �3 day�

Working capital cycle

Working capital cycle = receivable days + inventory days – payable days
[Where inventory days = 365 days ÷ inventory turnover ratio]

Investment ratios
Gearing ratio
-this ratio is an important measure of the company’s risk and stability because it expresses the
relationship between a company’s borrowings and its own funds.

Gearing ratio = X 100

[Fixed cost capital = long-term loans + preference shares, total capital = fixed cost capital +
equity, equity = issued ordinary share capital + reserves ]
Interest cover

78
-this indicates how many times the profit covers interest charge
�
Interest cover =

-the higher the ratio the better, the company is in a better position to pay the fixed charge of
interest.
Dividend cover
-directors’ dividend policy and the potential of a company to be able to maintain dividends in
the future may be examined by calculation of dividend cover.

Dividend cover =

Earnings per share (EPS)

-investors regard this ratio as a convenient measure of the success of a company

EPS =

Price earnings ratio (PER)

-may be regarded as the number of years’ earnings that investors are prepared to pay for in
the purchase price of the company’s shares

PER =

-the higher the PER , the greater the confidence of investors in the future of the company.
Dividend yield

Dividend yield =

Users of ratios
1. Investors -to compare their investments with alternatives forms of investment.
2. Bankers and finance houses-to assess credit worthiness of businesses
3. Financial analysts
4. Government statisticians
5. Management :
a) -to analyse past results
b) -to plan for the future
c) -to control their business

79
Worked example
The directors of Khumalo Ltd provide the following balances extracted from the ledgers of
the company at 30 September 2012.
Dr Cr
$000 $000
Cost of sales and Sales 819 1 626
Operating expenses 672
Interest paid 12
600 000 ordinary shares of $0.50 each - 300
10 % redeemable preference shares - 100
8% Debentures (2016) - 150
Interim preference dividend paid 5 -

Additional information:
The market price of the ordinary shares on 30 September 2012 was $1.60.
The directors wish to make provision for:
(i) Corporation taxation for the year of $28 000.
(ii) Final preference dividend.
(iii) Final ordinary dividend of $35 000 (no interim dividend was paid).
The corporation tax charge for the year was $28 000.

REQUIRED
(a) Prepare the Income Statement for the year ended 30 September 2012.

The following information relates to the Profit and Loss and Appropriation Account for the
year ended 30 September 2011.
$000
Operating profit 120
Debenture interest paid 12
Provision for corporation tax 25
Preference dividends for the year 10

80
Proposed ordinary dividend (no interim dividend was paid) 20

The market price per share at 30 September 2011 was $1.35.

The issued ordinary share capital was 600 000 shares of $0.50 each at both balance sheet
dates.
REQUIRED
(b) Calculate the following ratios for each of the years ended 30 September 2011 and 30
September 2011:
(i) interest cover;
(ii) earnings per share (EPS);
(iii) price earnings ratio (P/E);
(iv) dividend yield;
(v) dividend cover.

(c) Comment on the changes in the ratios calculated in (b) over the two years.

Solution
. (a) Statement of Comprehensive Income for the year ended 30 September 2006
$000 $000
Sales 1626
Cost of sales ( 819)
Gross profit 807
Operating expenses (672)
Operating profit 135
Interest paid (12 )
Profit before tax 123
Taxation ( 28)
Profit after tax 95
Preference dividend paid 5
Proposed dividends preference 5
Ordinary 35 (45)
Retained profit for the year 50
Balance brought forward 130
Balance carried forward 180

(b) 2006 2005

Interest cover 11.25 times 10 times
EPS $0.14 or 14.17 c $0.12 or 12.17 c
P/E ratio 11.29 11.09

81
Dividend yield 3.64% 2.47%
Dividend cover 2.43 times 3.65 times

N.B. write the formulas in full when calculating ratios.

(c) Interest cover shows how many times interest payments are covered by operating profits
cover has improved and interest charges are still comfortably covered increased by 1.2 times .

Earnings per share shows how much profit (after interest, tax and preference dividends) is
attributable to each ordinary share the ratio is used as a convenient measure of success. The
ratio has improved by 2 cents in the second year.

Price earnings ratio relates the market price of a share to its earnings. There has been a slight
improvement indicating greater confidence of Investors in the company.

Dividend yield expresses the dividend as a percentage of the market price of a share this will
indicate to investors how much they can expect as a return on each $ invested. There has been
an improvement of about 50% over the year.

Dividend cover shows how many times the ordinary dividend can be paid out of profits after
interest, tax and preference dividends. There has been a deterioration of about 1/3 this year
which might indicate that future dividends might be at risk.

Examination type question

The summarised Statement of Financial Position of NZ Ltd at 31 December 2012 was as

follows:
$000
PPE 1 900
Net current assets 1 500
3 400
10% debentures 2013/2014 400
3 000
Share capital and reserves
Ordinary shares of $1 1 000
8% preference shares of $1 800
Share Premium account 180
Profit and Loss Account 1 020
3 000

82
On 1 January 2013 before any other transactions had taken place the following occurred.
1. Redemption of all the debentures at a premium of 5%.
2. Redemption of all the preference shares at $1.25 per share. The shares had originally been
issued at $1.10 per share.
REQUIRED
(a) A revised Statement of Financial Position at 1 January 2013 as it appeared after the
redemption of the debentures and the preference shares.

NZ Ltd’s profit before interest for the year ended 31 December 2012 was $600 000. A dividend
of $0.40 was paid on its ordinary shares for the year. The ordinary shares were quoted at $3.50
on 31 December 2002 and at $3.84 on 1 January 2003 after the redemption of the debentures
and preference shares.

REQUIRED

(b) Calculate the following ratios both at 31 December 2012 and on 1 January 2013 after the
Debentures and Preference shares had been redeemed. Give your answers to two decimal
places.
(i) Gearing
(ii) Dividend cover
(iii) Earnings per share (EPS)
(iv) Price earnings ratio (PER)
(v) Dividend yield
REQUIRED
(c) Comment on the changes in the ratios you have calculated in (b) as a result of the
transactions in (a).

In May 2013 the directors of NZ Ltd plan to build an additional factory. This requires initial
capital expenditure of $600 000 and is expected to start producing revenue and be profitable in
three years’ time. The directors are considering raising the additional funds for the project by
one of the following methods.
1. The issue of 12% debentures 2016/2018 at par.
2. A rights issue of ordinary shares at $4 per share.

83
3. An issue of ordinary shares to the public at $4 per share.
The present rate of ordinary dividend would be maintained on all the old and new shares for
the foreseeable future.
REQUIRED
(d) Discuss each of the methods of raising the capital, and state with reasons which method
the directors should choose.
Solution
Journal entries DR CR
$000 $000
Debentures 400
Share premium 20
Bank 420
Preference shares 800
Share premium ($0,10 X 800 ) 80
Profit and loss account($0,15 X 800) 120
Bank 1000

Profit and loss account 800

Capital redemption reserve 800

(a)NZ ltd: Revised statement of financial position as at 1 January 2013

Assets $000
PPE 1900
Net current assets (1500-420-1000) 80
1980
Share capital and reserves
Ordinary shares of $1 1000
Share premium account (180-20-80) 80
Capital redemption reserve 800
Profit and loss account (1020-120-800) 100
Shareholders fund 1980

84
 31/12/2002 1/1/2003
b)(i) Gearing 35.29% nil
or 54.54%
(ii) Dividend cover 1.24 times 1.5 times
(iii) Earnings per share $0.496 $0.60
(iv) Price earnings ratio 7.06 6.40
(v) Dividend yield 11.43% 10.42%

(c) (i) Gearing. The company was low geared before the redemption of the debentures and
preference shares. After the redemptions, the gearing was nil. There are now no prior charges
for debenture interest and preference dividends; all profits are now available for the ordinary
shareholders.
(ii) Dividend cover has increased marginally. Future dividends are slightly less at risk if
profits are not maintained.
(iii) Earnings per share have increased by $0.104. This is because there are now no prior
charges for debenture interest and preference dividends. This may result in increases in future
dividends and/or increase in value of shares.
(iv) Price earnings ratio has decreased slightly. It shows the price as a multiple of earnings. It
is a measure of investors' confidence in the ability of a company to maintain its earnings. In
present circumstances, the PER might have been expected to rise. However, share prices may
be affected by many factors which are not mentioned in the question.
(v) The dividend yield has decreased by 1%. This is due to the rise in the share price running
ahead of the EPS. The increase in the price of the shares seems to indicate confidence
generally in the company regardless of the slight decreases in the PER and the dividend yield.

(d) (i) Interest on the debentures would amount to $72000 per annum . This would be a prior
charge on profit. The debentures could be redeemed as soon as the new factory becomes
profitable so that all the additional benefits from the investment would accrue to the existing
shareholders.
(ii) The success of the rights issue depends upon all the new shares being subscribed for by
the existing shareholders .The required additional capital would be raised by the issue of an
additional 150000 shares. The additional dividend would amount to $60 000. The control of
the company by the existing shareholders will not be diminished by the addition of new
Shareholders. All the additional benefits from the investment would accrue to the existing
shareholders.
(iii) A public issue of shares to them would be a more permanent form of capital than an
issue of debentures. A public issue may be more successful than a rights issue which is
limited to existing shareholders. The control of the company by the existing shareholders
would be diminished by the addition of new shareholders. Profits would have to be shared
between the existing and the new shareholders.

Recommendation: The additional capital should be raised by a rights issue. It should be

attractive to the shareholders and will not involve sharing control or profit with outsiders.

85
MANUFACTURING ACCOUNTS
-these are accounts prepared by manufacturing businesses i.e. businesses that acquire raw
materials and convert them into finished goods.
Classification of costs
Direct costs are those costs that can easily be traced in the products or goods being
manufactured. The total of direct costs is known as prime cost.
-direct costs include:
Direct materials / raw materials
-these are unprocessed materials which actual form part of the finished goods
Direct labour / manufacturing wages
-these are wages paid to productive workers (i.e. those that are directly involved in the
production of goods.)
Direct expenses
-these are expenses which are direct attributed to production e.g. patent fees, royalties, license
fees, trademarks etc.
Factory overheads refers to all indirect expenses. These are part of production costs but are
difficult to trace in the goods being manufactured. Production costs is the sum of prime cost
and indirect manufacturing expenses (factory overheads). These include depreciation of plant
and machinery, indirect materials, indirect labour, rent of the factory etc
Work in progress (WIP)
-refers to partly finished goods
-those goods remaining unfinished at the end of the accounting period
Set of final accounts
1. Manufacturing account
2. Trading and profit and loss account (Income statement )
3. Balance sheet (Statement of financial position )

Formats

86
Manufacturing account
$ $
Opening inventory of raw materials X
Add purchases of raw materials X
Less returns outwards of raw materials X X
Add carriage inwards X
Customs duty (on raw materials) X
X
Less closing inventory of raw materials X
Cost of raw materials consumed X
Add direct labour X
Direct expenses X
PRIME COST X
Add factory overheads
Factory rent X
Indirect labour X
Indirect materials X
Depreciation of plant and machinery X X
X
Add opening work in progress X
Less closing work in progress X X
Production cost of finished goods X
Add manufacturing profit X
Transfer cost of finished goods (to the trading acc) X

Income statement
$ $
Sales X
Less cost of sales
Opening inventory of finished goods X
Add manufacturing transfer cost X
Purchase of finished goods X
X
Less closing inventory of finished goods X
Cost of goods sold X
Gross profit X
Add other income X
X
Less expenses
Office salaries X
Bad debts X
Carriage outwards X
Rent and rates X
Depreciation of office equipment X X
Net trading profit X
Add manufacturing profit X
Adjustment for unrealised profit X X

87
 Overall net profit (profit for the year) X

Unrealised profit
-an organisation assumes a manufacturing profit when goods are manufactured at a lower
price than the purchase price of the finished product , that difference is referred to as the
manufacturing profit.
-however the profit is unrealised because the goods are not sold since it is in fact not an actual
profit but an assumed profit
-effect is that profits and inventory are overstated therefore an adjustment must be prudently
made to the two
Calculation of unrealised profit
Closing inventory of finished goods X margin
If margin or mark-up is not given then following formula may apply:
manufac�u��ng p�of��
� clo��ng �nven�o�y of f�n��hed good�
��an�fe� co��
Accounting treatment
In the income statement a decrease in the provision is added and increase in the provision is
subtracted from the manufacturing profit.
In the balance sheet calculated provision (of the current year) for unrealised profit is deducted
from the closing inventory of finished goods.
Balance sheet extract
Current assets
Inventory: Raw materials X
Work in progress X
Finished goods X
Less provision of unrealised profit X X

Trade receivables X
Less provision for doubtful debts X X

N.B.-the manufacturing account section is sometimes referred to as factory and therefore

record all costs incurred in the production of goods
-profit and loss account section is referred to as office or general administration and therefore
record all administration and selling and distribution costs.

88
COST AND MANAGEMENT ACCCOUNTING
Costing is mainly concerned with collection of cost data, analysis and calculation of cost per
unit.
Management accounting is mainly concerned with collection of cost data and interpretation
of cost data to aid decision making.
N.B. the terms ‘costing’ and ‘management accounting are often used to mean the same thing.
Differences between costing and financial accounting
Costing accounting Financial accounting
Information is for internal use e.g. managers It is for external reporting e.g. shareholders,
and employees creditors, banks, lenders, government
No IAS’s and prescribed formats. It follows IAS’s and prescribed formats
Focuses at a section of the organisation e.g. Focuses at the organisation as a whole
production department
Uses past ,current and future information Uses past information to prepare final
accounts i.e. historical data

Definition of key terms

Cost unit –it is a unit of a product to which cost can be accumulated.
Cost centre –it is a section of the organisation or an asset to which only cost can be
accumulated e.g. production department
Revenue centre –it is a section of the organisation which accumulate only revenues. e.g. sales
department
Profit centre –it is a department to which both revenue and cost are accumulated.
Cost classification
-cost can be classified by:
i. function
ii. nature
iii. behaviour
By nature
-it is when cost is classified as direct material, indirect material, indirect labour, direct labour

89
By function
-costs can be classified as being production and non-production costs.
Non production costs include administration, selling, distribution and finance costs.
By behaviour
-costs classified as being fixed, variable, semi-variable
i. variable costs these are costs which vary in direct proportion with the level of activity e.g.
direct materials, direct labour, variable overheads
-as activity levels increase then total variable costs will also increase.
ii. fixed costs these are costs which remain constant or unchanged in total regardless of
changes in the level of activity e.g. factory rent, insurance of premises
-it should be noted that total cost remains constant over a given level of activity but that the
cost per unit falls as the level of activity increases.
iii. semi-variable costs these are costs which include both variable and fixed elements e.g.
metered electricity
Characteristics of direct costs
-they are always variable
-increase or decrease proportionately with the level of activity/output.
-they are recorded in both marginal and absorption costing.
-they can fall under any of these categories –direct materials ,direct labour and direct
expenses.
Examples
-timber for furniture production
-varnish for furniture production
-wages paid to carpenters etc.
Characteristics of indirect costs
-these are costs which cannot be economically identified with each cost unit.
-they can be either variable or fixed.
-can fall under any of these categories –indirect labour ,indirect material ,indirect expenses.
Examples

90
-factory supervisors salary
-canteen staff salary
-factory electricity
-depreciation of manufacturing machinery etc.
Analysis of costs into fixed and variable elements
There are a number of methods that exist for analysing semi-variable costs into their fixed
and variable elements.
-for these studies high/low method will be used.
High/low method
Step 1: select the highest and lowest levels of activity, and their respective costs.
Step 2: find the variable cost per unit
h�gh level of ac��v��y co�� − low level of ac��v��y co��
� � � � =
h�gh level of ac��v��y − low level ac��v��y
Step 3: find the fixed cost by substitution, using either the high or low activity level.
ABSORPTION COSTING / TOTAL COSTING
-this a costing method which treats all costs incurred in production as product costs.
-this means it treats both variable and fixed costs as product costs.
Definition of terms
Production department
-this a department which actually involved in the production of goods e.g. cutting department,
painting department
-these departments make a direct contribution into the final being of the product. (cost per
unit )
Service department
-this is a department which render services to production departments, therefore they do not
directly contribute to the actual production of goods.
Reciprocal service department
-this is a service department which assist production department in the production process
and possible assist each other

91
Cost allocation
-is the cost attribution process by which costs are charged to specific cost centres.
-it is charging of the whole item of an expense to the relevant department.
Cost apportionment
-is the cost attribution process by which costs are shared among two or more cost centres
using appropriate base.
Primary apportionment
-it is the distribution of an overhead item among departments using an appropriate production
base.
Secondary apportionment /Re-apportionment
-it is the re-distribution of service department to production departments only to enable the
calculation of overhead absorption rate. (OAR)
Cost element Basis of apportionment
Rent Floor area
Electricity: Factory power Kilowatt hours
: Heating and Lighting Floor area
Depreciation :Premises Floor area
:Plant and machinery Plant value
Canteen Number of employees
Personnel Number of employees
Stores Number of material recquisation
Insurance :Premises Floor area
:Plant and machinery Plant value

Overhead analysis sheet

-it is a table presentation of cost centres to which overhead can be traced before they are
absorbed using appropriate absorption basis.

Overhead analysis sheet extract

92
 Production departments Service departments
Basis of
Overhead apportionment Machining Assembling Canteen Personnel Total

Allocation
Indirect
material Allocated xxx xxx xxx xxx xxx
xxx xxx xxx xxx xxx
Primary
apportionment
Rent
Insurance
Factory power

Re-
apportionment
Personnel
Canteen

Overhead absorption rate (OAR)

-it is a process of charging overheads to units produced.
-the OAR is used to calculate the amount of overhead to be attributed to each cost unit.
-the amount of overheads absorbed by a cost unit is usually calculated by reference to the
time taken to produce it (the time taken is I n form of direct labour hour or machine hour )
-overheads can be absorbed into cost units using the following absorption bases:
i. machine-hour rate (when production is machine intensive)
ii. labour-hour rate (when production is labour intensive)
The OAR may be calculated as follows:
�o�al p�oduc��on ove�head
��� =
�o�al of ab�o�p��on ba���
-the absorption basis is most commonly units of a product, labour hours, or machine hours.
Departmental OARs
-It is usual for a product to pass through more than one department during the production
process. -Each department will normally have a separate departmental OAR.
-For example, a machining department will probably use a machine hour OAR.

93
- Similarly, a labour intensive department will probably use a labour hour OAR.

Predetermined OARs
-Production overheads are usually calculated at the beginning of an accounting period in
order to determine an OAR for products before they are sold to customers.
-This means that budgeted (or expected) figures must be used for production overheads and
activity levels (machine hours, labour hours).
- The predetermined OAR is calculated as follows:
budge�ed ove�head�
��� =
budge�ed level of ac��v��y
N.B. Where budgeted level of activity may be budgeted labour hours or budgeted machine
hours, depending on whether one is calculating direct labour OAR or machine hour OAR.
Absorption of overheads
-At the end of an accounting period, the overheads absorbed will be calculated as follows:
Overheads absorbed = predetermined OAR × actual level of activity

Under-and over-absorption of overheads

Over-absorption occurs when actual activity is above budgeted activity or actual overhead is
below budgeted overheads.
-the overheads absorbed are greater than the actual overheads.
-it is a cost saving and therefore favourable to the entity and is credited to the income
statement.
Under-absorption –occurs when actual expenditure is greater than budgeted expenditure or
actual output is less than budgeted output.
-the overheads absorbed are less than the actual overheads.
-it is unfavourable to the entity and it is debited to the income statement.
N.B. Under-absorption is sometimes referred to as under-recovery of overheads and
over-absorption is sometimes referred to as over- recovery of overheads.

94
Determination of under-and over-absorption

Actual overhead xxx

Less absorbed overhead xxx
(over) /under absorption xxx

Advantages of absorption costing

-it confirms with the accrual concept by matching revenue with full cost incurred in
generating that revenue.
-analysing over/under absorption of overheads is a useful exercise in controlling costs of an
organisation.
-in small organisations, absorbing overheads into the costs of products is the best way of
estimating job costs and profits on jobs.
-a pricing policy based on adding a profit element to the full production cost, ensures costs
are covered.

Absorption costing and Marginal costing

Absorption costing
-is a costing method which treat all costs incurred in production as product costs.
-it values its stock/inventory at full cost.
-it is used to make long-term decisions.
Marginal costing
-is a costing method in which variable costs are charged to cost units and fixed costs for the
period are written off in full to the income statement.
-the marginal cost of a unit of product is the total of variable costs of the product (i.e. direct
materials, direct labour and variable overheads).
-the marginal cost of a product is therefore the additional cost of producing an extra unit of
that product.

-it values stock at marginal cost (variable cost).

95
-it is used to make short-term decisions.

Absorption and marginal costing

-Marginal costing values inventory at the total variable production cost of a unit of product.

-Absorption costing values inventory at the full production cost of a unit of product.

-Inventory values will therefore be different at the beginning and end of a period under
marginal and absorption costing.

Absorption costing income statement (statement of comprehensive income)

Sales X

Less Cost of sales: (valued at full production cost)

Opening inventory X

Variable cost of production X

Fixed overhead absorbed X

Less closing inventory (X)

(X)

(under)/over-absorption (X) / X

Gross profit X

Less Non-production costs (X)

Profit/loss X

Valuation of inventory

-draw up the cost card to calculate the total cost per unit and multiply it by the number of
inventory units to get the value of inventory.

Absorption cost card (cost per unit) $

96
Direct materials xx

Direct labour xx

Variable production costs xx

Total cost per unit xx

Value of inventory =inventory in units X total cost per unit

Marginal costing income statement (statement of comprehensive income)

$ $

Sales X

Less: Cost of sales (marginal production costs only)

Opening inventory X

Variable cost of production X

less Closing inventory (X)

(X)

Less Other variable costs (X)

Contribution X

Less fixed costs (actually incurred) (X)

Profit/loss X

Valuation of inventory

Marginal cost card (cost per unit) $

Direct materials xx

Direct labour xx

Variable production overheads xx

Marginal cost per unit xx

Value of inventory = inventory in units X marginal cost per unit

97
-Under/over-absorbed overhead – no adjustment for under or over absorption of overheads
is needed in marginal costing income statements (statement of comprehensive income).

- The fixed costs actually incurred are deducted from contribution earned in order to
determine the profit for the period.

Reconciling profits reported under the marginal costing and absorption costing

Marginal profit xxx

Add closing inventory (OAR X inventory units) xxx

xxx

Less opening inventory (OAR X inventory units) xxx

Absorption profit xxx

Advantages of marginal costing

-it is used for making short-term decisions.

Example of short-term decision –ascertain selling price under current expected market
conditions.

-the separation of fixed and variable cost facilitate control of costs.

-it is simple to operate.

-there is no under or over absorption of overheads (and hence no adjustment is required in the
income statement).

Decision making (marginal costing)

-the day to day running of a business requires management to make decision.

-total costing is inadequate for these decisions to be implemented.

98
-marginal costing is basically used in decision making and inventory valuation.

-marginal costing simply takes into consideration variable costs, not fixed costs when making
a decision (fixed costs do not change, therefore need to be excluded)

-marginal costing distinguish between variable and fixed costs and only variable costs affect
decisions.

* the concept of contribution per unit is extensively used.(selling price –marginal cost per
unit)

Guideline in analysing the decision to be taken in marginal costing:

*fixed costs must remain unchanged.

*calculate revenue.

*calculate contribution per unit

Types of short-term decision making

i.make or buy decision

ii. acceptance of special order below the normal selling price

iii.decision on whether to reduce selling price in order to maximise profit

iv.utilisation of scarce resources

1.Make or buy decision

-it seeks to maximise revenue and profit by reducing costs

-the comparison is between marginal cost of manufacturing and the buying price.

Procedure

Step 1: calculate marginal cost of production per unit

Step 2: compare marginal cost of production per unit and purchase price of a component

Step 3: decision-choose the lower cost between the two i.e. marginal cost of production per
unit and purchase price.

Non financial factors to take into consideration

-consistency of the quality from an outside supplier

99
-delivery and liability

-price stability

2.Acceptance of special order below the normal selling price

-it is applied when the entity is currently producing below full capacity and can increase
profits by accepting special order.

Procedure

Step 1:calculate contribution based on the offered special price

Decision –if the special offer price gives positive contribution ( i.e. selling price > marginal
costs) ,accept the special offer.

Non financial factors to consider

-action by costumers

3.Decision on whether to reduce selling price

-it is applied when the entity is currently producing below full capacity

Procedure

Step 1:calculate profit based on the current activity level

Step 2:calculate profit based on the reduced price and revised activity level

N.B. take into account cost behaviour

Decision-choose the option yielding the greatest profit

4.Utilisation of scarce of resources

-scarce resource refers to key factor / limiting factor / principal budget factor

Definition-refers to a constraint which hinders the attainment of set production targets e.g.
shortage of raw materials, shortage of labour, shortage of machine hours.

Procedure

Step 1: calculate contribution per unit (selling price-marginal cost)

Step 2: calculate quantities of the limit factor required per unit

Step 3: calculate contribution per limiting factor (step 1 ÷ step 2)

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Step 4: rank products according to the size of contribution per limiting factor

Step 5: prepare a production schedule

Break even analysis /Cost Volume Profit analysis (CVP analysis)

-it studies relationship of cost and profit at different levels of activity.

Assumptions of CVP analysis

-it assumes that variable cost will vary in direct proportion with the level of activity

-selling price will remain constant

-the entity sell a single type of a product

-fixed cost will remain constant /unchanged

-cost can be presented in straight line or behave in a linear fashion

Break even point is the level of activity at which the organisation does not make either a
profit or a loss.

-an entity needs to know the break even point for –pricing decisions

-production levels

CVP analysis makes use of the contribution concept in order to assess the following measures
for a single product:

• contribution to sales (C/S) ratio

• breakeven point

• margin of safety

• target profit

Algebraic formulae

C/S ratio = OR

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 Break even point in units =

Break even point in sales value = break even point in units X selling price

Break even point in sales revenue =

Margin of safety

-is the amount by which anticipated sales (in units) can fall below budget before a business
makes a loss.

Margin of safety (in units) = current output – break-even point in units

Target profit

- an organisation might wish to know how many units of a product it needs to sell in order to
earn a certain level of profit (or target profit).

+
Sales volume to achieve a target profit =

+
Sales revenue to achieve a target profit � =

Advantages of break even charts

-it shows the volume needed to break even point and start to make profit.

-it shows the relation between cost and unit i.e. it depicts what happens to cost when output is
increased

Limitations of the break even analysis

-assumes that costs can be separated into variable and fixed, which is not always possible
eventhough in practise there might be semi-variable costs.

-it is also based on the assumption that the selling price is constant thereby ignoring items
like discounts.

-assumes that cost and sales levels can be predicted with certainty, in practice these variables
are uncertain as they are also determined by macro-eonomic activities e.g. inflation

N.B-for more limitations just criticise the assumptions of the break even analysis.

Question –past exam paper ZIMSEC

102
CGN Ltd manufactures plastic garden chairs. The chair has a selling price of $5 each. The
following is the production budget for the quarter ended 31 October 2007. Budgeted costs are
based on a normal level of 120 000 units per quarter

Variable material and labour costs 240 000

Variable production overheads 72 000

Fixed production overheads 36 000

Variable selling overheads 48 000

Fixed selling overheads 24 000

The company has calculated its overhead absorption rate on the basis of normal level of
activity. 150 000 chairs were produced in the quarter ended 31 October 2007. There were

30 000 chairs of stock at 1 August 2007 and 50 000 chairs were in stock at the end of the
quarter. No stocks of raw materials are held and there is no wastage.

Required

(i) Calculate an overhead absorption rate for fixed production overheads and fixed
selling overheads at a normal activity level.
(ii) Calculate the fixed production overhead absorbed during the quarter ended 31
October 2007 and the extent of any under or over absorption
(iii) Prepare a comparative profit statement using both absorption costing and marginal
costing method.
(iv) Reconciliation of profits.

Solution

ℎ
(i) OAR for fixed production overheads =
� � �

$
=
�

= $0,30 per unit

ℎ
OAR for fixed selling overheads =
� � �

$
=
�

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 = $0,20 per unit

(ii)Fixed production overhead absorbed = OAR X actual level of activity

= $0,30 X 150 000

= $45 000

Budgeted overheads 36 000

Less absorbed overheads 45 000

Over absorption (9 000)

(iii)Workings

Absorption cost card $ Marginal cost cord $

Variable costs 2 Variable costs 2

Variable production overheads 0,6 Variable production overheads 0,6

Fixed production overheads 0,3 2,6

2,9 Valuation of stock

Valuation of stock Opening stock = $2,6 X 30 000

Opening inventory = $2,9 X 30 0000 = $78 000

= $87 000 Closing stock = $2,6 X 50 000

Closing stock = $2,9 X 50 000 = $130 000

= $145 000

-to calculate the costs per unit you use the budgeted costs and divide by the normal level
units. For instance, the variable production overhead per unit = $72 000 ÷ 120 000= $0,6

104
(iii)Comparative profit statement

Using 150 000 units Absorption Marginal

costing costing

$000 $000 $000 $000

Sales (150 X 5) 750 750

Less Cost of sales

Opening stock 87 78

Variable costs (2 X 150) 300 300

Variable production overheads 90 90

Fixed overhead absorbed 45 -

522 468

Less closing stock 145 377 130 338

Less other variable costs 373 412

Variable selling overheads 60

Contribution 352

Add over absorption 9

Gross profit 382

Less non-production costs

Variable selling overheads 60

Fixed selling overheads 24 (84)

Less fixed costs

Fixed production overheads 36

Fixed selling overheads 24 (60)

Net profit 298 292

-for each costs you find cost per unit and multiply by 150 000 units.

-remember fixed costs do not vary with the level of activity

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 (iv) Reconciliation of profits

Marginal profit 292 000

Add closing stock (0,3 X 50 000) 15 000

307 000

Less opening stock (0,3 X 30 000) 9 000

Absorption profit 298 000

-here we use the OAR for fixed production overheads to multiply with units of stock, as it can
be seen that it is the difference between the absorption cost card and the marginal cost card

STANDARD COSTING AND VARIANCE ANALYSIS

Standard costing
-is a process of establishing standard ,implementing ,monitoring and evaluating performance
and also investigating differences between actual result and standard result.
Standard cost
-is the planned unit cost of a product
-is a predetermined unit cost of a product.
Standard costs per unit
-prepare a standard cost card to calculate standard cost per unit.
Standard cost card $
Direct materials xx
Direct labour xx
Variable production overheads xx
Standard cost per unit(of a product) xx
Standard hour is a measure of the amount of work which can be done per hour by a
competent worker.
Types of costs standards
-there are four main types which are:
• Basic/Fixed standards.
• Ideal standards.
• Attainable standards.

106
• Current standards.
Ideal standards
-it is the most desired cost of a product under perfect operating conditions
- perfect operating conditions include: no wastage; no scrap; no breakdowns; no stoppages;
no idle time.
-ideal standards may have an adverse motivational impact because they are unlikely to be
achieved.
Current standards
-it is a measure of current levels of efficiency of the entity in terms of allowances for
breakdowns, wastage, losses
-the disadvantage of this standard is that they do not provide any incentive to improve on the
current level of performance.
Attainable standards
-it is a challenging standard which is achievable when enough effort is placed upon.
-they are based upon efficient (but not perfect) operating conditions.
-include allowances for the following: normal or expected material losses; fatigue; machine
breakdowns.
Basic standards
-it is a predetermined cost of a unit which is not altered in-line with changes in costs.
-these are long-term standards which remain unchanged over a period of years.
-their sole use is to show trends over time for items such as material prices, labour rates, and
labour efficiency
-basic standards are the least used and the least useful type of standard.
Benefits of standard costing
-it fosters planning
-it enables controlling of costs
-basis for preparing budgets
- standard costs are also essential for calculating and analysing variances
-it fosters responsibility accounting
-facilitate management by exception
-a target of efficiency is set for employees -motivation

107
Variance analysis
variance –is the difference between standard cost and actual cost.
Variance analysis- is the process of comparing actual and standard result, investigating the
causes for corrective measures to be taken.
notes
-it must be appreciated that the prime motive of getting into business is to make a profit
-at the end of the period the profit may be different from the intended one.
What are the causes? –to trace the cause we must know that the budgeted profit is the product
of several different budgets
These are main budgets:-direct material budget, direct labour budget and sales budget.
-the point is that calculation of variances arise due to the willingness of knowing the cause of
difference in standard profit and actual profit.
Types of variances
*variances are interpreted as either favourable (F) or adverse (A) (unfavourable)
Material variances
-it is the difference between budgeted direct material cost and actual direct material cost for a
given level of output.
1.material price variance = (standard price – actual price ) X actual quantity
= (SP – AP) X AQ
2.material usage variance =(standard quantity – actual quantity) X standard price
= (SQ – AQ) X SP
3.total material cost variance =standard cost – actual cost
=SC – AC, or material price variance + material usage variance
Labour variances
1.labour rate variance =(standard rate – actual rate ) X actual hours
=(SR – AR ) X AH
2.labour efficiency variance =(standard hour – actual hour) X standard rate
=(SH – AH ) X SR
3.total labour cost variance =standard cost – actual cost
=SC – AC, or labour rate variance + labour efficiency variance
Sales variances
1.sales price variance =(actual price – standard price ) X actual quantity

108
 =(AP – SP ) X AQ
2.sales volume variance=(actual quantity – standard quantity) X standard price
=(AQ – SQ ) X SP
N.B.(standard costing compares like with like )
Possible causes of variances
Material price variance
Favourable(F) Adverse (A)
-glut in the market -high quality material than budgeted
-low quality material purchased -shortage of materials in the market
-quantity discount on purchased material -inflation in the economic environment

Material usage variance

Favourable (F) Adverse (A)
-high quality material purchased -poor machinery
-efficient machinery -low skilled labour
-high skilled labour -poor quality material

Labour rate variance

Favourable (F) Adverse (A)
-low skilled labour employed -high skilled labour
-errors in estimation -overtime or bonus payments which are
different from budgeted

Labour efficiency variance

Favourable (F) Adverse (A)
-use of high grade labour force -use of low skilled labour
-use of efficient machinery -poor machinery used
-high quality material -poor quality material

Sales volume variance

Favourable Adverse
-improved marketing strategy -high competition in the market
-low competition in the market -change in consumer tastes
-seasonal variations

Sales price variance

Favourable Adverse
-increase in sales price -quantity discounts
-price control by government

109
Possible interrelationships between variances
-the cause of a particular variance may affect another variance in a corresponding or opposite
way.
Examples:
(i)workers trying to improve productivity (favourable labour efficiency variance) might
become careless and waste more material (adverse materials usage variance).
(ii)purchase of poor quality material (favourable material price variance) which was fragile
unworkable causing inefficiency in production (adverse labour efficiency variance).
**in each of these cases, if one variance has given rise to the other, there is an argument in
favour of combining the two variances and ascribing them to the common cause. In view of
these possible interrelationships, care has to be taken when implementing a bonus scheme. If
the chief buyer is rewarded for producing a favourable price variance, this may cause trouble
later as shoddy materials give rise to adverse usage variances.
Purpose of variance analysis
I. Assessing current performance
II. For control purpose or adherence to standards
III. To effect corrective measures

Question 4 N2013 P3 (ZIMSEC)

TJK Ltd uses a standard costing system.
The company planned to produce and sell 1 500 chairs. The standard costs for producing
1 500 chairs were:
Direct material 1 400 at a cost of $2 per
Direct labour 2 400 hours at $4,20 per hour
Actual production was 1 125 chairs. All production was sold. Actual costs were:
Direct materials 1 210 at $2 178
Direct labour 1 810 hours at $7 421
The actual net profit for the month was $7 000.
Required
a) State any four advantages of using a standard costing system.
b) Calculate
(i) material price variance
(ii) material usage variance
(iii) total material cost variance
(iv) labour rate variance
(v) labour efficiency variance
(vi) total labour cost variance

110
 c) Reconcile the actual net profit to the budgeted net profit
d) Examine any two possible links between the labour and material variances calculated
above.
Solution
(b)i)material price variance = (SP – AP) X AQ
= ($2 - $1,80) X 1210
= $242 F
ii)material usage variance = (SQ – AQ) X SP
= (1 050 - 1 210) X $2
= $320 A
iii)total material cost variance = SC – AC
= $2 100 - $2 178
= $78 A
iv)labour rate variance = (SR – AR) X AH
= ($4,20 - $4,10) X 1 810
= $181 F

v)labour efficiency variance = (SH – AH) X SR

= (1 800 – 1 810) X $4,20

= $42 A

vi)total labour cost variance = SC – AC

= $7 560 - $7 421

= $139 F

111
Reconciliation of actual and budgeted profit

$ $

Actual net profit 7 000

Add adverse variances: Material usage 320

Labour efficiency 42

7362

Less favourable variance: Labour rate 181

Material price 242 (423)

Budgeted net profit 6 939

(d)possible links:

(i)favourable material price variance and adverse labour efficiency

(ii)adverse material usage variance and favourable labour rate

 explain further

Notes

-the above question needed one to flex the standard costs for producing 1 500 chairs to
standard costs of producing 1 125 chairs just like actual production.

-thus standard costing compares like with like

-you cannot calculate your variance when budgeted output is not the same as actual output
,so better change the standard costs to match with the actual output

For instance (what was done to the above question)

Standard quantity =( 1 400 ÷ 1 500) X 1125 = 1 050

Standard hour = (2 400 ÷ 1 500) X 1 125 = 1 800 hours

Standard cost for materials = SQ X SP

Standard cost for labour = SH X SR

-all that is done is to make the standard costs be of the same output as actual output , then
when calculating variances we will be comparing like with like.

112
 -when reconciling the profits don’t make a mistake by including total cost variances ,thus
total labour variance or total material variance because you will repeating the individual
variances recorded.

-when in the question you are given budgeted profit you add favourable variances and deduct
adverse variances to obtain the actual profit.

JOB COSTING
-is a form of specific order costing and it is used when customer orders job to be done.
-each job is priced separately
-each job is unique.
-main aim of job costing is to identify the costs associated with completing the order and to
record them carefully.
-individual jobs are given a unique job number and the costs involved in completing the order
are recorded on the job cost sheet or job card.
-selling prices of jobs are calculated by adding a certain amount of profit to the cost of the job.
Job cost card $
Direct materials X
Direct labour X
Direct expenses X
PRIME COST X
Variable production overheads X
MARGINAL PRODUCTION OVERHEAD X
Fixed production overhead X
TOTAL PRODUCTION OVERHEADS X
Non production overheads X
TOTAL COST X
Profit X
Sale price X
Differences between job costing and process costing
Job costing Process costing
-each job is unique -identical products or standardised output
-jobs are costed separately -costing is per process
-low volume -mass production (high volume)

113
 PROCESS COSTING
-Is a type of costing method used when mass production of many identical products takes place.
-one of the distinguishing features of process costing is that all the products in a process are
identical and indistinguishable from each other.
-for this reason ,an average cost per unit is calculated for each process.

Cost per unit =

-output of one process forms the material input of the next process.
Example 1
Units $
Materials input 1000 24000
Direct labour 4000
Overheads 3000
Calculate the average cost per unit .
Process costing with losses and gains
-sometimes in a process ,the total of inputs units may differ from the total of output units.
-losses may occur due to the evaporation or wastage of materials and this may be an expected part
of the process..
-losses may sometimes be sold and generate revenue which is generally referred to as scrap value
or scrap proceeds.
Normal loss
-is the loss that is expected in a process and it is often expressed as a percentage of the materials
input to the process.

Average cost per unit =

� –

Example
Total cost = $1800
Units input=1000units
Normal loss is 10% of the input

114
*Calculate the average cost per unit
Hint :prepare a process account for easy calculations ,thus also practice for next concepts.
Norma loss and scrap value
-if normal loss is sold as scrap it is not given a cost but the revenue is used to reduce the input
costs of the process.
−
Average cost per unit =
−

Example
The following data relates to process 1 :
Materials input -1000units costing $10000
Labour costs -$8000
Overheads -$6000
Normal loss is 4% of input and is sold as scrap for $12 per unit
*calculate the average cost per unit in process 1 and complete the process account and the scrap
account.
Abnormal losses and gains
-normal loss is expected loss in a process.
-normal gain is expected gain in a process.
-if loss or gain in a process is different to what is expected ,then there is an abnormal gain or loss
in the process.
-abnormal loss and gain units are valued at the same costs as units of goods output.
Example
Same data as above example .
Actual output = 944units
*Calculate the average cost per unit in process 1 and complete the process account, abnormal
gains and losses account and scrap account.
Work-In-Progress (WIP) and Equivalent Units (EUs)
-at the end of an accounting period there may be some units that have entered a production
process but the process has not been completed. (i.e. closing WIP units )

115
-assuming that there is no opening WIP ,then output at the end of a period will consist of
(i)fully-processed units and
(ii)part-processed units (closing WIP)
-it would not be fair to allocate a full unit cost to part processed units and there is need to use the
concept of EUs which spreads out the process costs of a period fairly between the fully-processed
and part-processed units.
Concept of EUs
-idea behind this concept is that a part-processed unit can be expressed as a proportion of a fully-
completed unit.
-for example ,if 100 units are exactly half way through the production process ,they are
effectively equal to 50 fully-completed units.
to 50 fully-completed units.
Different degrees of completion
-most processes the material is input at the start of the process ,so it is only the addition of labour
and overheads that will be incomplete at the end of the period .
-this means that the material cost should be spread over all units ,but conversion costs should be
spread over the EUs.
-this can be achieved using an expanded statement of EUs which separates out the materials and
labour costs.
N.B. the term conversion costs is often used to describe the addition of labour and overheads in a
process.
Statement of EUs
-completed units refers to fully- completed units (+abnormal loss or gain units ,if any).
-equivalent units are calculated as: % of completion relating to cost element x closing WIP units.
-total effective production is completed units + equivalent units of WIP.

116
Cost element Completed Equivalent Total Total Cost per unit
units units of WIP effective Cost
production
Materials X X X X X
Labour costs X X X X X
Overheads X X X X X
Total cost per XX
unit

Process account
Units(/kg) $ Units(/kg) $
Materials XX X Normal loss XX X
Labour costs XX X Finished goods XX X
Overheads XX X Work-in-progress XX X
Abnormal gain XX X Abnormal loss XX X
XX X XX X

**thus the general extract of a process account, where you record input elements in the debit
side and credit side as for output elements--not all of these elements will occur once so one
has to record those applicable to a given question, reference of calculations have been studied
earlier so good luck on your attempts to revision and past exam questions.
Joint and by products
-nature of processing costing is such that process often produce more than one product.
-these additional products may be described as either joint products or by products.
-essentially joint products are both main products whereas by-products are incidental to the
main products.
Joint products
-these are two or more products separated in the course of processing ,each having a
sufficiently high saleable value to merit recognition as a main product.
-joint products include a result of oil –refining process ,for example petrol and paraffin.
-petrol and paraffin have similar sales value and are therefore equally important (joint)
products.
By-products
-these are outputs of some value produced incidentally in manufacturing something else
(main products).

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-grease is a by-product when crude oil is refined.
-grease has a relatively low sales value.
Accounting treatment
-its sales proceeds are credited in the process account to reduce production cost.
-also its sales proceeds are credited to the statement of comprehensive income.
Waste product
-is a product incidentally produced from a process which have an insignificant sales value
compared to other products.
-wood shavings in the production of furniture are a waste product.
Valuation of joint products
1. joint cost these are common cost incurred in the process before split-off point.
2. split-off point is the point at which joint products are separated.
3. further processing cost these are costs incurred in processing a joint product ,after split-
off point.
Accounting treatment of joint products
Joint process costs occur before split-off point ,they are sometimes called pre-separation
costs or common costs.
-the joint costs need to be apportioned between the joint products at the split-off point to
obtain the cost of each of the products in order to value closing inventory (and cost of sales ).
-the basis of apportionment of joint costs to products is usually one of the following :
~sales value of production units (market value)
~production units (physical quantity produced method)
~net realisable value
Physical quantity produced method

X
�

118
Sales value of units produced
Product A (units X selling price) XXX
Product B (units X selling price) XXX
Product C (units X selling price) XXX
Total revenue XXX

Examination type question

Skitsoz chemicals Ltd manufactures an adhesive which passes through two processes, Y and
Z.
Details of the second process, Process Z for the month of May were as follows:
Opening work in progress Nil
Materials transferred from process Y 5 000 kilos at $23 000
Labour costs 5 000 hours at $4,40 per hour
Overheads 60% of labour cost
Output transferred to finished goods 4 000 kilos
Closing work in progress 400 kilos
Normal loss 10% of input (scrap value of $1 each)
Closing work in progress is 100% complete for material content and 75% complete for both
labour and other overheads.

119
Required
(a)i)Prepare process Z account for the month of May showing clearly the value of the transfer
to finished inventory account and also valuation of work in progress.
(b)Explain in relation to process costing the concept of ‘equivalent units’
Solution
Process Z account
Units $ Units $
Normal loss 500 500
Materials 5 000 23 000 Finished goods 4 000 23 200
Labour 2 200 Work in progress 400 2 240
Overheads 1 320 Abnormal loss 100 580
5000 26 520 5 000 26 520

Completed Equivalent Total effective Total cost Cost per unit

Cost element units units of WIP production $ $
Materials 4 100 100% X 400 4 500 22 500 5
Labour 4 100 75% X 400 4 400 2 200 0,50
overheads 4 100 75% X 400 4 400 1 320 0,30
5,80

Total cost of materials = 23 000 – normal loss

Valuation of finished goods = $5,80 X 4000

= $23 200
Valuation of WIP $
Materials (400 X 5) 2 000
Labour (300 X 0,50) 150
Overheads (300 X 0,30) 90
2 240

120
BUDGETING
Definitions
Budget is a statement expressed in financial terms of management’s plans for operating
business over a future period of time and their plans for the position of the business at the end
of that time.
- is a quantitative expression of a plan of action prepared in advance of the period to which it
relates
Budget centre is any part of an organisation for which a budget is prepared.
Budgeting
-is a process of preparing budget and allocating resources to achieve specific set targets.
Benefits /Purposes of budgeting
• Planning for the future-in line with the objectives of the organisation.
• Controlling costs - by comparing the plan of the budget with the actual results and
investigating significant differences between the two.
• Co-ordination -of the different activities of the business by ensuring that managers are
working towards the same common goal (as stated in the budget).
• Communication -budgets communicate the targets of the organisation to individual
managers.
• Motivation-budgets can motivate managers by encouraging them to beat targets or budgets
set at the beginning of the budget period. Bonuses are often based on ‘beating budgets’
• Evaluation (performance appraisal) – the performance of managers is often judged by
looking at how well the manager has performed ‘against budget’.
**If asked to state purposes of budgeting just list –planning, controlling, co-ordination,
communication, motivation, performance appraisal
Budgeting process
1. Functional budget
2. Cash budget
3. Master budget
Functional budgets
-is a budget of income and/or expenditure which applies to a particular function.

121
-main functional budgets that you need to be able to prepare are as follows:
−−−−−− −−−−−−−−−
Sales budget ⇒ Production budget ⇒ Material purchase budget
Sales budget
-it is based upon the forecast demand for the goods
-the forecast will be based upon market research, salesman report and other trading sources.
-sales are key factor in a business and they are used to determine the shape of other budgets.
It can be classified into two:
(i) a simple sales budget will record quantity price and total revenue
(ii) a complicated sales budget will require the following equation to be used

Sales = production + opening inventory –closing inventory

Sales budget extract
Product Quantity Unit price Total revenue
A XXX XXX XXX
B XXX XXX XXX
C XXX XXX XXX
XXX

Production budget
-for the production of finished goods, manufacturing companies require production budget.
-volume of production required monthly is determined by the sales budget.
-budgeted production levels can be calculated as follows:
Production =sales + closing inventory –opening inventory
**budgeted production = forecast sales + closing inventory of finished goods –opening
inventory of finished goods
-it is prepared in units.
Production budget extract
A B C
Sales X X X
Add closing inventory X X X
X X X
Less opening inventory (X) (X) (X)
Production in units X X X

122
Material purchase budget
-this budget is derived from the production budget.
-following formula is used:
Material purchases budget =material used in production +closing inventory –opening
inventory
*inventory is for materials
*material used in production is referred to as material usage budget (simply the budgeted
production for each product multiplied by the quantity (e.g kg) required to produce one unit
of the product).
Material purchase budget extract
Products
A B C
Production in units X X X
Multiplied by X X X
material requirement
Total material X X X
required
Multiplied by X X X
material price per
unit
Total revenue X X X

Flexible budget
-is a budget which is designed to change with the level of activity by recognising cost
behaviour.
-is a budget that recognises the different behaviours of fixed and variable costs at different
levels of activity.
-variable cost are calculated using high-low method.
Master budget
-a budgeted statement of comprehensive income (income statement) and statement of
financial position (balance sheet).

123
Cash budget
Cash budget extract
January February March
Receipts
Cash sales X X X
Receipts from X X X
debtors X X X
Issue of shares
Sale of non-current X X X
assets X X X
Interest received X X X
Dividend received X X X
Total receipts
Payments X X X
Cash purchases X X X
Payments to X X X
suppliers X X X
Rent
Insurance X X X
Purchase of non- X X X
current assets X X X
Redemption of
shares X X X
Total payments X X X
Net receipts X X X
/(payments)
Add opening balance
Closing cash balance

-cash budgets are prepared on a cash and not an accrual basis.

-once the outline template has been prepared ,it is not too difficult to fill in the figures ,but
careful reading of the question , a little common sense and great care in performing
calculations are essential.
-non-cash items like depreciation should be ignored (not recorded).
-take care to enter receipts and payments in the period in which the money is expected to be
received or paid.
-any item, revenue or capital in nature, which should appear in the cash book in the period in
question should be included in the budget.

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INVESTMENT APPRAISAL
-it involves purchase of a non-current assets (fixed assets), committing large sums of money.
-returns are expected over a long period of time.
Cost of the assets is the amount paid to purchase a non-current asset including any other cost
incurred in bringing the assets to its present location and condition.
Initial outlay is part of the cost which is paid immediately on investment.
-Cash flows in investment appraisal are assumed to accrue at the end of the year.
-Initial outlay occurs at the year 0.
-investment appraisal uses relevant cost (incremental cost) only those costs that arise because
of investment.
There are 4 appraisal methods
1Payback period method
2Accounting Rate of Return (ARR)
3Net Present Value (NPV)
4Internal Rate of Return (IRR)
Payback period method
-it measures the risk associated with time taken to recover the initial outlay
-it is measured in years
-the sooner the initial cash outlay is recovered by future cash inflows the better.
Decision -accept the project with the shortest payback period
− � ℎ
Payback period = year of last –ve cumulative cash flow +
� � + � ℎ

-ve thus negative and +ve thus positive

Example
N.Z investments want to acquire a machine with an initial outlay of $800 000, with the
following forecasted cash flows
Year Cash flow
1 $150 000
2 $200 000
3 $300 000
4 $600 000
5 $700 000

Calculate the payback period

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 Solution
Year Cash flows Cumulative cash flows
0 (800 000) (800 000)
1 150 000 (650 000)
2 200 000 (450 000)
3 300 000 (150 000)
4 600 000 450 000
5 700 000

Payback period = 3years +

= 3,25 years (3years 3months)

Accounting rate of return (ARR)

-this is the rate of return from capital invested versus accounting profits
�
ARR = X 100
� �

Where average capital employed = (cost of the asset + scrap value) X ½

Decision – accept an investment when ARR is greater than the cost of capital (the percentage
profit)
Advantages
-ARR is easy to calculate
Disadvantages
-it ignores the timing of cash flows
-considers profit which in most cases has an element of non-cash items
-also ignores time value of money

N.B. ARR and Payback period do not take into account the time value of money, the
following methods however take into account the time value of money by discounting cash
flows.

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Discounting is a process of calculating the present value of future cash inflows and out flows
using the discounting factors. [discounting factor for year 0 is 1]
Net Present Value (NPV)
-it is the difference between the present value expected or future cash flows and the present
value cash outflows.
Example
The following cash flows relate two projects
Year Project A ($) Project B ($)
0 (500 000) (400 000)
1 140 000 90 000
2 200 000 (80 000)
3 230 000 200 000
4 230 000 50 000

The cost of capital is 12%

Year 1 2 3 4
Discounting factor 0.893 0.797 0.712 0.636

Calculate NPV for each project.

Solution
Project A
Year Cash flow Discounting factor Present value
0 (500 000) 1 (500 000)
1 140 000 0.893 125 020
2 200 000 0.797 159 400
3 230 000 0.712 163 760
4 230 000 0.636 146 280
NPV 94 460

Project B
Year Cash flow Discounting factor Present value
0 (400 000) 1 (400 000)
1 90 000 0.893 80 370
2 (80 000) 0.797 (63 760)
3 200 000 0.712 142 400
4 50 000 0.636 31 800
NPV (209 190)

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Decision
-project A should be accepted since it has a positive NPV
-project B should not be accepted because if the expected cash flows are
discounted against their present value we get a negative present value

Internal Rate of Return (IRR)

-this is the actual rate of return earned by the project
-IRR is a rate of return such that if it is used to discount the cash flows, the NPV of the
project shall be equal to zero.
-to calculate IRR, two distinct and far apart discounting rates should be used to give a
positive and negative NPV.
Decision
-projects with an IRR greater than the cost of capital should be accepted (since it would be
earning more than what is being paid to providers of finance)
− � ���
IRR = A +
��� −���
Where: A = the rate giving the positive NPV
B = the rate giving the negative NPV
NPVa = positive NPV
NPVb= negative NPV
Example
Taking facts for Project A from previous example.
Cost of capital is 12%. Following table is given:
Year 1 2 3 4
Discounting 0.769 0.592 0.455 0.350
factor @ 30%

NPV @ 12% is $94 690. (already calculated in the above example)

Calculate the IRR for this project.
Solution

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Calculation of NPV at 30%
Year Cash flows Discounting factor Present value
0 (500 000) 1 (500 000)
1 140 000 0.769 107 660
2 200 000 0.592 118 400
3 230 000 0.455 104 650
4 230 000 0.350 80 500
NPV (88 790)

− �
IRR = 12 +
+
�
= 12 +

= 12 + 9,28940484
= 21,3%

Notes
- ARR use profits while other methods use cash flows.
- scrap value is a cash flow and is added to the last year
- given net profit you can add back depreciation to obtain cash flows for each year, and
subtract depreciation from cash flow to obtain net profit.

Non-conventional cash flows

-it refers to a situation where the purchase of fixed assets does not result in the direct inflow
of cash but result in cost savings.
Cost savings becomes the cash inflow and the operational cost of cash flows
Note: now or current refers to year zero, initial outlay occurs at year zero
-in the calculation of cash flows adjust cost savings and operational costs accordingly.

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