FAC3704

FAC1502
PART A

THE BASIC PRINCIPLES AND

SPHERES OF ACCOUNTING

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
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 TOPIC A

THE BASIC CONCEPTS, PRINCIPLES

AND OBJECTIVES OF ACCOUNTING

Learning outcome

You should be able to describe, to calculate and to record the financial performance and
the financial position of a sole proprietor, using the basic accounting equation and the
double-entry system of accounting to record the various types of transactions.

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CONTENTS

Study units
THE BASIC CONCEPTS, PRINCIPLES AND OBJECTIVES
OF ACCOUNTING
THE FINANCIAL POSITION
THE FINANCIAL PERFORMANCE (RESULT)
4 THE DOUBLE-ENTRY SYSTEM AND THE ACCOUNTING PROCESS

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STUDY UNIT

1
The basic concepts, principles and objectives of
accounting
Learning outcome

You should be able to explain the nature of accounting, as well as accounting principles,
policy, practices and procedures.

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Contents
Page
Key concepts 6
Introduction 6
What is accounting? 7
Definition 7
The nature of accounting 8
1.2.3 The purpose of accounting 8
1.2.4 The accounting process 9
Why study accounting? 10
Developments in accounting 11
The function of accounting 12
1.6 Universal accounting denominator 13
1.7 The entity concept 13
1.8 Users of financial information 14
1.9 The fields of accounting 15
1.9.1 Financial accounting 15
1.9.2 Management accounting 15
1.10 The objective of general-purpose financial reporting 16
1.11 Accounting principles 17
1.12 Accounting policy 17
1.13 Disclosure of accounting policy 17
1.14 International Financial Reporting Standards (IFRS) 17
1.15 Accounting standards and statements 18
1.15.1 Introduction 18
1.15.2 The Conceptual Framework for Financial Reporting 2010 18
1.15.2.1 The objective of financial statements 18
1.15.2.2 Underlying assumption 18
1.15.2.3 The qualitative characteristics of useful financial
Information 18
1.15.2.4 Financial statements and the reporting entity 20

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 1.15.2.5 The elements of financial statements 21
1.15.2.6 Recognition and measurement of the elements of
financial statements 22
1.16 Exercise and solution 25
Self-assessment 26

KEY CONCEPTS
• financial information
• decision-making
• nature of accounting
• unit of measurement
• forms of ownership
• fields of accounting
• accounting principles
• international financial reporting standards
• accounting statements
• accounting policy
• going concern
• qualitative characteristics
• elements of financial statements

1.1 Introduction
This module will introduce you to the concepts, principles and procedures of accounting. The
first two study units are mainly intended to give you some background knowledge. The
information may appear to be rather confusing at first, but if you follow the study guide step by
step, working through all the examples and exercises, the various methods and procedures will
become clear. To master this subject, you must get as much practice as you can – so start early
in the semester.
Accounting developed in conjunction with, and as part of the economic system over the
centuries and it performs an extremely useful and important function in society.

Through the ages, records have been kept by hand; nowadays, computers are used
increasingly for this purpose. Whichever method is used, the basic principles remain the same
since all activities in a business are still expressed in terms of money and are recorded.
Nonetheless, it is necessary to know the procedures used in a manual system in order to
understand how a computerised accounting system works.

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 GOLDEN RULE
Accounting cannot be studied by merely reading/memorising information. You need to
practice, practice and practice!

1.2 What is accounting?

1.2.1 Definition
Accounting can be defined as the orderly and systematic recording of the monetary values of
financial transactions of individuals or business enterprises and the reporting of the results of
such recording by way of the preparation and presentation of financial statements (section
1.15.2.3) to enable the users of the information obtained in this way (section 1.8) to make
decisions.

Accounting is therefore a process that consists of the following three activities:

● Identifying those events that are evidence of economic activity (transactions) relevant to
the particular business or entity.
● Recording the monetary value of economic events (transactions) in order to provide a
permanent history of the financial activities of the business or entity. Recording involves
keeping a chronological diary of measured events in an orderly and systematic manner
and classifying and summarising economic events.
● Communicating the recorded information to interested users. This information is
communicated through the preparation and distribution of accounting reports, the most
common of which are known as financial statements.

GOLDEN RULE
Accounting involves the recordings of transactions in order to provide useful information for
decision-making.

The objectives of accounting are therefore to enable the users of financial information to
ascertain the financial results and the financial position of an entity readily. With this statement
we mean that accounting provides the users of financial information with answers to the
following questions:
a) Did the entity trade at a profit or a loss?
b) What was the income of the entity and what expenses were incurred in producing that
income?
c) How much does the entity owe to other entities?
d) How much do customers owe to the entity?
e) What is the nature of the assets that the entity possesses and what is the amount (in
value) of the various kinds of property and other assets that the entity possesses?
f) What is the amount of the entity’s capital (equity)?
It is important to distinguish between the concepts “accounting” and “bookkeeping” which are
often erroneously regarded as synonymous.

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Bookkeeping
Bookkeeping is concerned with the daily recording of business transactions from source
documents in such a way that entities or individuals can determine their exact financial position.
It is therefore mainly confined to the recording of financial transactions. If this definition is
compared to the one of accounting given above, it becomes apparent that accounting includes
bookkeeping, but bookkeeping does not include accounting.
In brief, accounting includes bookkeeping, and if we talk about bookkeeping, we include only
those aspects of accounting that can be classified as bookkeeping (basically the first two of the
abovementioned activities).
1.2.2 The nature of accounting
Accounting is a specialised means of communication that conveys a specialised message
about an entity’s finances. The recipient of this specialised message (that is, the user of
financial information) must understand it, otherwise the information that is conveyed has no
value.
In accounting, words and figures are used to convey financial information to the users of that
information. As you progress with your study of accounting, you will become familiar with the
meaning of these words and figures, which are also known as the concepts, principles and
procedures of accounting. This knowledge will ultimately help you understand the message
contained in financial statements.
Each and every person who is involved in an entity uses financial information to a greater or
lesser degree. Each of us also needs to know something about accounting to manage our
personal financial affairs. Financial resources are limited or scarce, and if we are going to spend
them, we must plan properly. Knowledge of accounting is therefore also useful in this area.
Accounting is therefore a ‘‘language’’ that is used to convey financial information to interested
parties.
1.2.3 The purpose of accounting
Accounting provides financial information to users which is illustrated in diagram 1.1.
Diagram 1.1: The supply of information by accounting

Financial information __ Accounting __ Reports __ User decisions

system
| |
Financial Investing
statements Approving
Special reports loans
Tax returns Assessing taxes
Regulatory Negotiating
reports labour contracts
Managerial Establishing
reports budgets

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Accounting is a specialised medium for communicating financial information. In the business
world, it is essential that useful financial information be presented truly and fairly. Users of
financial information expect it to be accurate and comprehensive, and accounting has been
developed to satisfy this specific requirement.
The aim of accounting is to provide quantitative information that is primarily financial in nature
to provide answers to questions such as the following:

• Can the entity generate enough income to exist?

• What are the entity’s expenses in relation to its sales?
• Is too little or too much inventory being kept?
• Should the entity expand its operations?
• Is the entity’s pricing policy correct?
The information needed for answering questions like these is contained in accounting reports.
1.2.4 The accounting process
Financial accounting functions as an information system. Since far-reaching decisions are
taken on the basis of the results reported in financial statements, business transactions have
to be measured, classified, summarised and recorded continuously. We call these actions the
financial accounting cycle. This cycle is demonstrated in diagram 1.2.

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Diagram 1.2: The financial accounting cycle

TRANSACTION
DATA
↓
INPUT record on
↓
SOURCE
DOCUMENTS
↓
prepare
↓
SUBSIDIARY
JOURNALS → → → → →
↓ ↓
post to Update
↓ ↓
PROCESSING GENERAL SUBSIDIARY
LEDGER LEDGERS
↓
extract
↓
TRIAL
BALANCE
↓
prepare
↓
OUTPUT ANALYSIS DECISION-
FINANCIAL → AND → MAKING BY
STATEMENTS INTERPRETATION MANAGEMENT

Financial accounting is the systematic recording of the financial transactions of an entity in such
a manner that any information required by the entity is readily available. The systematic
recording of the financial information is called a financial accounting cycle, which consists of
the elements listed in diagram 1.2.
The processing stage entails the recording of transactions and this process is known as
bookkeeping. The ultimate goal of the input stage and the processing stage is to prepare
financial statements.

1.3 Why study accounting?

Accounting is the study of methods that enable the orderly and systematic recording of all
proceedings or activities in an entity. These proceedings or activities are called transactions.
The monetary value of transactions is recorded in the accounting records of an entity, the aim
of which is to enable the businessperson or the owner of the entity to ascertain the financial
position and the financial results of the entity at all times.

The advantages to be gained from studying accounting can be described as follows:

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The advantages for an individual are as follows:

• It enables a person to understand business terms and concepts and to apply them.
• It promotes logical thought processes.
• It teaches a person to plan and systematise his/her own finances.
• It teaches a person to work accurately.
• It develops a person’s sense of responsibility.
• It teaches a person the value of money.
The advantages for an entity are as follows:

• It communicates financial information to the users of such information.

• It enables an entity to keep an accurate record of its daily business activities.
• It enables an entity to determine whether it made a profit or suffered a loss.
• It enables an entity to calculate the total value of its assets and liabilities.
• It enables an entity to function effectively and efficiently.

1.4 Developments in Accounting

Ordinary people, entities and other organisations, for example schools, churches, hospitals and
clubs are constantly engaged in economic activities like working, trading and providing services.
These economic activities are largely based on transactions between interested parties. If, for
example, you buy bread from your local baker, you engage in a business transaction. The baker
has something that you need, and you are willing to pay him/her money (the price of the bread)
in order to get the product (bread). The baker, in order to bake and sell bread, must also enter
into transactions. He/she must buy flour and other ingredients to bake bread. Some of these
transactions can be conducted in cash while others may be on credit (i.e., payment in cash is
made sometime in the future).
In accounting, we refer to a business as an entity. The average size entity can enter into a large
volume of transactions in a single day. The owner of an entity cannot keep all the transactions
in his/her head and must write them down in order to keep a record of them. The owner or
somebody who has the necessary knowledge and who has been appointed by the owner must
capture the essential data of transactions on business documents. The data on these
documents is then captured in accounting records used specifically for this purpose by the
process known as bookkeeping.
Accounting is relevant to individuals (you) as well as entities. Entities need to keep a record of
and control over their business transactions. The main concern of accounting is to keep a record
of and to report the financial transactions of an entity, which must be done in such a way that
the management of the entity can rely on the accuracy of the accounting data when making
financial decisions that concern the financial affairs of the entity.
The ever-changing economic and social circumstances influenced the historical development
of accounting. Clay tabloids from Babylonia and records reserved from Greek and Roman
civilisations are proof that financial records were kept in order to record details of transactions
and the financial relationship between parties.
Trading activities increased through the centuries, which brought about stronger competition
and resulted in lower profits for traders. In order to stay successful, traders had to improve their
methods of recording financial information to enable them to make better business decisions
so that they could maximise their profits.

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Before 1494 there was no systematic or uniform accounting method. Modern accounting had
its origin in Italy during the Renaissance when Lucas Pacioli, an Italian mathematician,
published his well-known work Sūma de arithmetica, geometria, proportioni et proportionalita
(Summary of arithmetic, geometry, proportions and proportionality) in Venice in 1494. It
contained the first description of the principle of double entry on which modern accounting is
based.
Originally, accounting records were kept by hand. Today, computers are increasingly being
used for this purpose due to their ability to process a very large number of transactions very
quickly. Whichever method is used, the basic principles remain unchanged, since all activities
in an entity are still expressed in terms of money and are recorded as such. However, it is
important to know and understand the procedures used in a manual system in order to
understand the operations of a computerised accounting system. It is not possible to develop
computerised accounting systems without expert accounting knowledge.
It would be problematic if each entity kept individualised records of its transactions since that
would make it difficult to compare the performance of an entity with the performance of other
similar entities. Consequently, the accounting profession has standardised the way in which
entities are required to keep a record of their transactions.
The South African Statements of Generally Accepted Accounting Practice (SA GAAP) was
introduced to improve uniformity. In 1995, SA GAAP was fully harmonized with the International
Financial Reporting Standards (IFRS). SA GAAP is now identical to the IFRS. Financial
reporting standards, in terms of the Companies Act 71 of 2008 (Companies Act, 2008), allow
entities that meet the scope requirements of the conceptual framework for small and medium-
sized entities to use the IFRS for Small and Medium-sized Entities (IFRS for SMEs), which is a
scaled-down version of the complete IFRS.
In South Africa, international financial reporting standards as set by the Financial Reporting
Standards Council (FRSC) govern the recording and reporting of financial information. The
purpose of these financial accounting standards is to ensure that the same type of transaction
is recorded by different entities in more or less the same way. This will eventually ensure that
the financial statements of different entities conducting the same type of business are
comparable and that an entity’s financial statements will be comparable to those prepared in
previous years.

1.5 The function of accounting

Accounting can be defined as the orderly and systematic identification and recording of the
monetary values of financial transactions of an individual or a business entity and the reporting
of the results of these transactions by way of the preparation and presentation of financial
statements to enable interested users to use the information obtained in these financial
statements as a basis for decision-making. Accounting is a specialised method of
communicating financial information about an entity and its activities to those persons or entities
that have an interest in the activities of the entity.
Accounting is a process that involves three activities:
• The first activity is identification, which involves selecting those events that are
evidence of economic activity (transactions) relevant to the particular entity.
• The second activity is to record the monetary value of the economic events
(transactions) so as to provide a permanent history of the financial activities of the
entity. Recording consists of keeping a chronological diary of measured events in an

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 orderly and systematic manner. Recording also implies that economic events are
classified and summarised.
• The third activity encompasses the communication of the recorded information to
interested users. The information is communicated through the preparation and
distribution of accounting reports, the most common of which are known as financial
statements, that consist of:

- a statement of financial position

- a statement of profit or loss and other comprehensive income
- a statement of changes in equity
- a statement of cash flow
- notes, comprising a summary of significant accounting policies and other
explanatory notes.

The word “entity” does not necessarily refer to a business entity - it can also refer to an
educational institution, a religious institution or a private household.

1.6 Universal accounting denominator

The common unit of measurement in accounting is money. The currency used in the Republic
of South Africa is known as the rand. All of an entity’s transactions are converted into monetary
values before they are processed. Using money as the common denominator, however, has two
important limitations:
● Not all events can be expressed in monetary terms.
● The value of money is unstable and is influenced by many economic factors such as
inflation.

1.7 The entity concept

Basically, all business entities can be narrowed down to two types namely, service entities and
trading entities:
Service entities
These types of entities render services (sell their skills and knowledge) for a fee. Examples are
firms that render services like transport and storage, repairs and/or maintenance (e.g.,
electricians, plumbers and carpenters) and personal services (e.g., hairdressers, bookkeepers,
accountants, estate agents, medical doctors, dentists, lawyers and photographers).
Trading entities
These types of entities specialise in the buying and selling of merchandise. Examples are
florists, ladies and gent’s outfitters, butchers, grocers, cafes, hardware stores and general
merchants.
It is, however, important to note that some business entities not only render a service but also
sell merchandise, that is, they are also traders. An example of such an entity is a hairdressing
salon that renders a service and sells hair-care products. Usually, the product complements the
service.
A business is seen as an entity that is completely separate from its owner(s). The different
forms of business ownership are set out below.

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Forms of ownership
Forms of business ownership refer to the way in which businesses are owned and managed
– how the original funds for starting the businesses were raised and how the profits, losses
and risks in the businesses are divided.
The following forms of ownership exist in South Africa:
● a sole trader
● a partnership
● a close corporation
● a profit company, like a state-owned company (SOC Ltd), a private company ((Pty)
Ltd), a personal liability company (Inc) and a public company (Ltd).
● a non-profit company (NPC) for public benefit or for an object relating to social or
cultural activities. (Koppeschaar et al 2018:4)

1.8 Users of financial information

Financial statements are prepared and presented at least once a year and are directed towards
the common information needs of a wide range of users who analyse the information for various
decision-making purposes.
The following categories of users, and their need for accounting information, have been
identified:

User Information needs

Clients/customers of an entity … need accounting information to assess the ability of
the entity to continue as a going concern.
Employees … need accounting information to assess the ability of
their employer to provide stable employment and
remuneration.
Government and its agencies … need accounting information to regulate activities of
enterprises, to compile statistics and to determine
resource allocation and tax policies.
Investors … need accounting information to assess the risk of
investing in an enterprise and the expected return on
their investment.
Lenders … need accounting information to assess the ability of
an enterprise to pay interest on loans and to repay
loans.
Suppliers and other trade creditors need accounting information to assess the ability of
… an enterprise to pay amounts owing.
Management of an enterprise … need accounting information for planning purposes,
that is, determining future actions to be taken,
or for the
exercise of control, that is, evaluating the current
situation of the enterprise and taking corrective steps,
if necessary.
The public … requires information such as a particular entity’s
contribution to the economy, the creation of work
opportunities, taxes and charitable causes.

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Although the employees of an entity are considered to be part of the entity, not all of them have
the same access or unlimited access to its accounting records.
Users of financial statements need information on whether the reporting entity has made
efficient and effective use of the resources provided to it through the respective equity and/or
debt investments. This is known as the stewardship concept. In recent times this notion has
manifested itself in concepts such as corporate governance and accountability.

1.9 The fields of accounting

Users of financial information can be subdivided into the following two categories:
● internal users – for example, management and employees
● external users – for example, investors, creditors and government
Two fields of accounting have developed as a result of this distinction between the users of
financial information. Financial accounting is concerned with the provision of financial
information to external parties for the most part, while management accounting is concerned
with the provision of financial information to people within an entity.
1.9.1 Financial accounting
This field of accounting is concerned with the measurement and recording of transactions for
an entity and the periodic preparation of various reports on the basis of records of transactions
in the form of financial statements. The reports provide useful information concerning the entity
as a whole for managers, owners, creditors, financial institutions, governmental agencies and
the public. These reports are called financial statements and they contain information regarding
the financial position of the entity and the result of its activities. Financial accounting is governed
by international financial reporting standards, which consist of external standards that must be
adhered to. These standards ensure the comparability of financial statements between entities.
1.9.2 Management accounting
Management accounting concerns historical and estimated data that the management of an
entity use in conducting and evaluating current operations and planning future operations. In
other words, management accounting provides specific information about specific aspects of
an entity’s activities. An accountant, in preparing an entity’s management reports, incorporates
information that will be useful in helping managers make relevant decisions concerning the
entity. It would be difficult for management to manage the entity effectively without this financial
information.
Financial and management factors within an entity are both components of the same
information system. In practice, these two aspects of accounting often overlap. For example,
information needed for future planning by management will be extracted from the historical data
contained in financial accounting reports.
In this course, we concern ourselves with financial accounting. When we refer to accounting,
we mean financial accounting.

GOLDEN RULE
Financial statements must give a fair presentation of the financial position, the financial
performance and the cash flow of an entity.

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1.10 The objective of general-purpose financial reporting
The objective of general-purpose financial reporting is to provide information about the financial
position, the financial performance and changes in the financial position of an entity that is
useful to a wide range of users in making economic decisions relating to the provision of
resources to the entity.
Users’ decisions involve decisions about (2018 IFRS Conceptual Framework Project Summary,
p 5)

buying, selling or holding equity or providing or settling loans voting, or otherwise

debt instruments and other forms of credit influencing
management’s actions

To make these decisions, users assess (2018 IFRS Conceptual Framework Project Summary,
p 5)

prospects for future net cash inflows to the management’s stewardship of the entity’s
entity economic resources

To make both these assessments, users need information about both (2018 IFRS Conceptual
Framework Project Summary, p 5)

• the entity’s economic resources, claims against the entity and changes in those resources
and claims
• how efficiently and effectively management has discharged its responsibilities to use the
entity’s economic resources

The information is usually provided in the following components of financial statements:

• Statement of financial position as at the end of a financial period

Information on an entity’s economic resources and the claims against these resources,
as well as information on its liquidity and solvency, is recorded at a specific date in the
statement of financial position (Assets = Equity + Liability). The information on liquidity
and solvency is necessary to determine whether the entity will be able to meet its
commitments when they become due.

• Statement of profit or loss and other comprehensive income for the period
Information on the financial performance (Income – Expenses) of an entity in a
specified period is provided in the statement of profit or loss and other comprehensive
income. The financial performance of an entity should be reflected by the concept of
accrual accounting. In accordance with this concept, the effects of transactions are
recognised when they occur (and not as cash is received or paid) and they are recorded
in the accounting periods and reported in the financial statements of the periods to
which they relate.

• Statement of changes in equity for the period

Information about changes in the structure of an entity’s equity, as well as information
on capital transactions and other distributions made to owners, is provided in the
statement of changes in equity for the period.

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• Statement of cash flows for the period
Information on changes in the financial position of an entity, is provided in order to
assess the entity’s investing, financing and operating activities and the way in which
the entity acquires and distributes cash and cash equivalents. Information can also
be gathered on the entity’s ability to generate cash and cash equivalents, and the need
to utilise cash flows.

• Notes to the financial statements for the period

Additional information and information on the accounting policies applied are provided
for a better understanding of the financial statements.

1.11 Accounting principles

In this study unit we turn our attention to the theory of accounting. You may well ask: ‘‘Why?
Accounting is supposed to be a practical subject.’’ This is true, but no subject that is logically
structured can exist without a theoretical foundation.
The techniques used in the practice of accounting are based on conceptual and
theoretical ideas. These techniques are generally known as accounting principles.

1.12 Accounting policy

Some situations that occur in our everyday lives are repetitive (i.e., they are always the same),
but they would each have a different outcome if we were to act differently each time. If we do
not have some kind of guideline on how we should act in such situations, our actions would
probably be inconsistent. Our friends would think we were unreliable. If we lay down a guideline
so that we always act the same way in a particular situation, we can say that we are
determining a policy for our actions, which will result in our actions being consistent.
In accountin, transactions of a repetitive nature occur frequently, and the requirement of
consistency means that an entity has to establish an accounting policy to determine exactly
how such transactions should be treated. Accounting policy is therefore a set of decisions about
how an entity will handle transactions of the same type in order to achieve a consistent result.

1.13 Disclosure of accounting policy

Since an accounting policy represents an entity’s decisions about situations that it could deal
with in various ways, it has to disclose its accounting policy in its financial statements. For
example, an entity has to indicate what basis it has used to deal with the depreciation of
property, plant and equipment.

1.14 International Financial Reporting Standards (IFRS)

The IFRS is the next important concept that you will encounter in your accounting studies.
If everyone were to develop his or her own language and grammatical rules, communication
would break down. We therefore have generally applicable language and grammar rules.
Accounting, as a specialised medium of communication, has precisely the same problem. If
each entity were to prepare financial reports according to its own accounting rules and its

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interpretation of accounting theory and principles, chaos would result in the world of economics
and business.

1.15 Accounting standards and statements

1.15.1 Introduction
The objective of creating accounting standards for particular issues (e.g., the treatment of
taxation in financial statements) is to limit the variety of available accounting practices, but
without striving for strict uniformity or creating a set of rigid rules for all circumstances. The
ultimate aim of accounting standards is to encourage widespread use of particular standards
in financial reporting and to eliminate undesirable alternatives.

1.15.2 The Conceptual Framework for Financial Reporting 2010

Bear in mind that the Conceptual Framework is not a standard. It sets out the objectives and
concepts which underlie the preparation and presentation of financial statements’’.

1.15.2.1 The objective of financial statements

Refer to section 1.10 on page 16.

1.15.2.2 Underlying assumption

According to the Conceptual Framework, the going concern concept is an underlying
assumption in the preparation of financial statements.
The financial statements of an entity are normally prepared on the assumption that the entity is
a going concern and will continue to operate for the foreseeable future.

1.15.2.3 The qualitative characteristics of useful financial information

For information to be useful, it must both be relevant and provide a faithful representation of
what it purports to represent. Relevance and faithful representation are the fundamental
qualitative characteristics of useful financial information and the guiding concepts that are
applied throughout the revised Conceptual Framework.
The fundamental qualitative characteristics are as follows:
(1) Relevance
To be useful, information must be relevant to the decision-making needs of users
with respect to an asset or a liability and any related income and expense. Information
has the quality of being relevant when it influences the economic decisions of users by
helping them evaluate past, present or future events or helping them confirm, or correct,
their past evaluations. Therefore, relevant information has one or both of the
characteristics of predictive value and confirmatory value.
Materiality plays an important role when the relevance of information is
evaluated. Information is considered to be material if its omission or misstatement
could influence the decisions of users that are based on that information.

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(2) Faithful representation
All items that have an influence on the financial position and/or the financial
performance of an entity must be reported in an appropriate manner in the financial
statements. Information must faithfully represent the substance of what it purports to
represent.
According to the Conceptual Framework, faithful representation has the following three
characteristics:

• completeness
• neutrality (lack of bias)
• the absence of errors
A faithful representation is affected by the level of measurement uncertainty.
For information to be useful, it must be both relevant and faithfully represented.
Enhancements to the qualitative characteristics of financial information are as follows:
(1) Comparability
Users must be able to compare the financial statements of an entity through time in
order to identify trends in its financial position and financial performance. Therefore, the
aim of this quality is to introduce a common language into the presentation of
financial statements so that users can compare information about an entity for
different periods, or with information of other similar entities.
Comparability in the accounting treatment should be consistent for:

• the same items over time

• the same items in the same period
• similar items of different but similar entities over time and in the same period
(2) Verifiability
This characteristic of financial information is related to users’ ability to confirm that the
information presented does, in fact, faithfully present the events or transactions
it is supposed to present. There are two ways in which information can be verified,
namely,

• direct verification, whereby the cash balance can be verified by counting the cash
• indirect verification, whereby the closing balance on inventories can be confirmed
by physically counting the quantities and recalculating the cost value by using the
same valuation method used by the reporting entity.
(3) Timeliness
Recent and reliable information increases the usefulness of the financial statements.
Usually, older information is less useful and may only be useful to identify and assess
certain trends.
(4) Understandability
An essential quality of the information provided in financial statements is that it is

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 readily understandable to the average user. The Conceptual Framework (par 25)
indicates that users are assumed to have

• a reasonable knowledge of business and economic activities

• a willingness to study the information with reasonable diligence.
The Conceptual Framework adds that information of a complex nature should not be
excluded from the financial statements (where relevant to users’ decision-making)
merely because it may be too difficult for certain users to understand. However,
information should be included only if the benefits are considered to outweigh the
costs of providing the information.
Earlier, we said that the aim of financial statements is to report on the financial position,
changes in the financial position and the financial performance of an entity. We use
three different financial statements to do just that. They are as follows:

• The statement of financial position is used to report on the financial position

of a business entity.
• The statement of cash flows reports on change in the financial position of an
entity.
• The statement of profit or loss and other comprehensive income reports on
financial performance.
Each of these statements consists of different elements. It is important to get to know
these elements as quickly as possible.
1.15.2.4 Financial statements and the reporting entity
A reporting entity is

• an entity that is required, or chooses, to prepare financial statements.

• not necessarily a legal entity – it could be a portion of an entity or comprise of more
than one entity. (2018 IFRS Conceptual Framework Project Summary, p 7)

Financial statements are:

a particular form of financial reports that provide information about the reporting entity’s
assets, liabilities, equity, income and expenses (2018 IFRS Conceptual Framework Project
Summary, p 7)

20
1.15.2.5 The elements of financial statements

GOLDEN RULE
The elements of financial statements are as follows:

■ Elements that measure the financial position (assets = equity + liabilities):

(1) assets
(2) liabilities
(3) equity

■ Elements that measure profitability (profit or loss = increase or decrease in equity):

(4) income
(5) expenses

The elements of financial statements are set out below.

• The statement of financial position

The statement of financial position reports on the financial position of an entity. At the
end of the financial period, it summarises all the assets, liabilities and equity accounts
of the entity. The Conceptual Framework (par 49) defines these elements as follows:
Assets
Assets are present economic resources controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce economic
benefits
Further on in this study guide you will learn that assets can be classified into two
categories, namely, current assets and non-current assets.
Equity
Equity is the residual interest in the assets of the entity after all its liabilities have been
deducted.
Equity is also described as the part of the entity that belongs to the owners of the
entity, which could be one person (sole trader), two to twenty partners (partnership),
one to ten members (close corporation) or numerous shareholders (companies).
Changes that occurred in respect of equity in a financial period will be disclosed in the
statement of changes in equity.
Liabilities
Liabilities are present obligations of the entity to transfer economic resources as a result
of past events.
An obligation is a duty or a responsibility that the entity has no practical ability to avoid.
Similar to assets, liabilities can also be classified into two categories, namely, current
liabilities and non-current liabilities.

21
• The statement of profit or loss and other comprehensive income
The statement of profit or loss and other comprehensive income reports on the
financial performance of an entity. At the end of the financial year all income and
expense accounts are closed off to the statement of profit or loss and other
comprehensive income. The Conceptual Framework (par 70) defines these elements
as follows:
Income
Income refers to increases in assets or decreases in liabilities that result in increases
in equity, other than those relating to contributions from holders of equity claims.
Income accounts include, among others, sales, rental income, commission income and
credit losses recovered.
Expenses
Expenses refers to decreases in assets or increases in liabilities that result in
decreases in equity, other than those relating to distributions to holders of equity claims.
Expense accounts include, among others, cost of sales, water and electricity, salaries
and wages, interest expenses, stationery, credit losses, depreciation and other
operating expenses.
Once you are able to define the different elements of financial statements, you must be able to
recognise them in financial statements.
1.15.2.6 Recognition and measurement of the elements of financial statements
Recognition is the process of incorporating in the statement of financial position or the
statement of profit or loss and other comprehensive income an item that meets the definition of
an element and satisfies the criteria for recognition.
An item that meets the definition of an element should be recognised in the statement of
financial position or the statement of profit or loss and other comprehensive income if

• it is probable that any future economic benefit associated with the item will flow to or
from the entity
• the item has a cost or a value that can be measured with reliability
The following measurement bases are identified in paragraph 4.55 of the Conceptual
Framework:

22
Historical cost measurement bases (2018 IFRS Conceptual Framework Project Summary,
p 12)

• Historical cost provides information derived, at least in part, from the price of the
transaction or other event that gave rise to the item being measured.
• The historical cost of assets is reduced if the assets become impaired and the
historical cost of liabilities is increased if the liabilities become onerous.
• One way to apply a historical cost measurement basis to financial assets and
financial liabilities is to measure them at amortised cost (cost after subtracting
depreciation).

Historical cost measures are entry values and provide monetary information about assets,
liabilities and related income and expenses, using information derived, at least in part, from the
price of the transaction or other event that gave rise to them. Transaction costs are taken into
account if they are incurred in a transaction or other event giving rise to an asset or a liability
(2018 Descriptive Accounting IFRS Focus paragraph 2.7.1.1, p 19).
The historical cost of an asset is updated over time to depict, if applicable,

• the consumption of part or all of the economic resources that constitute the asset
(depreciation)
• payments received that extinguish part or all of the assets
• the effect of events that cause part or all of the historical cost of the asset to be no
longer recoverable (impairment)
• the accrual of interest to reflect any financing component of the asset
The historical cost of a liability is updated over time to depict, if applicable,

• fulfilment of part or all of the liability

• the effect of events that increase the value of the obligation to transfer the economic
resources needed to fulfil the liability to such an extent that the liability becomes
onerous (it is onerous if the historical cost is no longer sufficient to depict the obligation
to fulfil the liability)
• the accrual of interest to reflect any financing component of the liability

For financial assets and financial liabilities, a way to apply the historical cost basis is to measure
the items at amortised cost. The amortised cost of a financial asset or financial liability is
updated over time to depict subsequent changes.
Current value measurement bases (2018 IFRS Conceptual Framework Project Summary,
p 12)
Assets should be recorded at the amount paid, or the fair value of the consideration given, to
acquire the assets at the time of their acquisition. Liabilities should be recorded at the amount
of proceeds received in exchange for the obligation, or in some circumstances (for example,
income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the
liabilities in the normal course of business (Conceptual Framework, par 4.55(a)).

23
 • Current value provides information updated to reflect conditions at the measurement
date.
• Current value measurement bases include) fair value, value in use (for assets),
fulfilment value (for liabilities) and current cost.

Fair value

• Fair value is the price that would be received to sell an asset, or paid to transfer a
liability, in an orderly transaction between market participants at the measurement
date.
• Fair value reflects market participants’ current expectations about the amount, the
timing and the uncertainty of future cash flows.

Assets are carried at the present discounted value of the future net cash inflows that the item
is expected to generate in the normal course of business. Liabilities are carried at the present
discounted value of the future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business (Conceptual Framework, par 4.55(d)).
A basis that is not mentioned in the Conceptual Framework is the fair value basis, which is
frequently referred to in the IFRS. Fair value is defined in the IFRS as “the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date” (IFRS 13, “Fair Value Measurement”).
Currently, the most commonly adopted method is the historic cost method. This method is
sometimes used in combination with other methods such as fair value.
Value in use (for assets) and fulfilment value (for liabilities)

This value reflects entity-specific current expectations about the amount, the timing and the
uncertainty of future cash flows. It is therefore the present value of the cash flows, or other
economic benefits that an entity expects to derive from the use of an asset and from its
ultimate disposal. An exit value.

Assets are carried at the amount of cash or cash equivalent that could currently be obtained by
selling the assets in an orderly disposal. Liabilities are carried at their settlement values, that
is, the undiscounted amounts of cash or cash equivalent expected to be paid to satisfy the
liabilities in the normal course of business (Conceptual Framework, par 4.55(c)).

Current cost

Current cost reflects the current amount that would be

• paid to acquire an equivalent asset

• received to take on an equivalent liability

Assets are carried at the amount of cash or cash equivalent that would have to be paid if the
same or equivalent assets were acquired currently. An entry value. Liabilities are carried at the

24
undiscounted amount of cash or cash equivalent that would be required to settle the obligation
currently (Conceptual Framework, paragraph 4.55(b)).
Assets are carried at the amount of cash or cash equivalent that could currently be obtained by
selling the assets in an orderly disposal. Liabilities are carried at their settlement values, that
is, the undiscounted amounts of cash or cash equivalent expected to be paid to satisfy the
liabilities in the normal course of business (Conceptual Framework, par 4.55(c)).

1.16 Exercise and solution

We end this study unit with a few revision questions. It is in your own interest to try to answer
these by referring to the study unit.

EXERCISE

(1) Discuss the nature of accounting.

(2) What is the common unit of measurement in accounting?
(3) Name the four main forms of ownership in South Africa.
(4) Discuss the different users of financial information.
(5) Differentiate between financial accounting and management accounting.
(6) Name the qualitative characteristics of financial information.
(7) Define the concept of accounting policy.
(8) What is meant by disclosure of accounting policy?
(9) Describe the concept of international financial reporting standards.
(10) Discuss the underlying assumption in the preparation of financial statements.
(11) Name the fundamental qualitative characteristics of financial statements.
(12) Name the elements of financial statements.

SOLUTION

(1) Refer to section 1.2.2.

(2) The common unit of measurement in accounting is money.
(3) Sole trader
Partnership
Close corporation
Company
(4) See section 1.8.
(5) See section 1.9.
(6) See section 1.15.2.3.
(7) See section 1.12.
(8) See section 1.13.
(9) See section 1.14.

25
 (10) See section 1.15.2.2.
(11) Relevance
Faithful representation
(12) Assets
Liabilities
Equity
Income
Expenses

SELF-ASSESSMENT

Now that you have studied this study unit, can you

• describe the importance of financial information as a basis for

decision-making?
• discuss the different users of financial information and their
needs?
• state the different forms of ownership?
• discuss the nature of accounting?
• explain the difference between financial and management
accounting?
• name the qualitative characteristics of financial statements?
• explain what is meant by accounting policy?
• explain what is meant by the disclosure of accounting policy?
• explain what is meant by international financial reporting
standards?
• explain what is meant by accounting standards and statements?

26
 FAC3704
FAC1502
STUDY UNIT 2

THE FINANCIAL POSITION

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

2
The financial position

Learning outcome
You should be able to describe the primary purpose of accounting and the double-entry
system. You should also be able to calculate the financial position of an entity and the
elements of the basic accounting equation.

2
Contents
Page

Key concepts 3
2.1 Introduction 4
2.2 Accounting entity 4
2.3 The financial period 4
2.4 Financial position 4
2.5 The elements of financial statements 5
2.5.1 Assets 5
2.5.2 Liabilities 7
2.5.3 Equity 8
2.6 The basic accounting equation (BAE) 9
2.7 The double-entry system 10
2.8 Revision exercises and solutions 13
2.8.1 Revision exercise 1 13
2.8.2 Revision exercise 2 13
Self-assessment 15

KEY CONCEPTS
● Accounting entity
● Accounting equation
● Financial position
● Asset
● Liability
● Equity
● Double-entry system
Net worth

3
2.1 Introduction
The primary purpose of accounting (section 1.2.3) is to give information (section 1.2.4) on the
financial position (section 4.7) and the financial result (section 4.15.1) of an entity. This study
unit deals with the key elements of the financial position (section 1.15.2.5) of an entity.

2.2 Accounting entity

Every entity for which separate financial records are kept is an accounting entity (section 1.7).
It is extremely important to see a business as a separate entity from its owners because
transactions entered into by an entity have to be dealt with from the point of view of the entity
for which accounting records are kept.

2.3 The financial period

The financial statements of any business entity, regardless of whether it operates as a
company, a close corporation, a partnership or a sole trader, consist of at least a statement of
financial position, which provides information about the financial position of the business at the
end of a specified period (monthly, every three months, every six months or every twelve
months). The heading of the statement of financial position identifies the date at which it is
reporting, for example:
XYZ Traders
Statement of financial position as at 30 September 20.2
If the financial period is one year, the period will be from 1 October 20.1 until 30 September 20.2
and the statement of financial position will be as at the last day of the financial year. Therefore,
the statement of financial position reports on the assets, the liabilities and the equity of the
entity for only one day. (section 3.2.7)

2.4 Financial position

The financial position of an entity is described in terms of assets, liabilities and equity at a given
time, which are reflected in a statement of financial position. The statement of financial position
is essentially an accounting report on the financial position of the entity. The statement of
financial position communicates relevant financial information to the owners, creditors/trade
payables and other interested parties.
A simplified example of a statement of financial position according to the basic accounting
equation is as follows:

4
BUSINESS TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.9
R
ASSETS
Tools and equipment 88 800
Bank 8 200
97 000

EQUITY AND LIABILITIES

Capital 40 000
Creditor/Trade payables 7 000
Long-term loan 50 000
97 000

COMMENT
This example of a statement of financial position (balance sheet) is in a
basic form. We will deal with statements of financial position (balance
sheets) in more detail later.

2.5 The elements of financial statements

Every entity implements a financial accounting system according to the minimum financial
accounting standards and practices when it draws up financial statements that are used in
making economic decisions. Financial statements (section 1.15.2.4) reflect the financial effects
of transactions. These effects are grouped into broad classes according to their economic
characteristics, namely, assets, equity, liabilities, income and expenses. Assets, equity,
liabilities, income and expenses are called the elements of financial statements.

The elements directly related to the measurement of financial position at a given time in the
statement of financial position are assets, liabilities and equity.
2.5.1 Assets

Let’s have a look at the difference between non-current assets and current assets.

5
 ASSETS

Assets are present economic resources

controlled (used) by an entity, as a result
of past events (assets were bought).
An economic resource is a right that has
the potential to produce economic
benefits.

CURRENT ASSETS NON-CURRENT ASSETS

An asset is classified as current when it All other assets (that is, assets that are not
satisfies any of the following criteria (IAS 1.66): classified as current assets are classified as
non-current) (IAS 1.60).
• It is expected to be converted into money Non-current assets include tangible,
(realised) or is intended for sale or intangible and financial assets of a long-
consumption in the entity’s normal term nature. (In this module, we will only
operating cycle. concern ourselves with tangible non-current
assets.)
• It is held primarily for the purpose of being It is not the intention of the entity to sell non-
traded. current assets but to use these assets over
the long-term in its business operations to
earn an income.
• It is expected to be converted into money Non-current assets are those assets with a
(realised) within 12 months of the statement useful life of longer than one year.
of financial position date.
• It is cash or cash equivalent unless it is
restricted from being exchanged or used to
settle a liability for at least 12 months after
the end of the reporting period.
Examples of current assets are Examples of non-current assets are
• trading inventories • land
• consumable stores on hand • buildings
• debtors/trade receivables • vehicles
• accrued income • furniture
• prepaid expenses • equipment
• bank (favourable balance) • machinery
• cash float
• petty cash

An asset is recognised as an element of an entity’s financial statements when

• it is probable that economic benefits will flow to the entity
• the cost or the valuation of the asset can be measured reliably. (Koppeschaar et al
2017:21)

6
The following examples of how assets may be employed by an entity are given in paragraph
4.10 of the Conceptual Framework:
Assets may be
• used singly or in combination with other assets in the production of goods or services
to be sold by the entity
• exchanged for other assets
• used to settle a liability
• distributed to the owners of the entity

2.5.2 Liabilities
Let’s have a look at the difference between current liabilities and non-current liabilities.

LIABILITIES

Liabilities are present obligations (debts) of

an entity to transfer economic resources
(payments) as a result of past events
(borrowing or purchasing).
An obligation is a duty or a responsibility
that an entity has no practical ability to
avoid.
-

CURRENT LIABILITIES NON-CURRENT LIABILITIES

A liability is classified as current when it All other liabilities (that is, liabilities that are
satisfies any of the following criteria (IAS not classified as current liabilities are
1.69): classified as non-current) (IAS 1.69).
• It is expected to be settled in the entity’s Non-current liabilities are long-term debts
normal operating cycle (usually one year). and have to be settled after one year of the
statement of financial position date.
• It is held primarily for the purpose of being
traded.
• It is expected to be settled within 12 .
months after the statement of financial
position date.
• The entity does not have an unconditional
right to defer settlement of the liability for
at least 12 months after the end of the
reporting period.
Examples of current liabilities are Examples of non-current liabilities are
• creditors/trade payables • long-term loans
• bank overdrafts • mortgage
• current portion of long-term borrowings • debentures
• short-term borrowings
• accrued expenses
• income received in advance
7
A liability is recognised as an element of an entity’s financial statements when

• it is probable that economic benefits will flow from the entity when an obligation is
settled
• the amount of the benefit to be given up can be measured reliably. (IAS 37, “Provisions,
Contingent Liabilities and Contingent Assets”)
The settlement of obligations can take place in a number of ways, for instance, through

• the payment of cash

• the transfer of other assets
• the provision of services
• the replacement of one obligation with another
• the conversion of an obligation into equity (Conceptual Framework, par 4.16)

2.5.3 Equity
The difference between the value of assets owned by an entity and the liabilities it has incurred
represents the net asset value. If we express this as an equation, then
ASSETS - LIABILITIES = NET ASSET VALUE
The net asset value represents the portion by which the assets exceed the liabilities and is
therefore also called EQUITY.
According to these principles the correct statement of financial position for Business Traders is
as follows:
BUSINESS TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.9
R
ASSETS
Non-current assets
Tools and equipment 88 800
Current assets
Bank 8 200
97 000
EQUITY AND LIABILITIES
Equity
Capital 40 000
Non-current liability
Long-term loan 50 000
Current liability
Creditor/Trade payables 7 000
97 000

8
2.6 The basic accounting equation (BAE)
The logical method of recording transactions by way of the accounting equation is used to
process transaction data. Transactions may

• affect assets and/or equity and/or liabilities

• generate income or give rise to expenditure

The accounting equation states that

ASSETS = EQUITY + LIABILTIES

A = E + L

OR

EQUITY = ASSETS - LIABILTIES

E = A - L

The equity of an entity equals all the assets in the entity less all the claims against
those assets (liabilities).

The accounting equation is a mathematical equation that should always balance. The financial
position of an entity is indicated by this equation.

Since the accounting equation should always balance, the involvement of two accounts
is required for each transaction. The accounting equation is, therefore, based on the
double-entry accounting system.

Basic requirements for the accounting equation

• A minimum of two accounts must be used for each transaction.
• The equation must remain in balance after each transaction. In other words, the
debit side (A) is equal to the credit side (E + L).

Consider the following example of transactions that affect assets and/or equity and/or liabilities:
Before the entity starts to do business, the accounting equation will look like this:

Debit side = Credit side

A = E + L
Possessions the entity owns = Amounts owed to the + Amounts owed to third
owner of the entity parties
What the entity owns = What the entity owes
0 = 0

Note that the recording of transactions is done from the point of view of the business
entity independent from its owner.

Every entity for which separate financial records are kept is a financial accounting entity. It is
extremely important to see the entity as separate from its owner: transactions entered into by
the entity have to be dealt with from the point of view of the entity whose books are being done.
9
Why do we say that the accounting equation is a fact and not a rule? To answer this question,
you need to know what each concept in the equation means:

• Assets are basically all the resources controlled by an entity (whether they are owned
by the entity or not).
• Liabilities are the debts of an entity (all the money owed to third parties).
• Equity refers to the wealth of the owner(s) of an entity (from the business only). It is an
indication of how much of the asset base actually belongs to the owner(s).

An easy way to remember the accounting equation is to ask:

What would the owner have left for him-/herself if he/she closed his/her business today, sold
all the assets and paid back all the liabilities?

Remember, not all assets controlled by an entity are owned by the entity. If a business entity
bought a vehicle on credit, for example, the vehicle does not belong to the entity until the final
instalment is paid. Until then, the vehicle actually belongs to the financier, and it will be
accompanied by a liability (debt) in the accounting records of the entity. If the owner decides to
close the business, the money owed on this vehicle will still be due. In simple language, the
accounting equation therefore states a fact.

Equity (wealth) equals all the valuables (assets) in a business less all the claims
against those assets (liabilities).

Before you will be able to use the accounting equation, you have to learn about the double-
entry principle that drives the accounting process.

2.7 The double-entry system

Bookkeeping is the part of financial accounting that is concerned with the recording of
transactions. The transactions are recorded in an account.

An account consists of a left-hand side and a right-hand side and is presented in a

“T” format. The left-hand side is referred to as the debit side and the right-hand side
is referred to as the credit side. The name of the “T”-account is written across the
centre at the beginning of the account.

This can be illustrated as follows:

Dr (debit side) …… Account (credit side) Cr

Left-hand side (LHS) Right-hand side (RHS)

For each asset, liability, equity, expense and income there will be a “T”-account in the
accounting records of an entity. All these “T”-accounts together are called the general ledger.
The double-entry principle provides a logical method of recording transactions. When the
double-entry system is used, the monetary (money) value of each transaction must be
entered on the debit side of one ledger account as well as on the credit side of another
ledger account. The entry in one ledger account refers to the corresponding entry in the
other ledger account.
As the entries in the two ledger accounts have been entered on opposite sides, the use of the
double-entry system allows for cross references. Each transaction is entered in two separate
10
accounts on opposite sides, and it is therefore possible to check and control the arithmetical
and accounting accuracy of the work. If each transaction is recorded so that the debit and
credit entries are equal, the same sum of all the debits to the account must equal the
sum of all the credits. This can be explained by way of the accounting equation.

The double-entry system is based on the fact that every transaction affects two or
more items in the BAE. In principle, this means that each transaction must be recorded
in such a way that the equation remains in balance. The dual effect that each
transaction has on the elements of the BAE is the fundamental principle on which all
entries in an accounting system are based.

When the double-entry principle is applied, the following rules need to be followed:
Dr (debit side) Assets (credit side) Cr
+ -

Dr (debit side) Equity, Liabilities (credit side) Cr

- +

The above can be summarised as follows:

• Assets increase on the (left) debit side and decrease on the (right) credit side of the
T-account.
• Equity increases on the (right) credit side and decreases on the (left) debit side of
the T-account.
• Liabilities increase on the (right) credit side and decrease on the (left) debit side of
the T-account.

For you as a learner in accounting the reality is that the double-entry rules are not concepts
that you can try to understand – you have to learn them!

Refer to section 2.5.3 for an example of a statement of financial position.

EXERCISE 1

Maxi Services’s assets amount to R30 000 and its liabilities (creditors/trade
payables) amount to R5 000.
Calculate the equity.

We use the BAE. The amounts that are given are substituted for the appropriate
symbol and the unknown symbol is calculated.

A = E + L
This basic accounting equation will be adjusted so that the equity can be
calculated:
E = A - L (Creditors/Trade payables)
R30 000 - R5 000
R25 000

11
EXERCISE 2

Tom is the owner of Zebra Services, which offers a carpet cleaning service. On
30 November 20.1 Zebra Services owns equipment amounting to R100 000.
Clients owe R40 000 for services rendered and Zebra Services owes R20 000 to
a supplier for parts purchased. Zebra Services also has R10 000 in cash in the
bank.

Show the BAE for Zebra Services and determine the equity.

Step 1: Identify the assets

Equipment = R100 000
Trade receivables = R 40 000
Bank = R 10 000

Step 2: Identify the liabilities

Trade payables = R20 000
Substitute these amounts into the equation:

A = E + L
This basic accounting equation will be adjusted so that the equity can be
calculated:
E = A - L
Equity Equipment + Trade receivables + Trade payables
Bank
R(100 000 + 40 000 +10 000) - R20 000
R130 000

Zebra Services’s financial position can also be presented in the form of a

statement of financial position (previously known as balance sheet) as follows:

ZEBRA SERVICES
STATEMENT OF FINANCIAL POSITION AS AT 30 NOVEMBER 20.1
R
ASSETS
Equipment 100 000
Trade receivables 40 000
Bank 10 000
150 000

EQUITY AND LIABILITIES

Equity 130 000
Trade payables 20 000
150 000

12
2.8 Revision exercises and solutions
2.8.1 Revision exercise 1
(1) Define the concept of an accounting entity.
(2) Describe the financial position of an entity in terms of the BAE.
(3) Explain the nature (section 1.15.2.5) of
(a) assets
(b) equity
(c) liabilities
(4) Name two sources of financing.
(5) What is meant by the double-entry system?

Solution: Revision exercise 1

(1) An accounting entity is any entity for which separate financial records are
kept.
(2) ASSETS = EQUITY + LIABILITIES
(3) (a) Assets are all the resources controlled by an entity (whether they are
owned by the entity or not), that is, the possessions of an entity.
(b) Equity is the interest that the owner of an entity has in the business
and that the entity therefore owes to him/her.
(c) Liabilities are creditors’ interests (trade payables’ interest) or
interests of parties other than the owners of an entity. Liabilities are
therefore the debts of an entity.
(4) The owner
Trade payables
(5) In principle, it means that every transaction has a dual effect on the
elements of the BAE and that after every transaction the BAE must
remain in balance.

2.8.2 Revision exercise 2

Calculate the missing figures using the BAE.

R
(1) Bank = 4 000
Vehicles = 5 000
Equipment = 7 000
Capital = ?

13
 R
(2) Capital = 150 000
Loan = 50 000
Bank = ?
Machinery = 190 000

(3) Bank = 5 000

Trade receivables = 15 000
Buildings = 100 000
Furniture = 40 000
Trade payables = 50 000
Capital = ?

(4) Capital = 60 000

Loan = 10 000
Trade payables = 6 000
Assets = ?

Solution: Revision exercise 2

(1)

A = E + L
This basic accounting equation will be adjusted so that the equity can be
calculated:
E = A - L
Capital Bank + Vehicles +
Equipment
R(4 000 + 5 000 + 7 000) - R0
R16 000

(2)

A = E + L
Machinery + Bank Capital Loan
R190 000 + Bank = R150 000 + R50 000
Bank = R10 000*
* R190 000 – R(150 000 + 50 000)

14
 (3)

A = E + L
This basic accounting equation will be adjusted so that the equity can be
calculated:
E = A - L
Capital Bank + Trade receivables + Trade payables
Buildings + Furniture
R(5 000 + 15 000 + 100 000 R50 000
+ 40 000) -
R160 000 - R50 000
R110 000

(4)

A = E + L
Assets Capital Loan + Trade payables
R60 000 + R(10 000 + 6 000)
R76 000

SELF-ASSESSMENT

Now that you have studied this study unit, can you

• describe the primary purpose of accounting?

• describe an entity?
• describe the financial position of an entity?
• describe the double-entry system?
• calculate the elements of the basic accounting equation?

15
 FAC3704
FAC1502
STUDY UNIT 3

THE FINANCIAL
PERFORMANCE (RESULT)

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
1
STUDY UNIT

3
The financial performance ( result)

Learning outcome

You should be able to apply the concepts of income and expenditure to determine the
gross and net profits (or losses) and their effect on equity.

2
Contents
Page
Key concepts 2
Introduction 4
The financial performance (result) 4
Income 4
Expenditure 6
Influence of profit or loss on equity 7
Statement of profit or loss and other comprehensive income (financial
performance) 9
Statement of changes in equity 9
Accounting policies and explanatory notes 9
Revision exercises and solutions 10
Revision exercise 1 10
Revision exercise 2 10
Self-assessment 11

KEY CONCEPTS

• financial result
• profit/loss
• income
• expenditure

3
3.1 Introduction
In section 2.3 we discussed the first component of the primary goal of accounting, which is
to determine the financial position of an entity as it is reflected in the statement of
financial position. In this study unit we discuss the second component of this primary goal,
namely, the financial performance of the entity, and indicate how it is reflected in the form
of a statement of profit or loss and other comprehensive income.

3.2 The financial performance ( result)

The financial result of an entity is measured in terms of the profit or loss that the entity has
made over a specific period, which is referred to as the financial period and which is normally
a year. An entity makes a profit when the income it has earned is more than the expenditure it
has incurred in generating or producing that income. The difference between income and
expenditure is known as a profit or a loss. Profit is a business owner’s reward for the capital
he/she has invested and the entrepreneurial spirit he/she has shown. It therefore increases the
equity of the business.
The statement of profit or loss and other comprehensive income of a business provides
information about the results of the operating activities of the business in a specified period,
that is, its performance. The heading of the statement of profit or loss and other comprehensive
income identifies the period on which it is reporting, for example:
XYZ TRADERS
Statement of profit or loss and other comprehensive income for the year ended
30 September 20.2
The statement of profit or loss and other comprehensive income of an entity reports its income
and expenses, including its gains and losses.

3.3 Income
Profit or loss is frequently used as a measure of performance. The elements directly related
to the measurement of an entity’s financial performance for a period in the statement of profit
or loss and other comprehensive income are income and expenses.

Income less expenses = profit/loss for the year

The objective of every entity is to earn as large an income as possible.

Income is the income that an entity earned through its normal everyday business
activities in a financial accounting period (normally a year). Examples are sales, rent
income, interest income and credit losses recovered.

Expenses are the running expenses that an entity incurred to earn an income in a
financial accounting period (normally a year). Example are purchases, rent expenses,
telephone expenses, water and electricity and salaries and wages.

4
 INCOME

Profit/income refers to increases in assets or

decreases in liabilities that result in
increases in equity, other than those relating
to contributions from holders of equity
claims.

REVENUE PROFIT/GAINS

Revenue is income earned through an Gains are increases in economic benefits that
entity’s normal activities (daily operating do not arise from the normal activities of an
activities), for example, entity, for example,
• fees earned • profit on the sale of non-current assets
• sales
• interest income
• rental income
• commission income
• credit losses recovered

When the double-entry principle is applied, the following rules have to be followed:
Dr (debit side) Equity, Liabilities & Income (credit side) Cr
- +

• Income increases on the (right) credit side and decreases on the (left) debit side of
the T-account because income increases the profit for the year.
Income is recognised when

• an increase in economic benefits through an increase in assets or a decrease in

liabilities of an entity has arisen for the entity
• it can be measured reliably (Koppeschaar et al, 2017:21)
Income is therefore recognised simultaneously with an increase in assets or a decrease in
liabilities. In practice, it is normally required that revenue be earned before it is recognised.

5
3.4 Expenditure
Expenditure is incurred to earn income.

EXPENSES

Losses/expenses are decreases in assets, or

increases in liabilities that result in
decreases in equity, other than those
relating to contributions to holders of equity
claims.

EXPENDITURE LOSSES

Expenses are incurred in the normal course Losses are decreases in economic benefits
of an entity’s activities. They arise from the that do not arise from the normal activities of
generation of income. Examples of expenses an entity, for example,
are:
• cost of sales • a loss on the sale of a non-current asset
• wages and salaries
• interest expenses
• rental expenses
• advertising
• credit losses
• insurance
• repairs and maintenance
• telephone expenses
• water and electricity
• postage
• rates and taxes
• stationery
• consumables
• packing materials
• bank charges
• depreciation
• administrative expenses

When the double-entry principle is applied the following rules have to be followed:
Dr (debit side) Expenses (credit side) Cr
+ -

6
The above can be summarised as follows:

• Expenses increase on the (left) debit side and decrease on the (right) credit side of
the T-account because expenses decrease the profit for the year.
Expenses are regarded as

• a decline in economic benefits resulting from a decrease in assets, or an increase in

liabilities
• that can be measured reliably (Koppeschaar et al: 2017:22)

Expenses are therefore recognised simultaneously with an increase in liabilities or a decrease

in existing assets.

3.5 Influence of profit or loss on equity

Equity refers to the wealth of the owner of an entity. One can say that if the owner of a business
closed down the entity at a particular date, sold all the valuables (assets) in the entity and paid
all the liabilities, the amount left would constitute the equity. There are two methods by which
equity can be calculated, namely, by means of the accounting equation and by means of
income and expenses.
Income (profit) increases and expenditure (losses) decreases the owner’s interest.
Equity can be calculated by the following two methods:

• Method A: – by using the accounting equation

Equity = Assets – Liabilities
• Method B: – by using equity accounts

Dr (debit side) Capital (credit side) Cr

- +

BUSINESS TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.9
R
Capital (Opening balance) xx xxx
Plus: Additional capital contributions during the year xx xxx
Plus: Total comprehensive income for the year xx xxx
Less: Drawings (xx xxx)
Capital (closing balance) xx xxx

7
EXERCISE

The financial position (BAE) of T Payn, an attorney, on 28 February 20.0 is as

follows:

Assets = E+ L
R50 000 R30 000 R20 000

For the year ended 28 February 20.1 he had the following income and
expenditure:
R
Services rendered 180 000
Salaries 100 000
Administrative costs 20 000
Insurance expenses 10 000

Calculate T Payn’s equity on 28 February 20.1.

SOLUTION

We use the equation that we discussed in section 3.5:

Profit = Income – Expenditure
= Services rendered – (Salaries + administrative costs + insurance
expenses)
= R180 000 – R(100 000 + 20 000 + 10 000)
= R180 000 - R130 000
= R50 000
E = R30 000 + R50 000
= R80 000

COMMENTS
• Capital plus profit form the equity of the owner. See the above exercise
– R(30 000 + 50 000) = R80 000.
• Profit is income minus expenditure.

8
3.6 Statement of profit or loss and other comprehensive income
(financial performance)
The financial performance of an entity is measured in the statement of profit or loss and other
comprehensive income (previously known as the income statement).
The correct statement of profit or loss and other comprehensive income for Business Traders
is as follows:
BUSINESS TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20.9
Notes R
Services rendered xx xxx
Other income x xxx
Rental income x xxx

xx xxx
Distribution, administrative and other expenses (x xxx)
Telephone expenses x xxx
Salaries x xxx

Profit for the year xx xxx

Other comprehensive income for the year * -
Total comprehensive income for the year xx xxx

* Other comprehensive income for the year falls outside the scope of the FAC1502 syllabus.

Refer to an example of the statement of profit or loss and other comprehensive income in
section 4.15.1 of study unit 4.

3.7 Statement of changes in equity

The purpose of the statement of changes in equity of an entity (refer to the example of Method
B in section 3.5) is to reconcile the equity at the beginning of the financial period with the equity
at the end of the financial period. The balance of the equity at the end of the financial period is
then shown in the statement of financial position.
Refer to an example of a statement of changes in equity in section 4.15.2 of study unit 4.

3.8 Accounting policies and explanatory notes

Additional information on items appearing in the financial statements of an entity is given in the
notes to the financial statements. Refer to an example of notes to the financial statements in
section 4.15.4 of study unit 4.

9
3.9 Revision exercises and solutions
3.9.1 Revision exercise 1
(1) How is the financial performance (result) of an entity calculated in
accounting terms? Which financial report reflects the financial
performance?
(2) Give three examples of income.
(3) Give three examples of expenditure.
(4) How is profit/loss determined for a financial period?
(5) Does a loss increase or decrease the equity of the owner of an entity?

Solution: Revision exercise 1

(1) Income minus expenditure. The statement of profit or loss and other
comprehensive income reflects the financial performance.
(2) Refer to section 3.3.
(3) Refer to section 3.4.
(4) Expenditure is subtracted from income. Refer to section 3.5.
(5) A loss decreases equity.

3.9.2 Revision exercise 2

On 28 February 20.2 Alpha Services showed the following income and
expenditure for the financial year
R

Services rendered 850 000

Salaries 520 000
Wages 50 000
Telephone expenses 4 000
Stationery 2 000
Interest income 1 000
Insurance 12 000

Calculate the net profit/loss of Alpha Services on 28 February 20.2.

Solution: Revision exercise 2

Income = Services rendered + Interest income
= R(850 000 + 1 000)
= R851 000
Expenditure = Salaries + Wages + Telephone expenses + Stationery +
Insurance
= R(520 000 + 50 000 + 4 000 + 2 000 + 12 000)
= R588 000
Profit = Income - Expenditure
= R851 000 - R588 000
= R263 000

10
 SELF-ASSESSMENT

Now that you have studied this study unit, can you:

• describe the concept of income?

• describe the concept of expenditure?
• calculate the profit (or loss) of an entity?
• calculate the effect of profit/loss on equity?

11
 FAC3704

FAC1502
STUDY UNIT 4

THE DOUBLE-ENTRY
SYSTEM AND THE
ACCOUNTING PROCESS

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

4
The double-entry system and the accounting process

Learning outcome

You should be able to analyse and record transactions in the books of an entity and
prepare financial statements.

2
Contents
Page
Key concepts 4
4.1 Introduction 4
4.2 The double-entry system 4
4.3 The effect of transactions on the basic accounting equation 5
4.4 Transactions that affect only assets, equity and liabilities 5
4.4.1 Capital contributions 5
4.4.2 Acquisition of loans 6
4.4.3 Purchase of assets for cash 7
4.4.4 Buying assets on credit (debt) 8
4.4.5 Payments to creditors 8
4.4.6 Withdrawals by owner 9
4.5 Transactions that give rise to income and expenditure 10
4.5.1 Income (cash) 10
4.5.2 Expenditure (cash) 11
4.5.3 Income (credit) 12
4.5.4 Expenditure (credit) 13
4.5.5 Payments received from debtors 14
4.6 Summary of transactions 15
4.7 Basic form of a statement of financial position (previously known as a
balance sheet 15
4.8 Revision exercises and solutions 17
4.8.1 Revision exercise 1 17
4.8.2 Revision exercise 2 19
4.9 The general ledger account 21
4.9.1 Assets 22
4.9.2 Equity and liabilities 22
4.10 Balancing an account 22
4.11 Schematic representation 23
4.12 Recording of transactions in ledger accounts 23
4.13 The general ledger 26
4.14 The trial balance 29
4.15 Preparing financial statements 31
4.15.1 The statement of profit or loss and other comprehensive income 31
4.15.2 The statement of changes in equity 32
4.15.3 The statement of financial position 33
4.15.4 Notes 35
4.16 Summary 36
4.17 Revision exercises and solutions 36

3
 4.17.1 Revision exercise 1 36
4.17.2 Revision exercise 2 36
4.17.3 Revision exercise 3 36
4.17.4 Revision exercise 4 37
4.17.5 Revision exercise 5 37
Self-assessment 37

KEY CONCEPTS

• debit and credit

• ledger
• transaction
• contra account
• effect on financial position
• folio number
• T-account
• trial balance

4.1 INTRODUCTION
We mentioned the double-entry system in section 2.6 of study unit 2 - read that section
again. To make a double-entry correctly, you need a good working knowledge of the
appropriate names for different concepts in accounting, particularly the concepts of
"debit" and "credit". It is very important that you master this study unit since it explains
the foundation on which the accounting system is built.

4.2 THE DOUBLE-ENTRY SYSTEM

At this stage we are simply using the accounting equation as a teaching aid to explain the
analysis of transactions. The BAE does not form part of a formal accounting system.
To make a double-entry you must:
• think about what effect the transaction is going to have on the BAE, in other
words, how it is going to affect the financial position of the entity
• identify the components (accounts) that are involved, that is, the components
that will have the desired effect on the equation
• determine which account(s) has/have to be debited and which account(s)
has/have to be credited
• be sure that the amount(s) debited is/are equal to the amount(s) credited
• be able to indicate the date of the transaction
• indicate the name of the contra ledger account in the account in which you are
making the entry, the contra account is the other account that is involved in the
transaction: the one account refers to the other
• indicate the folio number of the subsidiary journal

4
4.3 THE EFFECT OF TRANSACTIONS ON THE BASIC ACCOUNTING
EQUATION
A transaction is an agreed-upon transfer of value from one party to another that affects (i.e.,
changes) the amount, the nature or the composition of an entity's assets, liabilities or
equity. In other words, it affects the BAE. Entering into a transaction gives rise to the first
step in the accounting cycle, namely, the completion of a source document.
Transactions may
• affect assets and/or equity and/or liabilities
• generate income or give rise to expenditure

4.4 TRANSACTIONS THAT AFFECT ONLY ASSETS, EQUITY AND

LIABILITIES
Below we give practical examples of transactions that affect only assets or interests. (A “+”
indicates an increase and a “-” indicates a decrease.)

4.4.1 Capital contributions

Transaction
1 Feb 20.1 T Tom decided to start a carpet-cleaning business called Fix-'n-Mat. He
made a direct EFT of R130 000 from his personal savings account to the
bank account of Fix-'n-Mat.

Analysis (1) The asset “Bank” increases by R130 000 and there is now money in
Fix-'n-Mat's bank account.
(2) The owner, T Tom, provides Fix-'n-Mat with funds and increases his
interest in Fix-'n-Mat. The equity “Capital” increases by R130 000.

ASSETS = EQUITY + LIABILITIES

Bank Capital
R R R
Previous balances 0 0 0
This transaction + 130 000 + 130 000 0

New balances 130 000 = 130 000 + 0

5
 COMMENTS
• In an entity that has not yet entered into any transaction, the elements
of the equation will always be 0.
• The terms “bank” and “capital” in the analysis are actually names of
accounts.
• The investment of capital is usually the first transaction.
• Capital may be contributed in the form of cash or any other asset (e.g.,
furniture). “Furniture” instead of “Bank” will then increase.
• The BAE balances after the transaction.

4.4.2 Acquisition of loans

Transaction
2 Feb 20.1 Fix-'n-Mat obtained a loan of R25 000 with a payback period of more than
a year from ABC Bank. The amount was paid into Fix-‘n-Mat’s bank
account.

Analysis (1) The asset “Bank” increases by R25 000.

(2) ABC Bank now has a claim against or an interest in Fix-'n-Mat, and a
liability, namely, “Loan: ABC Bank” comes into being.

ASSETS = EQUITY + LIABILITIES

Bank Capital
R R R
Balances brought 130 000 130 000 0
down
This transaction + 25 000 0 + 25 000

New balances 155 000 = 130 000 + 25 000

6
 COMMENTS
• The results of the first transaction form the balances that are brought
down in this transaction.
• Liabilities arise when another party or institution supplies funds (makes
loans) to the entity.
• Amounts (in this case, R25 000) are added to both the left-hand side
and the right-hand side of the BAE.
• The BAE balances after the transaction.

4.4.3 Purchase of assets for cash

Transaction
6 Feb 20.1 Fix-’n-Mat bought equipment from XY Furnishers for R100 000 and paid
the amount directly, via EFT (Electronic Funds Transfer) into XY
Furnishers’s bank account.

Analysis (1) The asset “Bank” decreases by R100 000 since money has been
withdrawn.
(2) The asset “Equipment” increases.

ASSETS = EQUITY + LIABILITIES

Loan:
Equipment Bank Capital
ABC Bank
R R R R

130 000 25 000

Balances brought down 155 000
This transaction +100 000 –100 000 0 0

New balances 100 000 55 000 = 130 000 + 25 000

COMMENTS
• Assets now consist of bank and equipment.
• The left-hand side of the equation increases and decreases. One
asset is exchanged for another asset.
• The BAE balances after the transaction.
7
4.4.4 Buying assets on credit (debt)

Transaction
10 Feb 20.1 Fix-’n-Mat bought furniture for R2 000 on credit from Joc Limited.

Analysis (1) The asset “Furniture” increases by R2 000.

(2) A liability, “Trade payables”, comes into being.

ASSETS = EQUITY + LIABILITIES

Furniture Equipment Bank Capital Loan: Trade

ABC Bank payables
R R R R R R

Balances brought
down 0 100 000 55 000 130 000 25 000 0

This transaction +2 000 0 0 0 0 +2 000

New balances 2 000 100 000 55 000 = 130 000 + 25 000 2 000

COMMENTS
• Assets may also be bought on credit, in which case a creditor (trade
payables) comes into being.
• The transaction is recorded when it is entered into and not when the
payment is made.
• The left-hand side and the right-hand side of the BAE increase.
• The BAE balances after the transaction.

4.4.5 Payments to creditors (trade payables)

Transaction
Fix-’n-Mat made an EFT to Joc Limited's account to pay its account of
11 Feb 20.1
R2 000.

Analysis (1) The asset “Bank” decreases by R2 000.

(2) A liability, “Trade payables”, decreases by R2 000.

8
 ASSETS = EQUITY + LIABILITIES

Furniture Equipment Bank Capital Loan: Trade

ABC Bank payables

R R R R R R
Balances brought
down 2 000 100 000 55 000 130 000 25 000 2 000
This transaction 0 0 −2 000 0 0 −2 000
New balances 2 000 100 000 53 000 = 130 000 + 25 000 0

COMMENTS
• The left-hand side and the right-hand side of the BAE decrease.
• The BAE balances after the transaction.

4.4.6 Withdrawals by owner

Transaction
12 Feb 20.1 The owner took R1 000 cash for his own use.

Analysis (1) Fix-‘n-Mat’s “Bank” decreases by R1 000.

(2) T Tom’s, “Capital” (equity) in Fix-’n-Mat decreases by R1 000.

ASSETS = EQUITY + LIABILITIES

Furniture Equipment Bank Capital Loan: Trade

ABC Bank payables

R R R R R R
Balances brought
down 2 000 100 000 53 000 130 000 25 000 0
This transaction 0 0 −1 000 −1 000 0 0
New balances 2 000 100 000 52 000 = 129 000 + 25 000 0

9
 COMMENTS
• Withdrawals are the opposite of capital contributions and reduce
capital. Remember, withdrawals are not expenditure.
• Where the entity pays personal expenses of the owner, it is also
treated as a withdrawal, called “Drawings”.
• The left-hand side and the right-hand side of the BAE are reduced.
• The BAE balances after the transaction.

4.5 TRANSACTIONS THAT GIVE RISE TO INCOME AND EXPEN-

DITURE

4.5.1 Income (cash)

Transaction
13 Feb 20.1 Fix-’n-Mat provided services for a client, S Silver, after which an amount
of R1 000 was paid directly into the bank account of Fix-‘n-Mat.

Analysis (1) The asset “Bank” increases by R1 000.

(2) The service fees that Fix-’n-Mat earns are income. Equity therefore
increases by R1 000.

ASSETS = EQUITY + LIABILITIES

Furniture Equipment Bank Capital Income/ Loan: Trade

Expenditure ABC Bank payables
R R R R R R R

Balances brought down 2 000 100 000 52 000 129 000 0 25 000 0

This transaction 0 0 +1 000 0 +1 000 0 0

New balances 2 000 100 000 53 000 = 129 000 1 000 + 25 000 0

10
 COMMENTS
• Income earned increases equity. It is the objective of the entity to
earn income for the entrepreneur.
• The left-hand side and the right-hand side of the BAE increase.

• The BAE balances after the transaction.

4.5.2 Expenditure (cash)

Transaction
16 Feb 20.1 Fix-’n-Mat paid wages of R800 cash.

Analysis (1) The asset “Bank” decreases by R800.

(2) Wages are an expenditure item and therefore equity decreases by
R800.

ASSETS = EQUITY + LIABILITIES

Income/ Loan:
Furniture Equipment Bank Capital Trade
Expenditure ABC Bank payables
R R R R R R R

Balances brought down 2 000 100 000 53 000 129 000 1 000 25 000 0

This transaction 0 0 ‒800 0 ‒800 0 0

New balances 2 000 100 000 52 200 = 129 000 200 + 25 000 0

COMMENTS
• In essence, expenditure incurred decreases income and therefore
also decreases equity.
• The left-hand side and the right-hand side of the BAE decrease.
• The BAE balances after the transaction.

11
4.5.3 Income (credit)

Transaction
18 Feb 20.1 Fix-’n-Mat provided services worth R6 000 to C Canon on credit.

Analysis (1) C Canon becomes a debtor of Fix-’n-Mat. The asset “Trade

receivables” comes into being and increases by R6 000.
(2) “Service fees” earned are an income item, and equity increases by
R6 000.

ASSETS = EQUITY + LIABILITIES

Trade Furniture Equipment Bank Capital Income/ Loan: Trade

receivables Expend- ABC Bank payables
iture

R R R R R R R R

Balances brought
0 2 000 100 000 52 200 129 000 200 25 000 0
down
This transaction + 6 000 0 0 0 0 +6 000 0 0

New balances 6 000 2 000 100 000 52 200 = 129 000 6 200 + 25 000 0

COMMENTS
• Organisations or clients who owe money to the entity are known as
debtors (trade receivables). Debtors arise when the entity renders
services or goods on credit.
• The left-hand side and the right-hand side of the BAE increase.
• The realisation principle applies here, and the income is shown
as having been earned on 18 February, when the service was
provided, and not the date on which the cash is received.

12
4.5.4 Expenditure (credit)

Transaction
21 Feb 20.1 Fix-’n-Mat placed an advertisement in a local newspaper for R200.
Payment was due only in 30 days.

Analysis (1) The liability “Trade payables” increases by R200.

(2) “Advertising expenses” are an expenditure item, and the equity
decreases by R200.

ASSETS = EQUITY + LIABILITIES

Trade Income/ Loan: Trade

Furniture Equipment Bank Capital
receivables Expend- ABC payables
iture Bank

R R R R R R R R

Balances brought
6 000 2 000 100 000 52 200 129 000 6 200 25 000 0
down
This transaction 0 0 0 0 ‒200 0 +200

New balances 6 000 2 000 100 000 52 200 = 129 000 6 000 + 25 000 200

COMMENTS
• Expenditure may also be incurred on credit (for goods/services
received).
• The organisations to which money is owed are known as creditors
(trade payables).
• The right-hand side of the BAE increases and decreases.
• The expenditure is shown on 21 February 20.1 and not only when
the amount is paid. The accrual principle applies here.
• The BAE balances after the transaction.

13
4.5.5 Payments received from debtors (trade receivables)

Transaction
28 Feb 20.1 C Canon settled part of its account, R2 000, in cash.

Analysis (1) The asset “Bank” increases by R2 000.

(2) The asset “Trade receivables” decreases by R2 000.

ASSETS = EQUITY + LIABILITIES

Trade Furniture Equipment Bank Capital Income/ Loan: Trade

receivables Expend- ABC payables
iture Bank

R R R R R R R R

Balances brought
6 000 2 000 100 000 52 200 129 000 6 000 25 000 200
down
This transaction ‒2 000 0 0 +2 000 0 0 0 0

New balances 4 000 2 000 100 000 54 200 = 129 000 6 000 + 25 000 200

COMMENTS
• This transaction affects assets only.
• The left-hand side of the BAE increases and decreases.
• The BAE balances after the transaction.

14
4.6 SUMMARY OF TRANSACTIONS
Fix-’n-Mat’s transactions for February 20.1 can now be summarised as follows:

ASSETS = INTERESTS

EQUITY + LIABILITIES

Date Trade Income/ + Loan: Trade

receivables Furniture Equipment Bank Capital Expenditure ABC Bank payables

20.1 R R R R R R R R
Feb
1 +130 000 = +130 000
2 +25 000 = +25 000
6 +100 000 ‒100 000 =
10 +2 000 = +2 000
11 ‒2 000 = ‒2 000
12 ‒1 000 = ‒1 000
13 +1 000 = +1 000
16 ‒800 = ‒800
+6 000 = +6 000
21 = ‒200 +200
28 ‒2 000 +2 000 =
+4 000 +2 000 +100 000 +54 200 = +129 000 +6 000 + +25 000 +200

160 200 = 135 000 + 25 200

= 160 200

COMMENT
• Note that these totals correspond to the closing balances in section
4.5.5 above.

4.7 BASIC FORM OF A STATEMENT OF FINANCIAL POSITION

(PREVIOUSLY KNOWN AS THE BALANCE SHEET)
Now we are going to prepare a statement of financial position using the totals of the BAE
(refer to section 4.6). The basic form of the statement of financial position is based on the
BAE. You have already come across a very simple statement of financial position in section
2.5. A statement of financial position is a report and, in essence, it is a formal presentation
of the elements of the BAE.

15
FIX-’N-MAT
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1

ASSETS Note R
Non-current assets 102 000
Equipment 100 000
Furniture 2 000

Current assets 58 200

Trade and other receivables 4 000
Cash and cash equivalents 54 200

Total assets 160 200

EQUITY AND LIABILITIES

Total equity 135 000
Capital 135 000

Non-current liabilities 25 000

Long-term borrowings 25 000

Current liabilities 200

Trade and other payables 200
Total equity and liabilities 160 200

COMMENTS
• The statement of financial position balances and shows the same
totals as the BAE.
• Note the heading -- the statement of financial position is prepared to
reflect the financial position on a specific date.
• The withdrawals are subtracted from the capital. As mentioned
earlier, withdrawals are not an expenditure item.
• The equity in the BAE is also R135 000.

16
4.8 REVISION EXERCISES AND SOLUTIONS

4.8.1 REVISION EXERCISE 1

D Paulus started a television antenna installation business on 1 June 20.1. The following
transactions took place in the first month:

Transactions:
June 1 Cash was deposited directly into the bank account of the business as opening
capital, R25 000.
2 D Paulus made his private equipment available to the business, R9 000.
3 Additional equipment purchased and paid for with the credit card of the
business, R12 000.
4 Installation fees for work done on account for Kannadrift Municipality, R4 200.
6 Vehicle purchased on credit from Virginia Cars Limited, R22 400. This vehicle
was financed by obtaining a loan from Crown Bank at an interest rate of 9%
per annum.
17 Kannadrift Municipality paid R2 200 on its account.
28 Wages paid, R4 000.
29 Money drawn for private use, R1 300.
30 Paid R9 000 for loan from Crown Bank.

REQUIRED
Using the basic accounting equation, analyse the abovementioned
transactions as follows:
NB: (1) Show the effect of each transaction on the basic accounting
equation, using a plus sign (+) for an increase and a minus
sign (-) for a decrease.
(2) Balance the equation.

Example: On 1 July 20.1 D Paulus received R2 000 in cash for an installation done for
Cook Financing Corporation.

Date Basic accounting equation

A = E + L

20.1 R R R
July 1 +2 000 +2 000 0

17
SOLUTION: REVISION EXERCISE 1
D PAULUS
ACCOUNTING EQUATION

Basic accounting equation

Date
A = E + L
20.1 R R R
June 1 +25 000 +25 000
2 +9 000 +9 000
3 +12 000 +12 000
4 +4 200 +4 200
6 +22 400 +22 400
17 +2 200
‒2 200
28 ‒4 000 ‒4 000
29 ‒1 300 ‒1 300
30 ‒9 000 ‒9 000
Total 46 300 32 900 13 400

46 300

COMMENT
• If a payment is made by credit card the business paid is paid directly
but D Paulus will still owe the amount to the bank until the credit
card amount due is paid in full. A creditor (liability) bank: credit card
will be created.

18
4.8.2 REVISION EXERCISE 2

The following transactions in January 20.1 relate to the business of F Fox, an attorney.

Date Transactions Amount

20.1 R
Jan 3 F Fox deposited opening capital, directly into the bank account
of the business. 20 000
Paid rental for January 20.1 2 300
4 Bought law library on credit from Book Limited 24 000
Bought a computer for cash from Leo Limited 1 700
6 Provided services for cash 7 200
9 Debited D Dunn with fees for services rendered 8 318
10 Leo Limited repaired equipment on credit 100
13 F Fox withdrew money for private use 1 234
18 F Fox, the business, received commission on a property
transaction 1 350
29 Made the following EFTs:
(i) Salaries 8 350
(ii) Leo Limited (on account) 100
30 Received payment from D Dunn on his account 1 500

REQUIRED
(1) Analyse the above transactions in tabular form as follows:
ASSETS = EQUITY + LIABILITIES

Trade Trade
Library and Income/
Date receivables/ Bank Capital payables/
Equipment Expenditure
Debtors Creditors

R R R R R R

= +

Total = +

(2) Prepare the statement of financial position of F Fox as at 31 January 20.1.

19
SOLUTION: REVISION EXERCISE 2

F FOX
(1) ACCOUNTING EQUATION

ASSETS = EQUITY + LIABILITIES

Library Trade Income/ Trade

Date and receivables/ Bank Capital Expendi- payables/
Equipment Debtors ture Creditors

20.1 R R R R R R
Jan 3 +20 000 = +20 000 +
–2 300 = –2 300 +
+24 000 = + +24 000
+1 700 –1 700 = +
+7 200 = +7 200 +
+8 318 = +8 318 +
10 = –100 + +100
13 –1 234 = –1 234 +
18 +1 350 = +1 350 +
29 –8 350 = –8 350 +
–100 = + –100
30 –1 500 +1 500 = +
Total +25 700 +6 818 +16 366 = +18 766 +6 118 + +24 000

R48 884 R48 884

20
F FOX
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20.1
ASSETS Note R
Non-current assets 25 700
Equipment 1 700
Library 24 000
Current assets 23 184
Trade and other receivables 6 818
Cash and cash equivalents 16 366
Total assets 48 884
EQUITY AND LIABILITIES
Total equity 24 884
Capital 24 884
Current liabilities 24 000
Trade and other payables 24 000
Total equity and liabilities 48 884

4.9 THE GENERAL LEDGER ACCOUNT

Up to now, we have dealt only with asset, equity and liability items appearing in a statement
of financial position or a BAE.
We recorded transactions in columns in a summary of a BAE to show their effect on a
specific asset, equity or liability item. We had columns for debtors/trade receivables,
furniture, equipment, capital and so on. But it is impractical to prepare a new equation after
every new transaction - just think what would happen in a business with thousands of
transactions! Therefore, we are now going to open an account in the general ledger for
every column of the BAE. We speak of the general ledger because there are also
subsidiary ledgers, which we will explain later.
An account is opened in the general ledger for every asset, equity and liability item. Every
account appears on its own on a page in the ledger and each account is given a number,
which is known as a folio number.
An account is an accounting record in which all transactions relating to a specific
item are recorded. Please have a look at page 10 of study unit 2, as well as the content
explanation for study unit 2.

Dr Name of account Cr
Year Contra account Amount Year Contra account Amount
Month Day details Fol R Month Day details Fol R

21
4.9.1 Assets
Please have a look at section 2.5.1 of study unit 2, as well as the content explanation for
study unit 2.

4.9.2 Equity and liabilities

Please have a look at sectiond 2.5.2 and 2.5.3 of study unit 2, as well as the content
explanation for study unit 2.

4.10 BALANCING AN ACCOUNT

Considering what you have learnt about an account, you now know that an account may
have entries on the debit or the credit side or on both sides. Please have a look at the
content explanation for study unit 2.

NB:
The closing balance of the previous period becomes the opening balance of the next
period.
• c/d = carried down, which indicates the amount to be carried down to the following
month
• b/d = brought down, which indicates that the amount has been brought down from
the previous month

22
4.11 Schematic representation
Refer to Study unit 4_Schematic representation.

COMMENTS
• The top level of the schematic representation shows the basic
accounting equation (BAE).
• The second level of the schematic representation shows how each of
the components of the BAE becomes part of the accounting system.
The left-hand side of the account is known as the debit side (Dr) and
the right-hand side is known as the credit side (Cr).
• The total of the amounts on the debit side of an asset account is
usually larger than that on the credit side. The account therefore
usually has a debit balance (brought down). The total of the amounts
on the credit side of a liability account is usually larger than that on the
debit side. The account therefore usually has a credit balance (brought
down).
• The capital account reflects the equity of the owner at the date of the
statement of financial position. The balance on this account is the
result of income, expenditure, drawings and capital investment. These
components are all dealt with separately in the accounting system.
• Additional capital contributions and income increase equity.
• Drawings and expenditure decrease equity.
• But note: drawings are not an expenditure and therefore do
not reduce the profit.
• The left-hand side (EQUITY SECTION) forms the basis for the
preparation of the statement of profit or loss and other comprehensive
income and the statement of changes in equity.
• The Capital (EQUITY SECTION) and the right-hand side (ASSETS
and LIABILITIES) form the basis for the preparation of the statement
of financial position.

4.12 RECORDING OF TRANSACTIONS IN LEDGER ACCOUNTS

When we enter a transaction in a ledger account, we have to ask ourselves: Which
accounts are affected? In answer to this question, we are now going to record the
transactions discussed in sections 4.4 and 4.5 in ledger accounts (T-accounts).

23
Transaction
(4.4.1)

Dr Bank Cr Dr Capital Cr
130 000 130 000

(4.4.2)

Dr Bank Cr Dr Loan Cr
25 000 25 000

(4.4.3)

Dr Equipment Cr Dr Bank Cr
100 000 100 000

(4.4.4)

Dr Furniture Cr Dr Trade payables (Joc Ltd) Cr

2 000 2 000

(4.4.5)

Dr Bank Cr Dr Trade payables (Joc Ltd) Cr

2 000 2 000

24
(4.4.6)

Dr Bank Cr Dr Drawings Cr
1 000 1 000

COMMENT
All drawings by the owner are recorded in a separate account, namely,
"Drawings", and not directly in the capital account. Drawings represent a
disbursement of the profit to the owner and are not expenses resulting
from business operations.

(4.5.1)

Dr Bank Cr Dr Service fees Cr

1 000 1 000

(4.5.2)

Dr Bank Cr Dr Wages Cr
800 800

(4.5.3)

Dr Trade receivables (C Canon) Cr Dr Service fees Cr

6 000 6 000

25
(4.5.4)

Dr Trade payables Cr Dr Advertising expenses Cr

200 200

(4.5.5)

Dr Bank Cr Dr Trade receivables (C Canon) Cr

2 000 2 000

GOLDEN RULE
For each transaction you need to make a debit entry as well as a credit entry for the debit
side (dr) to be equal to the credit side (cr).

4.13 THE GENERAL LEDGER

In the previous example two accounts were opened each time for each transaction. In
practice, all transactions that affect, say, bank are summarised in one account for bank.
Given the information we have above, the accounts will take the following form (each one is
closed off and the balance determined):

GOLDEN RULE
Assets (e.g., Bank) increase on the debit side (dr) and decrease on the credit side (cr) of
the account.

26
Dr Bank Cr

Date Details Fol Amount Date Details Fol Amount

20.1 R 20.1 R
Feb 1 Capital 130 000 Feb 6 Equipment 100 000
2 Loan:ABC Bank 25 000 11 Trade payables 2 000
13 Service fees 1 000 12 Drawings 1 000
28 Trade receivables 2 000 16 Wages 800
28 Balance c/d 54 200
158 000 158 000
20.1
Mar 1 Balance b/d 54 200

Dr Equipment Cr

20.1 R
Feb 6 Bank 100 000

Dr Furniture Cr

20.1 R
Feb 10 Trade payables 2 000

Dr Trade receivables Cr

20.1 R 20.1 R
Feb 18 Service fees 6 000 Feb 28 Bank 2 000
Balance c/d 4 000
6 000 6 000
20.1
Mar 1 Balance b/d 4 000

GOLDEN RULE
Equity (e.g., Capital) and liabilities (e.g., Trade payables) increase on the credit side (cr)
and decrease on the debit side (dr) of the account.

27
GOLDEN RULE
Income (e.g., sales, service fees) increases equity and is credited (cr) to the particular
income account.

GOLDEN RULE
Expenses (e.g., wages) decrease equity and are debited (dr) to the particular expense
account.

Dr Capital Cr

20.1 R
Feb 1 Bank 130 000

Dr Drawings Cr

20.1 R
Feb 12 Bank 1 000

Dr Loan: ABC Bank Cr

20.1 R
Feb 2 Bank 25 000

Dr Trade payables Cr

20.1 R 20.1 R
Feb 11 Bank 2 000 Feb 10 Furniture 2 000
28 Balance c/d 200 21 Advertising
expenses 200
2 200 2 200
20.1
Mar 1 Balance b/d 200

28
Dr Wages Cr

20.1 R
Feb 16 Bank 800

Dr Advertising expenses Cr

20.1 R
Feb 21 Trade payables 200

Dr Service fees Cr

20.1 R
Feb 13 Bank 1 000
18 Trade
receivables 8 000
7 000

COMMENT
• Note that an item in a ledger account is simply the name of the
other ledger account involved in the transaction. This other ledger
account is known as the contra ledger account.

4.14 THE TRIAL BALANCE

A trial balance is a list of the balances brought down (b/d) of the accounts in the general
ledger on a specific date. The debits must be equal to the credits - this is a possible
indication of the correctness of the recording of transactions in the general ledger.

GOLDEN RULE
The balance “brought down” (b/d) must be used to prepare the trial balance.

29
The following trial balance has been prepared according to the ledger accounts in section
4.12.

FIX-’N-MAT
TRIAL BALANCE AS AT 28 FEBRUARY 20.1
Dr Cr
R R

Bank 54 200
Equipment 100 000
Furniture 2 000
Trade receivables control 4 000
Capital 130 000
Drawings 1 000
Loan: ABC Bank 25 000
Trade payables control 200
Wages 800
Advertising expenses 200
Service fees 7 000
162 200 162 200

GOLDEN RULE
Asset and expense accounts have debit (dr) balances brought down (b/d) and are entered
on the debit side of the trial balance.

GOLDEN RULE
Equity (capital), liability and income accounts have credit (cr) balances brought down (b/d)
and are entered on the credit side of the trial balance

30
 COMMENTS
• The trial balance balances.
• Note that an account with a debit balance (brought down) is shown
on the debit side of the trial balance and an account with a credit
balance (brought down) is shown on the credit side.
• If we compare the totals of the trial balance with the totals of the
columns of the BAE (refer to section 4.6), we note the following:
• Capital in the BAE is R129 000. In the trial balance capital, R130 000
(Cr), and drawings, R1 000 (Dr), are shown separately, which also
gives a net total of (R130 000 – R1 000) = R129 000.
• Income less expenditure = R6 000 profit. If the expenses in the trial
balance, namely, wages and advertising expenses with debit
balances of R800 and R200 respectively are subtracted from the
income, namely, service fees with a credit of R7 000, the net amount
is R(7 000 - 1 000) = R6 000 credit, which corresponds to the income
in the BAE.

4.15 PREPARING FINANCIAL STATEMENTS

In this module we deal with statements of financial position, statements of profit or loss and
other comprehensive income and statements of changes in equity as well as some of the
notes. Statements of cash flows will be dealt with in FAC1601.

As mentioned previously, the trial balance serves as a basis for preparing the statement of
profit or loss and other comprehensive income, the statement of changes in equity, and the
statement of financial position for an entity. The trial balance represents a summary of
the balances in the general ledger to see if all the debits are equal to the credits. The
statement of profit or loss and other comprehensive income shows the entity's financial
result, and the statement of financial position shows its financial position.

4.15.1 The statement of profit or loss and other comprehensive income

We will now use the information from the trial balance in section 4.14 above to prepare a
statement of profit or loss and other comprehensive income for Fix-'n-Mat. This statement
will be discussed in detail in study unit 15.

31
FIX-’N-MAT
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE MONTH ENDED 28 FEBRUARY 20.1

Notes R
Revenue 7 000
Distribution, administrative and other expenses (1 000)
Wages 800
Advertisesing expenses 200

Profit for the period 6 000

Other comprehensive income for the period --
Total comprehensive income for the period 6 000

COMMENTS
• Note the title. A statement of profit or loss and other
comprehensive income is prepared for a period ended, not on a
certain date.
• The profit for the period as determined in the statement of profit or
loss and other comprehensive income corresponds to the
income/expenditure column in the BAE.
• The income and expenditure accounts are called nominal
accounts.

GOLDEN RULE
Revenue (consisting of service fees) less expenses result in a profit or a loss.

4.15.2 The statement of changes in equity

This statement shows all the changes in equity that occurred in the financial period. The
purpose of a statement of changes in equity is to reconcile an entity’s equity at the
beginning of the financial period with its equity at the end of the financial period. The
balance of the equity at the end of the financial period is then shown in the statement of
financial position. Equity will be discussed in more detail later.

32
FIX-’N-MAT
STATEMENT OF CHANGES IN EQUITY FOR THE MONTH ENDED 28 FEBRUARY 20.1
Capital
R
Balance at 1 February 20.1 130 000
Total comprehensive income for the period 6 000
Drawings (1 000)
Balance at 28 February 20.1 135 000

GOLDEN RULE
A profit increases equity and a loss decreases equity.

COMMENTS
• Note that a statement of changes in equity is prepared for a period
ended and not on a specific date.
• The equity at the end of the month corresponds to the net total in
the BAE in section 4.6.

GOLDEN RULE
The balance at the end of the period on an entity’s statement of changes in equity must be
the same as the “capital” reflected in its statement of financial position.

4.15.3 The statement of financial position

Before we prepare a statement of financial position, please refer to sections 2.4 and 2.5
and the statement of financial position for Fix-'n-Mat that we compiled in section 4.7.

33
We will now show the statement of financial position of Fix-'n-Mat in narrative form and in
compliance with IFRS.

FIX-’N-MAT
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1
ASSET Note R
Non-current assets 3 102 000
Property, plant and equipment 102 000

Current assets 58 200

Trade and other receivables 4 000
Cash and cash equivalents (bank) 54 200

Total assets 160 200

EQUITY AND LIABILITIES

Total equity 135 000
Capital 135 000

Total liabilities 25 200

Non-current liabilities 25 000
Long-term borrowings 25 000

Current liabilities 200

Trade and other payables 200

TOTAL EQUITY AND LIABILITIES 160 200

COMMENTS
• Refer to section 4.15.4 for the calculation of property, plant and
equipment.
• The amount for total assets, that is, R160 200 corresponds to the
total as shown in the BAE in section 4.6.
• The total equity and liabilities of R160 200 corresponds to the total
as shown in the BAE in section 4.6.
• Words and figures between brackets are for explanatory purposes
only and do not form part of a financial statement.

34
 GOLDEN RULE
• Assets, at this stage, are grouped into non-current and current assets.
• Non-current assets do not change often and are used in ordinary business or
production or to render services.
• Current assets change after every operating transaction, in other words, very often.
• Equity (the interest of the owner(s) in the entity) at this stage, consisting of capital
only.
• Liabilities, at this stage, consisting of non-current and current liabilities.
• Non-current liabilities are to be paid after 12 months and do not change often.
Current liabilities are short term, change often and must be repaid within 12 months.

4.15.4 Notes
Additional information on items appearing in the financial statements of an entity is given in
notes to the financial statements. These explanatory notes are shown after the statement of
cash flows.

We do not deal with statements of cash flows in this module and will therefore show the
notes after a statement of profit or loss and other comprehensive income.

Note number 1 is used to reveal the accounting policies of the business. Now let us prepare
the notes of Fix-'n-Mat.

FIX ’N MAT
NOTES FOR THE MONTH ENDED 28 FEBRUARY 20.1
(1) Accounting policy:
The financial statements were prepared on the historical cost basis and comply with
International Financial Reporting Standards.
(2) Revenue represents fees earned for services rendered to clients.

35
(3)

Property, plant and equipment Equipment Furniture Total

R R R
Carrying amount: Beginning of
period
Cost – – –
Accumulated depreciation – – –

Additions 100 000 2 000 102 000

Depreciation – – –
Carrying amount: End of
period 100 000 2 000 102 000
Cost 100 000 2 000 102 000
Accumulated depreciation – – –

No depreciation was written off in this financial period. This note, together with the
methods writing off depreciation will be discussed in detail in study unit 11.

4.16 SUMMARY
We began by explaining the financial position (statement of financial position) and the
financial performance (statement of profit or loss and other comprehensive income) of an
entity and then went back to how an entity enters into a transaction to set the accounting
process in motion.

4.17 REVISION EXERCISES AND SOLUTIONS

4.17.1 REVISION EXERCISE 1

Please attempt 4.17.1_REVISION EXERCISE 1 under the heading “CONTENT”. The

answer will be provided at a later stage.

4.17.2 REVISION EXERCISE 2

Please attempt 4.17.2_Revision EXERCISE 2 under the heading “CONTENT”. The answer
will be provided at a later stage.

4.17.3 REVISION EXERCISE 3

Please attempt 4.17.3_REVISION EXERCISE 3 under the heading “CONTENT”. The
answer will be provided at a later stage.

36
4.17.4 REVISION EXERCISE 4
Please attempt 4.17.4_REVISION EXERCISE 4 under the heading “CONTENT”. The
answer will be provided at a later stage.

4.17.5 REVISION EXERCISE 5

Please attempt 4.17.5_REVISION EXERCISE 5 under the heading “CONTENT”. The
answer will be provided at a later stage.

SELF-ASSESSMENT

Now that you have studied this study unit, can you prepare

• ledger accounts?
• a trial balance?
• a basic statement of profit or loss and other comprehensive
income?
• a statement of changes in equity?
• a basic statement of financial position?
• certain notes to the financial statements of an entity?

37
 FAC1502

PART B
COLLECTING AND PROCESSING THE
ACCOUNTING DATA OF ENTITIES

Financial Accounting 1:

Financial Accounting
Concepts, Principles and
Procedures
 TOPIC B

COLLECTING AND PROCESSING THE

ACCOUNTING DATA OF ENTITIES

Learning outcome
You should be able to collect, to process, to adjust (where necessary) and to record
financial information in order to complete the statement of profit or loss and other
comprehensive income (thereby calculating the gross and net profits) and the
statement of changes in equity for the financial period and the statement of financial
position at the end of the financial period of a sole proprietor.

2
CONTENTS

Study-units

5 PROCESSING ACCOUNTING DATA

6 ADJUSTMENTS
7 THE CLOSING-OFF PROCEDURE, DETERMINING THE
PROFIT OF AN ENTITY AND PREPARING FINANCIAL
STATEMENTS

3
STUDY UNIT

5
Processing accounting data

Learning outcome

You should be able to prepare all journals, to post entries to ledger accounts and to
prepare a trial balance.

Contents
Page
Key concepts 5
5.1 Introduction 5
5.2 The accounting cycle 5
5.3 Books of first entry: journals 6
5.4 Types of journals 6
5.5 Cash journals 7
5.5.1 Cash receipts journal 7
5.5.2 Cash payments journal 8
5.6 Credit journals and the general journal 15
5.6.1 Introduction 15
5.6.2 Inventory systems 15
5.6.3 Purchases journal and purchases returns journal 15
5.6.4 Sales journal and sales returns journal 17
5.6.5 General journal 19
5.7 The trial balance 20
5.8 Revision exercise and solution 21
5.9 Settlement discount 31
5.9.1 Settlement discount granted 31
5.9.2 Settlement discount received 31
5.10 Value added tax (VAT) 32
5.10.1 Background 32
5.10.2 Tax period 33

4
 5.10.3 Accounting bases 34
5.11 Revision exercise and solution 41
Self-assessment 42

KEY CONCEPTS

• Source documents • General ledger

• Accounting cycle • Trade receivables ledger
• Cash receipts journal • Trade payables ledger
• Cash payments journal • Comprehensive taxation
• Purchases journal • Vendor
• Purchases returns journal • Taxable supplies
• Sales journal • Exempted supplies
• Sales returns journal • Settlement discount granted
• General journal • Settlement discount received
• Output (VAT) • Value added tax (VAT)
• Zapper payments • Input (VAT)
• E-wallet payments • Snapscan payments
• Electronic Funds Transfer • CashPay payments

5.1 INTRODUCTION
In the previous study units you learnt how to analyse transactions and to determine their
effect on the basic accounting equation. You were then shown how to record all the
transations in the accounts in the general ledger. We explained the principles of the double-
entry system and emphasised the importance of that system. This created a framework for
studying the processing of accounting data in greater detail, which is what we are going to
do next.

5.2 THE ACCOUNTING CYCLE

Accounting data are processed within a definite framework, which is known as the
accounting cycle.
The following diagram shows the accounting cycle:

5
 Transactions
taking place

Completion of
source documents

Recording of transactions
in journals

Posting to ledgers

Reporting in
financial statements

Analysis and interpretation

of financial statements

Decision-making by management

5.3 BOOKS OF FIRST ENTRY: JOURNALS

Because a large number of transactions take place in an entity, recording each transaction
directly in the ledger will make the ledger very bulky and unmanageable, and, in a manual
system only one person can write up the books. For this reason, transactions of the same
type are grouped together and analysed in subsidiary journals or books of first entry before
they are recorded in summarised form in the ledger.
A journal is thus a link between source documents and the ledger. No transaction may be
recorded in the ledger before it has been recorded in a journal and no transaction
may be recorded in a journal without the necessary source document as proof that a
transaction actually took place.

5.4 TYPES OF JOURNALS

There are various types of journals or books of first entry. For the time being, we will
concentrate on

• the cash receipts journal and the cash payments journal, in which all cash
transactions are recorded
• the purchases journal and the purchases returns journal, in which all credit
purchases and returns of credit purchases are recorded

6
• the sales journal and the sales returns journal, in which all credit sales and
returns of credit sales are recorded
• the general journal, in which transactions are recorded that are not recorded in
one of the other journals, for example, the correction of errors and the writing off of
credit losses (bad debts) are recorded

5.5 CASH JOURNALS

5.5.1 Cash receipts journal

All moneys received that are deposited in the entity’s bank account are recorded in the
cash receipts journal. At the end of the month only one amount, which represents the
entire month’s cash receipts, is debited to the bank account. The other column totals
represent the contra accounts and are credited to such accounts. The amounts in the
sundry accounts column are credited individually to the relevant accounts.

Let us now go back to the information we had for Fix-'n-Mat in study unit 4, sections 4.4 and
4.5. Fix-'n-Mat’s cash receipts journal and ledger accounts will look as follows:

FIX-'N-MAT
CASH RECEIPTS JOURNAL - FEBRUARY 20.1 CRJ1
Sundry accounts
Document Day Details Analysis of Bank Service
number receipts fees Amount Fol Details
R R R R
B/S R001 1 T Tom 130 000 130 000 Capital
B/S R002 2 ABC Bank 25 000 25 000 Loan: ABC Bank
B/S R003 13 S Silver 1 000 1 000
Receipt 001 28 C Canon 2 000 2 000 2 000 C Canon
158 000 1 000 157 000

Dr Bank Cr Dr Capital Cr
20.1 R 20.1 R
Feb 28 Total receipts 158 000 Feb 1 Bank 130 000

Dr Service fees Cr Dr Loan: ABC Bank Cr

20.1 R 20.1 R
Feb 18 ..... ..... Feb 2 Bank 25 000
28 Bank 1 000

Dr C Canon Cr
20.1 R 20.1 R
Feb 18 ..... ..... Feb 28 Bank 2 000

7
 COMMENTS
• Source documents for entries in the cash receipts journal are the
cash register roll, the bank statement, duplicate receipts,
duplicate cash invoices and duplicate deposit slips.
• The cash (EFT, cash, credit card, debit card or Zapper) receipts for
the month are recorded and analysed in date order.
• Each cash amount received in the course of a day is not banked
immediately. Cash receipts are first recorded in the analysis of
receipts column, and the amount that is banked for that day is
recorded in the bank column. Any direct payment into the bank
account of the entity will not be entered into the analysis of receipts
column but will be entered directly into the bank column.
• Electronic Funds Transfers are deposited directly into the bank
account and will be entered every day in the books of the entity
from the bank statement of the entity. These amounts will be
entered directly in the bank column.
• The addition in the columns must be checked by cross-casting. In
other words, when the totals of the analysis columns are added,
they must equal the total in the bank column.
• Entries in the sundry accounts column are posted individually to the
general ledger.
• Only the totals of the other columns are posted.
• The cash receipts journal is a book of first entry. The double-entry
system has to be applied in the general ledger.
• The amounts are not recorded individually again in the bank
account in the general ledger. Note that the credit entries in the
accounts add up to R158 000, which corresponds to the debit entry
in the bank account.
• The number and headings of columns in the journal will depend on
the frequency of occurrence of transactions and can differ from one
entity to another.

5.5.2 Cash payments journal

All cash payments, that is, payments made by way of cheque (no longer accepted by most
banks), EFT, credit card, debit card, cash, e-wallet, Snapscan, CashPay and Zapper are
recorded in the cash payments journal. At the end of the month only one amount, which
represents the entire month’s cash payments, is credited to the bank account. The other
column totals represent the contra accounts and are debited to such accounts. The
amounts in the sundry accounts column are debited individually to the relevant accounts.

Fix-'n-Mat’s cash payments journal and ledger accounts will look as follows:

8
FIX-'N-MAT
CASH PAYMENTS JOURNAL – FEBRUARY 20.1 CPJ1
Sundry accounts
Document Day Details Bank Wages Amounts Fol Details
number
R R R
P/R P001 6 XY Furnishers 100 000 100 000 Equipment
P/R P002 11 Joc Limited 2 000 2 000 Joc Limited
P/R P003 12 Cash 1 000 1 000 Drawings
P/R P004 16 Cash 800 800
103 800 800 103 800

Dr Bank Cr Dr Furniture Cr
20.1 R 20.1 R 20.1 R
Feb 28 … Feb 28 Sundry Feb 6 Bank 100 000
payments 103 800

Dr Wages Cr Dr Joc Limited Cr

20.1 R 20.1 R 20.1 R
Feb 28 Bank 800 Feb 11 Bank 2 000 Feb 10… ...

Dr Drawings Cr
20.1 R
Feb 1 Bank 1 000

The complete bank account will now take the following form:

Dr Bank Cr
20.1 R 20.1 R
Feb 28 Total receipts CRJ1 158 000 Feb 28 Total payments CPJ1 103 800
Balance c/d 54 200
158 000 158 000

20.1
Mar 1 Balance b/d 54 200

Note that this balance is the same as the bank balance we calculated using the BAE in
section 4.6 and the bank account in section 4.13 of study unit 4.

9
 COMMENTS
• Source documents for entries in the cash payments journal are
cheque counterfoils (cheques are no longer accepted by most of the
commercial banks), debit notes and credit card slips, together with
original cash invoices or the bank statement issued by the bank
(EFT transactions will be numbered in the bankstatement according
to payment request numbers, p for payment and number). The
original cash invoices will be attached to the payment requests.
• Entries are recorded and analysed in the cash payments journal in
the same order as the payment request numbers.
• The amount that appears on the payment request is the amount that
is recorded in the bank column.
• The addition in the columns must be checked by cross-casting to
ensure it is correct. In other words, when the totals of the analysis
columns are added, they must equal the total of the bank column.
• Entries in the sundry accounts column are posted individually to the
general ledger.
• Only the totals of the other columns are posted.
• The amounts are not recorded individually again in the bank account
in the general ledger.
• The cash payments journal is a book of first entry. The double-entry
system has to be applied in the general ledger.
• More analysis columns can be included as required by the entity.

EXERCISE 5.1

Ms Beauty Baloyi opens a hairdressing salon, Beauty’s Hair, on 1 June 20.3 and enters into
the following transactions in June:

20.3
Jun 1 Ms Beauty Baloyi deposited R10 000 directly into the business’s bank account.
Made an EFT to Huurtru, to pay the month’s rental of R1 000.
Made an EFT to pay the water-and-electricity deposit of R500.
2 Bought R2 500’s worth of equipment and R845’s worth of consumable inventory
from Head Suppliers and and paid the amount of R3 345 with the credit card of
the business.
5 Money for services rendered paid directly into the bank account of Beauty’s Hair,
R350.
7 Ms Beauty Baloyi withdrew cash from the business account at an ATM to pay
her assistant’s wages of R200.

10
10 Cash register roll total for services rendered, R556. The money was deposited
into the bank account of the business.
14 Ms Beauty Baloyi withdrew R500 cash from the business account at an ATM to
pay the week’s wages of R200, the remainder being for Ms Baloyi’s own use.
15 Cash register roll total for services rendered, R642. The money was deposited
into the bank account of the business.
17 Bought stationery from Office Suppliers, R80, and paid with the credit card of the
business.
19 Cash register roll total for services rendered, R438. The money was deposited
into the bank account of the business.
21 Made an e-wallet payment to pay the week’s wages, R200.
22 Bought shampoo and other accessories from Head Suppliers and made a direct
payment into their bank account for the amount of R550.
24 Cash register roll total for services rendered, R387. The money was deposited
into the bank account of the business.
25 Made a direct payment to Telkom to pay the telephone account, R260, which
included installation costs of R180.
28 Ms Beauty Baloyi withdrew R1 500 cash from the business account at an ATM.
R1 300 was for Ms Baloyi’s own use and R200 was for the week’s wages.
30 Cash register roll total for services rendered, R875. The money was deposited
into the bank account of the business.

REQUIRED
(1) Prepare the cash receipts journal for Beauty's Hair for June 20.3.
(2) Prepare the cash payments journal for Beauty's Hair for June 20.3.
(3) Show the postings from these journals to the general ledger accounts.
(4) Prepare the trial balance as at 30 June 20.3.

11
 SOLUTION: EXERCISE 5.1

(1)
BEAUTY'S HAIR
CASH RECEIPTS JOURNAL - JUNE 20.3 CRJ1
Analysis Sundry accounts
Document- Date Details of Bank Services Amount Fol Details
number receipts rendered
R R R R
Rec 001 1 B Baloyi 10 000 10 000 B4 Capital
CRR 001 5 Services rendered 350 350 350
CRR 002 10 Services rendered 556 556 556
CRR 003 15 Services rendered 642 642 642
CRR 004 19 Services rendered 438 438 438
CRR 005 24 Services rendered 387 387 387
CRR 006 30 Services rendered 875 875 875
13 248 3 248 10 000
B3 N1
(Rec = Receipt)
(CRR = Cash register roll)

(2)
BEAUTY'S HAIR
CASH PAYMENTS JOURNAL - JUNE 20.3 CPJ1
Sundry accounts
Document Date Details Bank Consumable Wages Amount Fol Details
number stores
R R R
P/R P001 1 Huurtru 1 000 1 000 N2 Rental expenses
P/R P002 Municipality Water and
500 500 B2 electricity deposit
P/R P003 2 Head
Suppliers 3 345 845 2 500 B1 Equipment
P/R P004 7 Cash 200 200
P/R P005 14 Cash 500 200 300 B5 Drawings
P/R P006 17 Office 80 80 N3 Stationery
Suppliers
P/R P007 21 Cash 200 200
P/R P008 22 Head 550
Suppliers 550
P/R P009 25 Telkom 260 260 N4 Telephone
expenses
P/R P0010 28 Cash 1 500 200 1 300 B5 Drawings
8 135 1 395 800 5 940
B3 N5 N6

12
(3)
BEAUTY'S HAIR
GENERAL LEDGER
Dr Equipment B1 Cr
20.3 R
Jun 2 Bank CPJ1 2 500

Dr Water and electricity deposit B2 Cr

20.3 R
Jun 1 Bank CPJ1 500

Dr Bank B3 Cr
20.3 R 20.3 R
Jun 30 Total receipts CRJ1 13 248 Jun 30 Total payments CPJ1 8 135
Balance c/d 5 113
13 248 13 248
20.3
Jul 1 Balance b/d 5 113

Dr Capital B4 Cr
20.3 R
Jun 1 Bank CRJ1 10 000

Dr Drawings B5 Cr
20.3 R
Jun 14 Bank CPJ1 300
28 Bank CPJ1 1 300
1 600

Dr Services rendered N1 Cr
20.3 R
Jun 30 Bank CRJ1 3 248

Dr Rental expenses N2 Cr
20.3 R
Jun 1 Bank CPJ1 1 000

Dr Stationery N3 Cr
20.3 R
Jun 17 Bank CPJ1 80

Dr Telephone expenses N4 Cr
20.3 R
Jun 25 Bank CPJ1 260

Dr Consumable stores N5 Cr
20.3 R
Jun 30 Bank CPJ1 1 395

13
Dr Wages N6 Cr
20.3 R
Jun 30 Bank CPJ1 800

(4)
BEAUTY'S HAIR
TRIAL BALANCE AS AT 30 JUNE 20.3
Fol Debit Credit
R R
Equipment B1 2 500
Water and electricity deposit B2 500
Bank B3 5 113
Capital B4 10 000
Drawings B5 1 600
Services rendered N1 3 248
Rental expenses N2 1 000
Stationery N3 80
Telephone expenses N4 260
Consumable stores N5 1 395
Wages N6 800
13 248 13 248

COMMENTS
• The B numbers indicate the accounts that will be balanced and
shown in the statement of financial position and the N numbers
indicate the nominal accounts that the accounts that will be posted
and closed off to the profit or loss account (statement of profit or loss
and other comprehensive income). Nominal accounts are income
and expenditure accounts while statement of financial position
accounts are capital, asset and liability accounts.
• In the folio column in the general ledger, the cash receipts or cash
payments journal is given as a reference, but in the details column
the names of the contra ledger accounts (other accounts involved in
the transaction) are entered.
• The summarising effect of the subsidiary journals can be clearly
seen in the general ledger. Note the entries in the bank account and
the services rendered account.
• An e-wallet payment is a payment that is made to a person who
does not have a bank account. The cell phone number of that
person (the recipient) becomes their account number. The recipient
can draw the money at a ATM using their ID number as well as the
verification number sent by the person who made the payment.

14
5.6 CREDIT JOURNALS AND THE GENERAL JOURNAL
5.6.1 Introduction
In many business entities, goods are bought and sold on credit. In the process, accounts
have to be opened for debtors and creditors individually. If all these accounts are included
in the general ledger, the same sort of problem arises that we have already mentioned –
the general ledger becomes too bulky and unmanageable, and, in a manual system, only
one person can write up the books. For this reason, a trade receivables ledger and a
trade payables ledger are opened in which the individual debtors’ accounts and creditors’
accounts are kept. A single account is then held in the general ledger for debtors, namely, a
trade receivables control account, and one account is held for creditors, namely, a trade
payables control account. This means that the entire accounting system is adapted to make
provision for the control accounts. In the cash receipts journal and the cash payments
journal, provision is made for additional columns for trade receivables control and
trade payables control.

You can learn more about trade receivables control in study unit 9 and trade payables
control in study unit 13.

5.6.2 Inventory systems

We distinguish between the periodic inventory system and the perpetual inventory system,
which will be dealt with in detail in study unit 7. At this stage, all you need to know is that
trading inventory (merchandise) that is purchased has to be debited to a purchases
account if the periodic inventory system is used. Provision must therefore be made for a
purchases column in the subsidiary journal. If the perpetual inventory system is used,
trading inventory (merchandise) is debited to an inventory account, and an inventory
column is required instead of a purchases column in the subsidiary journal.

5.6.3 Purchases journal and purchases returns journal

Merchandise purchased on credit is recorded in the purchases journal. At the end of the
month, only the total of the credit purchases for the month is debited to the purchases
account and credited to the trade payables control account. If some of the goods are
returned, they are recorded in the purchases returns journal.
Because entities have a large number of creditors, a separate subsidiary ledger, called the
trade payables ledger, is kept in which all the individual creditors are entered.
NB: For the purpose of this module, only merchandise purchased on credit is
recorded in the purchases journal. All other credit purchases are recorded in the
general journal.
A trade discount is often granted by wholesalers to retailers. The discount percentage that
is agreed upon, is calculated and deducted on the cash or credit invoice. The net amount
on the invoice is recorded as the amount of purchases in the accounting records of the
purchaser. Thus, the trade discount amount is never recorded in the accounting
records of the purchaser.
To encourage a debtor to pay his/her account within a certain perod, a discount option is
given to the debtor. If the account is settled within the stipulated period, the discount will be

15
recorded in the settlement discount granted account in the seller’s accounting records and
the settlement discount received account in the buyer’s accounting records. The full amount
of the invoice must be paid if the account is not settled within the stipulated period.
A purchases journal and purchases returns journal have the following formats:

ABC DEALERS
PURCHASES JOURNAL - MAY 20.3 PJ5
Trade
Invoice Date Details Fol Purchases payables
number control
R R
1534 3 Grand Wholesalers CL2 1 258 1 258
1535 7 XY Company CL3 983 983
1536 11 AA Limited CL1 2 324 2 324
1537 14 XY Company CL3 437 437
1538 21 XY Company CL3 1 212 1 212
1539 25 Grand Wholesalers CL2 538 538
1540 30 AA Limited CL1 215 215

6 967 6 967

ABC DEALERS
PURCHASES RETURNS JOURNAL - MAY 20.3 PRJ5
Trade
Credit note Date Details Fol Purchases payables
number returns control
R R
C115 10 Grand Wholesalers CL2 158 158
C116 27 XY Company CL3 114 114

272 272

GENERAL LEDGER TRADE PAYABLES LEDGER

Dr Purchases Cr
20.3 R R Date Details Fol Debit Credit Balance
May 31 Trade payables control 6 967 20.3 R R R
May

Dr Trade payables control Cr AA Limited CL1

20.3 R 20.3 R 11 Invoice 1536 PJ5 2 324 2 324
May 31 Purchases returns 272 May 31 Purchases 6 967 30 Invoice 1540 PJ5 215 2 539

Dr Purchases returns Cr Grand Wholesalers CL2

20.3 R 3 Invoice 1534 PJ5 1 258 1 258
May 31 Trade payables 10 Credit note C115 ATJ5 158 1 100
control 272 25 Invoice 1539 PJ5 538 1 638

XY Company CL3
7 Invoice 1535 PJ5 983 983
14 Invoice 1537 PJ5 437 1 420
21 Invoice 1538 PJ5 1 212 2 632
27 Credit note C116 PRJ5 114 2 518

16
 COMMENTS
• The source documents for entries in the purchases journal are
original invoices. Because these invoices come from different
businesses, they are renumbered consecutively.
• The source documents for entries in the purchases returns journal
are the original credit notes received from the creditors and they
must be renumbered consecutively.
• Entries are recorded and analysed in date order in the purchases
journal and the purchases returns journal.
• A creditor’s name and the amount for which purchases or returns
were made must be clearly shown.
• Only the totals of the columns are posted to the general ledger.
• The amounts in the purchases and the trade payables control
columns are the same in the purchases journal because we are still
ignoring VAT. The same goes for the purchases returns journal.
• The creditors’ accounts are credited individually in the trade
payables ledger with purchases and debited with returns. A three-
column ledger is preferable to the traditional T-account format
because the balance can be calcutated after each transaction.
• The total of all the balances of the individual creditors’ accounts
must correspond with the balance of the trade payables control
account.
• The purchases journal and the purchases returns journal are books
of first entry. The double-entry procedure has to be applied in the
general ledger.

5.6.4 Sales journal and sales returns journal

Merchandise sold on credit is recorded in the sales journal. At the end of the month, only
the total credit sales for the month are credited to the sales account and debited to the
trade receivables control account. If the debtors return some of the goods, they are
recorded in the sales returns journal.
Because entities have a large number of debtors, a separate subsidiary ledger, called the
trade receivables ledger, is kept in which all the individual debtors are entered.
NB: For the purposes of this module, only merchandise sold on credit is recorded in
the sales journal. All other credit sales are recorded in the general journal.
A sales journal and a sales returns journal have the following formats:

17
ABC DEALERS
SALES JOURNAL - MAY 20.3 SJ5
Trade
Invoice Date Details Fol Sales receivables
number control
R R
2018 2 M Moloi DL4 268 268
2019 5 A Abdul DL1 315 315
2020 12 G Green DL3 424 424
2021 14 E Els DL2 176 176
2022 17 G Green DL3 587 587
2023 21 M Moloi DL4 643 643
2024 29 E Els DL2 269 269
2025 30 A Abdul DL1 103 103

2 785 2 785

ABC DEALERS
SALES RETURNS JOURNAL - MAY 20.3 SRJ5
Trade
Credit note Date Details Fol Sales receivables
number returns control
R R
D223 8 M Moloi DL4 75 158
D224 19 G Green DL3 114 114
D225 21 E Els DL2 92 92

281 281

GENERAL LEDGER TRADE RECEIVABLES LEDGER

Dr Sales Cr
20.3 R Date Details Fol Debit Credit Balance
May 31 Trade receivables 20.3 R R R
control 2 785 Mayi

Dt Trade receivables control Cr A Abdul DG1

20.3 R 20.3 R 5 Invoice 2019 SJ5 315 315
May 31 Sales 2 785 May 31 Sales returns 281 30 Invoice 2025 SJ5 103 418

Dr Sales returns Cr E Els DG2

20.3 R 14 Invoice 2021 SJ5 176 176
May 31 Trade receivables 21 Credit note D225 SRJ5 92 84
control 281 29 Invoice 2024 SJ5 269 353

G Green DG3
12 Invoice 2020 SJ5 424 424
17 Invoice 2022 SJ5 587 1 011
19 Credit note D224 SRJ5 114 897

M Moloi DG4
2 Invoice 2018 SJ5 268 268
8 Credit note D223 SRJ5 75 193
21 Invoice 2023 SJ5 643 836

18
 COMMENTS
• The source documents for entries in the sales journal are the
duplicates of sales invoices.
• The source documents for entries in the sales returns journal are
the duplicates of credit notes issued to the debtors.
• A debtor’s name and the amount of the transaction should be
clearly indicated.
• Entries are recorded and analysed in date order in the sales journal
and the sales returns journal.
• Only the totals of the columns are posted to the general ledger.
• The amounts in the sales and the trade receivables control
columns are the same in the sales journal and the sales returns
journal because we are still ignoring VAT. The effect of VAT will be
explained later. The same goes for the sales returns journal.
• The debtors’ accounts are debited individually in the trade
receivables ledger with sales and credited with sales returns.
• The total of all the balances of the individual debtors’ accounts
must correspond with the balance of the trade receivables control
account.
• The sales journal and the sales returns journal are books of first
entry; they provide a summary of sales and returns. The double-
entry system has to be applied in the general ledger.

5.6.5 General journal

All transactions that cannot be entered in one of the journals we have discussed are
entered in the general journal. Examples are credit losses (bad debts) that are written off,
interest on debtors‘ accounts, errors that are corrected and year-end adjustments (which
will be discussed in study unit 6).
NB: Purchases and sales of goods, other than merchandise, are recorded in the
general journal for the purposes of this module.

A general journal takes the following form:

19
ABC DEALERS
GENERAL JOURNAL - MAY 20.3 GJ5
Date Details Fol Debit Credit
R R
5 Vehicles 43 000
Loan: ABC Bank 43 000
Delivery vehicle bought on credit per invoice F147 from
ORA Motors. The delivery vehicle was financed by
obtaining a loan from ABC Bank at an interest rate of 9%
per annum.
16 Packing material 430
Stationery 430
Packing material per invoice Z214 incorrectly debited to
the stationery account.
18 Credit losses (bad debts) 84
F Field/ Trade receivables control 84
F Field’s balance written off as irrecoverable.

COMMENTS
• The account that is entered first is the account that has to be debited
in the general ledger.
• The narration is very important since it gives the reason for the entry;
it must also refer to source documents.
• The general journal is a book of first entry . The double-entry system
has to be applied in the general ledger.
• The general journal can have additional columns that make provision
for trade receivables control debit and credit columns as well as
trade payables control debit and credit columns. The totals of these
columns will be posted to either the trade receivables control
account or the trade payables control account as journal debits or
journal credits.
• Theoretically, all transactions can be recorded in the general journal.

5.7 THE TRIAL BALANCE

For each transaction, the debit entry must equal the credit entry. The total of all the debit
balances should, therefore, correspond to the total of all the credit balances. A list of
balances is prepared periodically to determine whether any errors have been made. This
list of balances is called a trial balance.

20
5.8 REVISION EXERCISE AND SOLUTION
On 1 March 20.5 A Apple opened a supermarket under the tradename AA Supermarket. He
decided to use the periodic inventory system and entered into the following transactions in
March 20.5:
20.5

March 1 A Apple deposited R50 000 directly into the bank account op the entity as a
capital contribution.
Made an EFT to JHB Letting Agents to pay the rent of R2 000.
Bought shop equipment from EQUIP on credit, R10 000, and paid R1 000
by credit card as a deposit.
Made a direct payment to the municipality to pay the water and electricity
deposit, R1 000.
2 Purchased merchandise on credit from TR Wholesalers, R23 541.
Purchased packing material from S Suppliers and paid by credit card, R468.
3 Drew cash at an ATM from the account of the entity, R500. The amount will
be used as cash float.
4 Cash sales per cash register roll on opening day, R18 674.
5 Purchased merchandise on credit from the following wholesalers:
BB Dealers R7 832
DBN Distributors R6 965
6 Sublet a storeroom to G Gold, who paid an amount of R250 directly into the
bank account of AA Supermarket.
Cash sales per cash register roll, R12 455.
10 E-wallet payments were made to pay wages, R1 200.
12 Issued invoices to the following people for goods sold:
B Blue R478
S Silver R693
13 Made an EFT of R5 378 to Z Zulu for merchandise purchased.
14 Purchased a computer from HI-Q, R5 260. Paid R1 478 by credit card,
which included a deposit of R1 000 and R478 for paper and computer
supplies.
15 Sold goods on credit to the following people:
G Gree R324
R Red R299
16 Cash sales per cash register roll, R8 790.

21
20.5
March 17 Drew money at an ATM for the following:
Wages R1 500
Owner’s own use R1 000

19 B Blue made a payment of R200 directly into the bank account of AA

Supermarket.
20 Made an EFT of R2 675 to TR Wholesalers for merchandise purchased.
Merchandise sold for cash as per cash register roll, R12 570.
21 Goods sold on credit:
B Blue R362
R Red R178
23 S Silver paid R100 on his account.
Cash sales as per cash register roll, R10 238.
24 Made an EFT of R550 to The Newsmaker for the placement of
advertisements.
Drew cash to pay wages, R1 500.
25 Purchased stationery on credit from HI Q, R267.
Issued a receipt to R Red for R299 in part payment of his account.
27 Made EFTs to the following entities in part settlement of their accounts:
TR Wholesalers R20 000
BB Dealers R 6 000
DBN Distributors R 5 000
HI-Q R 1 000
29 Credit sales to S Silver, R262. He paid R200 on his account.
Cash sales as per cash register roll, R16 742.
30 Made EFTs for the following:
L Lemon, salary of the manager R2 500.
EQUIP on account R1 000.
JHB Letting Agents for April’s rental R2 000.
31 Made a direct payment to Telkom to pay the telephone account, R595.
Cash sales as per cash register roll, R15 284.
Issued receipts to the following debtors for money received on their
accounts:
G Green R324
B Blue R640
Drew R3 000 cash at the ATM to pay wages, R1 500, and the balance was
for the owner’s own use.

22
 REQUIRED
Prepare
(1) the subsidiary journals of AA Supermarket for March 20.5.
(2) the general, trade receivables and trade payables ledgers of
AA Supermarket for March 20.5.
(3) the trial balance of AA Supermarket as at 31 March 20.5.
Ignore VAT.

Solution: Revision exercise

(1) SUBSIDIARY JOURNALS
(a)
AA SUPERMARKET
CASH RECEIPTS JOURNAL - MARCH 20.5 CRJ1
Analysis Trade Sundry accounts
Document Date receivables
number
Details Fol of Bank Sales
receipts control Amount Fol Details
R R R R R
Rec 1 1 A Apple 50 000 50 000 B7 Capital
CRR 1 4 Sales 18 674 18 674 18 674
Rec 2 6 G Gold 250 250 N2 Rental income
CRR 2 Sales 12 455 12 455 12 455
CRR 3 16 Sales 8 790 8 790 8 790
Rec 3 19 B Blue DL1 200 200
CRR 4 20 Sales 12 570 12 570 12 570
Rec 4 23 S Silver DL2 100 100
CRR 5 Sales 10 238 10 338 10 338
Rec 5 25 R Red DL4 299 299 299
Rec 6 29 S Silver DL2 200 200
CRR 6 Sales 16 742 16 942 16 942
CRR 7 31 Sales 15 284 15 284
Rec 7 G Green DL3 324 324
Rec 8 B Blue DL1 640 16 248 640
146 766 94 753 1 763 50 250
B5 N1 B3

23
(b)
AA SUPERMARKET
CASH PAYMENTS JOURNAL - MARCH 20.5 CPJ1
Trade Sundry accounts
Document Date Details Fol Bank payables Purchases Wages Amount Fol Details
numbers control
R R R R R
P/R P001 1 JHB Letting Agents 2 000 2 000 N8 Rental expenses
P/R P003 Municipality 1 000 1 000 B2 Water and electricity
deposit
P/R P005 3 Cash 500 500 B4 Cash float
P/R P006 10 Cash 1 200 1 200
P/R P007 13 Z Zulu 5 378 5 378
P/R P009 17 Cash 2 500 1 500 1 000 B8 Drawings
P/R P010 20 TR Wholesalers 2 675 2 675
P/R P011 24 The Newsmaker 550 550 N6 Advertisements
P/R P012 Cash 1 500 1 500
P/R P013 27 TR Wholesalerss CL1 20 000 20 000
P/R P014 BB Dealers CL2 6 000 6 000
P/R P015 DBN Distributors CL3 5 000 5 000
P/R P016 HI-Q CL5 1 000 1 000
P/R P017 30 L Lemon 2 500 2 500 N7 Salaries
P/R P018 EQUIP CL5 1 000 1 000
P/R P019 JHB Letting Agents 2 000 2 000 N8 Rental expenses
P/R P020 31 Telkom 595 595 N9 Telephone expenses
P/R P021 Cash 3 000 1 500 1 500 B8 Drawings
58 398 33 000 8 053 5 700 11 645
B5 B6 N3 N10

(c)
AA SUPERMARKET
PURCHASES JOURNAL - MARCH 20.5 PJ1
Trade
Invoice Date Details Fol Purchases payables
number control
R R
A0001 2 TR Wholesalers CL1 23 541 23 541
A0002 5 BB Dealers CL2 7 832 7 832
A0003 DBN Distributors CL3 6 965 6 965
38 338 38 338
N3 B6

24
(d)
AA SUPERMARKET
SALES JOURNAL - MARCH 20.5 SJ1
Trade
Invoice Date Details Fol Sales receivables
number control
R R
F001 12 B Blue DL1 748 748
F002 S Silver DL2 693 693
F003 15 G Green DL3 324 324
F004 R Red DL4 299 299
F005 21 B Blue DL1 362 362
F006 R Red DL4 178 178
F007 29 S Silver DL2 262 262
2 596 2 596
N1 B3

(e)
AA SUPERMARKET
GENERAL JOURNAL - MARCH 20.5 GJ1
Date Details Fol Debit Credit
R R
1 Equipment B1 10 000
EQUIP/Trade payables control CL4/B6 10 000
Shop equipment bought on credit per invoice Z001
EQUIP/Trade payables control CL4/B6 1 000
Bank: credit card/Trade payables control CL6/B6 1 000
Paid R1 000 deposit to EQUIP by credit card. P/R
P002 and original receipt.
2 Packing material N5 468
Bank: credit card/Trade payables control CL6 468
Purchased packing material and paid by credit card.
P/R P004, duplicate credit card slip and cash
register slip.
14 Equipment B1 5 260
HI-Q/Trade payables control CL5/B6 5 260
Computer bought on credit per invoice Z002
Stationery N4 478
HI-Q/Trade payables control CL5/B6 1 000
Bank: credit card/Trade payables control CL6/B6 1 478
Paid R1 000 deposit to HI-Q and bought stationery
from them and paid by credit card. PR P008,
duplicate credit card slip, original receipt and cash
regsiter slip.
25 Stationery N4 267
HI Q/Trade payables control CL5/B6 267
Stationery bought on credit per invoice Z003

25
(2) LEDGERS

(a)
AA SUPERMARKET
GENERAL LEDGER
Dr Equipment (at cost) B1 Cr
20.5 R
Mar 1 EQUIP/Trade payables
control GJ1 10 000
14 HI-Q/Trade payables
control GJ1 5 260
15 260

Dr Water and electricity deposit B2 Cr

20.5 R
Mar 1 Bank CPJ1 1 000

Dr Trade receivables control B3 Cr

20.5 R 20.5 R
Mar 31 Sales SJ1 2 596 Mar 31 Bank CRJ1 1 763
Balance c/d 833
2 596 2 596
20.5
Apr 1 Balance b/d 833

Dr Cash float B4 Cr
20.5 R
Mar 3 Bank CPJ1 500

Dr Bank B5 Cr
20.5 R 20.5 R
Mar 31 Total receipts CRJ1 146 766 Mar 31 Total payments CPJ1 58 398
Balance c/d 88 368
146 766 146 766
20.5
Apr 1 Balance b/d 88 368

Dr Trade payables control B6 Cr

20.5 R 20.5 R
Mar 1 Bank: credit card GJ1 1 000 Mar 1 Equipment GJ1 10 000
14 Bank: credit card GJ1 1 000 EQUIP 1 000
31 Bank CPJ1 33 000 Packing material GJ1 468
Balance c/d 21 811 14 Equipment GJ1 5 260
HI-Q GJ1 1 000
Stationery GJ1 478
25 Stationery GJ1 267
31 Purchases PJ1 38 338
56 811 56 811
20.5
Apr 1 Balance b/d 21 811

26
Dr Capital B7 Cr
20.5 R
Mar 1 Bank CRJ1 50 000

Dr Drawings B8 Cr
20.5 R
Mar 17 Bank CPJ1 1 000
31 Bank CPJ1 1 500
2 500

Dr Sales N1 Cr
20.5 R
Mar 31 Trade receivables
control SJ1 2 596
Bank CRJ1 94 753
97 349

Dr Rental income N2 Cr
20.5 R
Mar 6 Bank CRJ1 250

Dr Purchases N3 Cr
20.5 R
Mar 31 Trade payables control PJ1 38 338
Bank CPJ1 8 053
46 391

Dr Stationery N4 Cr
20.5 R
Mar 14 Bank: credit card/Trade
payables control GJ1 478
25 HI-Q/Trade payables
control GJ1 267
745

Dr Packing material N5 Cr
20.5 R
Mar 2 Bank: credit card GJ1 468

27
Dr Advertisements N6 Cr
20.5 R
Mar 24 Bank CPJ1 550
Dr Salaries N7 Cr
20.5 R
Mar 30 Bank CPJ1 2 500

Dr Rental expenses N8 Cr
20.5 R
Mar 1 Bank CPJ1 2 000
30 Bank CPJ1 2 000
4 000

Dr Telephone expenses N9 Cr
20.5 R
Mar 31 Bank CPJ1 595

Dr Wages N10 Cr
20.5 R
Mar 31 Bank CPJ1 5 700

(b)
AA SUPERMARKET
TRADE RECEIVABLES LEDGER
B Blue DL1
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 12 Invoice F001 SJ1 478 478
19 Receipt number 3 CRJ1 200 278
21 Invoice F005 SJ1 362 640
31 Receipt number 8 CRJ1 640 -

S Silver DL2
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 12 Invoice F002 SJ1 693 693
23 Receipt number 4 CRJ1 100 593
29 Invoice F007 SJ1 262 855
Receipt number 6 CRJ1 200 655

G Green DG3
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 15 Invoice F003 SJ1 324 324
31 Receipt number 7 CRJ1 324 -

28
R Red DG4
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 15 Invoice F004 SJ1 299 299
21 Invoice F006 SJ1 178 477
25 Receipt number 5 CRJ1 299 178

Trade receivables list R

S Silver 655
R Red 178
833 Corresponds to the balance of account B3.

GOLDEN RULE
The total of all the balances of the individual debtors’ accounts in the subsidiary trade
receivables ledger MUST equal the balance of the trade receivables control account in the
general ledger.

(c)
AA SUPERMARKET
TRADE PAYABLES LEDGER
TR Wholesalers CL1
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 2 Invoice A0001 PJ1 23 541 23 541
27 P/R P013 CPJ1 20 000 3 541

BB Dealers CL2
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 5 Invoice A0002 PJ1 7 832 7832
27 P/R P014 CPJ1 6 000 1 832

DBN Distributors CL3

Date Details Fol Debit Credit Balance
20.5 R R R
Mar 5 Invoice A0003 PJ1 6 965 6 965
27 P/R P015 CPJ1 5 000 1 965

EQUIP CL4
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 1 Invoice Z001 PJ1 10 000 10 000
P/R P002 GJ1 1 000 9 000
30 P/R P018 CPJ1 1 000 8 000

29
HI-Q CL5
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 14 Invoice Z002 GJ1 5 260 5 260
P/R P008 CPJ1 1 000 4 260
25 Invoice Z003 GJ1 267 4 527
27 P/R P016 CPJ1 1 000 3 527

Bank: credit card CL6

Date Details Fol Debit Credit Balance
20.5 R R R
Mar 1 P/R P002 GJ1 1 000 1 000
2 P/R P004 GJ1 468 1 468
14 P/R P008 GJ1 1 478 2 946

Trade payables list R

TR Wholesalers 3 541
Dealers 1 832
DBN Distributors 1 965
EQUIP 8 000
HI-Q 3 527
Bank: credit card 2 946
21 811 Corresponds to the balance of account B6.

GOLDEN RULE
The total of the balances of the individual creditors’ accounts in the subsidiary trade
payables ledger MUST equal the balance of the trade payables control account in the
general ledger.

30
(3)
AA SUPERMARKET
TRIAL BALANCE AS AT 31 MARCH 20.5
Fol Debit Credit
R R
Equipment (at cost) B1 15 260
Water and electricity deposit B2 1 000
Trade receivables control B3 833
Cash float B4 500
Bank B5 88 368
Trade payables control B6 21 811
Capital B7 50 000
Drawings B8 2 500
Sales N1 97 349
Rent income N2 250
Purchases N3 46 391
Stationery N4 745
Packing material N5 468
Advertisements N6 550
Salaries N7 2 500
Rental expenses N8 4 000
Telephone expenses N9 595
Wages N10 5 700
167 410 167 410

5.9 SETTLEMENT DISCOUNT

5.9.1 Settlement discount granted

A discount is often offered to debtors in order to encourage quick settlement of their debts
within the stated credit term. The credit term will be shown on the credit invoice, for
example, 30 days from the date of sale.

5.9.2 Settlement discount received

A discount is often received from creditors in order to encourage quick settlement of
entities’ outstanding accounts.

31
5.10 VALUE-ADDED TAX (VAT)
5.10.1 Background
VAT is levied at every point in the chain of production and distribution of goods and
services. VAT is based on a tax credit system that allows every producer or distributor
along the chain to recover the VAT that was previously paid by the business. The tax borne
by each producer or distributor through whose hands the goods or services pass before
reaching the end user is, in effect, the tax on the value added by the business.

The tax that must eventually (every two months) be paid to the South African Revenue
Service (SARS) is the tax on the supply of goods (sales) and/or services rendered by the
entity (OUTPUT VAT) less the tax paid by the entity on the goods (purchases) and/or
services supplied to the entity (INPUT VAT).

GOLDENT RULES
• OUTPUT VAT is the tax levied (charged) by the entity on sales of good or services
rendered by the business.
• INPUT VAT is the tax paid (or payable) on goods delivered and/or services rendered
to the entity, including imports. Deductions for input tax will only be allowed if a
proper tax invoice is received and kept.
• OUTPUT VAT minus INPUT VAT = amount payable/refundable, that is, the amount
that is payable to SARS or the amount that can be claimed from SARS.

VAT can only be charged by persons who, in terms of the Value-Added Tax Act, are
registered as VAT vendors. Registration is compulsory if a person carries on as an entity
and the total value of the entity’s supplies for a 12-month period exceeds or is likely to
exceed a stipulated (in the Act) amount.
An entity may also register voluntarily if the total value of its sales or services rendered is
below the stipulated amount.
The stipulated amount excludes tax, exempted supplies and abnormal receipts.
Some products are zero-rated supplies, which will be indicated in transactions. An input tax
(15%) can be claimed on these products, but no output tax because the products are zero-
rated (0%) – that means no tax can be levied on the final products for human consumption.
The following goods and services are zero-rated:
• Exports
• 19 basic food items
• Illuminating paraffin
• Goods that are subject to the fuel levy (petrol and diesel)
• International transport services
• Farming inputs
• Sales of going concerns
• Certain grants offered by government
Since changes can occur in the list of zero-rated supplies, you are advised to go
to www.sars.gov.za

32
The following basic foodstuffs are zero-rated in South Africa:
• Dried beans
• Samp
• Maize meal
• Rice
• Brown bread
• Vegetables
• Fruits
• Vegetable oil
• Mealie rice
• Pilchards in tins
• Edible legumes and pulses of leguminous plants
• Eggs
• Milk
• Dried mealies
• Dairy powder blend
• Lentils
• Cultured milk
• Milk powder
• Brown wheaten meal
• Sanitary pads
• Bread flour
• Cake flour
Financial services, especially interest received and interest paid, and educational services
provided by the State are exempt from VAT. This means that neither input tax nor output
tax can be claimed on these services.
Goods and services exempted from VAT are:
• Non-free-related financial services
• Educational services provided by an approved educational institution
• Residential rental accommodation
• Public road and rail transport
If an entity is not registered as a VAT vendor, no output tax may be charged and no
deduction for input tax can be claimed. The onus is on the entity to register, where
necessary, and this must be done within 21 days of becoming liable to register.
Salaries and wages are subjected to income tax such as pay as you earn (PAYE) and not
VAT.

33
5.10.2 Tax period
A tax period is allocated to every entity. The return submitted by an entity must cover the
period allocated to it.
Some enities registered for VAT (vendors) must submit their returns every two months for
those two months. Some entities must complete and submit their returns for unequal
months, that is, January, March, May and so on, and others must submit theirs for equal
months, that is, February, April and so on.

5.10.3 Accounting bases

There are only two bases for the calculation of a VAT liability, namely,
• the invoice basis
• the payments basis
On the invoice basis, tax is accounted for upon
• the issue of an invoice or
• the receipt of payment, whichever comes first

On the payments basis, tax is accounted for when payments are made (purchases) and
payments are received (sales).
Certain requirements have to be met before a vendor may use the payments basis.

34
 EXERCISE 5.2

To grasp the principles of VAT, work through the following exercise thoroughly. VAT at 15%
is applicable.
The following information relates to Rundu Dealers, who is registered as a VAT vendor and
who uses the periodic inventory system: (the VAT period of the business ends on unequal
months):

(a) TRIAL BALANCE AS AT 28 FEBRUARY 20.4

Debit Credit
R R
Capital 177 150
Land and buildings 144 200
Equipment 29 700
Inventory - 1 November 20.3 19 200
Bank 4 467
W Wolf 1 583
L Lion 770
T Tiger 2 310
VAT input 2 715
VAT output 2 925
Sales 86 400
Purchases 45 650
Distribution, administration and other expenses 20 500
268 785 268 785

(b) TRANSACTIONS FOR MARCH 20.4

March 1 Cash sales, R15 504.

5 Paid the account of T Tiger by direct payment after deducting a R114
discount.
. 7 Received a direct payment from W Wolf for R1 468 in full settlement of
his account.
Received a direct payment from L Lion for R701 and granted a R69
discount.
12 Received an account from Stationers Ltd for the printing of documents,
R690.
13 Credit sales:
- L Lion R2 300
- W Wolf R1 150
14 Sold an old computer to O Old for R299 and received his direct payment
for the amount due.
Cash sales, R6 900.

35
21 Issued a credit note to L Lion for an overcharge on the invoice of the
13th, R69.
23 Paid C Cheetah by a direct payment for carraige on goods purchased,
R1 150.
28 Received a credit invoice from T Tiger for goods purchased, R14 720.
29 Made direct payments for salaries and wages, R5 746, and for
purchases from B Bam, R8 050.
30 Issued a debit note to T Tiger for goods returned to him, R805.

REQUIRED
(1) Record the above transactions in the following subidiary
journals, properly totalled, of Rundu Dealers for March 20.4:
(a) Cash receipts journal (analysis columns for bank, sales,
VAT output, trade receivables control, VAT input (Dr),
settlement discount granted and sundries)
(b) Cash payments journal (analysis columns for bank
purchases, trade payables control, settlement discount
received, VAT input, VAT output (Cr) and sundries)
(c) Sales journal (analysis columns for VAT output, sales
and trade receivables control)
(d) Purchases journal (analysis columns for VAT input,
purchases and trade payables control)
(e) Sales returns journal (analysis columns for VAT output,
sale returns and trade receivables control)
(f) Purchases returns journal (analysis columns for VAT
input, purchases returns and trade payables control)
(g) General journal
(2) Post the entries recorded above to the VAT input and VAT
output accounts. Close off these accounts to the VAT control
account. Balance the VAT control account at 31 March 20.4, the
end of the business’s VAT period.

36
SOLUTION: EXERCISE 5.2

(1) SUBSIDIARY JOURNALS

(a)
RUNDU DEALERS
CASH RECEIPTS JOURNAL --- MARCH 20.4 CRJ2
Settlement
VAT Trade VAT discount Sundry accounts
Date Details Fol Bank Sales output receivables input granted
control Dr Dr Amount Fol Details
R R R R R R R
1 Sales 15 640 13 600 2 040
7 W Wolf 1 468 1 583 (15*)# (100)
L Lion 701 770 (9)# (60)
14 O Old 299 39 260 Equipment
Sales 6 900 6 000 900
25 008 19 600 2 979 2 353 (24) (160) 260
B16 B15

* Discount includes 15% VAT, therefore,

R115
/1 x 15/115 = R15.
The VAT output has already been calculated on the sales amount and paid over to SARS, but now
the full amount of the sales will not be paid because the business granted a discount. The
business can therefore claim the amount of VAT paid on the discount back as VAT input.
# VAT input is debited. (See # under comments on p 38.)

(b)
RUNDU DEALERS
CASH PAYMENTS JOURNAL - MARCH 20.4 CPJ2

Trade VAT VAT Settlement Sundry accounts

Date Details Fol Bank Purchases payables input output discount
control received Amount Fol Details
Cr Cr
R R R R R R R
5 T Tiger 2 195 2 310 (15*) (100)

23 C Cheetah 1 150 150 1 000 Carriage on

purchases
29 Cash 5 746 5 746 Salaries and
wages
B Bam 8 050 7 000 980

17 141 7 000 2 310 1 200 (15) (100) 6 746

B15 B16

* Discount includes 15% VAT, therefore,

R115
/1 x 15/115 = R15.
The VAT input has already been calculated on the purchases amount and claimed from SARS, but
now the full amount of the purchases will not be paid because the business received a discount.
The business must therefore pay the amount of VAT claimed on the discount received over as
VAT output.

37
(c)
RUNDU DEALERS
SALES JOURNAL - MARCH 20.4 SJ2
Trade
Date Details Fol VAT Sales receivables
output control
R R R
13 L Lion 300 2 000 2 300
W Wolf 150 1 000 1 150
450 3 000 3 450
B16

(d)
RUNDU DEALERS
PURCHASES JOURNAL - MARCH 20.4 PJ2
Trade
Date Details Fol VAT Purchases payables
input control
R R R
28 T Tiger 1 920 12 800 14 720
1 920 12 800 14 720
B15

(e)
RUNDU DEALERS
SALES RETURNS JOURNAL - MARCH 20.4 VTJ2
Date Details Fol VAT Trade
output Sales receivables
returns control
R R R
21 L Lion 9 60 69
9 60 69
B16

(f)
RUNDU DEALERS
PURCHASES RETURNS JOURNAL - MARCH 20.4 ATJ2
Trade
Date Details Fol VAT Purchases payables
input returns control
R R R
30 T Tiger 98 700 798
98 700 798
B15

38
(g)
RUNDU DEALERS
GENERAL JOURNAL - MARCH 20.4 GJ2
Date Detail Fol Debit Credit
R R
12 Printing 600
VAT input B15 90
Stationers Ltd/Trade payables control 690
Account received for printing services.

31 VAT control B17 5 844

VAT input B15 5 844
Transfer of VAT input to the VAT control account.

VAT output B16 6 360

VAT control B17 6 360
Transfer of VAT output to the VAT control account.

NB: The last two journal entries can only be done after the VAT input account and the
VAT output account in the general ledger have been completed. It is, in fact, the
“balances” of these two accounts that are transferred to the VAT control account.

(2) LEDGER

RUNDU DEALERS
GENERAL LEDGER
Dr VAT input B15 Cr
20.4 R 20.4 R
Mar 1 Balance b/d 2 715 Mar 31 Trade payables
31 Bank CPJ2 1 200 control PRJ2 105
Trade receivables VAT control 5 844
control CRJ2 24
Trade payables
control PJ2 1 920
Trade payables
control GJ2 90
5 949 5 949

39
Dr VAT output B16 Cr
20.4 R 20.4
Mar 31 Trade receivables Mar 1 Balance b/d 2 925
control SRJ2 9 31 Bank CRJ2 2 979
VAT control GJ2 6 360 Trade receivables
control SJ2 450
Trade payables
control CPJ2 15
6 369 6 369

Dr VAT control B17 Cr

20.4 R 20.4 R
Mar 31 VAT input GJ2 5 844 Mar 31 VAT output GJ2 6 360
Balance c/d 516
6 360 6 360
20.4
Apr 1 Balance b/d 516*
* A payment must be made to the South African Revenue Service for this amount before 25 April 20.4.

COMMENTS
• The calculation of VAT on all amounts that include 15% VAT is as follows:
% or R
Amount without VAT = 100 1,00
VAT = 15 0,15
Amount VAT inclusive = 115 1,15

The calculation of an amount if VAT was included is as follows:

15
/115 x Amount given
Example: Amount received on 1 March 20.4 = R15 640 (including VAT)
(see cash receipts journal). The calculations are as follows:
15
VAT = /115 x R15 640 = R2 040
100
SALES = /115 x R15 640 = R13 600
or
SALES = R15 640 ÷ R1,15 = R13 600
• VAT on cash sales is credited to the VAT ouput account because
Rundu Dealers received VAT for payment to the South African
Revenue Service.
• VAT on credit sales is credited to the VAT output account.
• VAT on cash purchases is debited to the VAT input account.
• VAT on credit purchases is debited to the VAT input account.
• VAT on sales returns is debited to the VAT output account. (to cancel

40
 the VAT output portion of the sales returned.)
• VAT on purchases returns is credited to the VAT input account. (to
cancel the input portion of the purchases returned.)
• VAT on settlement discounts to debtors is debited to the VAT input
account (to reduce the amount owed to the South African Revenue
Service).
• VAT on settlement discounts received from creditors is credited to
the VAT output account (to increase the amount owed to the South
African Revenue Service).
• The balances of the VAT input and VAT output accounts are
transferred to the VAT control account to determine what amount
must be paid to or claimed from the South African Revenue Service.
• When the difference between the debit and credit sides of the VAT
control is a
• credit, the difference is payable to the South African Revenue
Service (current liability)
• debit, the difference is refundable by the South African
Revenue Service (current asset)

NB: VAT is charged on services, for example, the provision of telephone services, water
and electricity, and repairs.

5.11 REVISION EXERCISE AND SOLUTION

Please attempt 5.11_REVISION EXERCISE under the heading “CONTENT”. The answer
will be provided at a later stage.

41
SELF-ASSESSMENT
Now that you have studied this study unit, can you

• prepare the following journals, taking Value-Added Tax into

account?
• cash receipts journal
• cash payments journal
• purchases journal
• purchases returns journal
• sales journal
• sales returns journal
• general journal
• post to the following ledgers?
• General ledger
• Trade receivables ledger
• Trade payables ledger
• prepare a trial balance?

42
 FAC1502

STUDY UNIT 6

ADJUSTMENTS

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

6
Adjustments

Learning outcome

You should be able to do year-end adjustments to balances in the books of an entity.

Contents
Page
Key concepts 3
6.1 Introduction 3
6.2 Short-term adjustments 4
6.2.1 Prepaid expenses 4
6.2.2 Accrued expenses 7
6.2.3 Consumable inventory on hand 9
6.2.4 Income received in advance 12
6.2.5 Accrued income 14
6.2.6 Credit losses (bad debts) 17
6.2.7 Allowance for settlement discount granted 18
6.3 Long-term adjustments (depreciation) 19
6.4 Preparation of the trial balance 21
6.4.1 Pre-adjustment trial balance 21
6.4.2 Post-adjustment trial balance 21
6.4.3 Post-closing trial balance 21
6.5 Revision exercise and solution 21
Self-assessment 22

2
 KEY CONCEPTS
• Adjustments
• Closing
• Prepaid expenses
• Accrued expenses
• Consumable inventory adjustments
• Income received in advance
• Credit losses (bad debts)
• Settlement discount
• Depreciation
• Accumulated depreciation
• Asset contra account
• Carrying amount
• Pre-adjustment trial balance
• Post-adjustment trial balance
• Post-closing trial balance

6.1 INTRODUCTION
An entity usually does business on a permanant basis without any interruptions. Moreover,
the owners and managers of an entity need regular information on its financial results and
financial position. The life of an entity is therefore divided into equal periods, called
financial periods. A financial period is usually 12 months. The profit or loss of an entity is
determined in respect of a financial period.
Thus far it was assumed that all transactions recorded were in respect of a specific
financial period. The closing off of accounts and the determination of profit were recorded
under this assumption. This does not always happen. An entity’s accounts (and eventually
statements) sometimes have to be adjusted to “correct“ the balances before the final
accounts and financial statements can be prepared.

For more accurate finanial statements at the end of a financial period, additional entries,
which do not originate from source documents, may be necessary.

The five steps relating to adjustments are as follows:

Step 1: Identify the accounts that must be adjusted.
Step 2: Determine how the accounts would be affected and what the balances of these
accounts should be.
Step 3: Calculate the amounts involved in the adjustments.
Step 4: Record the necessary adjustments in the general journal and post the entries to
the ledger(s).
Stap 5: Ensure that the new balances of the accounts are now correct.

3
6.2 SHORT-TERM ADJUSTMENTS
The profit or loss account (statement of profit or loss and other comprehensive income) is
always for a specific financial period. All the income and expenses must be included for the
full financial period, whether they were paid/received or not (for e.g., expenses for a next
financial period that have already been paid or income for a next financial period that has
already been received). For this purpose, short-term adjustments are sometimes
necessary. Short-term adjustments have to do with the apportionment of income and
expenditure to consecutive periods within a year. This is income that is received in one
period but that was earned in an earlier period or will be earned in a later period. The same
applies to expenses that are incurred in another period.

6.2.1 Prepaid expenses

A prepaid expense is an expense that has been paid in the current financial period of an
entity, where all or part of the expense relates to a future financial period. For example,
insurance expenses are usually payable in advance. Therefore, when the financial year of
a business entity ends, a portion of the insurance expense could relate to the next financial
period. An adjustment is consequently necessary to match only that portion of the expense
that relates to the current financial period with the income for that period.

On 2 January 20.1 Xa-Xa Dealers paid a new annual insurance premium of R2 400. Its
financial year ends on 28 February 20.1. Using this information you can work out that the
actual amount it spent on insurance up to and including 28 February 20.1 was only R400,
which is R2 400/12 = R200 per month for two months, namely, January and February. The
R2 000 that was paid in advance represents an asset at this point. The apportionment of
the amount between asset and expenditure elements will be as follows: R400 is an
expenditure item in respect of insurance for the current financial year. This amount must
appear in the profit or loss account and the statement of profit or loss and other
comprehensive income. The R2 000 is a prepaid expense and therefore represents an
amount that will be used in future. It must appear on the statement of financial position as
at 28 February 20.1 and is therefore a short-term (current) asset.

A short-term asset is only created for disclosure in the statement of financial position as at
the end of the financial year. At the beginning of the next financial year, the asset account
will again be closed off and the amount returned to the specific nominal account, in this
case, insurance.

GOLDEN RULE

One entry or “leg“ of the adjustment journal always affects a nominal account and thereby
the trading account or the profit or loss account. The other entry or “leg“ of the journal
always affects a statement of financial position account (balance sheet account).

4
ACCOUNTING ENTRIES
The debit balance in the expense account for insurance has to be reduced by R2 000. To
reduce an expense account, a credit entry has to be made. The balance of the insurance
account will then reflect the actual expense, namely, R400, and this amount can be written
off against the profit or loss account. The prepaid amount of R2 000 is a temporary asset
on the date of the statement of financial position, it is debited in the prepaid expense
account and shown on the statement of financial position under current assets.

JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Prepaid expenses B55 2 000
Insurance N40 2 000
Adjustment of insurance account

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Profit or loss account N60 400
Insurance N40 400
Closing of insurance account to profit or loss account

XA-XA DEALERS
GENERAL LEDGER
Dr Insurance N40 Cr
20.1 R 20.1 R
Jan 2 Bank CPJ 2 400 Feb 28 Prepaid expenses GJ12 2 000
Profit or loss account GJ12 400
2 400 2 400

Dr Prepaid expenses B55 Cr

20.1 R
Feb 28 Insurance GJ12 2 000

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Insurance GJ12 400

5
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
ASSETS
Non-current assets

Current assets xx xxx

Prepaymentsa 2 000

a
Prepayments are a separate line-item under current assets.

ADJUSTMENT REVERSAL (PREPAID EXPENSES) ON THE FIRST DAY OF THE NEXT

FINANCIAL YEAR

At the beginning of the next financial year a totally new set of journals, as well as ledger
accounts, will be created. Only the balance sheet accounts will have balances in the
general ledger for the new year because all the nominal accounts will have been closed off
to the profit or loss account at the end of the previous financial year. You will open a new
insurance account for the new financial year. The temporary asset account (prepaid
expenses will be credited) will be closed off to the new insurance account (see T-accounts
below). All the nominal accounts will be created from scratch for the new financial year.

The insurance account will be debited because the amount for insurance is an expense
paid for the new financial year.

XA-XA DEALERS
REVERSAL TRANSFER – 1 MARCH 20.1 GJ1
Details Fol Debit Credit
R R
Insurance N40 2 000
Prepaid expenses B55 2 000
Transfer of prepaid expenses back to the insurance account

XA-XA DEALERS
GENERAL LEDGER
Dr Prepaid expenses B55 Cr
20.1 R 20.1 R
Feb 28 Insurance GJ12 2 000 Mar 1 Insurance GJ1 2 000

Dr Insurance N40 Cr
20.1
Mar 1 Prepaid expenses GJ1 2 000

6
6.2.2 Accrued expenses
An accrued expense is an expense that relates to the current financial period but is still
unpaid at the end of that period.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’s water and electricity
account shows expenses of R2 880. On closer examination Xa-Xa Dealers’s accountant
establishes that the February water and electricity account of R360 has not been taken into
account. Using this information, the actual expenditure on water and electricity for the year
can be determined, namely, R2 880 + R360 = R3 240. The apportionment of the item
between actual expenditure and amount owing (liability) will be as follows: R3 240 was the
actual expenditure (to be reflected in the profit or loss account and the statement of profit
or loss and other comprehensive income) and R360 is still owed (to be reflected in the
statement of financial position) and must be paid at a future date (current liability).

ACCOUNTING ENTRIES
The debit balance on the water and electricity expense account has to be increased by
R360. To increase an expense account, a debit entry has to be made. The balance on the
water and electricity account will now reflect the actual expenditure, namely, R3 240. This
amount can be written off against the profit or loss account (and the statement of profit or
loss and other comprehensive income). The outstanding amount of R360 is a liability on
the date of the statement of financial position; it is credited in the accrued expense account
and shown on the statement of financial position under current liabilities.

JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Water and electricity N41 360
Accrued expenses B56 360
Adjustment of water and electricity account

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Profit or loss account N60 3 240
Water and electricity N41 3 240
Closing of water and electricity account to profit or loss account

7
 XA-XA DEALERS
GENERAL LEDGER
Dr Water and electricity N41 Cr
20.1 R 20.1 R
Feb 28 Balance b/d 2 880 Feb 28 Profit or loss account GJ12 3 240
Accrued expenses GJ12 360
3 240 3 240

Dr Accrued expenses B56 Cr

20.1 R
Feb 28 Water and electricity GJ12 360

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Water and electricity GJ12 3 240

XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
EQUITY AND LIABILITIES
Equity
Non-current liabilities
Current liabilities xx xxx
Trade and other payablesa 360

a
Accrued expenses will be disclosed as part of trade and other payables. The amount for accrued expenses
will therefore be added to the balance of the trade payables control account at the end of the financial year.

ADJUSTMENT REVERSAL (ACCRUED EXPENSES) ON THE FIRST DAY OF THE

NEXT FINANCIAL YEAR

At the beginning of the next financial year a totally new set of journals, as well as ledger
accounts, will be created. Only the balance sheet accounts will have balances in the
general ledger for the new year because all the nominal accounts will have been closed off
to the profit or loss account at the end of the previous financial year. You will open a new
water and electricity account for the new financial year. The temporary liability account
(accrued expenses) will be closed off to the new water and electricity account (see T-
accounts below). All the nominal accounts will be created from scratch for the new financial
year.

The water and electricity account will be credited because the amount is applicable to the
previous financial year and not the new financial year. The amount will therefore be
subtracted from the expenses for water and electricity for the new financial year.

8
XA-XA DEALERS
REVERSAL TRANSFER – 1 MARCH 20.1 GJ1
Details Fol Debit Credit
R R
Accrued expenses B56 2 000
Water and electricity N41 2 000
Transfer of accrued expenses back to the water and electricity
account

XA-XA DEALERS
GENERAL LEDGER
Dr Accrued expenses B56 Cr
20.1 R 20.1 R
Mar 1 Water and electricity GJ1 360 Feb 28 Water and electricity GJ12 360

Dr Water and electricity N41 Cr

20.1 R
Mar 1 Accrued expenses GJ1 2 000

6.2.3 Consumable inventory on hand

Consumables are all the expenses with regard to inventory bought not for sale but for use
in the process of earning an income, for example, stationery and packing material. There
will be physical inventory left at the end of the financial year that can be counted; a closing
amount can then be determined.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’ stationery account
shows that stationery to the value of R500 was purchased during the year. At a physical
count it is determined that stationery worth R150 is still on hand. Using this information, the
actual expenditure on stationery can be calculated, namely, R500 - R150 = R350. The
apportionment of the item between actual expenditure (profit or loss account and
statement of profit or loss and other comprehensive income) and the asset element
(statement of financial position) will be as flollows: R350 represents expenditure on
stationery while R150 represents the value of the stationery that will be used in the future.

ACCOUNTING ENTRIES
The debit balance in the stationery expense account has to be reduced by R150. To
reduce an expense account, a credit entry has to be made. The balance on the
stationery account will now show the actual expenditure, namely, R350. This amount can
now be written off against the profit or loss account. The stationery on hand, worth R150, is
an asset on the date of the statement of financial position; it is debited in the consumable
inventory on hand account and shown in the statement of financial position under current
assets.

9
JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Consumable inventory on hand: stationery B57 150
Stationery N42 150
Adjustment of stationery account

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Profit or loss account N60 350
Stationery N42 350
Closing of stationery account to profit or loss account

XA-XA DEALERS
GENERAL LEDGER
Dr Stationery N42 Cr
20.1 R 20.1 R
Feb 28 Balance b/d 500 Feb 28 Consumable inventory on
hand: stationery GJ12 150
Profit or loss account GJ12 350

500 500

Dr Consumable inventory on hand: stationery B57 Cr

20.1 R
Feb 28 Stationery GJ12 150

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Stationery GJ12 350

10
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
ASSETS
Non-current assets

Current assets xx xxx

Inventoriesa 150

a
Consumable inventory on hand: Stationery will be disclosed as part of inventories. The amount of
inventories will consist of trade inventory plus consumable inventories on hand.

ADJUSTMENT REVERSAL (CONSUMABLE INVENTORY ON HAND: STATIONERY)

ON THE FIRST DAY OF THE NEXT FINANCIAL YEAR

At the beginning of the next financial year a totally new set of journals, as well as ledger
accounts, will be created. Only the balance sheet accounts will have balances in the
general ledger for the new year because all the nominal accounts will have been closed off
to the profit or loss account at the end of the previous financial year. You will open a new
expense account, stationery, for the new financial period and you will close the temporary
asset account (credit the consumable inventory on hand: stationery) and enter the amount
in the new stationery account (see T-accounts below). All the nominal accounts will be
created from scratch for the new financial year.

The stationery account will be debited because the amount is applicable to the new
financial year.

XA-XA DEALERS
REVERSAL TRANSFER – 1 MARCH 20.1 GJ1
Details Fol Debit Credit
R R
Stationery N42 150
Consumable inventory on hand: stationery B57 150
Transfer of consumable inventory on hand: stationery back to
the stationery account

XA-XA DEALERS
GENERAL LEDGER
Dr Stationery N42 Cr
20.1
Mar 1 Consumable inventory on
hand: stationery GJ1 360

Dr Consumables inventory on hand: stationery B57 Cr

20.1 R 20.1 R
Feb 28 Stationery GJ12 150 Feb 28 Stationery GJ1 150

11
6.2.4 Income received in advance
Income received in advance is income that has been received during the current financial
period but relates to a future financial period. Only the portion relating to the current
financial period must be recorded as income, and an adjustment is necessary for the
portion received in advance.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’s rental income account
shows that R10 400 was received. Xa-Xa Dealers rents out a part of its building for R800 a
month. On closer investigation it is established that the rental for March 20.1 has already
been received.
Using this information, the actual income received in rental for the year can be determined,
that is, R10 400 - R800 = R9 600 (= R800 x 12).
The apportionment of the item between actual income and the liability (amount owing)
component will be as follows: R9 600 is the actual income and R800 is due to the lessee
because it was paid in advance. Differently stated, the income has not yet been earned.

ACCOUNTING ENTRIES
The credit balance in the rental income account has to be reduced by R800. To reduce an
income account, a debit entry has to be made. The balance on the rental income account
will now show the actual income, namely, R9 600. This amount can now be written off
against the profit or loss account. The amount received in advance is a liability on the date
of the statement of financial position; it is credited in the income received in advance
account and shown in the statement of financial position under current liabilities.

JOURNAL ENTRIES

XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Rental income N44 800
Income received in advance B59 800
Adjustment of rental income account

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Rental income N44 9 600
Profit or loss account N60 9 600
Closing of rental income account to profit or loss account

12
 XA-XA DEALERS
GENERAL LEDGER
Dr Rental income N44 Cr
20.1 R 20.1 R
Feb 28 Income received in Feb 28 Balance b/d 10 400
advance GJ12 800
Profit or loss account GJ12 9 600
10 400 10 400

Dr Income received in advance B59 Cr

20.1 R
Feb 28 Rental income GJ12 800

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Rental income GJ12 9 600

XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
EQUITY AND LIABILITIES
Equity
Non-current liabilities
Current liabilities xx xxx
Income received in advancea 800

a
Income received in advance are a separate line item under current liabilities.

ADJUSTMENT REVERSAL (INCOME RECEIVED IN ADVANCE) ON THE FIRST DAY

OF THE NEXT FINANCIAL YEAR

At the beginning of the next financial year a totally new set of journals, as well as ledger
accounts, will be created. Only the balance sheet accounts will have balances in the
general ledger for the new year because all the nominal accounts will have been closed off
to the profit or loss account at the end of the previous financial year. You will open a new
income account, rental income, for the new financial period and you will close the
temporary liability account (debit the income received in advance account) and enter the
amount in the new rental income account (see T-accounts below). All the nominal
accounts will be created from scratch for the new financial year.

The rental income account will be credited because the amount is applicable to the new
financial year.

13
XA-XA DEALERS
REVERSAL TRANSFER – 1 MARCH 20.1 GJ1
Details Fol Debit Credit
R R
Income received in advance B59 800
Rental income N44 800
Transfer of income received in advance back to the rental
income account

XA-XA DEALERS
GENERAL LEDGER
Dr Rental income N44 Cr
20.1
Mar 1 Income received in
advance GJ3 800

Dr Income received in advance B59 Cr

20.1 R 20.1 R
Mar 1 Rental income GJ3 800 Feb 28 Rental income GJ2 800

6.2.5 Accrued income

Accrued income is income that relates to the current financial period but that has not yet
been received.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’s commission income
account shows an income of R2 200. On closer examination it is established that an
amount of R200 earned in commission has not yet been received.
Using this information, the actual income in commission can be determined, that is, R2 200
+ R200 = R2 400. The apportionment of the item between actual earnings in commission
and the associated asset (the commission that has not yet been received) will be as
follows: R2 400, which has actually been earned, and R200, which is still to be received.

ACCOUNTING ENTRIES
The credit balance in the commission income account has to be increased by R200. To
increase an income account, another credit entry has to be made. The balance of the
commission income account will now reflect the actual income, namely, R2 400. This
amount can now be written off against the profit or loss account. The outstanding amount
of R200 is a temporary asset on the day of the statement of financial position; it is
debited in the accrued income account and shown on the statement of financial position
under current assets.

14
JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Accrued income B61 200
Commission income N45 200
Adjustment of commission income account

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Commission income N45 2 400
Profit or loss account N60 2 400
Closing of commission income account to profit or loss account

XA-XA DEALERS
GENERAL LEDGER
Dr Commission income N45 Cr
20.1 R 20.1 R
Feb 28 Profit or loss account GJ12 2 400 Feb 28 Balance b/d 2 200
Accrued income GJ12 200

2 400 2 400

Dr Accrued income B55 Cr

20.1 R
Feb 28 Commission income GJ12 200

Dr Profit or loss account (extract) N60 Cr

R 20.1 R
Feb 28 Commission income GJ12 2 400

15
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
ASSETS
Non-current assets

Current assets xx xxx

Trade and other receivablesa 200

a
Accrued income will be disclosed as part of trade and other receivables. The amount for accrued income
will therefore be added to the balance of the trade receivables control account at the end of the financial
year.

ADJUSTMENT REVERSAL (ACCRUED INCOME) ON THE FIRST DAY OF THE NEXT

FINANCIAL YEAR

At the beginning of the next financial year a totally new set of journals, as well as ledger
accounts, will be created. Only the balance sheet accounts will have balances in the
general ledger for the new year because all the nominal accounts will have been closed off
to the profit or loss account at the end of the previous financial year. You will open a new
income account, commission income, for the new financial period and you will close the
temporary asset account (credit the accrued income account) and enter the amount in the
new commission income account (see T-accounts below). All the nominal accounts will be
created from scratch for the new financial year.

The commission income account will be debited because the amount is applicable to the
previous financial year. The amount will be subtracted from the commission income for the
new financial year.

XA-XA DEALERS
REVERSAL TRANSFER – 1 MARCH 20.1 GJ1
Details Fol Debit Credit
R R
Commission income N40 200
Accrued income B55 200
Transfer of prepaid expense back to the insurance account

XA-XA DEALERS
GENERAL LEDGER
Dr Commission income N45 Cr
20.1
Mar 1 Accrued income GJ1 2 000

Dr Accrued income B55 Cr

20.1 R 20.1 R
Feb 28 Commission income GJ12 200 Mar 1 Commission income GJ1 2 000

16
6.2.6 Credit losses (bad debts)
When a credit transaction occurs, there is always a possibility that the debt might not be
paid. Such a debt that is never paid is known as a credit loss or irrecoverable debt. The
amount that will never be paid by the debtor will be written off to the account called credit
losses, which will be written off as a loss to the profit or loss account (the statement of
profit or loss and other comprehensive income) at the end of the financial period. The
debtor will then owe the entity no more money.
On 25 January 20.1 Xa-Xa Dealers received a notification that a debtor, A Tago, is
insolvent. On closer investigation it is established that the debtor still owes Xa-Xa Dealers
R230.
Using this information, an adjustment must be made in A Tago’s account. The outstanding
amount of R230 must be removed from his account and shown as an expense or a loss.
The assets will therefore decrease and an expense or loss component, namely, credit
losses will come into being.

ACCOUNTING ENTRIES
The debit balance of R230 on A Tago’s account has to be written off since he is insolvent
and cannot pay. To reduce an asset account, a credit entry has to be made. A Tago’s
account in the trade receivables ledger will be credited and will now show no balance. The
trade receivables control account in the general ledger must also be credited and the credit
losses account debited. The debt that cannot be paid is an expense/loss and is written off
against the profit or loss account at the end of the financial year.

JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Credit losses N46 230
A Tago/trade receivables control account DL2/B6 230
Write-off of the account of A Tago, a debtor, as irrecoverable

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Profit or loss account N60 230
Credit losses N46 230
Closing of credit losses account to profit or loss account

17
 XA-XA DEALERS
GENERAL LEDGER
Dr Trade receivables control account B6 Cr
20.0 R 210.1 R
Mar 1 Balance b/d xx xxx Jan 25 Credit losses GJ12 230

Dr Credit losses N46 Cr

20.1 R 20.1 R
Jan 25 A Tago/trade receivables Feb 28 Profit or loss account GJ12 230
control account GJ12 230
230 230

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Credit losses GJ12 230

XA-XA DEALERS
TRADE RECEIVABLES LEDGER
Dr A Tago 2 Cr
20.1 R 20.1 R
Mar 1 Balance b/d 230 Jan 25 Credit losses GJ12 230

XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
R
ASSETS
Non-current assets

Current assets xx xxx

Trade and other receivablesa R(xx xxx – 230) xx xxx

a
The new balance for the trade receivables control account will be disclosed under the heading “Trade and
other receivables” together with accrued income under the heading “Current assets”.

The writing off of credit losses is explained in detail in study unit 9. The above solution is
done according to method 2, as explained in section 9.5.6.

6.2.7 Allowance for settlement discount granted

Allowance for settlement discount granted is explained in detail in section 9.3.

18
6.3 LONG-TERM ADJUSTMENTS (DEPRECIATION)
(Depreciation is discussed in detail in study unit 11.)

Business entities buy tangible assets (property, plant and equipment) that are not for
resale but are used in the operation of the businesses. As these assets are used, they
decrease in value. This decline in value of a tangible asses is charged against the profits of
a business and is spread (apportioned) over the expected useful life of the asset.
The apportionment of the cost of an asset usually takes the form of depreciation entries.
Xa-Xa Dealers bought machinery to the value of R80 000 during the year. On
28 February 20.1, the end of its financial year, an amount of R12 000 has to be written off
as depreciation.
Using this information, an adjustment can be made in the books. An expense, namely,
depreciation of R12 000 is created. Instead of crediting the machinery account, a special
account, namely, accumulated depreciation: machinery account is credited. The
account is known as a contra asset account.

ACCOUNTING ENTRIES
Depreciation is an expense to the entity and the depreciation account will therefore be
debited with R12 000. The expense will then be written off against the profit or loss
account. The apportionment of the depreciation is credited in the contra asset account,
namely, accumulated depreciation: machinery. The accumulated depreciation is subtracted
from the cost price of the machinery to determine the carrying amount of the machinery.
The carrying amount is shown under non-current assets in the statement of financial
position and is part of property, plant and equipment.

JOURNAL ENTRIES
XA-XA DEALERS
ADJUSTMENT ENTRY - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Depreciation N47 12 000
Accumulated depreciation: machinery B56 12 000
Adjustment to make provision for depreciation

XA-XA DEALERS
CLOSING TRANSFER - 28 FEBRUARY 20.1 GJ12
Details Fol Debit Credit
R R
Profit or loss account N60 12 000
Depreciation N47 12 000
Closing of depreciation account to profit or loss account

19
 XA-XA DEALERS
GENERAL LEDGER
Dr Accumulated depreciation: machinery B56 Cr
20.1 R
Jan 25 Depreciation GJ12 12 000

Dr Depreciation N47 Cr
20.1 R 20.1 R
Feb 28 Accumulated depreciation: Feb 28 Profit or loss account GJ12 12 000
machinery GJ12 12 000
12 000 12 000

Dr Profit or loss account (extract) N60 Cr

20.1 R
Feb 28 Depreciation GJ12 12 000

XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (EXTRACT)
Notes R
ASSETS
Non-current assets 68 000
Property, plant and equipment 3 68 000
Current assets

XA-XA DEALERS
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.1
Property, plant and equipment Machinery Total
R R
Carrying amount: Beginning of year - -
Cost - -
Accumulated depreciation - -

Additions 80 000 80 000

Disposals - -
Depreciation (12 000) (12 000)
Carrying amount: End of year 68 000 68 000
Cost 80 000 80 000
Accumulated depreciation (12 000) (12 000)

20
6.4 PREPARATION OF THE TRIAL BALANCE
A trial balance is a statement of all debits and credits in a double-entry account book, with
any disagreement indicating an error. It is therefore important to be able to identify at what
stage in the accounting process a trial balance is prepared.
A trial balance is prepared as many times as required, but at least every month. At the end
of the financial year, as many as three trial balances are prepared.

6.4.1 Pre-adjustment trial balance

This trial balance is compiled to test the correctness of entries after the posting from the
subsidiary journals to the general ledger (the same as the usual monthly trial balance). Its
purpose is to test whether the requirements of the double-entry system have been
met because if the trial balance does not balance at this point, the statement of financial
position will not balance either.

6.4.2 Post-adjustment trial balance

This trial balance is compiled after all the adjusment journal entries have been posted to
the general ledger.

6.4.3 Post-closing trial balance

This trial balance is compiled after the closing transfer journal entries have been posted to
the ledger. In this trial balance, all the nominal accounts are closed off and the profit or loss
account and the drawings account are transferred to the capital account. All that remains in
the trial balance at this point are the assets, liabilities and equity accounts. These are the
accounts that appear as items in the statement of financial position.

6.5 REVISION EXERCISE AND SOLUTION

Please attempt 6.5_REVISION EXERCISE 1 under the heading “CONTENT”.

21
SELF-ASSESSMENT
Now that you have studied this study unit, can you

• list the accounts and the items that have to be adjusted?

• record adjustments in respect of the following?
- short-term adjustments, such as
▪ prepaid expenses
▪ accrued expenses
▪ consumable inventory on hand
▪ income received in advance
▪ accrued income
▪ credit losses (bad debts)
- long-term adjustments, such as
depreciation
• calculate the amounts in question?
• record the necessary entries in the books?
• prepare a pre-adjustment trial balance, a post-adjustment trial
balance and a post-closing trial balance?
• show the effect of adjustments in the statement of profit or loss
and other comprehensive income and the statement of financial
position?

22
 FAC3704
FAC1502

STUDY UNIT 7

PERFORMING THE CLOSING-

OFF PROCEDURE,
DETERMINING PROFIT OF AN
ENTITY AND PREPARING
FINANCIAL STATEMENTS

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

7
Performing the closing-off procedure, determining profit
of an entity and preparing financial statements

Learning outcome

You should be able to carry out the closing-off procedure, to determine the profit or loss of an
entity and to prepare more advanced financial statements.

Contents
Page
Key concepts
7.1 Introduction 3
7.2 Financial performance of a service entity 4
7.3 Components of the financial performance of an entity 4
7.3.1 Gross profit 4
7.3.2 Profit for the year/period 4
7.3.3 Cost price of sales 4
7.4 Inventory systems (trading inventory) 5
7.4.1 A perpetual (continuous) inventory system 5
7.4.2 A periodic inventory system 10
7.4.3 Additional purchase costs 15
7.4.4 Drawings and donations of inventory 17
7.5 Closing-off of nominal accounts 17
7.5.1 Trading account 19
7.5.2 Profit or loss account 25
7.6 Preparation of financial statements 29
7.6.1 The statement of profit or loss and other comprehensive income (financial 29
performance)
7.6.2 The statement of changes in equity 30
7.6.3 The statement of financial position 31
7.6.4 Notes to the financial statements 33

2
7.7 Gross profit percentage 34
7.8 Integrated example 34
7.9 Revision exercises and solutions 47
7.9.1 Revision exercise 1 47
7.9.2 Revision exercise 2 47
7.9.3 Revision exercise 3 47
7.9.4 Revision exercise 4 47
7.9.5 Revision exercise 5 47
7.9.6 Revision exercise 6 47
7.9.7 Revision exercise 7 48
7.9.8 Revision exercise 8 48
Self-assessment 48

KEY CONCEPTS
• Financial period
• Nominal accounts
• Cost of sales
• Gross profit
• Profit for the year/period
• Inventory (merchandise, trading goods)
• Perpetual inventory system
• Periodic inventory system
• Closing entries
• Trading account
• Profit or loss account
• Statement of profit or loss and other comprehensive income
• Statement of changes in equity
• Statement of financial position and notes

7.1 INTRODUCTION
This study unit will give you the background knowledge you need to prepare the financial
statements of a service entity and a trading concern.

Given the accounting entries we have dealt with so far, you already know how to determine,
with respect to an entity,
• the owner's capital
• the entity's assets (including trading inventory and cash)
• the entity's liabilities
• income and expenditure accounts (nominal accounts), which include the following
in the case of a trading concern:
- merchandise sales
- merchandise purchases
- all other expenditure
- other income

3
Since the preparation of financial statements goes hand in hand with the closing-off
procedure every financial year, we will explain the closing entries that have to be made
annually. All the nominal accounts (income and expenditure) are closed off; they
provide the details necessary for compiling the statement of profit or loss and other
comprehensive income.
The accounts that remain in the trial balance after closing, namely, the asset, liability
and capital accounts, form the basis of the information that is included in the
statement of financial position.

7.2 FINANCIAL PERFORMANCE OF A SERVICE ENTITY

Entities that don’t sell any inventory but rather deliver a service to clients are known as
service entities (e.g., bookkeepers). The revenue for these entities will consist of service
fees.

7.3 COMPONENTS OF THE FINANCIAL PERFORMANCE OF AN ENTITY

The most important question that is asked in respect of a business is, "How has the
business fared financially?" In other words, has the business made a profit or a loss? The
calculations that are made to answer this question relate to a specific financial period,
usually a year.

7.3.1 Gross profit

Gross profit is the difference between sales and the cost price of sales. The relevant
accounts are closed off to the trading account.

7.3.2 Profit for the year/period

Profit for the year/period is the amount that remains from the gross profit after all
expenditure necessary to manage the business has been subtracted and other income has
been added. These income and expenditure accounts are closed off and transferred to the
profit or loss account.

7.3.3 Cost price of sales

Before you can determine the cost price of sales, you need to look at inventory. The
merchandise inventory that an entity buys during a financial period is not necessarily all
sold during that period. The inventory that is still in an entity at the beginning of an
accounting period is known as the opening inventory and the inventory that is still in the
entity at the end of that period is known as the closing inventory. The amount of the closing
inventory in the entity are determined by way of a physical inventory count at the end of the
financial period. The closing inventory at the end of the financial period will be the opening
inventory for the next financial period.

4
7.4 INVENTORY SYSTEMS (TRADING INVENTORY)
An entity can use either a perpetual (continuous) inventory system or a periodic inventory
system, depending on the nature of the entity, the type of merchandise sold and the level of
computerisation in the entity. Thus far we have worked with a periodic inventory system.
In the case of a perpetual inventory system, an entity will keep continuous track of inventory
levels for the different inventory items it sells. This method is ideally suited to an entity that
sells items that can be easily identified and, measured and to which a value can be
attached. The use of scanners and bar codes enables many entities to apply this method of
inventory recording.

7.4.1 A perpetual (continuous) inventory system

Under a perpetual inventory system, the purchase of inventory is recorded directly into the
inventory account at cost price. At the time of sale, the cost price of the goods sold is
transferred from the inventory account to the cost of sales account.

The accounting entries under such a system can be summarised as follows (VAT is ignored
in these examples):

Purchase of inventory for cash:

Dr Inventory ......... (because the asset “inventory” increases)
Cr Bank ................ (because the asset “bank” decreases when money is paid out)
The transaction is recorded in the cash payments journal at cost price.

Purchase of inventory on credit:

Dr Inventory (see above)
Cr Creditor (because a liability is created or increased)
and
Cr Trade payables control
The transaction is recorded in the purchases journal at cost price.

Sale of merchandise for cash:

Dr Bank (an asset increases with money received) (selling price)
Cr Sales (an income that increases equity) (selling price)

Dr Cost of sales (an expense that decreases equity) (cost price)

Cr Inventory (an asset decreases) (cost price)
The transaction is recorded in the cash receipts journal.

Note that the difference between the cost of sales and the selling price is the gross profit
which is the amount by which the equity increases.

5
Merchandise sold on credit:
Dr Debtor (an asset is created or increased) (selling price)
and
Dr Trade receivables control
Cr Sales (see above) (selling price)

Dr Cost of sales (see above) (cost price)

Cr Inventory (see above) (cost price)
The transaction is recorded in the sales journal.

When merchandise is returned by a debtor:

Dr Sales returns (this has the opposite effect than sales on equity it decreases
equity) (selling price)
Cr Debtor (the asset decreases because the debtor owes the business
less) (selling price)
and
Cr Trade receivables control

Cr Cost of sales (this has the opposite effect on equity than when merchandise
was sold) (cost price)
Dr Inventory (the asset increases by the amount of the merchandise returned)
(cost price)
The transaction is recorded in the sales returns journal.

Merchandise returned, previously sold for cash:

If the business has a policy of not repaying cash, a credit note will be issued to the client
that can be exchanged for other merchandise.

If the business is willing to refund the cash:

Dr Sales returns (see above) (selling price)
Cr Bank (the asset “bank” will decrease to cancel the previous increase)
(selling price)
The transaction is recorded in the cash payments journal.

To reinstate the merchandise as part of inventory:

Dr Inventory (the asset “inventory” increases) (cost price)

Cr Cost of sales (see above) (cost price)
The transaction is recorded in the general journal.

6
When merchandise is returned to a creditor:
Dr Creditor (because the liability decreases) (cost price)
and
Dr Trade payables control
Cr Inventory (an asset is decreased there is less inventory because of the
goods returned) (cost price)
The transaction is recorded in the purchases returns journal.

From the above discussion it is clear that the cost price of merchandise sold is recorded at
the same time as the sale of the merchandise. This procedure enables the entity to
determine the gross profit on each sale and to keep a continuous record of the rand value
of the inventory that has not yet been sold.
However, a physical inventory count still has to be performed at least once a year, usually
at the end of the financial year. Theoretically, the result of the inventory count should be the
same as the balance on the inventory account. This seldom happens. Some of the main
reasons why there is a difference include the theft of inventory, breakages, leakages and
evaporation. This loss of inventory will, of course, not be recorded in the inventory account
and will only be detected when a physical count of inventory is done.

GOLDEN RULES
• Perpetual inventory system: The cost of sales is determined with every sales
transaction:
• Debit: Cost of sales
• Credit: Inventory with the cost value of the sales
• Perpetual inventory system: No purchases or purchases returns accounts are kept
(see section 7.4.2).
• Perpetual inventory system: A physical inventory count will only disclose shortages
(or surpluses) of inventory.

EXERCISE 7.1

The following exercise illustrates a perpetual inventory system:

R
Inventory on 1 January 20.1 10 000
Transactions for the year up to 31 December 20.1
Credit purchases 50 000
Cash purchases 40 000
Credit sales (mark-up on cost price is 25%) 75 000
Cash sales (mark-up on cost price is 25%) 25 000

7
SOLUTION: EXERCISE 7.1

Accounting entries that have to be made

(1) In a perpetual inventory system, inventory is an asset. Inventory on hand and

inventory that is purchased are therefore debited in the asset account, “inventory”,
at cost price and the contra account, for example, “creditors” or “bank” is credited.
(2) When goods (merchandise) are sold, the sales account (income) is credited with
the selling price and the contra account, for example, “debtors” or “bank” is debited.
(3) Goods (merchandise) are taken out of the inventory (asset) account at cost price
(inventory account is credited) and debited to the cost of sales (expense) account.

LEDGER ENTRIES
GENERAL LEDGER
Dr Inventory B10 Cr
20.1 R 20.1 R
a
Jan 1 Balance b/d 10 000 Dec 31 Cost of sales SJ 60 000
b
Dec 31 Trade payables control PJ 50 000 Cost of sales CRJ 20 000
Bank CPJ 40 000 Balance c/d 20 000
100 000 100 000
20.2
Jan 1 Balance b/d 20 000
ab
See calculations below

Dr Sales N1 Cr
20.1 R 20.1 R
Dec 31 Trading account GJ 100 000 Dec 31 Trade receivables
control SJ 75 000
Bank 25 000
100 000 100 000

Dr Cost of sales Cr
20.1 R 20.1 R
a
Dec 31 Inventory SJ 60 000 Dec 31 Trading account GJ 80 000
b
Inventory CRJ 20 000
80 000 80 000

a R75 000
/125 x 100/1 = R60 000
b R25 000
/125 x 100/1 = R20 000

8
Dr Trading account Cr
20.1 R 20.1 R
Dec 31 Cost of sales 80 000 Dec 31 Sales 100 000
Profit or loss account
(Gross profit*) 20 000
100 000 100 000

* The gross profit is the difference between sales and the cost of sales. The gross profit is transferred to the
profit or loss account. If the cost of sales is more than sales, the result is a gross loss.

COMMENTS
• When determining the cost of sales, it is important to establish
whether the mark-up was made on the cost price or the selling price
since the price that applies is taken to be 100 (100%).
Suppose the mark-up of 25% is on the cost price as in the above
exercise.
Thus:
%
Cost price = 100
Mark-up = 25
Selling price = 125

The cost price in rand will obviously be less than the selling price.
Therefore:
Divide the smaller figure (100) by the larger figure (125) and multiply
the result by the cost of sales.
Cost of sales: R75 000
100 75 000
125 x 1
Cost price = R60 000

If the mark-up of 25% is on the selling price:

%
Selling price = 100
Mark-up = (25)
Cost price = 75

9
 The cost price will again be less than the selling price.
Thus: 75 75 000
100 x 1
Cost price = R56 250

• The gross profit, which is also called the trading profit, is determined
in the trading account.
• The details that are required to calculate the gross profit or loss are
transferred to the trading account by means of the general journal, as
follows:
- The sales account is debited and the trading account is credited
(sales account are closed off).
- The cost of sales account is credited (the account is closed) and
the trading account is debited. The balance on the trading
account represents the gross profit or loss.
• The closing balance of the inventory account (asset) represents the
closing inventory.

7.4.2 A periodic inventory system

Under a periodic inventory system, the purchase of inventory is not recorded in the
inventory account. Instead, it is recorded in a separate account known as the purchases
account. If inventory is returned to the seller for one reason or another, the return of the
inventory cannot be recorded in the inventory account but must be recorded in a separate
account known as the purchases returns account.
As a result of the above procedure, it should be clear that under a periodic inventory
system, the cost of sales is not determined at the time of the recording of a sale. The cost
of sales can thus only be determined at the end of the financial period after a physical
inventory count has been done.
The cost price of inventory sold during an accounting period will thus be determined as
follows:
Cost price of inventory at the beginning of the financial year (closing inventory
of previous year)
Add: Cost price of inventory purchased during the financial year (this is the total
amount spent on purchases)
Less: Cost price of inventory at the end of the financial year, determined by a
physical inventory count (this is the unsold inventory)

10
The accounting entries associated with a periodic inventory system can be summarised as
follows (VAT is ignored in the examples):

Purchase of inventory for cash:

Dr Purchases (under a periodic inventory system, purchases are regarded as
an expense that reduces equity)
Cr Bank (the asset “bank” decreases when money is paid out)

The transaction is recorded in the cash payments journal at cost price.

Purchase of inventory on credit:

Dr Purchases (see above)

Cr Creditor (“creditor” is a liability account that is created or increased)
and
Cr Trade payables control

The transaction is recorded in the purchases journal at cost price.

Sale of merchandise for cash:

Dr Bank (the asset increases with the money received)

Cr Sales (income that increases equity)

The transaction is recorded in the cash receipts journal at selling price.

Sale of merchandise on credit:

Dr Debtor (an asset that is created or increased)
and
Dr Trade receivables control
Cr Sales (see above)

The transaction is recorded in the sales journal at selling price.

When merchandise is returned by a debtor:

Dr Sales returns (equity decreases)
Cr Debtor (the asset decreases)
and
Cr Trade receivables control

The transaction is recorded in the sales returns journal at selling price.

11
Merchandise returned, previously sold for cash:
The policy of the business will determine whether a credit note will be issued (refer to the
discussion of a perpetual inventory system) or whether the cash will be refunded to the
client.

The entry for a cash refund will be as follows:

Dr Sales returns (the equity decreases)
Cr Bank (the asset “bank” will decrease to cancel the previous increase)

The transaction is recorded in the cash payments journal.

When inventory is returned to a creditor:

Dr Creditor (the liability decreases)
and
Dr Trade payables control
Cr Purchase returns (the actual purchase is reduced)

The transaction is recorded in the purchases returns journal at cost price.

Physical inventory count at the end of the financial year:

Dr Inventory (an asset account that is created with the inventory on hand at
the end of the financial year)
Cr Trading account (a nominal account that is used to determine the gross profit and
that increases equity if a gross profit is made)

The transaction is recorded in the general journal.

From the above summary it is clear that, under a periodic inventory system, there is no cost
of sales account but a purchases account. Therefore, the column headings of subsidiary
journals have to be adapted to accommodate this inventory system. Some of the accounts
kept in the general ledger will also have to be changed if a periodic inventory system is in
use.
It is very important in assignments to make sure that you know which inventory system a
business uses since this will determine how the subsidiary journals and the general ledger
will be laid out.

GOLDEN RULES

• Periodic inventory system: Purchases and purchases returns accounts are kept.
These accounts are closed off (made NIL) to the trading account at the end of the
financial period.
• Periodic inventory system: NO cost of sales account is kept. The cost of sales is
determined by means of via entries in the trading account.
• Periodic inventory system: A physical inventory count is essential.

12
 EXERCISE 7.2

The following exercise illustrates a periodic inventory system:

R
Inventory on 1 January 20.1 10 000
Transactions for the year up to 31 December 20.1
Credit purchases 50 000
Cash purchases 40 000
Credit sales (mark-up on cost price is 25%) 75 000
Cash sales (mark-up on cost price is 25%) 25 000

Additional information

The closing inventory on 31 December 20.1 is determined as amounting to R20 000.

SOLUTION: EXERCISE 7.2

Accounting entries that have to be made

(1) The opening balance on the inventory account (asset) is held in the books
throughout the financial period, which is usually a year, without any other entries.
This amount is closed off to the trading account at the end of the financial year.
(2) Inventory purchased is recorded (debited) at cost price in the purchases account
(expenditure) and the contra account, for instance, “creditor/trade payables control”
or “bank” is credited. The purchases account is closed off to the trading account
by means of a general journal entry (debit trading account and credit purchases
account) at the end of the financial year.
(3) When goods are sold, the sales account (income) is credited with the selling price
and the contra account, say, “bank” or “debtor/trade receivables” is debited.
(4) A physical inventory count is undertaken to determine the closing inventory (usually
at cost price R20 000 in the exercise). To record this figure, the inventory account is
debited and the trading account is credited. At this point, you should have a look at
the trading account in the ledger. A cost of sales account is not kept in this system.
(5) Since the opening inventory is either sold or included in the closing inventory, it
must be “transferredˮ. The inventory account is therefore credited and the trading
account debited. This means that the opening inventory is added to purchases. The
closing inventory is deducted (the trading account is credited) and the cost of sales
is thus calculated.

13
 COMMENTS
Determining cost of sales and gross profit R
Opening inventory at cost price 10 000
Plus: Purchases at cost price 90 000
Inventory available for sale at cost price 100 000
Less: Closing inventory at cost price 20 000
Cost of sales 80 000
Gross profit 20 000*
Sales 100 000
* Balancing figure

• When the gross profit is determined, the required details are

transferred to the trading account, as follows:
• The inventory account is credited and the trading account is
debited with the opening inventory (transfer of opening
inventory).
• The purchases account is credited and the trading account is
debited (the purchases account is closed).
• The sales account is debited and the trading account is credited
(the sales account is closed).

The closing inventory is given (see accounting entry 4 above) and has already
been entered in the inventory account and the trading account.

GENERAL LEDGER
Dr Inventory Cr
20.1 R 20.1 R
Jan 1 Balance b/d 10 000 Dec 31 Trading account 10 000
10 000 10 000

20.1
Dec 31 Trading account 20 000

Dr Purchases Cr
20.1 R 20.1 R
Dec 31 Trade payables control 50 000 Dec 31 Trading account 90 000
Bank 40 000
90 000 90 000

14
Dr Sales Dr Dr
20.1 R 20.1 R
Dec 31 Trading account 100 000 Dec 31 Trade receivables
control 75 000
Bank 25 000
100 000 100 000

Dr Trading account Cr
20.1 R 20.1 R
Dec 31 Inventory (opening) 10 000 Dec 31 Sales 100 000
Purchases 90 000 Inventory (closing) 20 000
Profit or loss account
(gross profit)* 20 000
120 000 120 000

* Balancing figure

COMMENTS
• The gross profit calculated is the same for both systems (see *
above and in the previous example).
• The main differences between the two systems are as follows:
(1) In a perpetual inventory system, purchases are recorded at
cost price in the inventory account (asset), and a cost of sales
account is kept during the financial period.
(2) In a periodic inventory system, purchases are recorded in
the purchases account (expenditure), and the cost of sales is,
by implication, calculated in the trading account.

7.4.3 Additional purchase costs

Carriage on purchases and railage are examples of expenses that an entity may have to
pay in order to transport the inventory that has been purchased to the premises of the
entity. Custom and excise duties may also have to be incurred when inventory is imported.
When a perpetual (continuous) inventory system is used, carriage on purchases and the
like are debited directly to the inventory account since the cost of sales must be brought
into account with each sales transaction and carriage constitutes an integral part of the cost
per unit.
When a periodic inventory system is used, all purchases of inventory during a financial
year are debited to the purchases account. Consequently, this account will show the total of
all purchases at the end of the financial year. Carriage on purchases (paid for in cash, as

15
well as on credit) in an entity that uses this inventory system will be debited to the carriage
on purchases account. This account will show the total amount spent on transporting
inventory to the premises of the entity. When the cost of sales is calculated at the end of the
financial year, carriage on purchases must also be taken into account. Custom and excise
duties will be treated in a similar manner.
Below is an illustration of how accounts under the different inventory systems will be
affected when additional purchase costs are incurred.

Transaction Perpetual inventory system Periodic inventory system

Payment of delivery costs Dr Inventory Dr Carriage on purchases

on inventory purchased Cr Bank Cr Bank
or or
Cr Creditor (and trade Cr Creditor (and trade
payables control) if on payables control) if on
credit credit

Use the following information from the books of Gogo Dealers to calculate the cost of sales:

R
Inventory (1 January 20.1) 95 000
Purchases 260 000
Carriage on purchases 3 600

A physical inventory count on 31 December 20.1 indicated that inventory on hand

amounted to R80 000.

Solution:

R
Inventory (1 January 20.1) 95 000
Add: Purchases 260 000
Carriage on purchases 3 600
358 600
Less: Inventory (31 December 20.1) (80 000)
Cost of sales 278 600

16
7.4.4 Drawings and donations of inventory

Drawings and donations of inventory are recorded by means of the general journal at cost
price.

Please study the following table carefully:

Transaction Perpetual inventory system Periodic inventory system

Inventory taken by owner Dr Drawings Dr Drawings
for personal use Cr Inventory Cr Purchases

Donation of inventory Dr Donations Dr Donations

Cr Inventory Cr Purchases

Drawings and donations are not exempted from VAT. VAT is calculated on the cost price
and must be credited to the VAT output account.

7.5 CLOSING- OFF OF NOMINAL ACCOUNTS

We have worked through the accounting cycle up to the trial balance. This means that we
have tested the arithmetic of our accounts while bearing the shortcomings of a trial balance
in mind. As mentioned previously, the main purpose of an entity is to make a profit. To
determine the financial result of an entity, the nominal accounts are closed by means of
closing journals and transferred to the trading account (a nominal account), in the case of a
trading entity, and/or to the profit or loss account.

The gross profit, as determined, is debited to the trading account and credited to the profit
or loss account (a nominal account). All the other nominal accounts with credit balances,
such as rental income and discount received, are debited (closed off) and the profit or loss
account is credited.

Similarly, all expense accounts with debit balances, such as telephone expenses, rental
expenses and salaries, are credited (closed off) and the profit or loss account is debited.

The difference between the debit and credit sides of the profit or loss account results in the
profit or loss, which is transferred to the capital account. The profit or loss account is,
therefore, also closed off.

Remember that the trading account and the profit or loss account form part of the
accounting system.

The closing off of the nominal accounts at the end of the accounting period will be
explained by means of the information in the following trial balance:

17
TOEKELA DEALERS
PRE-CLOSING TRIAL BALANCE AS AT 31 JANUARY 20.1
Fol Dr Cr
R R
Capital B1 103 400
Drawings B2 3 000
Bank B3 4 250
Inventory -- 1 February 20.0 B4 5 000
Vehicles (at cost) B5 91 000
Equipment (at cost) B6 19 500
Trade receivables control B7 10 100
Trade payables control B8 14 700
Sales N1 77 500
Sales returns N2 1 500
Purchases N3 52 500
Purchases returns N4 2 500
Rental income N5 600
Stationery N6 150
Wages N7 10 550
Water and electricity N8 950
Credit losses (bad debts) N9 300
Settlement discount granted N10 150
Settlement discount received N11 250
198 950 198 950

Because of the presence of a purchases account, we know that a periodic inventory system
is in use.
On 31 January 20.1 a physical inventory count was done and the value of the inventory was
found to be R8 000 according to the inventory list. Keep in mind that this amount still has to
be recorded in the books.

GOLDEN RULES
All nominal accounts (i.e., income or revenue and expense accounts) MUST be closed off
(made NIL) to either the trading account or the profit or loss account at the end of the
financial period.

Only entities that trade (i.e., buy and sell merchandise) will have a trading account.

18
7.5.1 Trading account
As mentioned previously, the gross profit is calculated in the trading account. The details
required to do this calculation are as follows:
• opening inventory at cost price
• purchases at cost price
• closing inventory at cost price
• sales at selling price
• cost price of goods sold

In accounting terms, the calculation will take the following form:

Opening inventory + purchases (all at cost price) – closing inventory (at cost price) = cost
price of goods sold
Gross profit = sales – cost price of goods sold

Using the details from a previous exercise, we have the following:

R10 000 + R90 000 - R20 000 = R80 000 (cost price of sales)
Gross profit = R100 000 - R80 000
= R20 000

The cost price of goods sold is influenced by all the expenses incurred up to the point
where the goods are offered for sale. It includes costs such as carriage on purchases,
customs duty, dock dues and freight. Such costs increase the cost price of goods sold and
therefore reduce the gross profit.

Closing inventory

In practice it seldom happens that an entity sells all the available inventory, that is, opening
inventory and purchases and is left with no closing inventory. If this does happen, the
closing inventory is simply left out of the calculation. The closing inventory is actually
counted, a list is made of it and it is valued at cost price or market price, whichever is the
lowest. It is then recorded in the books by means of a general journal entry. Since the
closing inventory is an asset, the inventory account is debited.
The necessary details, such as opening inventory, purchases and sales, are transferred
from the nominal ledger accounts to the trading account by means of closing transfers in
the general journal.

The gross profit is obtained when the “balanceˮ on the trading account is determined. The
journal entries for the closing transfers are given after the following ledger accounts:

19
 TOEKELA DEALERS
GENERAL LEDGER
Dr Capital B1 Cr
20.1 R
Jan 31 Balance b/d 103 400

Dr Drawings B2 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 3 000 Jan 31 Capital GJ 3 000

Dr Bank B3 Cr
20.1 R
Jan 31 Balance b/d 4 250

Dr Inventory B4 Cr
20.1 R 20.1 R
Feb 1 Balance b/d 5 000 Jan 31 Trading account GJ 5 000
20.1
Jan 31 Trading account GJ 8 000

Dr Vehicles (at cost) B5 Cr

20.1 R
Jan 31 Balance b/d 91 000

Dr Equipment (at cost) B6 Cr

20.1 R
Jan 31 Balance b/d 19 500

Dr Trade receivables control B7 Cr

20.1 R
Jan 31 Balance b/d 10 100

20
Dr Trade payables control B8 Cr
20.1 R
Jan 31 Balance b/d 14 700

Dr Sales N1 Cr
20.1 R 20.1 R
Jan 31 Sales returns GJ 1 500 Jan 31 Balance b/d 77 500
Settlement
discount granted GJ 150
Trading account GJ 75 850
77 500 77 500

Dr Sales returns N2 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 1 500 Jan 31 Sales GJ 1 500

Dr Purchases N3 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 52 500 Jan 31 Purchases returns GJ 2 500
Settlement
discount received GJ 250
Trading account GJ 49 750
52 500 52 500

Dr Purchases returns N4 Cr
20.1 R 20.1 R
Jan 31 Purchases GJ 2 500 Jan 31 Balance b/d 2 500

Dr Rental income N5 Cr
20.1 R 20.1 R
Jan 31 Profit or loss account GJ 600 Jan 31 Balance b/d 600

Dr Stationery N6 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 150 Jan 31 Profit or loss account GJ 150

21
Dr Wages N7 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 10 550 Jan 31 Profit or loss account GJ 10 550

Dr Water and electricity N8 Cr

20.1 R 20.1 R
Jan 31 Balance b/d 950 Jan 31 Profit or loss account GJ 950

Dr Credit losses (bad debts) N9 Cr

20.1 R 20.1 R
Jan 31 Balance b/d 300 Jan 31 Profit or loss account GJ 300

Dr Settlement discount granted N10 Cr

20.1 R 20.1 R
Jan 31 Balance b/d 150 Jan 31 Sales GJ 150

Dr Settlement discount received N11 Cr

20.1 R 20.1 R
Jan 31 Purchases GJ 250 Jan 31 Balance b/d 250
250 250

Dr Trading account N12 Cr

20.1 R 20.1 R
Jan 31 Inventory (opening) GJ 5 000 Jan 31 Sales GJ 75 850
Purchases GJ 49 750 Inventory (closing) GJ 8 000
Profit or loss
(gross profit) GJ 29 100
83 850 83 850

22
COMMENTS
CLOSING TRANSFER OF SETTLEMENT DISCOUNT, WHICH IS DONE IN THE
GENERAL JOURNAL

(1) Settlement discount granted transferred to sales

To transfer settlement discount granted to the sales account, the sales account is
debited and the settlement discount granted account is credited (thus the account
is closed).

20.1 R R
Jan 31 Sales 150
Settlement discount granted 150
Closing transfer of settlement discount granted

(2) Settlement discount received transferred to purchases

To transfer settlement discount received to the purchases account, the settlement
discount received account is debited (thus the account is closed) and the
purchases account is credited.

20.1 R R
Jan 31 Settlement discount received 250
Purchases 250
Closing transfer of settlement discount received

CLOSING TRANSFER TO THE TRADING ACCOUNT, WHICH IS DONE IN THE

GENERAL JOURNAL

(1) To transfer the opening inventory to the trading account, the inventory
account is credited (the account is closed) and the trading account is
debited by means of a closing transfer in the general journal.

20.1 R R
Jan 31 Trading account N12 5 000
Inventory B4 5 000
Closing transfer of opening inventory

23
(2) To transfer purchases to the trading account, the purchases account is
credited (the account is closed) and the trading account is debited.

20.1 R R
Jan 31 Trading account N12 49 750
Purchases N3 49 750
Closing transfer of purchases account

(3) To transfer sales returns to the sales account, the sales returns account is
credited (the account is closed) and the sales account is debited.

20.1 R R
Jan 31 Sales N12 1 500
Sales returns N2 1 500
Closing transfer of sales returns

(4) To transfer sales to the trading account, the sales account is debited (the
account is closed) and the trading account is credited.

20.1 R R
Jan 31 Sales N1 78 850
Trading account N12 78 850
Closing transfer of sales account

(5) To transfer purchases returns to the purchases account, the purchases

returns account is debited (the account is closed) and the purchases
account is credited.

20.1 R R
Jan 31 Purchase returns N4 2 500
Purchases N12 2 500
Closing transfer of purchases returns

(6) To record the closing inventory, which is an asset, in the books, the
inventory account is debited and the trading account is credited.

20.1 R R
Jan 31 Inventory B4 8 000
Trading account N12 8 000
To record the closing inventory in the
books

24
 (7) The trading account is now balanced. The result (balance) is the gross
profit, namely, R29 100, which is transferred by means of a closing
transfer to the profit or loss account, where the profit is determined.

20.1 R R
Jan 31 Trading account N12 29 100
Profit or loss account N13 29 100
Closing transfer of gross profit to profit
or loss account

(8) Instead of recording all the separate closing transfers, a combined entry
with the same effect can be made in the general journal.

General journal GJ1

20.1 R R
Jan 31 Sales N1 75 850
Inventory (closing) N4 8 000
Inventory (opening) N4 5 000
Purchases N3 49 750
Trading account N12 29 100*
Closing off and transfer of above
accounts to trading account.

* Balancing figure between debits and credits

The amount of R29 100, in itself, is NOT credited to the trading account. Each
entry is shown separately in the trading account (being contra entries), which will,
in effect, credit the trading account with the R29 100.

GOLDEN RULE
The trading account, being also a nominal account, is closed off to the profit or loss account.
(See the schematic representation.)

7.5.2 Profit or loss account

As mentioned previously, profit is calculated in the profit or loss account.

The details required to do this calculation are as follows:

• the gross profit
• all business expenditure
• all business income

25
Dr Profit or loss account N13 Cr
20.1 R 20.1 R
Jan 31 Stationery GJ 150 Jan 31 Trading account (gross
Wages GJ 10 550 profit) GJ 29 100
Water and electricity GJ 950 Rental income GJ 600
Credit losses GJ 300
Capital (total comprehensive
income for the year) GJ 17 750
29 700 29 700

COMMENTS
Closing journal entries

(1) The gross profit has already been transferred.

(2) To transfer the expenditure accounts to the profit or loss account,
the expenditure accounts, such as stationery, wages, and water and
electricity, are credited (the accounts are closed) while the profit or
loss account is debited with each account individually. This is done
so that the expenditure on each item can readily be identified.

TOEKELA DEALERS
CLOSING TRANSFERS OF EXPENDITURE GJ
20.1 R R
Jan 31 Profit or loss account N13 150
Stationery N6 150
Closing transfer

Profit or loss account N13 10 550

Wages N7 10 550
Closing transfer
N13 950
Profit or loss account
Water and electricity N8 950
Closing transfer
N13 300
Profit or loss account
Credit losses (bad debts) N9 300
Closing transfer

26
(3) To transfer the income accounts to the profit or loss account, the income accounts,
such as rental income and commission received, are debited (the accounts are
closed) and the profit or loss account is credited.

CLOSING TRANSFERS OF INCOME GJ

20.1 R R
Jan 31 Rental income N5 600
Profit or loss account N13 600
Closing transfer

(4) Instead of recording all the individual closing transfers, a combined entry can be
made, for instance:

TOEKELA DEALERS
GENERAL JOURNAL GJ
20.1 R R
Jan 31 Rental income N5 600
Profit or loss account N13 11 350*
Stationery N6 150
Wages N7 10 550
Water and electricity N8 950
Credit losses (Bad debts) N9 300
Closing off the above accounts against the profit
and loss account

* Balancing figure between debits and credits. Remember that the amounts in the nominal accounts are
shown separately in the profit or loss account, which means that the amount of R11 350, in itself, is not
posted to the account.

(5) The profit or loss is the result (“balanceˮ) of the profit or loss account.

(6) To transfer the profit due to the owner to the capital account, the profit or loss
account is debited (the account is closed) and the capital account is credited (equity
increases).

GOLDEN RULE
The profit or loss account, also being a nominal account, is closed off to the capital
account. The profit or loss must be disclosed in the statement of changes in equity. (See
the schematic representation.)

27
CLOSING TRANSFER OF PROFIT FOR THE YEAR/PERIOD GJ
20.1 R R
Jan 31 Profit or loss account N13 17 750
Capital B1 17 750
To transfer profit to capital

(7) If the entity suffers a loss, the profit or loss account is credited and the capital
account is debited (equity decreases).

(8) At the same time, the owner owes the amount in the drawings account to the entity.
To bring this debt into account, the drawings account is closed against the capital
account by crediting drawings and debiting the capital account (equity decreases).

TOEKELA DEALERS
GENERAL JOURNAL GJ
20.1 R R
Jan 31 Capital B1 3 000
Drawings B2 3 000
To close drawings

(9) The complete capital account will then look like this:

Dr Capital B1 Cr
20.1 R 20.1 R
Jan 31 Drawings GJ 3 000 Jan 31 Balance b/d 103 400
Balance b/d 118 150 Profit or loss account GJ 17 750
121 150 121 150
20.1
Feb 1 Balance b/d 118 150

(10) Post-closing trial balance

At this stage, a post-closing trial balance can be prepared. This trial balance will
contain the balances of all those accounts whose balances are to be carried
forward to the following financial period. These balances will be used to prepare the
statement of financial position.
In the above example, this trial balance is as follows (note that there are no
balances for the nominal accounts or no balance for the drawings account anymore
since the nominal accounts have been closed off/the drawings account has been
closed off):

28
TOEKELA DEALERS
POST-CLOSING TRIAL BALANCE AS AT 31 JANUARY 20.1

Fol Dr Cr
R R
Capital B1 118 150
Bank B3 4 250
Inventory B4 8 000
Vehicles (at cost) B5 91 000
Equipment (at cost) B6 19 500
Trade receivables control B7 10 100
Trade payables control B8 14 700
132 850 132 850

GOLDEN RULE
The post-closing trial balance contains only the balances of statement of financial position
accounts - no nominal accounts.

7.6 PREPARATION OF FINANCIAL STATEMENTS

The financial statements of an entity do not form part of the ledger accounts of the entity but
are prepared from the information in the accounts and the balances of the accounts. The
statements are prepared separately from the accounting records.

7.6.1 The statement of profit or loss and other comprehensive income

(financial performance)
The information in the trading and profit or loss accounts is communicated to interested
parties by means of the statement of profit or loss and other comprehensive income.

29
TOEKELA DEALERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 JANUARY 20.1
Notes R
Revenue 2 75 850
Cost of sales (46 750)
Opening inventory 5 000
Net purchases 49 750
54 750
Less: Closing inventory (8 000)

Gross profit 29 100

Other income 600
Rental income 600
29 700
Distribution, administrative and other expenses (11 950)
Stationery 150
Wages 10 550
Water and electricity 950
Credit losses (bad debts) 300

Profit for the year 17 750

Other comprehensive income for the year -
Total comprehensive income for the year 17 750

GOLDEN RULE

The statement of profit or loss and other comprehensive income is prepared from the
information in the trading account and the profit or loss account. (See the schematic
representation.)

7.6.2 The statement of changes in equity

The statement of changes in equity is discussed in section 4.15.2 - please study this
section again. This statement is prepared from the information in the capital account.

30
TOEKELA DEALERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 JANUARY 20.1

Capital
R
Balance at 1 February 20.0 103 400
Total comprehensive income for the year 17 750
Drawings (3 000)
Balance at 31 January 20.1 118 150

GOLDEN RULE

The statement of changes in equity is prepared from the information in the capital account.
(See schematic representation.)

7.6.3 The statement of financial position

The statement of financial position is compiled from those accounts that are not closed in
the process of determining the profit/loss of the entity. These accounts are either assets,
liabilities or equity accounts (the balances of these accounts appearing in the post-closing
trial balance). All the nominal accounts (expenditure and income) are closed. In the
statement of financial position, a summary is made of all the entity's assets and liabilities
based on the accounting equation, A = E + L.

The statement of financial position shows the entity's financial position on a specific
date, whereas the profit or loss account or the statement of profit or loss and other
comprehensive income shows the financial result over a financial period. The change in
equity from one financial period to the following financial period is reflected in the
statement of changes in equity.

31
TOEKELA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20.1
ASSETS Notes R
Non-current assets 110 500
Property, plant and equipment 3 110 500
Current assets 22 350
Inventories 8 000
Trade and other receivables 10 100
Cash and cash equivalents 4 250

Total assets 132 850

EQUITY AND LIABILITIES

Total equity 118 150
Capital 118 150
Current liabilities 14 700
Trade and other payables 14 700

Total equity and liabilities 132 850

COMMENTS
• When the totals of the different assets are calculated and added
together, the result is equal to
▪ the equity, plus
▪ the totals of the different liabilities that are calculated and added
together (in the example there is only one short-term liability,
namely, trade payables)
• Remember that the balances in the statement of financial position are
the opening balances of the ledger accounts for the next financial
period.
• There are usually more items under trade and other receivables and
trade and other payables than merely debtors and creditors. These
items will be listed under trade and other receivables and trade and
other payables and will be added to give the total for trade and other
receivables and trade and other payables.

32
 GOLDEN RULE
The statement of financial position is prepared from the balances in the post-closing trial
balance after the note on property, plant and equipment has been prepared.

7.6.4 Notes to the financial statements

(1) Accounting policy: The annual financial statements have been prepared on the
historical cost basis and comply with International Financial Reporting Standards.
(2) Income represents net sales to third parties.
(3)
Property, plant and equipment Equipment Vehicles Total

R R R
Carrying amount:
Beginning of year 19 500 91 000 110 500
Cost 19 500 91 000 110 500
Accumulated
depreciation (---) (---) (---)
Depreciation (---) (---) (---)
Carrying amount:
End of year 19 500 91 000 110 500
Cost 19 500 91 000 110 500
Accumulated
depreciation (---) (---) (---)

No depreciation was written off during the financial year.

GOLDEN RULE
The note on property, plant and equipment reflects all changes in all non-current assets
and the associated accumulated depreciation accounts.

GOLDEN RULE
The total of the “carrying amount: end of yearˮ must be the same as the amount
disclosed as “property, plant and equipmentˮ under "non-current assetsˮ in the statement
of financial position.

33
7.7 GROSS PROFIT PERCENTAGE
An entity calculates its gross profit separately because it gives an indication of its
performance in its major activity, namely, selling goods at a profit, apart from all the other
activities in which it engages to support this primary activity.

COMMENT
The gross profit is normally expressed as a percentage of either the
selling price or the cost price of goods sold.
Gross profit 100 29 000 100
Selling price x 1 = 76 000 x 1

= 38,2%

Gross profit 100 29 000 100

Cost of sales x 1 = 47 000 x 1

= 61,7%

Entities usually have a price policy that sets a certain gross profit percentage as an
objective. The selling price is determined by adding this profit percentage to the cost price
of merchandise. At the end of a financial period, an entity’s management can compare the
actual result (gross profit percentage) with the theoretical percentage (i.e., the profit-taking
policy), or compare the result with the results of other years or with those of other entities in
the industry.

7.8 INTEGRATED EXAMPLE

The following information pertains to Hot-Rod Dealers:

34
(1)
HOT-ROD DEALERS
PRE-ADJUSTMENT TRIAL BALANCE AS AT 31 DECEMBER 20.4
Fol Debit Credit
R R
Capital……………………………………………………………. B1 250 000
Drawings…………………………………………………………. B2 4 400
Land (at cost)……………………………………………………. B3 100 000
Buildings (at cost)……………………………………………….. B4 80 000
Vehicles (at cost)………………………………………………... B5 120 000
Furniture (at cost)……………………………………………….. B6 15 000
Inventory: trading (1 January 20.4).…………………………… B7 4 000
Trade receivables control………………………………………. B8 40 140
Bank………………………………………………………………. B9 5 900
Accumulated depreciation: vehicles…………………………... B10 26 000
Accumulated depreciation: furniture…………………………... B11 3 000
Trade payables control…………………………………………. B12 50 750
Sales……………………………………………………………… N1 253 615
Sales returns…………………………………………………….. N2 615
Carriage on sales……………………………………………….. N3 670
Commission income…………………………………………….. N4 480
Rental income……………………………………………........... N5 2 860
Purchases………………………………………………………... N6 170 550
Purchases returns………………………………………………. N7 550
Carriage on purchases…………………………………………. N8 400
Credit losses (bad debts)………………………………………. N9 230
Insurance………………………………………………………… N10 2 750
Packaging material………………………………………........... N11 800
Salaries…………………………………………………….......... N12 38 500
Water and electricity……………………………………………. N13 3 300
587 255 587 255

(2) Additional information

(a) Inventory on 31 December 20.4 R

Trading inventory 6 500
Packing material 175
(b) Debtor, S Sorry, is insolvent; his debt of R140 has to be written off as irrecoverable.
(c) An employee is on leave and his January 20.5 salary of R1 500 has been paid to
him in advance.
(d) Delivery fees of R100 on purchases have not been paid yet.
(e) An insurance premium of R250 per month has been paid until the end of
March 20.5.
(f) Rent income has been paid until the end of January 20.5.
(g) Commission in the amount of R880 was earned on 28 December 20.4; the amount
is still outstanding.

35
(h) Provision must be made for depreciation as follows:
Vehicles – R15 750
Furniture – R1 275

REQUIRED
(1) Open the accounts of Hot-Rod Dealers in the general ledger with the
given balances.
(2) Record the adjustments in the general journal and post to the
ledger accounts.
(3) Record the closing journal entries. Post to the ledger and show the
trading account and the profit or loss account for the year ended
31 December 20.4.
(4) Prepare a post-closing trial balance as at 31 December 20.4.
(5) Prepare the statement of profit or loss and other comprehensive
income of Hot-Rod Dealers for the year ended 31 December 20.4.
(6) Prepare the statement of changes in equity for the year ended
31 December 20.4.
(7) Prepare the statement of financial position of Hot-Rod Dealers as
at 31 December 20.4.
(8) Prepare the following notes to the financial statements:
(a) Accounting policy
(b) Property, plant and equipment

SOLUTION: INTEGRATED EXAMPLE

Please note: Only one set of general ledger accounts is used. The journal entries after
the accounts must be posted to the same set of accounts.

HOT-ROD DEALERS
GENERAL LEDGER (POSTINGS INCLUDED)
Dr Capital B1 Cr
20.4 R 20.4 R
Dec 31 Drawings GJ 4 400 Dec 31 Balance b/d 250 000
Balance c/d 273 610 Profit or loss account GJ 28 010
278 010 278 010
20.5
Jan 1 Balance b/d 273 610

36
Dr Drawings B2 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 4 400 Dec 31 Capital GJ2 4 400

Dr Land (at cost) B3 Cr

20.4 R
Dec 31 Balance b/d 100 000

Dr Buildings (at cost) B4 Cr

20.4 R
Dec 31 Balance b/d 80 000

Dr Vehicles (at cost) B5 Cr

20.4 R
Dec 31 Balance b/d 120 000

Dr Furniture (at cost) B6 Cr

20.4 R
Dec 31 Balance b/d 15 000

Dr Inventory B7 Cr
20.4 R 20.4 R
Jan 1 Balance b/d 4 000 Dec 31 Trading account GJ 4 000
Trading account GJ 6 500

Dr Trade receivables control B8 Cr

20.4 R 20.4 R
Dec 31 Balance b/d 40 140 Dec 31 Credit losses GJ 140
Balance c/d 40 000
40 140 40 140
20.5
Jan 1 Balance b/d 40 000

37
Dr Bank B9 Cr
20.4 R
Dec 31 Balance b/d 5 900

Dr Accumulated depreciation: vehicles B10 Cr

20.4 R
Dec 31 Balance b/d 26 000
Depreciation GJ 15 750
41 750

Dr Accumulated depreciation: furniture B11 Cr

20.4 R
Dec 31 Balance b/d 3 000
Depreciation GJ 1 275
4 275

Dr Trade payables control B12 Cr

20.4 R
Dec 31 Balance b/d 50 750

Dr Consumable inventory on hand: packing material B13 Cr

20.4 R
Dec 31 Packing material GJ 175

Dr Prepaid expenses B14 Cr

20.4 R
Dec 31 Salaries GJ 1 500
Insurance GJ 750
2 250

Dr Accrued income B15 Cr

20.4 R
Dec 31 Commission income GJ 880

38
Dr Income received in advance B16 Cr
20.4 R
Dec 31 Rental income GJ 220

Dr Accrued expenses B17 Cr

20.4 R
Dec 31 Carriage on purchases GJ 100

Dr Sales N1 Cr
20.4 R 20.4 R
Dec 31 Sales returns GJ 615 Dec 31 Balance b/d 253 615
Trading account GJ 253 000
253 615 253 615

Dr Sales returns N2 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 615 Dec 31 Sales GJ 615

Dr Carriage on sales N3 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 670 Dec 31 Profit or loss account GJ 670

Dr Commission income N4 Cr
20.4 R 20.4 R
Dec 31 Profit or loss account GJ 1 360 Dec 31 Balance b/d 480
Accrued income GJ 880
1 360 1 360

Dr Rental income N5 Cr
20.4 R 20.4 R
Dec 31 Income received in Dec 31 Balance b/d 2 860
advance GJ1 220
Profit or loss account GJ2 2 640
2 860 2 860

39
Dr Purchases N6 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 170 550 Dec 31 Purchases returns GJ 550
Trading account GJ 170 000
170 550 170 550

Dr Purchases returns N7 Cr
20.4 R 20.4 R
Dec 31 Purchases GJ 550 Dec 31 Balance b/d 550

Dr Carriage on purchases N8 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 400 Dec 31 Trading account GJ 500
Accrued expenses GJ 100
500 500

Dr Credit losses N9 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 230 Dec 31 Profit or loss account GJ 370
Trade receivables
control GJ 140
370 370

Dr Insurance N10 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 2 750 Dec 31 Prepaid expenses GJ 750
Profit or loss account GJ 2 000
2 750 2 750

Dr Packing material N11 Cr

20.4 R 20.4 R
Dec 31 Balance b/d 800 Dec 31 Consumable inventory
on hand: packing
material GJ 175
Profit or loss account GJ 625
800 800

40
Dr Salaries N12 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 38 500 Dec 31 Prepaid expenses GJ 1 500
Profit or loss account GJ 37 000
38 500 38 500

Dr Water and electricity N13 Cr

20.4 R 20.4 R
Dec 31 Balance b/d 3 300 Dec 31 Profit or loss account GJ 3 300

Dr Depreciation N14 Cr
20.4 R 20.4 R
Dec 31 Accumulated Dec 31 Profit or loss account GJ2 17 025
depreciation: vehicles GJ 15 750
Accumulated
depreciation: furniture GJ 1 275
17 250 17 025

(2)
HOT-ROD DEALERS
GENERAL JOURNAL: ADJUSTMENT ENTRIES - 31 DECEMBER 20.4 GJ
Debit Credit
R R
Consumable inventory on hand: packing material B13 175
Packing material N11 175
Packing material on hand at 31 December 20.4

Credit losses N9 140

Trade receivables control B8 140
Write S Sorry’s debt off as irrecoverable

Prepaid expenses B14 1 500

Salaries N12 1 500
Salaries prepaid

Carriage on purchases N8 100

Accrued expenses B17 100
Carriage on purchases still payable

Prepaid expenses B14 750

Insurance N10 750
Insurance prepaid for 3 months

41
 Debit Credit
R R
Rental income N5 220
Income received in advance B16 220
Rent received in advance for January 20.5
Accrued income B15 880
Commission income N4 880
Commission earned not yet received

Depreciation N14 17 025

Accumulated depreciation: vehicles B10 15 750
Accumulated depreciation: furniture B11 1 275
Provision for depreciation

(3)
HOT-ROD DEALERS
GENERAL JOURNAL: CLOSING ENTRIES - 31 DECEMBER 20.4 GJ
Debit Credit
R R
Purchases returns N7 550
Purchases N6 550
Closing transfer of purchases returns

Sales N1 615
Sales returns N2 615
Closing transfer of sales returns

Inventory (closing) B7 6 500

Sales N1 253 000
Trading account N15 259 500
Closing off and transfer of accounts to trading account

Trading account N15 174 500

Inventory (opening) B7 4 000
Purchases N6 170 000
Carriage on purchases N8 500
Closing off and transfer of accounts to trading account

Trading account N15 85 000

Profit or loss account N16 85 000
Transfer of gross profit

Commission income N4 1 360

Rental income N5 2 640
Profit or loss account N16 4 000
Closing off of accounts against profit or loss account

42
 Debit Credit
R R
Profit or loss account N16 60 990
Salaries N12 37 000
Water and electrisity N13 3 300
Carriage on sales N3 670
Insurance N10 2 000
Packing material N11 625
Credit losses N9 370
Depreciation N14 17 025
Closing off of accounts against profit or loss account

Profit or loss account N16 28 010

Capital B1 28 010
Transfer of profit to capital

Capital B1 4 400
Drawings B2 4 400
Close off drawings against capital

HOT-ROD DEALERS
GENERAL LEDGER
Dr Trading account N15 Cr
20.4 R 20.4 R
Dec 31 Inventory (opening) GJ 4 000 Dec 31 Sales GJ 253 000
Purchases GJ 170 000 Inventory (closing) GJ 6 500
Carriage on purchases GJ 500
Profit or loss account
(gross profit) GJ 85 000
259 500 259 500

Dr Profit or loss account N16 Cr

20.4 R 20.4 R
Dec 31 Salaries GJ 37 000 Dec 31 Trading account (gross
Water and electricity GJ 3 300 profit) GJ 85 000
Carriage on sales GJ 670 Commission income GJ 1 360
Insurance GJ 2 000 Rental income GJ 2 640
Packing material GJ 625
Credit losses GJ 370
Depreciation GJ 17 025
Capital (total comprehen
sive income for the year) GJ 28 010
89 000 89 000

43
(4)
HOT-ROD DEALERS
POST-CLOSING TRIAL BALANCE AS AT 31 DECEMBER 20.4
Fol Debit Credit
R R
Capital B1 273 610
Land (at cost) B3 100 000
Buildings (at cost) B4 80 000
Vehicles (at cost) B5 120 000
Furniture (at cost) B6 15 000
Inventory B7 6 500
Consumable inventory on hand: packing material B13 175
Trade receivables control B8 40 000
Bank B9 5 900
Accumulated depreciation: vehicles B10 41 750
Accumulated depreciation: furniture B11 4 275
Trade payables control B12 50 750
Prepaid expenses B14 2 250
Accrued income B15 880
Income received in advance B16 220
Accrued expenses B17 100
370 705 370 705

44
(5)
HOT-ROD DEALERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR
ENDED 31 DECEMBER 20.4
R
Revenue 253 000
Cost of sales (168 000)
Inventory (1 January 20.4) 4 000
Net purchases 170 000
Carriage on purchases 500
174 500
Less: Inventory (31 December 20.4) (6 500)

Gross profit 85 000

Other income 4 000
Rental income 2 640
Commission income 1 360

89 000
Distribution, administrative and other expenses (60 990)
Salaries 37 000
Water and electricity 3 300
Carriage on sales 670
Insurance 2 000
Packing material 625
Credit losses 370
Depreciation R(15 750 + 1 275) 17 025

Profit for the year 28 010

Other comprehensive income for the year -
Total comprehensive income for the year 28 010

COMMENTS
• Revenue is sales less sales returns: R(253 615 – 615) = R253 000.
• Net purchases are purchases less purchases returns: R(170 550 – 550) =
R170 000.

(6)
HOT-ROD DEALERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.4
Capital
R
Balance at 1 January 20.4 250 000
Total comprehensive income for the year 28 010
Less: Drawings (4 400)
Balance at 31 December 20.4 273 610

45
(7)
HOT-ROD DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.4
Notes R
ASSETS
Non-current assets 268 975
Property, plant and equipment 2 268 975
Current assets 55 705
Inventories R(6 500 + 175) 6 675
Trade and other receivables R(40 000 + 880)* 40 880
Prepayments 2 250
Cash and cash equivalents 5 900

Total assets 324 680

EQUITY AND LIABILITIES
Total equity 273 610
Capital 273 610
Current liabilities 51 070
Trade and other payables R(50 750 + 100)# 50 850
Income received in advance 220

Total equity and liabilities 324 680

*Trade receivables R40 000 + accrued income R880 = R40 880.

# Trade payables R50 750 + accrued expenses R100 = R50 850.

(8)
HOT-ROD DEALERS
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.4
1 Accounting policy:

1.1 The annual financial statements have been prepared on the historical cost
basis and comply with International Financial Reporting Standards appropriate
to the business of the entity.
1.2 Property, plant and equipment are shown at cost less accumulated
depreciation.
Land and buildings are classified as investment properties and are not
depreciated.

46
2
Property, plant and equipment
Land Buildings Vehicles Furniture Total
R R R R R
Carrying amount:
Beginning of year 100 000 80 000 94 000 12 000 286 000
Cost price 100 000 80 000 120 000 15 000 315 000
Accumulated depreciation (-) (-) (26 000) (3 000) (29 000)
Depreciation (-) (-) (15 750) (1 275) (17 025)
Carrying amount:
End of year 100 000 80 000 *78 250 *10 725 268 975
Cost price 100 000 80 000 120 000 15 000 315 000
Accumulated depreciation (-) (-) (41 750) (4 275) (46 025)

* Cost price – accumulated depreciation = carrying amount

R268 975 is the total carrying amount that should be disclosed in the statement of financial position as the amount for property, plant and
equipment.

7.9 REVISION EXERCISES AND SOLUTIONS

7.9.1 REVISION EXERCISE 1

Please attempt 7.9.1_REVISION EXERCISE 1 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.2 REVISION EXERCISE 2

Please attempt 7.9.2_REVISION EXERCISE 2 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.3 REVISION EXERCISE 3

Please attempt 7.9.3_REVISION EXERCISE 3 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.4 REVISION EXERCISE 4

Please attempt 7.9.4_REVISION EXERCISE 4 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.5 REVISION EXERCISE 5

Please attempt 7.9.5_REVISION EXERCISE 5 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.6 REVISION EXERCISE 6

Please attempt 7.9.6_REVISION EXERCISE 6 under the heading “CONTENT”. The answer
will be provided at a later stage.

47
7.9.7 REVISION EXERCISE 7

Please attempt 7.9.7_REVISION EXERCISE 7 under the heading “CONTENT”. The answer
will be provided at a later stage.

7.9.8 REVISION EXERCISE 8

Please attempt 7.9.8_REVISION EXERCISE 8 under the heading “CONTENT”. The answer
will be provided at a later stage.

SELF-ASSESSMENT
Now that you have studied this study unit, can you, with respect to an entity,

• calculate the gross profit of the entity?

• calculate the net profit of the entity?
• record transactions under a perpetual inventory system?
• record transactions under a periodic inventory system?
• post closing journal entries to the trading account and the profit or
loss account?
• prepare the statement of profit or loss and other comprehensive
income?
• prepare the statement of changes in equity?
• prepare the statement of financial position?
• prepare the notes to the financial statements?
• calculate appropriate percentages for evaluation puposes?

48
 FAC3704
FAC1502

STUDY UNIT 8

CASH AND CASH

EQUIVALENTS

Financial Accounting 1:

Financial Accounting
Concepts, Principles and
Procedures
TOPIC C
ACCOUNTABILITY FOR CURRENT AND NON-CURRENT
ASSETS

Learning outcome

You should be able to exercise control, t o record transactions, and to record the
necessary calculations for valuation (where applicable) and adjustments relating to current
and non-current assets.

CONTENTS

Study units
8 CASH AND CASH EQUIVALENTS
9 TRADE AND OTHER RECEIVABLES
10 INVENTORY
11 PROPERTY, PLANT AND EQUIPMENT
12 OTHER NON-CURRENT ASSETS

2
STUDY UNIT

8
Cash and cash equivalents

Learning outcome

You should know how to treat all transactions related to cash and cash equivalents
apart from cash receipts and payments.

Contents
Key concepts 4
8.1 The nature of cash and cash equivalents 4
8.2 Internal control over cash 5
8.3 Reconciliation of the bank statement balance with the bank account balance 5
8.3.1 Introduction 5
8.3.2 Why a bank reconciliation is necessary 6
8.3.3 Procedure to follow in the reconciliation process 7
8.3.4 VAT claimed on service fees 8
8.4 The petty cash journal 17
8.5 Revision exercises and solutions 20
8.5.1 Revision exercise 1 20
8.5.2 Revision exercise 2 25
8.5.3 Revision exercise 3 27
8.5.4 Revision exercise 4 27
8.5.5 Revision exercise 5 27
Self-assessment 27

3
KEY CONCEPTS

• Outstanding cheque
• Deposit
• Bank charges
• Interest on overdraft
• Direct deposit
• Dishonoured cheque
• Stale cheque
• Stopped/cancelled cheque
• Bank reconciliation statement
• Balance per bank account
• Balance per bank statement
• Petty cash float
• Imprest system
• Petty cash journal
• Electronic Funds Transfer (EFT)

8.1 THE NATURE OF CASH AND CASH EQUIVALENTS

Cash, in the accountancy environment, includes not only coins and notes but also postal
orders (no longer in use), cheques (most of the commercial banks have informed their
clients that they no longer accept cheques as a legal payment method) and credit cards.
We live in a digital era where cashless transactions are now the legal way of paying for
goods and services. People can, for example, scan barcodes with their smartphones to pay
at business establishments such as restaurants and retail stores, using apps like Zapper
and SnapScan (or SmartPay). Persons who do not have a bank account can be paid by
eWallet (some call it CashPay), as long as they have a valid South African cellphone
number. Electronic Funds Transfers (EFTs) replaced cheques as the most convenient way
of paying for goods and services. Cash equivalents include savings accounts or any
investment that can be converted into cash in a period shorter than 12 months. Cash and
cash equivalents qualify as current assets.

GOLDEN RULE
Cash must be handled carefully since a lack of cash may lead to the “downfall” of an
entity, accompanied by a loss of job opportunities and various other troubles.

4
8.2 INTERNAL CONTROL OVER CASH
Since money is necessary for survival, the internal controls applicable to cash are very
important in a business. The following are measures that a business can implement for
control purposes:

• Employees' duties should be divided in such a way that an error by one employee
will be detected by another employee in the normal performance of his/her duties.
It should take at least two employees to embezzle cash. A payment request must
be completed for each payment. A payment request must be signed off by at least
two different employees (the person making the payment will be one of the
employee’s signing off the payment after the payment has been made). If a
payment is for an amount bigger than, say, R10 000, then at least three different
people, of which one is a senior employee, must sign off the payment request. All
the necessary proof such as original invoices, as well as proof that the payment
has been made, must be attached to the payment request.
• Cash receipts should be recorded in such a way that the actual cash received can
be checked against an independent daily record. The cash receipts journal will
then be done daily from the bank statement since a lot of transactions will be direct
payments (EFTs) into the bank account of the entity.
• Cash received should be banked daily.
• All payments except petty cash payments (refer to section 8.4) should be made by
EFT.
• The bank statement should be compared with the cash receipts and cash
payments journals.
• The bank statement balance should be reconciled with the bank account balance.

8.3 RECONCILIATION OF THE BANK STATEMENT BALANCE WITH

THE BANK ACCOUNT BALANCE
8.3.1 Introduction
For purposes of safekeeping and cash control, all monies received by an entity are
deposited at a bank. Although a bank is a financial institution, it is managed like a
business. Every entity that entrusts its money to a bank is a creditor of the bank. People or
entities can also borrow money from a bank and are then debtors of the bank.

Banks issue, as often as requested or at least once a month, statements to entities that
show their record of transactions with the entities. In the case of internet banking, a
business can request an online bank statement daily to be able to do all the entries
regarding direct payments into the bank account of the business daily.

The following will be reflected on the bank statement of an entity:

• the opening balance (beginning of the month)

• deposits credited during the month
• cheques paid (debited) during the month
• bank charges for the month

5
• interest charged (debit) on overdraft or paid on a favourable (credit) bank balance
• debit and stop orders for the month
• direct payments by debtors into the bank account of the entity
• dishonoured cheques for the month (cheques deposited but not paid by the
drawers' banks)
• correction of errors made by the bank in the previous month
(For now, we will keep the information about cheques should you still get some cheque
transactions. We will do one example with cheques; the rest of the exercises are without
cheques.)

8.3.2 Why a bank reconciliation is necessary

If a bank and an entity keep record of the same transactions the balance of the bank
statement and the bank account in the books of the business must be the same.
In order to ascertain if the bank account in the books of the entity corresponds to the bank
statement, a bank reconciliation statement is prepared. This means the balance of the
bank account in the books of the entity is reconciled with the balance on its bank
statement.

The reconciliation process involves two steps:

• First, the entity's records are updated to account for actual transactions
reflected in the bank statement.
• Secondly, those transactions that the bank must still attend to are recorded in
the bank reconciliation statement.

The bank reconciliation could be seen as an extension of the bank statement. An

outstanding item that will be credited on the bank statement must be credited on the bank
reconciliation statement and vice versa.

REMEMBER
• A favourable bank account balance is on the debit side of the bank account, as
well as on the bank reconciliation statement.
• An unfavourable or overdrawn bank account balance is on the credit side of the
bank account, as well as on the bank reconciliation statement.
• A favourable bank statement balance is on the credit side of the bank
statement, as well as on the bank reconciliation statement.
• An unfavourable or overdrawn bank statement balance (indicated by DT, DR or
OD) is on the debit side of the bank statement, as well as on the bank
reconciliation statement.
• An EFT cannot be reversed. The business can contact the bank and the bank can
try to contact the person to whom the payment was made to ask him/her to pay
back the money. However, banks do not want to get involved in these types of
disputes. To prevent payments from being made into the wrong accounts, a small
amount is deposited into the bank account of a creditor when the profile of the
creditor is created on internet banking. When the business receives confirmation

6
 that the amount has been received by the creditor, a large amount can be paid
over. If a wrong payment was made to a creditor of the business the creditor can
be contacted directly by the business with the request to pay back the money. It is
usually a long process; the business needs a confirmation letter from the bank
(bearing the official stamp of the bank) as proof of the bank account details of the
business, as well as proof of the payment made, before the amount will be paid
back.
• Credit card and debit card transactions will be deposited automatically during the
day - credit cards as credit card deposits and debit cards as debit card deposits.

8.3.3 Procedure to follow in the reconciliation process

• Where a bank reconciliation statement was completed for the previous
month, the bank statement must first be compared with that bank reconciliation
statement to ascertain if the outstanding items and corrections have been
attended to by the bank. Remember to compare the items on the debit side of the
bank reconciliation statement with the entries on the debit side of the bank
statement and credit entries on the reconciliation with credit entries on the
statement.
• Compare the amounts in the cash receipts journal for the current month with the
entries on the credit side of the bank statement.
• Compare the amounts in the cash payments journal for the current month with
entries on the debit side of the bank statement.
The differences between the bank statement, the previous month's reconciliation statement
and the cash journals will then be corrected.

GOLDEN RULE

Transactions or corrections that the entity must attend to, for example, bank charges,
interest, debit/stop orders, errors in the books of the entity or stale cheques must be
recorded in the two cash journals of the entity.
This means that entries in the bank statement but not in the books of the entity must be
recorded in the books of the entity, that is the cash receipts journal or the cash payments
journal.

GOLDEN RULE

Transactions or corrections that the bank must (or will) attend to, for example, deposits not
yet credited, unpaid cheques and errors made by the bank to be corrected must be
recorded in the bank reconciliation statement.

The business cannot record these transactions, the bank has to record them. The business
will therefore show the transactions that need to be recorded by the bank in a bank
reconciliation statement. The business can then check if the transactions have been
recorded by the bank in the next month’s bank statement.

7
8.3.4 VAT claimed on service fees
A bank, as a registered VAT vendor, must pay VAT (VAT output) over to SARS if they
charge transaction fees on services rendered, for example, ledger fees and commission on
debit and credit card transactions. The VAT amount is shown on the bank statement of an
entity. The entity, that is registered as a VAT vendor, can then claim the amount (VAT
input) from SARS. The bank charges will be recorded in the CPJ in the bank column (full
amount), the sundry accounts column as bank charges (at cost less VAT input) and the
VAT in the VAT input column.

EXERCISE 8.1

The bank reconciliation statement for June 20.0 and the cash receipts journal (CRJ), the
cash payments journal (CPJ), the bank account and the bank statement of Benson Traders
for July 20.0 reflect the following:
NB: The ticks () indicate that the entries that appear in the books of the entity (i.e., the
bank reconciliation as at 30 June 20.0 and the two cash journals for July 20.0) also appear
on the bank statement for July 20.0. They do not require any further attention. You should
check these entries by yourself.

BENSON TRADERS
BANK RECONCILIATION STATEMENT AS AT 30 JUNE 20.0
Debit Credit
R R
Favourable balance per bank statement 11 350
Deposit not yet credited (deposited 1/7/20.0)  2 000
Cheques not yet presented for payment:
No 11 — dated 23/6/20.0 (donation)* 200
No 13 — dated 30/6/20.0 (ABC Stores)  350
Favourable balance per bank account 12 800
13 350 13 350
* Cheque no 11 was not presented for payment in July and must again be shown as outstanding on the July 20.0 bank reconciliation
statement.

8
BENSON TRADERS
CASH RECEIPTS JOURNAL - JULY 20.0 (BANK COLUMN ONLY) CRJ 7
Document Date Details Bank
number
R
CRR01 15 Cash sales  6 700
CRR02 25 Cash sales  3 300
CRR03 30 Cash sales 1 800
Pencil total 11 800
B/S 07/R01 Rental income 850
B/S 07/R02 Interest income 80
12 730
B15
Amounts in italics are amounts entered as a result of the amounts reflected on the bank statement but not yet
in the CRJ. This updates the CRJ.
The amount highlighted in yellow does not appear on the bank statement for July 20.0.

BENSON TRADERS
CASH PAYMENTS JOURNAL -- JULY 20.0 (BANK COLUMN ONLY) CPJ 7
Document Date Details Bank
number
R
PR P14 5 Municipality  900
PR P15 7 John's Wholesalers  2 500
PR P16 9 ABC Stores  1 200
B/S 07 14 S Swan (R/D cheque)*  200
PR P17 15 Cash (wages)  450
PR P18 30 Telkom 180
PR P19 Cash (wages)  450
Pencil total 5 880
B/S 07 P Saxo (R/D cheque)* 300
B/S 07 Insurance 500
B/S 07 Bank charges R(20 + 23) 43
6 723
B15

Amounts in italics are amounts entered as a result of the amounts reflected on the bank statement but not yet
in the CPJ. This updates the CPJ.
The amount highlighted in yellow does not appear on the bank statement for July 20.0.

* The accounts of S Swan and P Saxo in the trade receivables ledger must be debited with the amounts of
R200 and R300, respectively. If any discount was involved on receipt of the cheques, the discount must be
cancelled via a general journal entry. The accounts of S Swan and P Saxo would be debited and the
settlement discount granted would be credited.

9
COMMENTS
• All the entries not ticked in the cash journals do not appear on the
bank statement and must therefore be included in the bank
reconciliation statement as at the end of the month. The entity
needs to check at the end of the next month to see if the
transactions went through on the bank statement.
• The bank reconciliation statement is an extension of the bank
statement, that is, the account of the entity from the viewpoint of the
bank.
• Therefore, transactions in the CRJ will be credited in the bank
reconciliation statement.
• Transactions in the CPJ will be debited in the bank reconciliation
statement.
• Any mistakes made by the entity must be corrected by the entity in
its own books.

10
 REAL BANK LIMITED

Real Bank Limited Registered

Bank Reg no 93/2571
VAT-Reg No: 2600101432
Tel: (012) 555–5555
Fax: (012) 555–5556
BENSON TRADERS
PO Box 12345
PRETORIA
0001

Account no 01/200/998/9 Statement no 3

July 20.0

Details Cheque no Fee Date Debit Credit Balance

R R R R
Balance b/f 01/07 11 350
Deposit 01/07 2 000  13 350
Cheque 13 1,20 02/07 350  13 000
Unpaid cheque: S Swan 1,00 07/07 200  12 800
Cheque 15 3,50 09/07 2 500  10 300
Deposit 7,00 15/07 6 700  17 000
Cheque 14 1,50 15/07 900  16 100
Cheque 17 1,20 15/07 450  15 650
Cheque 16 1,20 20/07 1 200  14 450
Deposit 3,10 25/07 3 300  17 750
Unpaid cheque: P Saxo 1,60 30/07 300 17 450
Interest 30/07 80 17 530
Deposit: R Charles 30/07 850 18 380
Cheque 19 1,20 30/07 450  17 930
XYZ Insurance Co 0.50 30/07 500 17 430
Deposit book 20 17 410
Service fees: July 23 17 387

The unticked debit entries were entered in the CPJ before the journal was closed off for July 20.0.
The unticked credit entries were entered in the CRJ before the journal was closed off for July 20.0.
The balance highlighted in yellow is the “balance according to the bank statement” and will be
entered in the bank reconciliation statement as the opening balance.

Additional information
(a) S Swan and P Saxo are debtors of the business.
(b) The deposit on 30/07/20.0 pertains to rent received.

11
 COMMENTS
• The bank statement is the account of the business from the
viewpoint of the bank, as a business entity.
• Every entity that entrusts its money to a bank is a creditor of the
bank. In the books of the entity, the bank will be an asset (debtor)
because the bank owes the entity its money. That is why the amounts
in the cash receipts journal for the current month will be compared with
the entries on the credit side of the bank statement.
• The amounts in the cash payments journal for the current month
will be compared with the entries on the debit side of the bank
statement.
• Entries in the bank statement but not in the books of the entity must
be recorded in the books of the entity, that is the cash receipts
journal or the cash payments journal.
• All the transactions that were not ticked in the credit column of the
bank statement will be entered in the CRJ.
• All the transactions that were not ticked in the debit column of the
bank statement will be entered in the CPJ.
• If there is an entry that the bank made that is incorrect on the bank
statement, the entity will inform the bank and then the entity will do a
correction-of-error entry in the bank reconciliation statement. The
entity can check at the end of the next month if the bank has
corrected the error.

SOLUTION EXERCISE 8.1

BENSON TRADERS
GENERAL LEDGER
Dr Bank B15 Cr
20.0 R 20.0 R
Jul 1 Balance a/b 12 800 Jul 31 Total payments CPJ 7 6 723
31 Total receipts CRJ 7 12 730 Balance c/d 18 807
25 530 25 530
Aug 1 Balance b/d 18 807

See page 8 for the calculation of total receipts in the cash receipts journal.
See page 9 for the calculation of total payments in the cash payments journal.

12
 COMMENTS
• The balance brought down on the debit side of the bank accounts is
the same as the final balance calculated in the debit column of the
bank reconciliation statement.
• The balances were different before we did the reconciliation. Now
we know why the balances were different and that the differences
was not due to fraud.

BENSON TRADERS
BANK RECONCILIATION STATEMENT AS AT 31 JULY 20.0
Debit Credit
R R
Favourable balance per bank statement 17 387
Deposit not yet credited (deposited 1/8/20.0) 1 800
Cheques not yet presented for payment:
no 11 — dated 23/6/20.0 (donation) 200
no 18 — dated 30/7/20.0 (Telkom) 180
Favourable balance per bank account 18 807
19 187 19 187

EXERCISE 8.2

The following information relates to Cool Cat Carter Traders:

(a)
COOL CAT CARTER TRADERS
BANK RECONCILIATION STATEMENT AS AT 31 MAY 20.9
Debit Credit
R R

Debit balance as per bank statement 460

Deposit not yet credited  115
Incorrect entry by the bank  20
Credit balance as per bank account 325
460 460

The “credit balance as per bank account” will be the opening balance of the bank account in the General
ledger. In this case it is a liability, namely, a bank overdraft.

13
(b)
COOL CAT CARTER TRADERS
GENERAL LEDGER
Dr Bank Cr
20.9 R
Jun 1 Balance b/d 325

(c)

COOL CAT CARTER TRADERS

CASH RECEIPTS JOURNAL (bank column only) – JUNE 2.09 CRJ6
Document
Date Details Fol Amount
number
R
CRR01 2 Sales 600 
B/S 06/R01 15 K Nkome/Trade receivables control 90 
CRR02 25 Sales 240 
CRR03 28 Sales 70
1 000

The amount highlighted in yellow does not appear on the bank statement for June 20.0.

(d)
COOL CAT CARTER TRADERS
CASH PAYMENTS JOURNAL (bank column only) - JUNE 20.9 CPJ6
Document
Date Details Fol Amount
number
R

PR P450 3 B Nkura/Trade payables control 40 

PR P451 8 R Swart/Trade payables control 160 
PR P452 17 GEM Builders/Trade payables control 300 
PR P453 18 K Kum & Co/Trade payables control 170 
PR P454 27 S Soul/Trade payables control 200 
870

14
(e)
BANK STATEMENT — JUNE 20.9

Date Details Debits Credits Balance

R R R

1 Balance 460 Dr
Cash Deposit 115  345 Dr
3 ABC Deposit 950 012 CC 300  45 Dr
ABC Deposit 950 012 DC 150  105 Cr
Cash Deposit 150  255 Cr
EFT PR P450 40  215 Cr
8 EFT PR P451 160  55 Cr
15 EFT - K Nkome 90  145 Cr
17 EFT PR P452 300  155 Dr
18 EFT PR P453 170  325 Dr
19 EFT - J Dlamini 200 125 Dr
26 Cash deposit 200  75 Cr
ABC Deposit 951 013 CC 40  115 Cr
27 EFT PR P454 200  85 Dr
28 Debit order - insurance 50 135 Dr
EFT – T Nkwe 40 95 Dr
Error corrected 20  75 Dr
29 Bank interest 20 95 Dr
Commission on CC 6 101 Dr
Commission on DC 1 102 Dr
30 Service fees 10 112 Dr
CC = Credit card deposit
DC = Debit card deposit

The amounts highlighted in yellow do not appear in the cash receipts journal or the cash payments journal for
June 20.9.

REQUIRED
(1) Complete only the Bank column of the cash receipts and cash
payments journals of Cool Cat Carter Traders for June 20.9.
(2) Show the bank account in the general ledger of Cool Cat Carter
Traders properly balanced at 30 June 20.9.
(3) Prepare the bank reconciliation statement of Cool Cat Carter
Traders as at 30 June 20.9. Commence with the balance as per the
bank statement.

15
 SOLUTION EXERCISE 8.2

(1)
COOL CAT CARTER TRADERS
CASH RECEIPTS JOURNAL (bank column only) - JUNE 20.9 CRJ 6
Document
Date Details Fol Amount
number
R
CRR01 2 Sales 600 
B/S-06/01 15 K Nkome 90 
CRR02 25 Sales 240 
CRR03 28 Sales 70
B/S-06/02 30 J Dlamini/Trade receivables control 200
B/S-06/03 T Nkwe/Trade receivables control 40
1 240

COOL CAT CARTER TRADERS

CASH PAYMENTS JOURNAL (bank column only) - JUNE 20.9 CPJ 6
Document
Date Details Fol Amount
number
R

PR P450 3 B Nkuna/Trade payables control 40 

PR P451 8 R Swart/Trade payables control 160 
PR P452 17 GEM Builders/Trade payables control 300 
PR P453 18 K Kum & Co/Trade payables control 170 
PR P454 27 S Soul/Trade payables control 200 
B/S-06 30 Insurance (debit order) 50
B/S-06 Interest expenses 20
B/S-06 Bank charges R(10 + 6 + 1) 17
957

(2)
COOL CAT CARTER TRADERS
GENERAL LEDGER
Dr Bank Cr
20.9 R 20.9 R
Jun 30 Total receipts CRJ6 1 240 Jun 1 Balance b/d 325
Balance c/d 42 30 Total payments CPJ6 957

1 282 1 282
20.9
Jul Balance b/d 42

The bank has a credit balance, which is therefore a liability. The rules for liabilities in T-accounts will
therefore be applied. Liabilities will decrease on the debit side and increase on the credit side. The
rules for liabilities will be applied until the balance brought down is on the debit side (asset), in which
case the rules for assets in T-accounts will be applied. Assets will increase on the debit side and
decrease on the credit side.

16
(3)
COOL CAT CARTER TRADERS
BANK RECONCILIATION STATEMENT AS AT 30 JUNE 20.9
Debit Credit
R R
Debit balance as per bank statement 112
Deposit not yet credited by the bank 70
Credit balance as per bank account 42
112 112

COMMENTS
• Bank reconciliations are complicated by the fact that sales can
consist of cash sales, credit card sales, debit card sales, Zapper
sales, buying-aid sales (e.g., Koopkrag and Petroleum Trust) and
coupon sales, and all these amounts are deposited separately into
the bank account of the business. Some businesses have the
advantage that their cash register roll indicates the different sales
methods. In the above exercise, the sales of R600 in the CRJ
consisted of ABC Deposit 950 012 CC of R300, ABC Deposit
950 012 DC of R150 and a cash deposit of R150. Usually, a bank
will indicate same-date deposits for a specific business with the
same code, in this case, ABC Deposit 950 012. The deposit on
27 June is indicated as ABC Deposit 951 013 CC. If there had been
a debit card sale, the bank would have used for the same code for
the debit card deposit, that is, ABC Deposit 951 013 DC.
• Buying-aid sales are similar to credit card sales. In the case of
buying-aid sales, registered financial institutions like Koopkrag and
Petroleum Trust provide buying-aid cards.
• The sales on 25 June consisted of cash sales of R200 and credit
card sales of R40 (see the bank statement).
• The debit card sales and credit card sales are deposited
automatically, usually during the night, into the bank account of the
business.

8.4 THE PETTY CASH JOURNAL

For purposes of control, most of the payments in a business are made by EFT.

There are, however, smaller amounts to be paid daily, for example, amounts for postage,
carriage and wages for day workers, where the amounts are too small for EFTs and cash is
needed for the transactions.
Entities usually draw money from their accounts at ATMs to provide for a petty cash float to
pay for these types of expenses.

17
Items purchased out of the petty cash float of an entity are recorded in the petty cash
journal, which is part of the cash records but is separate from the cash payments journal.
Recording is done from suitable petty cash vouchers authorised by responsible officials of
the entity.
The so-called imprest system is preferable for controlling petty cash. The petty cashier is
provided with a float of, say, R100. Payments are made during the month and, when
necessary, cash is drawn to restore the float to R100.

EXERCISE 8.3

Books of Dickson Traders --- June 20.9

Drew R300 cash as petty cash on 1 June.

DICKSON TRADERS
PETTY CASH PAYMENTS - JUNE 20.9
Date Details Cash voucher Amount

R
4 Stationery 001 25,20
8 Stamps 002 18,10
12 Cleaner's wages 003 60,00
17 Pro-advertising poster 004 26,50
19 Cleaner's wages 005 60,00
21 Stamps 006 8,50
23 Paper 007 21,95
26 Cleaner's wages 008 60,00
27 Taxi fare for messenger 009 10,00

Drew cash on 30 June 20.9 to restore the petty cash float to R300.

REQUIRED
(1) Prepare a petty cash journal for June 20.9 with the following
payment analysis columns: total, wages, postage, stationery, and
sundries.
(2) Post to the petty cash control account in the general ledger and
balance this account

18
 SOLUTION EXERCISE 8.3

(1)
DICKSON TRADERS
PETTY CASH JOURNAL - JUNE 20.9 PCJ 1
Receipts Payments
Petty Sundries
Statio-
Date Fol Total Date Details cash Fol Total Wages Postage Amount Fol Details
nery
voucher
20.9 R 20.9 R R R R R
Jun CPJ8 300,00 4 Stationery 001 25,20 25,20
1
CPJ8 290,25 8 Stamps 002 18,10 18,10
30
1 Wages 003 60,00 60,00
2
17 Pro-ad 004 26,50 26,50 Advertising
19 Wages 005 60,00 60,00
21 Stamps 006 8,50 8,50
23 Paper 007 21,95 21,95
26 Wages 008 60,00 60,00
27 Messenger 009 10,00 10,00 Travelling
expenses
290,25 180,00 26,60 47,15 36,50
30 Balance c/d 300,00
590,25 590,25
20.9
Jul 1 Balance b/d 300,00

(2)
DICKSON TRADERS
GENERAL LEDGER

Dr Petty cash control Cr

20.9 R 20.9 R
Jun 1 Bank CPJ8 300,00 Jun 30 Sundry payments PCJ1 290,25
30 Bank CPJ8 290,25 Balance c/d 300,00
590,25 590,25
20.9
Jul 1 Balance c/d 300,00

19
8.5 REVISION EXERCISES AND SOLUTIONS

8.5.1 REVISION EXERCISE 1

The following information for January 20.9 relates to Monday Trading:
(a)
MONDAY TRADING
BANK RECONCILIATION STATEMENT AS AT 31 DECEMBER 20.8
Dr Cr
R R
Credit balance as per bank statement 2 300
Deposit not yet credited
2 100
Credit balance as per bank account 200
2 300 2 300

(b)
MONDAY TRADING
CASH RECEIPTS JOURNAL - JANUARY 20.9 (EXTRACT) CRJ 8
Document Date Details Amount Bank
number
R R
CRR01-01 1 Sales 1 250
R01/01 S Singh/Trade receivables control 300 1 550
CRR01-02 5 Sales 1 500
R01/02 Rental income 500 2 000
CRR01-03 19 Sales 2 000 2 000
BS-01/02 M Nkosi/Trade receivables control 400
CRR01-04 25 Sales 3 000 3 000
CRR01-05 30 Sales 1 200 1 200

10 150

The amount highlighted in yellow does not appear on the bank statement for January 20.9.

20
(c)
MONDAY TRADING
CASH PAYMENTS JOURNAL - JANUARY 20.9 (EXTRACT) CPJ 8
Document Date Details Amount Bank
number
R R
PR P851 3 Big Sales Traders - Purchases 1 500
PR P852 S Sono 100
PR P853 6 Municipality 150
Water and electricity 100
Property rates 50
PR P854 10 Big Sales Traders - Purchases 1 300
PR P855 15 Salaries 2 000
PR P856 18 B Small 400
PR P857 20 H Ebrahim 50
PR P858 Big Sales Traders - Purchases 4 000
PR P859 25 Furniture 2 000
PR P860 30 Petty cash 100
PR P861 R Seema 600

The amount highlighted in yellow does not appear on the bank statement for January 20.9.

21
(d)
BANK STATEMENT - JANUARY 20.9

Date Details Debits Credits Balance

R R R
1 Balance 2 300 Dr
Cash Deposit 2 100 200 Dr
2 Cash Deposit 850 650 Cr
ABC Deposit 900 001 CC 500 1 150 Cr
ABC Deposit 900 001 DC 200 1 350 Cr
3 EFT PR P851 1 500 150 Dr
EFT PR P852 100 250 Dr
5 EFT – S Baloyi 500 250 Cr
6 Cash Deposit 500 750Cr
ABC Deposit 900 002 CC 750 1 500 Cr
ABC Deposit 900 002 DC 250 1 750 Cr
EFT PR P853 150 1 600 Cr
10 EFT PR P854 1 300 300 Cr
15 EFT PR P855 2 000 1 700 Dr
18 EFT PR P856 400 2 100 Dr
20 EFT – M Nkosi 400 1 700 Dr
EFT PR P857 50 1 750 Dr
EFT PR P858 4 000 5 750 Dr
Cash Deposit 500 5 250 Dr
ABC Deposit 900 003 CC 1 500 3 750 Dr
25 EFT PR P859 2 000 5 750 Dr
26 ABC Deposit 900 004 CC 1 750 4 000 Dr
ABC Deposit 900 004 DC 550 3 450 Dr
EFT – T Naidoo 5 000 1 550 Cr
28 Interest 15 1 535 Cr
30 ATM Cash – PR P860 100 1 435 Cr
EFT – R Amer 400 1 835 Cr
EFT PR P861 6 000 4 165 Dr
Bank charges 35 4 200 Dr
Commission on CC 52 4 252 Dr
Commission on DC 18 4 260 Dr
Debit order – Pay Insurance Co 500 4 760 Dr

(e) Additional information:

• The debit order of R500 represents the annual inventory insurance premium with
Pay Insurance Co.
• The deposit of R5 000 (26 January 20.9) was made by the tenant of an office,
T Naidoo, in respect of the rental for January and February 20.9.
• The cash deposit for the sales on 25 January 20.09 in the CRJ, deposited on
26 January 20.09, did not appear on the bank statement for January 20.9 received
from the bank. An investigation by the bank revealed that the amount had been
deposited in the bank account of Monday Furnitures. The bank will correct this
error.
• On 30 January 20.9, R Amer made a direct payment to the business in full
settlement of his account of R410.
• The bookkeeper investigated the fact that the amount paid to a creditor, R Seema,
was indicated as R600 in the CPJ and reflected as R6 000 on the bank statement.

22
 The investigation revealed that the bookkeeper had added an extra zero when
paying the amount to the creditor. The bookkeeper contacted the creditor, who said
the matter will be investigated and requested the bookkeeper to put a pay-back
request on a letterhead of Monday Trading. The creditor also asked for a
confirmation letter, stamped by the bank confirming the banking details of Monday
Trading. The bookkeeper adhered to these requests and requested that the
amount be paid back.

REQUIRED
(1) Prepare the cash receipts and cash payments journals of Monday
Trading for January 20.9.
(2) Show the bank account in the general ledger of Monday Trading,
properly balanced at 31 January 20.9.
(3) Prepare the bank reconciliation statement of Monday Trading as at
31 January 20.9. Begin with the balance as per the bank statement.

SOLUTION: REVISION EXERCISE 1

(1)
MONDAY TRADING
CASH RECEIPTS JOURNAL - JANUARY 20.9 (EXTRACT)
Document Date Details Bank
number
R
31 Subtotal 10 150
BS-01/03 T Naidoo – Rental income 5 000
BS-01/04 R Amer/Trade receivables control 400
15 550

MONDAY TRADING
CASH PAYMENTS JOURNAL - JANUARY 20.9 (EXTRACT)
Document Date Details Bank
number
R
31 Subtotal 12 200
BS 01/P01 Interest expenses 15
BS 01/P02 Bank charges R(35 +52 + 18) 105
BS 01/P03 Pay Insurance Co - Insurance 500
BS 01/P04 R Seema/Trade payables control R(6 000 – 600) 5 400
18 220

23
(2)
MONDAY TRADING
GENERAL LEDGER
Dr Bank Cr
20.9 R 20.9 R
Jan 31 Total receipts CRJ 15 950 Jan 1 Balance b/d 900
Balance c/d 2 870 31 Total payments CPJ 18 220
15 950 15 950

20.9
Feb 1 Balance b/d 2 870

(3)
MONDAY TRADING
BANK RECONCILIATION STATEMENT AS AT 31 JANUARY 20.9
Debit Credit
R R
Debit balance as per bank statement 4 770
Correction of error R(3 000 – 2 300) 700
Credit outstanding deposit 1 200
Credit balance as per bank account 2 870

4 770 4 770

(4) (For explanation purposes only - not required)

MONDAY TRADING
GENERAL JOURNAL – JANUARY 20.9
Date Details Fol Debit Credit
R R
31 Settlement discount granted 10
R Amer/Trade receivables control 10
Take the settlement discount granted into account because
R Amer paid his account within 30 days.

24
8.5.2 REVISION EXERCISE 2
The following information relates to Ontario Traders:

Pencil totals of the bank column of the cash journals at 31 December 20.8:
R
• Cash receipts journal 25 718
• Cash payments journal 27 115
(a) An item that appeared on the bank reconciliation statement as at 30 November
20.8 but not on the bank statement:
• A cash deposit not yet credited by the bank because the bank deposited the
money into the bank account of Ontario Distributors. 1 350
(b) Items that appeared in the cash receipts and cash payments journals but not on
the bank statement:
• A deposit entered in the cash receipts journal on 30 December 20.8, banked
on 3 January 20.9 792
• A payment in the amount of R679 to a creditor, J Khoza. A payment with the
same cash payment request reference number as shown in the CPJ appears
in the bank statement, but the amount is for R769. An investigation showed
that the bookkeeper had paid the wrong amount.
(c) Items that appeared on the bank statement but not in the cash journals:
• Bank charges 62
• Interest on a bank overdraft 70
• A stop order for an annual donation to a primary school 220
• A direct deposit by a debtor, P Zobo 535
• A deposit paid directly into the bank account of Ontario Traders by a tenant,
F Flee 1 100
(d) Balance of the bank account in the general ledger at 30 November 20.8 (debit)
3 336
(e) Balance as per the bank statement at 31 December 20.8 (favourable) 990

REQUIRED
(1) Complete the cash receipts and cash payments journals of Ontario
Traders for December 20.8.
(2) Show the bank account in the general ledger of Ontario Traders
properly balanced at 31 December 20.8.
(3) Prepare the bank reconciliation statement of Ontario Traders as at
31 December 20.8. Begin with the balance as per the bank
statement.

25
 SOLUTION: REVISION EXERCISE 2

(1)
ONTARIO TRADERS
CASH RECEIPTS JOURNAL - DECEMBER 20.8 (EXTRACT)
Document Date Details Bank
number
R
31 Subtotal 25 718
BS-12/10 P Zobo/Trade receivables control 535
BS-12/11 Rental income 1 100
27 353

ONTARIO TRADERS
CASH PAYMENTS JOURNAL - DECEMBER 20.8 (EXTRACT)
Document Date Details Bank
number
R
BS 12/P10 31 Subtotal 27 115
J Khoza/Trade payables control R(769 – 679) 90
BS 12 Bank charges 62
BS 12 Interest on bank overdraft 70
BS 12 Donations 220
27 557

(2)
ONTARIO TRADERS
GENERAL LEDGER
Dr Bank Cr
20.8 R 20.8 R
Dec 1 Balance b/d 3 336 Total payments CPJ 27 557
31 Total receipts CRJ 27 353 Balance c/d 3 132
30 689 30 689
20.9
Jan 1 Balance b/d 3 132

26
(3)
ONTARIO TRADERS
BANK RECONCILIATION STATEMENT AS AT 31 DECEMBER 20.8
Debit Credit
R R
Credit balance per bank statement 990
Correction of error by the bank 1 350
Deposit not yet credited by the bank 792
Debit balance per bank account 3 132
3 132 3 132

8.5.3 REVISION EXERCISE 3

Please attempt 8.5.3_REVISION EXERCISE 3 under the heading “CONTENT”. The
answer will be provided at a later stage.

8.5.4 REVISION EXERCISE 4

Please attempt 8.5.4_REVISION EXERCISE 4 under the heading “CONTENT”. The
answer will be provided at a later stage.

8.5.4 REVISION EXERCISE 5

Please attempt 8.5.5_REVISION EXERCISE 5 under the heading “CONTENT”. The
answer will be provided at a later stage.

SELF-ASSESSMENT
Now that you have studied this study unit, can you

• describe the nature and the importance of cash?

• describe how control is exercised over cash?
• reconcile the bank statement balance with the bank account balance
of an entity?
• prepare a petty cash journal?

27
 FAC3704
FAC1502
STUDY UNIT 9

TRADE AND OTHER

RECEIVABLES

Financial Accounting 1:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

9
Trade and other receivables

Learning outcome

You should know how all aspects of trade receivables are to be treated in the books of
an entity.

Contents
Page
Key concepts
9.1 Introduction 3
9.2 Settlement discount granted 3
9.3 Allowance for settlement discount granted 6
9.4 Interest charged 9
9.5 Credit losses (bad debts) 11
9.5.1 Writing off credit losses 11
9.5.2 Allowance for credit losses 12
9.5.3 Creation of allowance for credit losses 12
9.5.4 Increasing the allowance for credit losses 14
9.5.5 Decreasing the allowance for credit losses 16
9.5.6 Writing off credit losses when an allowance for credit losses exists 18
9.5.7 Recovery of credit losses written off 22
9.5.8 VAT, credit losses and credit losses recovered 23
9.6 Presentation on the statement of financial position 23
9.7 Trade receivables control account 24
9.8 Contingent assets 32
9.9 Revision exercises and solutions 32
9.9.1 Revision exercise 1 32
9.9.2 Revision exercise 2 32
9.9.3 Revision exercise 3 32
9.9.4 Revision exercise 4 32
Self-assessment 33

2
 KEY CONCEPTS
• Credit transaction
• Trade receivables
• Credit term
• Settlement discount granted
• Credit losses (Bad debts)
• Current assets
• Allowance for credit losses
• Trade receivables control
• Contingent assets

9.1 INTRODUCTION
A sale made without the buyer paying at the time of the sale is known as a credit transaction.
A person or a business that owes money to an entity as a result of a credit sale is known as
a trade debtor. A debtor accepts responsibility for paying the debt within a specific period.
The period is known as a credit term and is predetermined in accordance with the credit policy
of the entity making the sale. Because some debtors do not pay their accounts, many firms
create an allowance for credit losses.
In this study unit we will concentrate on how debtors are encouraged to pay their accounts
on time. We will also look at the writing off of credit losses and the creation and adjustment
of the allowance for credit losses.

9.2 SETTLEMENT DISCOUNT GRANTED

A discount is often offered to debtors in order to encourage the quick settlement of their debts
within the stated credit term. The credit term will be shown on the credit invoice, for example,
30 days from the date of sale.

EXERCISE 9.1

A client purchased goods worth R3 450 on credit on 1 March 20.0.

The client has one month (the credit term) in which to settle the debt. If the client pays before
31 March 20.0, a discount of 2% will be granted. If the client settles the account before
31 March 20.0, it means that the amount payable is R3 381, calculated as follows:
2
R3 450 – R(3 450 × 100)
= R(3 450 - 69)
= R3 381

3
If value-added tax (VAT) at 15% is included in the R3 450, the VAT collected on behalf of the
South African Revenue Service (SARS) (recorded at the date of sale) will amount to

(R3 450 x 15/115)

= R450

and will be recorded in the VAT output account.

The selling price recorded in the sales account in the general ledger is

R3 450 – R450 (VAT)

= R3 000.

The fact that a discount has been granted does not affect the original selling price recorded
in the general ledger.

The discount will, however, have an influence on VAT. Although the debtor purchased the
goods for R3 450 the actual income for the business is R3 000. If a 2% discount is allowed
on the R3 000, the income for the business is as follows:

R3 000 – R(3 000 x 2/100)

= R(3 000 – 60)
= R2 940

VAT (calculated at 15%) on R2 940 (VAT exclusive) is

(R2 940 x 15/100)

= R441.

The original VAT of R450 is therefore overstated and must be reduced by

R(450 – 441)
R9

in other words, 2% x R450. Such adjustments are made in the VAT input account and NOT
in the VAT output account. The reason for this is that the net sales (sales less sales returns)
multiplied by the VAT percentage should result in the amount of VAT output.

The discount of R69 thus includes VAT of R9, which may be calculated as follows:
69 15
x 115
1
= R9

4
 SOLUTION: EXERCISE 9.1

The accounting entries for the exercise are as follows:

Dr Trade receivables control B1 Cr

20.0 R 20.0 R
Mar 1 Sales and VAT output SJ 3 450 Mar 31 Bank CRJ 3 381
Settlement discount
granted CRJ 60
VAT input CRJ 9
3 450 3 450

Usually bank, settlement discount granted and VAT input will be posted as one amount from the CRJ to the
trade receivables account. The amount posted will be the total amount in the trade receivables column in the
CRJ (see study unit 5). We showed you the separate entries for bank, settlement discount granted and VAT
input in the above trade receivables account for illustrative purposes only.

Dr Sales N1 Cr
R 20.0 R
Mar 1 Trade receivables control SJ 3 000

Dr VAT input B2 Cr
20.0 R
Mar Trade receivables control CRJ 9 2 500
31

Dr VAT output B3 Cr
20.0 R
Mar 1 Trade receivables control SJ 450

Dr Settlement discount granted N2 Cr

20.0 R l R
Mar 31 Trade receivables control CRJ 60 2 500

Dr Bank B4 Cr
20.0 R R
Mar 31 Trade receivables control CRJ 3 381 2 500

Settlement discount granted will be written off to the sales account at the end of the financial
period (closing transfer) and is therefore subtracted from sales in the statement of profit or
loss and other comprehensive income. The influence of discounts on VAT was also discussed
in exercise 5.2 in study unit 5.

5
9.3 ALLOWANCE FOR SETTLEMENT DISCOUNT GRANTED

GOLDEN RULE
IAS 37 defines and specifies the accounting for and the disclosure of provisions
(allowances).
A provision is a liability of uncertain timing or amount. The liability may be a legal obligation
or a constructive obligation. A constructive obligation arises from an entity’s actions,
through which it has indicated to others that it will accept certain responsibilities and, as a
result, has created an expectation that it will discharge those responsibilities. Examples of
provisions include:
- warranty obligations
- legal or constructive obligations to clean up contaminated land or to restore facilities
- obligations caused by a retailer’s policy to make refunds to customers

An entity recognises a provision if it is probable that an outflow of cash or other economic

resources will be required to settle the provision. If an outflow is not probable, the item is
treated as a contingent liability.

A provision is measured at the amount that the entity would rationally pay to settle the
obligation at the end of the reporting period or to transfer it to a third party at that time. Risks
and uncertainties are taken into account in measuring a provision. A provision is discounted
to its present value.

An entity with a settlement discount granted policy applicable to debtors who pay their
accounts fully in the settlement period must, at the end of the financial year, create an
allowance for settlement discount granted for those sales that took place in the current
financial year but in respect of which the settlement period falls in the next financial year.
When the allowance for settlement discount granted is created, certain accounting
procedures must be followed.

These procedures will be explained by way of the following exercise:

EXERCISE 9.2

On 30 June 20.0, the end of the financial year of Brio Traders, the outstanding trade
receivables control account amounted to R30 000 and the sales amounted to R70 000.
The entity’s credit policy allows a settlement discount granted of 5% if an account is settled
within 30 days after the sale took place. Over the years the entity established that 90% of its
customers take up the settlement discount granted.
90% x R30 000
= R27 000 (debtors who might take up the settlement discount granted offer)

The allowance for settlement discount granted is as follows: R27 000 x 5%

= R1 350

6
 SOLUTION: EXERCISE 9.2

The following accounting entries are necessary to create an allowance for settlement discount
granted:

BRIO TRADERS
GENERAL JOURNAL – JUNE 20.0
Debit Credit

R R
30 Sales N1 1 350
Allowance for settlement discount granted B5 1 350
Allowance for settlement discount granted
created at year-end.

BRIO TRADERS
GENERAL LEDGER
Dr Sales N1 Cr
20.0 R 20.0 R
Jun 30 Allowance for settlement Jun 30 Balance b/d 70 000
discount granted GJ 1 350

Dr Allowance for settlement discount granted B5 Cr

20.0 R
Jun 30 Sales GJ 1 350

COMMENTS
• The sales for the year represent an income of R(70 000 – 1 350) =
R68 650 in the statement of profit or loss and other comprehensive
income for the year ended 30 June 20.0.
• Keep in mind that the trade receivables control account is an asset
account and the allowance for settlement discount granted is a contra
asset account. The allowance for settlement discount granted must
be deducted from the trade receivables control (R30 000) to determine
the amount at which trade receivables must be taken into account
under trade and other receivables in the statement of financial position
as at 30 June 20.0.

7
Disclosure on the financial statements

NAME OF ENTITY
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED …
R
Revenue xxx xxx
Sales xxx xxx
Less: Settlement discount granted (xx xxx)
Less: Allowance for settlement discount granted (xx xxx)

Debtors (trade receivables) are current assets.

GOLDEN RULE:
Current assets are assets that the entity can reasonably expect to realise within the normal
business cycle of one year.

NAME OF ENTITY
STATEMENT OF FINANCIAL POSISTION AS AT …
R
ASSETS
Non-current assets xx xxx
Current assets xx xxx
Inventories xx xxx
Trade and other receivables xx xxx
Trade receivables xx xxx
Less: Allowance for credit losses (xx xxx)
Less: Allowance for settlement discount granted (xx xxx)
Cash and cash equivalents xx xxx

Total assets xx xxx

EQUITY AND LIABILITIES

8
 GOLDEN RULE
Settlement discount granted
Actual settlement discount granted will be written off against the trade receivables
control account.
When a debtor is granted a settlement discount the general ledger entries will be as follows:

Debit: Bank
Debit: Settlement discount granted
Credit: Trade receivables control/individual debtor
This is explained to you in exercise 9.1.

Then, at the end of the financial year, the settlement discount granted is transferred to sales
and the general ledger entries posted from the general journal will be as follows:

Debit: Sales
Credit: Settlement discount granted

Allowance for settlement discount granted

However, for a settlement discount granted in the future (usually at the end of a financial
year) based on current year sales, an allowance for settlement discount granted will be
created. The settlement discount granted has not yet been granted and can only be credited
to the trade receivables control account once the discount has been granted. We therefore
create a contra asset account, namely, an allowance for settlement discount granted
account, where provision is made for possible settlement discounts that will be granted in
future. The balance of this account will then be subtracted from the balance of trade
receivables in the statement of financial position at the end of a financial year so that future
income from trade receivables is not overstated. If the discount has been granted in future
the amount will be written off to the trade receivables control account.

9.4 INTEREST CHARGED

Many entities charge interest on outstanding debt if an account is not paid within the credit
term. Suppose the entity that sold the goods in the above example has a policy of charging
18% interest per annum on accounts that are not paid within the stated credit terms. If the
client, Ms Nkome, does not pay the account of R550 before 31 March 20.0, but only pays it
at the end of April, she will be charged 18% per annum interest (for one month) on R550 and
will have to pay R558,25, calculated as follows:
18 1
R550 + R(550 × x 12)
100
= R(550 + 8,25)
= R558,25

The interest (nominal account) increases the outstanding balance on the individual debtor's
account as well as the balance in the trade receivables control account. This transaction is
recorded by means of a general journal entry.

9
The accounting entries are as follows:

EXAMPLE TRADERS
GENERAL JOURNAL – MARCH 20.0
Debit Credit

R R
31 Ms Nkome/trade receivables control B5/DL1 8,25
Interest income N6 8,25
Bring 18% per annum interest into account for a
client who did not pay within the credit term.

EXAMPLE TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.0 R
Mar 31 Interest income GJ 8,25

Dr Interest income N6 Cr
20.0 Rr
Mar Individual debtor/trade
31 receivables control GJ 8,25

GOLDEN RULE

Transactions regarding transactions with individual debtors will be posted to each

individual debtor’s account in the trade receivables ledger. The total of the
transactions regarding debtors in the books of first entry will also be posted to trade
receivables control account in the general ledger.

The total of the list of balances of the trade receivables accounts of the individual debtors’
accounts in the trade receivables ledger must correspond to the balance in the trade
receivables control account in the general journal. If the balances differ, a reconciliation is
necessary to determine why they differ.

The trade receivables control account is therefore a control measure built into accounting
to determine if the entries in the individual debtors’ accounts in the trade receivables ledger
are correct.

10
9.5 CREDIT LOSSES (BAD DEBTS)
When a credit transaction occurs, there is always a possibility that the debt might not be paid.
Those debts that are never paid are known as credit losses or irrecoverable debts. Because
there is always the possibility that some debts will not be paid, most entities have a policy of
creating an allowance for credit losses.

9.5.1 Writing off credit losses

When an entity’s management decide that a specific debt will not be recovered, the amount
must be written off as a credit loss. When the credit loss is written off, the debtor's personal
account and the trade receivables control account are affected. The amount of the credit loss
will be debited to the credit losses account (a nominal account) and credited to the debtor's
personal account and the debtors control account (a statement of financial position account).

EXERCISE 9.3

On 15 May 20.0 AM Traders was informed that A Langa, a debtor who owed the entity R660,
had been declared insolvent. The amount must be written off as irrecoverable. The balance
on the trade receivables control account at 30 April was R18 000.

SOLUTION: EXERCISE 9.3

The accounting entries are as follows:

AM TRADERS
GENERAL JOURNAL – MAY 20.0
Fol Debit Credit
R R
15 Credit losses N3 660
A Langa/trade receivables control B5/DL2 660
Write A Langa's account off as irrecoverable.

AM TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.0 R 20.0 R
May 1 Balance b/d 18 000 May 15 Credit losses GJ 660

11
 Dr Credit losses N3 Cr
20.0 Rr
May 15 Trade receivables control GJ 660 May 15 Credit losses 660

AM TRADERS
TRADE RECEIVABLES LEDGER
A Langa DL2
Debit Credit Balance
20.0 R R
May 1 Account rendered 660
15 Credit losses 660 -

9.5.2 Allowance for credit losses

It is customary for entities that sell goods on credit to create an allowance for credit losses.
This allowance is based on the estimated credit losses (bad debts). The prospect of not
realising all debts is typical of this type of uncertainty. A thorough investigation needs to be
done of the debtors of an entity every financial year to determine which debtors are at risk of
not paying their accounts. An amount for the possible allowance for credit losses will then be
determined.

9.5.3 Creation of allowance for credit losses

When an allowance for credit losses is created for the first time, certain accounting
procedures must be followed. These procedures will be explained with the aid of the following
exercise:

EXERCISE 9.4

On 30 June 20.0, the end of the financial year of Trio Traders, outstanding trade debtors
amounted to R20 000.
The financial manager determined that the allowance for credit losses account should amount
to R1 350 at 30 June 20.0.

SOLUTION: EXERCISE 9.4

The following accounting entries are necessary to create a new allowance for credit losses:

12
TRIO TRADERS
GENERAL JOURNAL – JUNE 20.0
Fol Debit Credit
20.0 R R
Jun 30 Credit losses N10 1 350
Allowance for credit losses B8 1 350
Allowance for credit losses created at year-end.

TRIO TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.0 R 20.0 R
Jun 30 Balance b/d 20 000May 15 Credit losses 660

Dr Allowance for credit losses B8 Cr

20.0 R 20.0 Rr
Jun 30 20 000 Jun 30 Credit losses GJ 1 350

Dr Credit losses N1 Cr
20.0 R 20.0 R
Jun 30 Allowance for credit losses GJ 1 350 May 15 Credit losses 660

TRIO TRADERS
CLOSING JOURNAL ENTRY – JUNE 20.0
Fol Debit Credit
R R
30 Profit or loss account N12 1 350
Credit losses N10 1 350
Closing credit losses off to the profit or loss
account.

TRIO TRADERS
GENERAL LEDGER
Dr Credit losses N10 Cr
20.0 R 20.0 Rr
Jun 30 Allowance for credit losses GJ 1 350 Jun 30 Profit or loss account GJ 1 350

13
Dr Profit or loss account (extract) N12 Cr
20.0 R 20.0 R
Jun 30 Credit losses GJ 1 350 May 15 Credit losses 660

COMMENTS
• When an allowance is created the only accounts that are affected are
the credit losses account (a nominal account) and the allowance for
credit losses account (a contra asset account). In the general
ledger, the balance on the trade receivables control account remains
R20 000. The trade receivables control account will only be credited
when actual credit losses are verified.
• The allowance for credit losses (R1 350) is deducted from trade
receivables (R20 000). The R18 650 is shown in the statement of
financial position as current assets under trade and other receivables.
• The R1 350 credit losses is closed off to the profit or loss account.

GOLDEN RULE
Credit losses

The trade receivables control account will only be credited when actual credit losses are
verified.

Allowance for credit losses

For possible credit losses, an allowance for credit losses will be created. This debt is
not irrecoverable at this time and can only be credited to the trade receivables control
account if it becomes turns irrecoverable. We therefore create a contra asset account,
namely, an allowance for credit losses account, where provision is made for possible credit
losses of the future. The balance of this account will then be subtracted from the balance
of trade receivables in the statement of financial position at the end of a financial year so
that future income from trade receivables is not overstated. If the debt becomes
irrecoverable in future, the amount will be credited to the trade receivables control account.

9.5.4 Increasing the allowance for credit losses

EXERCISE 9.5

On 30 June 20.1 the outstanding trade debtors of Trio Traders (refer to exercise 9.4)
amounted to R30 000. According to exercise 9.4, the balance of the allowance for credit

14
losses account on 1 July 20.1 was R1 350. (Credit losses already written off during the year
amounted to R730.)

The financial manager determined that the allowance for credit losses account should amount
to R1 750 at 30 June 20.1.

SOLUTION: EXERCISE 9.5

The following accounting entries are necessary to adjust the allowance for credit losses:

TRIO TRADERS
GENERAL JOURNAL – JUNE 20.1
Fol Debit Credit
R R
30 Credit losses N10 400
Allowance for credit losses B8 400
Allowance for credit losses adjusted: rrrR
New allowance 1 750
Existing allowance 1 350
Amount needed for adjustment 1 400

TRIO TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.1 R 20.0 R
Jun 30 Balance b/d 30 000 May 15 Credit losses 660

Dr Allowance for credit losses B8 Cr

20.0 R
Jul 1 Balance b/d 1 350
20.1
Jul 1 Credit losses GJ 400
1 750

Dr Credit losses N10 Cr

20.1 R 20.1 R
Jun 30 Balance b/d 730 Jun 30 Profit or loss account GJ 1 130
Allowance for credit
losses GJ 400
1 130 1 130

15
 COMMENTS
• The credit losses written off during the year were debited to the credit
losses account (the current balance of R730) and credited to the
trade receivables control account before the balance of R30 000 was
calculated on the trade receivables control account.
• The trade receivables control account is not affected by a change in
the allowance for credit losses.
• The allowance for 20.0 (R1 350) is deducted from the allowance
calculated for 20.1 (R1 750). Only the difference is debited to the
credit losses account and credited to the allowance for credit losses
account.
• Keep in mind that the trade receivables control account is an asset
account and the allowance for credit losses account is a contra asset
account. The allowance for credit losses balance (R1 750) must be
deducted from the trade receivables control account balance
(R30 000) to determine the amount at which trade receivables must
be taken into account under trade and other receivables in the
statement of financial position.
• The credit losses for the year (R730) and the difference in the
allowance for credit losses (R400) are written off as an expense in
the profit or loss account (R1 130).

9.5.5 Decreasing the allowance for credit losses

EXERCISE 9.6

On 30 June 20.2 the outstanding trade debtors of Trio Traders (refer to exercise 9.5)
amounted to R26 000. According to exercise 9.5, the balance of the allowance for credit
losses account on 1 July 20.1 was R1 750. (Credit losses already written off during the year
amounted to R960.)
The financial manager determined that the allowance for credit losses account should amount
to R1 550 at 30 June 20.2.

SOLUTION: EXERCISE 9.6

The following accounting entries are necessary to adjust the allowance for credit losses:

16
TRIO TRADERS
GENERAL JOURNAL – JUNE 20.2

Debit Credit
R R
30 Allowance for credit losses B8 200
Credit losses N1
rrrR 200
Allowance for credit losses adjusted: 1 750
Existing allowance 1 550
New allowance
Amount needed for adjustment 1 200

TRIO TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.2 R 20.0 R
Jun 30 Balance b/d 26 000 May 15 Credit losses 660

Dr Allowance for credit losses B8 Cr

20.2 R 20.1 R
Jun 30 Credit losses GJ 200 Jul 1 Balance b/d 1 750
Balance c/d 1 550
1 750 1 750
20.2
Jul 1 Balance b/d 1 550

Dr Credit losses N1 Cr
20.2 R 20.2 R
Jun 30 Balance b/d 960 Jun 30 Allowance for credit
losses GJ 200
Profit or loss account GJ 760
960 960

COMMENTS
• The trade receivables control account is not affected by changes in
the allowance for credit losses.
• The credit balance that has increased from the original R1 350 to
R1 750 must now be reduced to R1 550. This has to be done by
making a debit entry in the allowance for credit losses account.
However, the balance carried forward on the allowance for credit
losses account will always be a credit balance.

17
 • The credit losses written off during the year were debited to the credit
losses account (the current balance of R960) and credited to the trade
receivables control account before the balance of R26 000 was
calculated on the trade receivables control account.
• The fact that in the years 20.0 and 20.1 the entries in the credit
losses account have been debited does not mean that all the entries
posted to the account will be debits. It is self-evident that if the
allowance for credit losses is decreased, the difference between the
existing allowance and the new allowance has to be added back.
The only way this can be done is to debit the allowance for credit
losses account and to credit the credit losses account.

9.5.6 Writing off credit losses when an allowance for credit losses exists
One of two methods can be followed to write off credit losses when an allowance for credit
losses exists. These methods are discussed below.

Method 1: Write credit losses off against the allowance for credit losses
account
As credit losses occur, the credit losses can be written off against the allowance for credit
losses account, as follows: debit the allowance for credit allowance account and credit the
debtor's personal account and the trade receivables control account.

EXERCISE 9.7

On 30 November 20.0, the end of the financial year of Trio Traders, outstanding trade
debtors amounted to R20 000 and the allowance for credit losses had a balance of R800.
On 30 November 20.1 Trio Traders was informed that B Down, a debtor who owed the entity
R730, had been declared insolvent.
During the financial year that ended on 30 November 20.1 credit sales amounted to R40 000
and R29 270 was received from debtors in payment of their accounts. The financial manager
determined that the allowance for credit losses account should amount to R1 200 at
30 November 20.1.

SOLUTION: EXERCISE 9.7

The accounting entries are as follows:

18
TRIO TRADERS
GENERAL JOURNAL – NOVEMBER 20.1

Fol Debit Credit

R R
30 Allowance for credit losses B8 730
B Down/trade receivables control B5/DL 730
Write B Down's account off as irrecoverable

TRIO TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.0 R 20.1 R
Dec 1 Balance b/d 20 000 Nov 30 Allowance for credit 1
20.1 losses GJ 730
Nov 30 Sales and VAT output SJ 40 000 Bank CRJ 29 270
Balance c/d 30 000
60 000 60 000
20.1
Dec 1 Balance b/d 30 000

Dr Allowance for credit losses B8 Cr

20.0 R 20.0 R
Nov 30 Trade receivables control GJ 730 Dec 1 Balance b/d 1 8800
Balance c/d 1 200 20.1
Nov 30 Credit losses* GJ 1 130
1 930 1 930
20.1
Jul 1 Balance b/d 1 200
*Balancing figure

Dr Credit losses N10 Cr

20.1 R 20.1 R
Nov 30 Allowance for credit losses GJ 1 130 Nov 30 Profit or loss account GJ 1 130

19
TRIO TRADERS
TRADE RECEIVABLES LEDGER
B Down
Debit Credit Balance
20.0 R R R
Dec 1 Account rendered 730
20.1
Nov 30 Allowance for credit losses 730 -

Method 2: Write credit losses off against the credit losses account

The allowance for credit losses account remains unchanged during the year. Credit losses
that occur during the year are written off against the credit losses account.

EXERCISE 9.8

On 30 November 20.0, the end of the financial year of Trio Traders, outstanding trade debtors
amounted to R20 000 and the allowance for credit losses had a balance of R800. On
30 November 20.1 Trio Traders was informed that B Down, a debtor who owed the entity
R730, had been declared insolvent.
During the financial year that ended on 30 November 20.1 credit sales amounted to R40 000
and R29 270 was received from debtors in payment of their accounts. The financial manager
determined that the allowance for credit losses account should amount to R1 200 at
30 November 20.1.

SOLUTION: EXERCISE 9.8

The accounting entries are as follows:

TRIO TRADERS
GENERAL JOURNAL – NOVEMBER 20.1
Fol Debit Credit
R R
30 Credit losses N10 730
B Down/trade receivables control B5/DL 730
Write B Down's account off as irrecoverable.

20
 TRIO TRADERS
GENERAL LEDGER
Dr Trade receivables control B5 Cr
20.0 R 20.0 R
Dec 1 Balance b/d 20 000 Nov 30 Credit losses 1 730
20.1 Bank 29 270
Nov 30 Sales and VAT output 40 000 Balance c/d 30 000
60 000 60 000
20.1
Dec 1 Balance b/d 30 000

Dr Allowance for credit losses B8 Cr

20.1 R 20.0 R
Jun 20 Dec 1 Balance b/d 800
30 000 20.1
Nov 30 Credit losses 400
1 200

Dr Credit losses N10 Cr

20.1 R 20.1 R
Nov 30 Trade receivables control 730 Nov 30 Profit or loss account 1 130
Allowance for credit losses 400
1 130 1 130

TRIO TRADERS
TRADE RECEIVABLES LEDGER
B Down
Debit Credit Balance
20.0 R R R
Dec 1 Account rendered 730
20.1
Nov 30 Credit losses 730 -

COMMENT
The amount written off as credit losses in the profit or loss account is the
same in both methods.

21
9.5.7 Recovery of credit losses written off
When money that was previously written off as irrecoverable (a credit loss) is recovered, it
must be recorded and disclosed separately. The amount has already been removed from the
account of the debtor/the trade receivables control account and can therefore not be taken to
that account. An account, credit losses recovered, will be opened for this purpose. The
money recovered will be debited against the bank account, and the credit losses recovered
account will be credited. Credit losses recovered are seen as an income and are added to
other operating income in the statement of profit or loss and other comprehensive income to
cancel the expense written off previously.

EXERCISE 9.9

An amount of R500 for a debtor, M Naidoo, previously written off on 31 March 20.0, was
recovered on 1 May 20.0.

SOLUTION: EXERCISE 9.9

The accounting entries are as follows:

TRIO TRADERS
GENERAL JOURNAL – MAY 20.0

Fol Debit Credit

R R
1 Bank B1 500
Credit losses recovered N11 500
Received an amount from M Naidoo, a debtor, that
had previously been written off as irrecoverable.
The entry will be done in the CRJ in the sundry accounts column as credit losses recovered. We just do the journal entry for
explanatory purposes.

TRIO TRADERS
GENERAL LEDGER
Dr Bank B1 Cr
20.0 R
May 1 Balance b/d Xx xxx
Credit losses recovered CRJ 500

22
 Dr Credit losses recovered N11 Cr
20.0 R 20.0 R
Xxx x Profit or loss account* GJ 500 May 1 Bank CRJ 500
500 500

*The amount will be closed off to the profit or loss account at the end of the financial year.

9.5.8 VAT, credit losses and credit losses recovered

The amount owed by a debtor always includes VAT. The VAT collected on credit sales is paid
over to the SARS every second month. If a debt is not paid and has to be written off, the seller
is entitled to claim the VAT portion that was included in the credit losses back from SARS.

Similarly, when a debt/credit loss that was previously written off is recovered, the seller is
responsible for paying over to SARS the VAT component of that sale. (You will not be tested
on this aspect in FAC1502.)

9.6 PRESENTATION ON THE STATEMENT OF FINANCIAL POSITION

Trade receivables are current assets. Current assets are assets that an entity can
reasonably expect to realise within the normal business cycle of one year.

According to the IFRS, current assets must be disclosed as follows on the statement of
financial position:

NAME OF ENTITY
STATEMENT OF FINANCIAL POSITION AS AT .........................
ASSETS R
Non-current assets
xxx xxxx
Current assets
Inventories xx xxx
Trade and other receivables xx xxx
Cash and cash equivalents x xxx

Total assets xxx xxx

EQUITY AND LIABILITIES

23
9.7 TRADE RECEIVABLES CONTROL ACCOUNT
Many entities sell their goods on credit. If only one or two credit transactions occurred, an
account for the debtor can be opened in the general ledger and the specific debtor will be
debited and the sales account credited with the amount of the transaction(s). But, as we
explained in study unit 5, if an entity mainly, or to a great extent, sells on credit, a sales journal
can be used for all the credit sales transactions. A separate ledger is then kept in which an
account is listed for every debtor. Posting from the journals to the trade receivables ledger
takes place on a daily basis.
To obtain a complete record of all the transactions, a control account is kept in the general
ledger. The trade receivables control account contains a summary of all the entries made in
the individual debtors' accounts. Posting to the trade receivables control account takes place
once a month when the totals of all the subsidiary journals are finalised.
The procedure can be summarised as follows:

Individual entries in the sales are posted to the personal accounts of debtors
journal (debit side) in the trade receivables
ledger on the days the transactions
take place.

The total of the trade receivables is posted to the trade receivables control account
control column in the sales journal (debit side) on the last day of the
month.

Individual entries in the sales are posted to the personal accounts of debtors
returns journal (credit side) in the trade receivables
ledger on the days the transactions
take place.

The total of the trade receivables is posted to the trade receivables control account
control column in the sales returns (credit side) on the last day of the
journal month.

Individual entries in the cash are posted to the personal accounts of debtors
receipts journal (credit side) in the trade receivables
ledger on the days the transactions
take place.

The total of the trade receivables is posted to the trade receivables control account
control column in the cash (credit side) on the last day of the
receipts journal month.

24
 EXERCISE 9.10

The opening balances on the individual debtors are as follows: debtor A: R450,00, debtor B:
R680,00 and debtor C: R220,00. (The VAT rate applicable is 15%.)

JOURNALS
SALES JOURNAL – MAY 20.2 SJ1
Date Details Fol Sales VAT Trade
output receivables

R R R
2 A DL1 200,00 30,00 230,00
B DL2 400,00 60,00 460,00
C DL3 100,00 15,00 115,00

700,00 105,00 805,00

GL 5

SALES RETURNS JOURNAL – MAY 20.2

Date Details Fol Sales VAT Trade
returns output receivables

R R R
8 B DL2 40,00 6,00 46,00
C DL3 20,00 3,00 23,00

60,00 9,00 69,00

GL5

25
CASH RECEIPTS JOURNAL – MAY 20.2
Date Details Fol Bank Trade Settlement VAT
receivables discount Input
granted
(Dr) (Dr)

R R R R
15 A DL1 600,00 680,00 70,00 *10,00
B DL2 400,00 400,00
C DL3 500,00 522,00 19,00 **3,00

1 500,00 1 602,00 89,00 13,00

GL5
* Approximation

GENERAL JOURNAL – MAY 20.2

Date Details Fol Debit Credit

R R
15 C/trade receivables control DL3/B5 805,00
Furniture B6 700,00
VAT output B10 105,00
Sold furniture on credit to C.

18 Furniture B6 220,00
VAT input B11 33,00
C/trade receivables control DL3/B5 253,00
Received furniture back from C.

1 058,00 1 058,00

COMMENT
In view of new developments, the specific debit and credit columns for
the debit entries and the credit entries for trade receivables in the
general journal will not be discussed. Bookkeeping programs that are
used to do the books of entities, like Pastel and Quick Books, do not
make provision for these types of distinctions and each general journal
entry must be booked over separately to the general ledger. Therefore,
journal debits and journal credits will not be used in the trade
receivables control account of an entity. We just use them for summary
purposes in some exercises so as not to take up too much space by
giving all the general journal entries in some short questions.

26
 REQUIRED
(1) Prepare the trade receivables control account in the general
ledger.
(2) Prepare the ledger accounts of the three debtors in the trade
receivables ledger.

SOLUTION: EXERCISE 9.10

GENERAL LEDGER
Dr Trade receivables control B5 Cr

20.2 R 20.2 R
May11 Balance* b/d 1 350,00 May 31 Sales returns and
31 Sales and VAT output SJ1 805,00 VAT output SRJ1 69,00
Furniture and VAT Bank, settlement
output GJ1 805,00 discount granted
and VAT input CRJ1 1 602,00
Furniture and
VAT input GJ1 253,00
Balance c/d 1 036,00

20.1 2 960,00 2 960,00

Jun 1 Balance** b/d 1 036,00

* List of opening balances of trade receivables:

R
A 450,00
B 680,00
C 220,00

1 350,00

GOLDEN RULE

The trade receivables control account is a summary of ALL transactions related to all the
individual debtors’ accounts in the trade receivables ledger.

27
 GOLDEN RULE

What was done (Dr or Cr) to the individual debtors’ accounts, must be done IN TOTAL to
the trade receivables control account.

TRADE RECEIVABLES LEDGER (GENERAL LEDGER FORMAT)

Dr A DL1 Cr

20.2 R 20.2 R
May11 Balance* b/d 450,00 May 15 Bank, settlement
12 Sales and VAT discount granted
output SJ1 230,00 and VAT input CRJ1 680,00

680,00 680,00

Dr B DL2 Cr

20.2 Rrr 20.2 R

May11 Balance* b/d 680,00 May 3 Sales returns and
32 Sales and VAT 8 VAT output SRJ1 46,00
output SJ1 460,00 15 Bank CRJ1 400,00
31 Balance c/d 694,00

1 140,00 1 140,00

20.2
Jun 1 Balance** b/d 694,00

Dr C DL3 Cr

20.2 Rrr 20.2 1 Rr

May11 Balance* b/d 220,00 May 38 Sales returns and
32 Sales and VAT 15 VAT output SRJ1 23,00
15 output SJ1 115,00 Bank, settlement
Furniture and VAT discount granted
output GJ1 805,00 and VAT input
Furniture and VAT CRJ1 522,00
input
Balance GJ1 253,00
c/d 342,00

1 140,00 1 140,00

20.1
Jun 1 Balance** b/d 336,00

** List of closing balances of trade receivables

28
 R
A –
B 694,00
C 342,00

1 036,00

GOLDEN RULE
The total of all the balances of the individual debtors’ accounts in the trade receivables
ledger must equal the balance of the trade receivables control account in the general
ledger.

COMMENTS
• The totals from the journals are posted to the trade receivables
control account.
• The opening and closing balances on the trade receivables
control account are the same as the totals of the lists of balances
of the individual debtors.
• T-accounts can also be done in vertical format with columns for debit,
credit and balance. Both methods are acceptable; marks will be
awarded if either of the two methods is applied.
• When debtors settle their accounts and they receive a discount, VAT
is affected. The actual amount received from a debtor is shown in
the bank column, the discount is shown in the settlement discount
granted column and the VAT that must be cancelled is shown in the
VAT input column. These three amounts must add up to the amount
shown in the trade receivables column. The total of the trade
receivables column that is posted to the trade receivables control
account at the end of the month already includes the discount and
VAT input and is posted as bank, settlement discount granted and
VAT input. The totals of the settlement discount granted column and
the VAT input column are consequently not credited separately to
the trade receivables control account.

29
 EXERCISE 9.11

The following information in respect of June 20.1 was obtained from the financial records of
N Nelson:

mR
Balance on the trade receivables control account – 31 May 20.1……………......... 19 190
Totals for the month:
Cash receipts journal:
Trade receivables column…………………………………………………………..... 16 860
Settlement discount granted column………………………………………………… 1 470
Sales journal (trade receivables column)…………………………………………….. 19 500
Sales returns journal (trade receivables column)……………………………………. 4 615
General journal:
Credit losses written off……………………………………………………………….. 751
Certain accounts with debit balances transferred from the trade payables ledger
to the trade receivables ledger……………………………………………………… 46
Interest charged on overdue accounts……………………………………………… 160
List of individual debtors per trade receivables ledger……………………………….. 16 230

Additional information

In the process of reconciling the balance on the trade receivables control account with the list
of balances as per the trade receivables ledger, the following errors were discovered:
(1) Sales invoice no 1001 for R2 270, which had been entered correctly in the sales
journal, was entered in A Abel's account as R2 770.
(2) Credit note no 52 for R30 was entered correctly in the sales returns journal but
erroneously posted as a debit to the account of B Brown.
(3) P Pet made a direct payment of R75, in full settlement of his account, into the bank
account of N Nelson. The amount was incorrectly analysed as sales in the cash
receipts journal.
(4) The sales journal was overcast by R1 000. ("Overcast" means that the amounts have
been added up incorrectly and that the total amount is R1 000 more than it should
be.)

REQUIRED
(1) Prepare the trade receivables control account in the general ledger
of N Nelson, at 30 June 20.1, properly balanced. Each entry must
indicate the correct contra ledger account.
(2) Reconcile the balance on the trade receivables control account as
determined in (1) above with the total of the trade receivables list.

30
 SOLUTION: EXERCISE 9.11

(1)
N NELSON
GENERAL LEDGER
Dr Trade receivables control B5 Cr

20.1 R 20.1 R
Jun111 Balance* b/d 19 190 Jun 30 Bank, settlement CRJ 16 860
30 Sales and VAT output discount granted and
R(19 500 – 1 000) (1) SJ 18 500 VAT input (3)
Trade payables control Sales returns and VAT SRJ
(2) GJ 46 output 4 615
Interest income GJ 160 Credit losses and VAT
input GJ 751
Sales and VAT output GJ 75
Balance c/d 15 595

37 896 37 896

20.1
Jun 1 Balance** b/d 15 595

(2)
N NELSON
RECONCILIATION
R R
Total of the list of trade receivables balances 16 230
Less: Error on A Abel's account
Less: R(2 770 – 2 270) (5) (500)
Less: Incorrect posting of credit note, B Brown
Less: (R30 × 2) (4) and (5) (60)
Less: Correction of error – P Pet m (75) (635)

Balance as per trade receivables control account 15 595

REMARKS
(1) When an error is made in totalling a journal, the mistake only affects the trade
receivables control account; it cannot affect the trade receivables list.

(2) It is possible for a creditor of a business to be a debtor of that business too. It is also
possible for a debtor to have a credit balance on his/her account. If either of these
situations occurs, it is advisable to transfer the debit or credit amount to the trade

31
 receivables control account (in the case of the debit amount) or the trade payables
control account (in the case of the credit amount).

(3) The amount in the trade receivables column is R16 860. This amount is the total
amount received from debtors, including any settlement discount granted.

(4) If an entry was made on the wrong side of an account, the effect of the correction is
double the amount of the error. First, the wrong entry must be cancelled and then the
amount must be correctly entered.

(5) In the case of both A Abel and B Brown, the entries in the trade receivables control
account are correct. The errors have to be corrected in the accounts of the debtors
and then on the trade receivables list.

When you are faced with a question on the reconciliation of a trade receivables control
account with the list of debtors, it is very important that you read the question very carefully.
As you read it, decide what type of error is involved. Also ensure that when you do the trade
receivables control account, you use the correct contra ledger account.

9.8 CONTINGENT ASSETS

Contingent assets are possible assets whose existence will be confirmed by the occurrence
or non-occurrence of uncertain future events that are not wholly within the control of the entity
concerned. An example of a contingent asset (and its related contingent gain) is a lawsuit
filed by an entity against a competitor for infringing on the entity’s patent. Contingent assets
are not recognised, but they are disclosed as a note to the financial statements when it is
more likely than not that an inflow of benefits will occur. However, when an inflow of benefits
is virtually certain, an asset is recognised in the statement of financial position because that
asset is no longer considered to be contingent.

9.9 REVISION EXERCISES AND SOLUTIONS

9.9.1 REVISION EXERCISE 1

Please attempt 9.9.1_REVISION EXERCISE 1 under the heading “CONTENT”. The answer
will be given as soon as you have made your choice and submitted it.

9.9.2 REVISION EXERCISE 2

Please attempt 9.9.2_REVISION EXERCISE 2 under the heading “CONTENT”. The answer
will be provided at a later stage.

9.9.3 REVISION EXERCISE 3

Please attempt 9.9.3_REVISION EXERCISE 3 under the heading “CONTENT”. The answer
will be provided at a later stage.

32
9.9.4 REVISION EXERCISE 4
Please attempt 9.9.4_REVISION EXERCISE 4 under the heading “CONTENT”. The answer
will be provided at a later stage.
SELF-ASSESSMENT
Now that you have studied this study unit, can you, in respect of an entity,

• calculate the amount of settlement discount granted on the early

payment of debts, calculate its effect on VAT and record the relevant
transactions?

• calculate the amount of allowance for credit losses and record it in

the books of the entity?

• record the entries involving credit losses (bad debts) that have been
written off?

• show how trade receivables are disclosed in the statement of

financial position?

• prepare a trade receivables control account?

33
 FAC3704
FAC1502
STUDY UNIT 10

INVENTORY

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

10
Inventory

Learning outcome

You should know and understand the importance of inventory and how entries related
to inventory are recorded in the books of an entity.

Contents
Page
Key concepts
10.1 Introduction 3
10.2 The importance of correct inventory valuation 4
10.3 Valuation of inventory at historical cost 6
10.4 Methods of estimating the value of inventory 7
10.5 Consistency in the application of procedures 8
10.6 Disclosure of inventory in the financial statements 9
10.7 Revision exercises and solutions
10.7.1 Revision exercise 1 10
10.7.2 Revision exercise 2 11
10.7.3 Revision exercise 3 11
10.7.4 Revision exercise 4 11
10.7.5 Revision exercise 5 11
Self-assessment 11

2
 KEY CONCEPTS

• Valuation of inventory
• Historical cost
• Consistency
• Gross profit percentage
• Disclosure in the financial statements

10.1 INTRODUCTION
Inventory is one of the more important assets for many entities. IAS 2, “Inventories – IAS
plus” contains the requirements on how to account for most types of inventory. The standard
requires inventory to be measured at the lower of cost and net realisable value (NRV) and
outlines acceptable methods of determining cost, including specific identification (in some
cases), first-in first-out (FIFO) and weighted average cost. Inventory can be classified as all
or any one of the following:
• goods that are kept to be sold in the normal course of business (merchandise)
• goods that are in the process of being manufactured for sale (work in process)
• goods that are used during the manufacture of inventory for sale (e.g., manufacturing
material)
• goods that are consumed in the normal business activities of an entity (e.g.,
stationery)
It is important to keep strict control over inventory. In many cases, this is often done by means
of an inventory count, which usually takes place at the end of the financial year. Even if an
inventory count occurs on a continuous basis throughout the year, it is customary to count
the inventory annually.
An entity can use either a perpetual (continuous) inventory system or a periodic inventory
system, depending on the nature of the entity, the type of merchandise sold and the level of
computerisation in the entity.

Perpetual inventory system

Under a perpetual inventory system, the purchase of inventory is recorded directly into the
inventory account at cost price. At the time of sale, the cost price of goods sold is transferred
from the inventory account to the cost of sales account.

Periodic inventory system

Under a periodic inventory system, the purchase of inventory is not recorded in the
inventory account. A separate account, known as the purchases account, is used to
record these purchases.
It follows that if inventory is returned to the seller, for one reason or another, the return of the
inventory cannot be recorded in the inventory account but must be recorded in a separate
account, known as the purchases returns account.
It should be clear that under a periodic inventory system, the cost of sales is not determined
at the time of the recording of the sale. The cost of sales can therefore only be determined at

3
the end of the financial period after a physical inventory count has been done. Refer to study
unit 7, section 7.4, for more information on inventory systems.

10.2 THE IMPORTANCE OF CORRECT INVENTORY VALUATION

It is very important to value inventory correctly. A mistake in the inventory figure will affect the
calculation of cost of sales, the gross profit and subsequently, the profit in the statement of
profit or loss and other comprehensive income. The total of the current assets, as well as the
equity, will then be incorrect on the statement of financial position. This mistake will also affect
the figures for the following year because the closing inventory for one year is the opening
inventory for the next year.

The following exercise illustrates what can happen when incorrect figures are used:

EXERCISE 10.1

The following information pertaining to three financial years ended 31 December was
obtained from the records of Wood Traders:

From the statement of financial position:

20.2 20.1 20.0

Total equity R R R
Capital 332 230 224 230 120 000

From the statement of profit or loss and other comprehensive income:

20.2 20.1

R R
Revenue 420 000)ll 396 000 ll
Cost of sales (252 000)ll (237 770)ll
Opening inventory 151 824) 144 000)
Purchases 256 176) 245 594)
408 000) 389 594)
Closing inventory (156 000) (151 824)

Gross profit 168 000 ll 158 230 ll

Distribution, administrative and other expenses (60 000)ll (54 000)ll

Profit for the year 108 000 104 230

Other comprehensive income for the year - -

Total comprehensive income for the year 108 000 l 104 230

4
Additional information

(a) Merchandise amounting to R4 104, received on 31 December 20.1, is included in

inventory but the invoice was only received and recorded in the purchases journal on
10 January 20.2.
(b) An invoice for merchandise with a cost price of R1 740 and a selling price of R2 106,
dispatched free on board on 31 December 20.1, was completed and recorded in the
sales journal on 3 January 20.2. These goods were included in the inventory at
31 December 20.1.
(c) The business uses a periodic inventory system.

REQUIRED
Prepare the adjusted statement of profit or loss and other
comprehensive income and calculate the equity of the owner that must
be shown in the statement of financial position for the years ended
31 December 20.1 and 31 December 20.2. Calculations must be clearly
shown.

SOLUTION: EXERCISE 10.1

Calculation of correct amounts:

R
(a) Inventory 31/12/20.1 151 824
Less: Merchandise already dispatched (1 740)
Correct inventory 31/12/20.1 150 084

(b) Purchases for 20.1 245 594

Add: Correction of goods already received 4 104
Correct amount of purchases for 20.1 249 698

(c) Purchases for 20.2 256 176

Less: Correction of goods already received (4 104)
Correct amount of purchases for 20.2 252 072

(d) Sales for 20.1 396 000

Add: Selling price of goods dispatched 2 106
Correct amount of sales for 20.1 398 106

(e) Sales for 20.2 420 000

Less: Selling price of goods dispatched (2 106)
Correct amount of sales for 20.2 417 894

5
Adjusted statement of profit or loss and other comprehensive income

20.2 20.1

R R
Revenue 417 894))l 398 106)l)
Cost of sales (246 156) ) (243 614))l
Opening inventory 150 084) 144 000)
Purchases 252 072) 249 698)
402 156) 393 698)
Closing inventory (156 000) (150 084)

Gross profit 171 738))l 154 492 )l

Distribution, administrative and other expenses (60 000))) (54 000))l

Profit for the year 111 738 100 492

Other comprehensive income for the year - -

Total comprehensive income for the year 11 738))l 100 492)ll

Adjusted equity of the owner

R
Equity (capital) – 20.1 (given) 224 230
Less: Incorrect profit given for 20.1 (104 230)
Equity – 20.0 120 000
Add: Revised profit for 20.1 100 492
Equity – 20.1 220 492
Add: Revised profit for 20.2 111 738
Equity – 20.2 332 230

10.3 VALUATION OF INVENTORY AT HISTORICAL COST

In this module, inventory is valued at historical cost. Inventory can also be measured
according to other methods, for example, first-in-first-out method and the weighted average
method - you don’t have to know how these methods are applied.

When determining the historical cost of inventory, more costs are involved than simply the
cost of purchasing the goods that are to be sold. Other costs that must be included are

6
• costs of purchase (including taxes, transport and handling) net of trade discounts
received, which include

- costs of transporting the goods from the point of purchase to the premises of the
business
- import duty – if goods are purchased from outside South Africa
- railage on goods purchased or carriage inwards
- insurance on goods purchased
- handling costs
• costs of conversion (including fixed and variable manufacturing overheads) and
• other costs incurred in bringing the inventories to their current location and condition

The above-mentioned costs form part of the cost price of inventory and will be used in
determining the gross profit of an entity.

Inventory should not include

• abnormal waste
• storage costs
• administrative overheads unrelated to production
• selling costs
• foreign exchange differences arising directly on the recent acquisition of inventories
invoiced in a foreign currency
• interest cost when inventories are purchased with deferred settlement terms

Railage on goods sold or any other delivery costs on goods sold will be shown as an expense
under distribution, administrative and other expenses in the statement of profit or loss and
other comprehensive income.

The same cost formula, that is, specific identification (in some cases), FIFO or weighted
average, should be used for all inventories with similar characteristics as to their nature and
use to the entity. For groups of inventories that have different characteristics, different cost
formulas may be justified.

There are disadvantages to using historical cost as a basis for valuation. For instance, if the
value of inventory falls below historical cost, then the value stated is not realistic. Inventory
must then be valued at NRV as an alternative to historical cost. NRF is the price at which
inventory can be sold. If it is necessary to incur any costs to complete the products or to incur
any costs to sell the products at the realisable value, these costs must be deducted from the
selling price to determine the NRV.

10.4 METHODS OF ESTIMATING THE VALUE OF INVENTORY

There is more than one method of estimating the value of inventory. The only method that
we will be discussing is the gross profit method. It is sometimes necessary to use this
method, for example, if inventory has been damaged or destroyed.

Gross profit is the difference between sales and cost of sales. If the amount of sales and
the cost of sales are known, then

7
 sales – cost of sales = gross profit
– =
R300 000 R200 000 R100 000

If only the cost of sales and gross profit are known, then

cost of sales + gross profit = sales

+ =
R200 000 R100 000 R300 000

The actual gross profit is sometimes given as a percentage of either the cost of sales or sales.

If the gross profit is expressed as a percentage of the cost of sales, then the following formula
is used:
Gross profit 100
× = Gross profit percentage on cost of sales
Cost of sales 1

If the gross profit is expressed as a percentage of sales, then the following formula is used:
Gross profit 100
× = Gross profit percentage on sales
Sales 1

When we apply the above figures to these formulas, we get the following gross profit
percentages:

Gross profit 100 R100 000 100

× = × = 50%
Cost of sales 1 R200 000 1

Gross profit 100 R100 000 100 1

× = × = 33 %
Sales 1 R300 000 1 3

10.5 CONSISTENCY IN THE APPLICATION OF PROCEDURES

Any valuation of inventory, that is, the lowest of cost or NRV, as well as the cost formula for
each group of inventory (FIFO or weighted average cost), should be applied consistently
throughout the year. Any change in the basis of inventory valuation from one year to the next
or during the same year must be disclosed. Disclosure takes place by means of a note to the
financial statements that explains the nature and effect of the change.

8
10.6 DISCLOSURE OF INVENTORY IN THE FINANCIAL STATEMENTS
IAS 18, “Revenue” deals with the recognition of revenue from the sale of goods. When
inventories are sold and revenue is recognised, the carrying amount of those inventories is
recognised as an expense (often called cost of goods sold). This happens in the statement
of profit or loss and other comprehensive income for the financial year. Any write-downs to
NRV and any inventory losses are also recognised as an expense when they occur in the
statement of profit or loss and other comprehensive income for the financial year, for
example, a trading inventory deficit when a perpetual inventory system is in use. A trading
stock deficit will be disclosed in the statement of profit or loss and other comprehensive
income under distribution, administrative and other expenses if the actual inventory count
amount is less than the closing inventory amount at the end of the financial year.

Inventory is a current asset. In this module, inventory consists mainly of finished products.
There may be other inventory items, such as packaging material, stationery and cleaning
materials, also called consumable stores on hand. The different inventories are subclassified
under inventories in the statement of financial position. The accounting policy applied for the
valuation of inventory must be disclosed in a note to the statement of financial position.

The required disclosures are as follows:

• the accounting policy for inventories

• the carrying amount, generally classified as merchandise, supplies, materials, work
in progress and finished goods - the classifications depend on what is appropriate for
the entity
• the carrying amount of any inventories carried at fair value less costs to sell
• the amount of any write-down of inventories recognised as an expense in the period
• the amount of any reversal of a write-down to NRV and the circumstances that led to
such reversal
• the carrying amount of inventories pledged as security for liabilities
• the cost of inventories recognised as an expense (cost of goods sold)

EXAMPLE

Presentation in the statement of profit or loss and other comprehensive income

(perpetual inventory system):

9
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED …
Note R
Revenue xx xxx
Sales
Less: Sales returns
Less: Settlement discount granted
Less: Cost of sales (xx xxx)
Less: Settlement discount received
Gross profit xx xxx
Other income
Distribution, administrative and other expenses
Trading stock deficit (xx xxx)
Stationery (xx xxx)

The cost of merchandise is part of the cost of sales, that is, it is used in calculating the gross
profit. Stationery is used in the sales function, and any expenses for stationery used are
written off under distribution, administrative and other expenses in the statement of profit or
loss and other comprehensive income when calculating profit for the year.

Presentation on the statement of financial position:

NAME OF ENTITY
STATEMENT OF FINANCIAL POSITION AS AT .........................
ASSETS R
Non-current assets
xxx xxxx
Current assets
Inventories R[60 000 (inventory) + 6 000 (consumable stores on hand)] 66 000
Trade and other receivables xx xxx
Cash and cash equivalents x xxx

Total assets xxx xxx

EQUITY AND LIABILITIES

10.7 REVISION EXERCISES AND SOLUTIONS

10.7.1 REVISION EXERCISE 1

Please attempt 10.7.1_REVISION EXERCISE 1 under the heading “CONTENT”. The answer
will be provided at a later stage.

10
10.7.2 REVISION EXERCISE 2
Please attempt 10.7.2_REVISION EXERCISE 2 under the heading “CONTENT”. The answer
will be provided at a later stage.

10.7.3 REVISION EXERCISE 3

Please attempt 10.7.3_REVISION EXERCISE 3 under the heading “CONTENT”. The answer
will be provided at a later stage.

10.7.4 REVISION EXERCISE 4

Please attempt 10.7.4_REVISION EXERCISE 4 under the heading “CONTENT”. The answer
will be provided at a later stage.

10.7.5 Revision exercise 5

Please attempt 10.7.5_REVISION EXERCISE 5 under the heading “CONTENT”. The answer
will be provided at a later stage.

SELF-ASSESSMENT

Now that you have studied this study unit, can you:

• explain why it is important to value and record inventory accurately?

• explain why an inventory valuation method must be applied

consistently and accurately?

• discuss what inventory consists of and how inventory is presented in

the statement of financial position of an entity?

11
 FAC3704
FAC1502
STUDY UNIT 11

PROPERTY, PLANT AND

EQUIPMENT

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

11
Property, plant and equipment

Learning outcome

You should be able to record transactions related to property, plant and equipment.

Contents
Page
Key concepts
11.1 Introduction 3
11.2 Determination of the cost price of property, plant and equipment 4
11.3 Safeguarding and control of property, plant and equipment 5
11.4 Recording the purchase of property, plant and equipment 5
11.5 The concept of depreciation 5
11.6 Recording depreciation 5
11.7 Methods of calculating depreciation 6
11.8 Acquisition of property, plant and equipment during the financial year 17
11.9 Disposal of property, plant and equipment 17
11.10 Revision exercises and solutions 26
11.10.1 Revision exercise 1 26
11.10.2 Revision exercise 2 26
11.10.3 Revision exercise 3 26
11.10.4 Revision exercise 4 26
Self-assessment 26

2
KEY CONCEPTS

• Historical cost price

• Tangible non-current assets
• land and buildings
• machinery
• vehicles
• furniture and equipment
• Depreciation
• Residual value
• Accumulated depreciation
• Sale of property, plant and equipment
• Disposal of property, plant and equipment

11.1 INTRODUCTION
IAS 16, “Property, Plant and Equipment” outlines the accounting treatment for most types of
property, plant and equipment. An item of property, plant and equipment is initially measured
at its cost, subsequently measured using either a cost model or revaluation model and
depreciated so that its depreciable amount is allocated on a systematic basis over its useful
life. The objective of IAS 16 is to prescribe the accounting treatment for property, plant and
equipment. The principal issues are the recognition of assets, the determination of their
carrying amounts and the depreciation charges and impairment losses to be recognised in
relation to them.
Items of property, plant and equipment should be recognised as assets of an entity if
• it is probable that the future economic benefits associated with the assets will flow to the
entity, and
• the cost of the assets can be measured reliably
For an item to be classified as an asset, the entity does not have to be the legal owner of the
item. Assets obtained on credit or under lease agreements can be treated as assets by the
entity, provided the corresponding liability is recorded. For accounting purposes, the
economic reality and not the legal ownership of an item must be taken into account in
determining whether the item can be classified as an asset - in other words, the principle of
substance over form applies.

Property, plant and equipment are tangible items that

• are held for use in the production or supply of goods or services, for rental to others or
for administrative purposes, and
• are expected to be used during more than one period

Non-current assets are, as you already know, acquired with the intention of carrying out,
supporting or facilitating operations. Non-current assets have an operating lifespan of more
than one year and can be used over and over. They are used but not consumed (i.e., non-
current assets are not used up in the short term). Property, plant and equipment are classified
as non-current assets.

Non-current assets may be tangible, intangible or financial assets.

3
Tangible non-current assets are assets such as buildings, machinery, vehicles and furniture.
They are assets that you can see and touch. They are shown in the statement of financial
position under the heading "Property, plant and equipment".

Because property, plant and equipment become obsolete after several years, they must be
written off over their expected economic life. This is usually done by means of a provision
referred to as depreciation. The annual amount written off is treated as an expense in the
profit or loss account.

When an asset can no longer operate economically, it is replaced. The proceeds on the
realisation (sale) of an asset are normally used to partly finance a new asset.

All aspects in the accounting system relating to the above issues will be explained further on
in this study unit.

11.2 DETERMINATION OF THE COST PRICE OF PROPERTY, PLANT AND

EQUIPMENT

MEASUREMENT AT RECOGNITION

An item of property, plant and equipment is initially measured at its cost. The cost price of an
item of property, plant and equipment consists of
• the purchase price of the item, including import duties and non-refundable purchase
taxes, after trade discounts and rebates have been deducted
• any costs directly attributable to bringing the asset to the location and the condition
necessary for it to be capable of operating in the manner intended by management, for
example, costs for site preparation, delivery and handling, related professional fees for
architects and engineers, and all installation costs, including, for example, the wages of
the business's technical personnel and any other expenses incurred in getting the asset
operational
• the estimated costs of dismantling and removing the item and restoring the site on which
it is located, unless those costs relate to inventories produced during that period

The cost price will remain constant throughout the life of the asset and is referred to as the
historical cost price. Financing costs on loans raised to acquire the asset are not included in
the cost price of the asset. The same applies to maintenance costs.

MEASUREMENT AFTER RECOGNITION

IAS 16 permits two accounting models for the measurement of an item of property, plant and
equipment subsequent to initial recognition. These models are as follows:
• Cost model. The asset is carried at cost less accumulated depreciation and impairment
(IAS 16.23). (We will be using the cost model in FAC1502.)
• Revaluation model. The asset is carried at a revalued amount, being its fair value at the
date of revaluation less subsequent depreciation and impairment, provided that the fair
value can be measured reliably (IAS 16.24). (This model is mentioned for explanatory
purposes only and is not applicable to this module.)

4
11.3 SAFEGUARDING AND CONTROL OF PROPERTY, PLANT AND
EQUIPMENT
An assets register is used in which the following important information regarding an asset is
recorded:
• location
• serial number
• cost price
• date of acquisition
• expected lifespan
• carrying amount
• current year's depreciation
• accumulated depreciation

11.4 RECORDING THE PURCHASE OF PROPERTY, PLANT AND

EQUIPMENT
The purchase of property, plant and equipment is recorded in the applicable asset accounts in
the general ledger. For example, machinery is recorded in the machinery (at cost) account
and vehicles in the vehicles (at cost) account.
Since the asset accounts in question do not contain any details, the asset register must be
kept up to date.
The totals of the cost prices in the asset register with regard to a specific asset account must
be equal to the balance of that asset account in the general ledger.
At the end of each period, the asset account is balanced and reconciled with the amount in
the asset register.

11.5 THE CONCEPT OF DEPRECIATION

An asset is acquired to generate income. Because income is generated, the cost of owning
the asset can be written off against income earned over the useful life of the asset.
Depreciation is the systematic allocation of the depreciable amount (cost less residual value)
of an asset over its useful life. The residual value is the expected value (e.g., scrap value,
trade-in value) of the asset at the end of its useful life. Once the depreciable amount has been
established, the method of allocating the depreciable amount must be decided on (refer to
section 11.7 on the methods of calculating depreciation). The method decided on for
allocating depreciation must represent a fair allocation of the cost of owning the asset each
year.

11.6 RECORDING DEPRECIATION

Depreciation of property, plant and equipment is governed by IAS 16. During the expected
useful life of an asset, a reasonable amount must be written off from the cost price of the
asset in each financial period and debited to a depreciation account. Depreciation begins
when the asset is available for use and continues until the asset is derecognised, even if it is
idle (except if the unit of production method is in use).
Under the double-entry system, the depreciation account will be debited and another account

5
will be credited with the same amount. In practice, it is not the asset account but a contra
asset account, namely, the accumulated depreciation account, that is credited with the
annual depreciation.
The difference between the debit balance on the asset account and the credit balance on the
accumulated depreciation account is known as the net carrying amount of the asset.
At the end of the financial year, depreciation for the current financial year will be closed off to
the profit or loss account.

11.7 METHODS OF CALCULATING DEPRECIATION

There are various methods of determining the amount of annual depreciation to be written off.
The depreciation method should allocate the depreciable amount (cost price – residual value)
of an asset on a systematic basis over its useful life and reflect the pattern in which the
asset’s future economic are expected to be consumed by the entity. We will discuss only the
straight-line method, the diminishing balance method and the production unit method.

EXERCISE 11.1

Suppose Zamokuhle bought a machine on 1 June 20.0 for R500 000 with a discount of
R60 000, transport costs of R15 000 and installation costs of R5 000. The depreciable cost
price of the machine is R(500 000 - 60 000 + 15 000 + 5 000) = R460 000. The estimated
lifespan of the machine is five years. (Zamokhule’s financial year ends on 31 May.) We will
now examine three methods of using this information.

REQUIRED
Use the given information and prepare
(1) depreciation schedules
(2) general journal entries and
(3) ledger accounts
to record the depreciation of the asset according to
(a) the straight-line method
(b) the diminishing balance method and
(c) the production unit method (using the given additional
information)

SOLUTION: EXERCISE 11.1

(a) Straight-line method

The cost price is written of evenly over the expected useful life (in years) of the asset.

6
(1) ASSET AND DEPRECIATION SCHEDULE: STRAIGHT-LINE METHOD
Date Cost Calculation of Annual Accumulated Net carrying
price depreciation depreciation depreciation amount
𝐂𝐨𝐬𝐭 𝐩𝐫𝐢𝐜𝐞 (b) (a) - (b)
(a) 𝑳𝒊𝒇𝒆𝒔𝒑𝒂𝒏 𝒊𝒏 𝒚𝒆𝒂𝒓𝒔

Or
*20% × cost price

May 31 R R R R

20.1 𝟒𝟔𝟎 𝟎𝟎𝟎 a

(End of financial year 1) 460 000 92 000 92 000 368 000
𝟓

20.2 𝟒𝟔𝟎 𝟎𝟎𝟎 b

(End of financial year 2) 460 000 92 000 184 000 276 000
𝟓

20.3 𝟒𝟔𝟎 𝟎𝟎𝟎

(End of financial year 3) 460 000 92 000 276 000 184 000
𝟓

20.4 𝟒𝟔𝟎 𝟎𝟎𝟎

(End of financial year 4) 460 000 92 000 368 000 92 000
𝟓

20.5 𝟒𝟔𝟎 𝟎𝟎𝟎

(End of financial year 5) 460 000 92 000 460 000 NIL
𝟓

Total depreciation 460 000

* 100% ÷ 5 = 20%
a
net carrying amount = cost – accumulated depreciation = R[460 000 – R92 000] = R368 000.
b
R[92 000 (accumulated depreciation at the end of financial year 1) + 92 000 (accumulated depreciation at the
end of financial year 2)] = R184 000

This method is also known as the fixed instalment method.

(2) JOURNAL ENTRIES FOR THE FIVE YEARS

ZAMOKUHLE
GENERAL JOURNAL – MAY 20.1

20.1 R R
31 Depreciation: machinery N10 92 000
Accumulated depreciation: machinery B8 92 000
Provision for depreciation under the straight-line
method (year 1)

Profit or loss account N11 92 000

Depreciation: machinery N10 92 000
Closing entry

The journal entries for the annual depreciation for years 20.2, 20.3, 20.4, and 20.5 would be
the same as those above.

7
 (3)
ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr
20.1 R
Jun 1 Bank *460 000

* Cost price: R500 000 – 60 000 + 15 000 + 5 000 = R460 000

Dr Accumulated depreciation: machinery B8 Cr

20.1 R 20.1 R
May 31 Balance c/d 92 000 May 31 Depreciation 20.1 GJ 92 000
20.2 20.1
May 31 Balance c/d 184 000 June 1 Balance b/d 92 000
20.2
May 31 Depreciation 20.2 GJ 92 000
184 000 184 000
20.3 20.2
May 31 Balance c/d 276 000 June 1 Balance b/d 184 000
20.3
May 31 Depreciation 20.3 GJ 92 000
276 000 276 000
20.4 20.3
May 31 Balance c/d 368 000 June 1 Balance b/d 276 000
20.4
May 31 Depreciation 20.4 GJ 92 000
368 000 368 000
20.5 20.4
May 31 Balance c/d 460 000 June 1 Balance b/d 368 000
20.5
May 31 Depreciation 20.5 GJ 92 000
460 000 460 000
20.5
June 1 Balance b/d 460 000

Dr Depreciation: machinery N10 Cr

20.1 R 20.1 R
May 31 Accumulated depreciation; May 31 Profit or loss account GJ 92 000
machinery GJ 92 000

The entries for the annual depreciation for years 20.2, 20.3, 20.4 and 20.5 would be the same
as those above.

Dr Profit or loss account (extract) N11 Cr

R
Depreciation: machinery GJ 92 000

The entries for the closing off of the depreciation to the profit or loss account for years 20.2,
20.3, 20.4 and 20.5 would be the same as those above.

8
 COMMENT
The depreciable amount is the cost of the asset less its residual value. The
residual value is the expected value (e.g., scrap value, trade-in value) of the
asset at the end of its useful life. No residual value was given in this example.

ZAMOKUHLE
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY (EXTRACT)
20.5 20.4 20.3 20.2 20.1
R R R R R
Non-current assets
Property, plant and equipment NIL 92 000 184 000 276 000 368 000

COMMENTS
• Only the carrying amount is shown on the face of the statement of
financial position.
• A detailed reconciliation of movements in the carrying amount from the
beginning to the end of the financial period is shown in a note.

The following is an example of the note for the year ended 31 May 20.2:

ZAMOKUHLE
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MAY 20.2

Property, plant and equipment Machinery Total

R R
Carrying amount:
Beginning of year 368 000 l) 368 000)l)
Cost 460 000) 460 000)
Accumulated depreciation (92 000) (92 000)

Additions –))l –)l

Disposals (–))) (–))l
Depreciation (92 000) ) (92 000) l

Carrying amount:
End of year 276 000))l 276 000))l
Cost 460 000) 460 000)
Accumulated depreciation (184 000) (184 000)

9
 COMMENT
Additions and disposals are shown in the exercise for illustrative purposes
only. They need not be shown unless there were additions or disposals
during the applicable financial period.

(b) Diminishing balance method

In this case a fixed percentage of the net carrying amount (cost price – accumulated
depreciation) is written off annually. Assume that a percentage of 20% is given.

(1) ASSET AND DEPRECIATION SCHEDULE: DIMINISHING BALANCE METHOD

Date Cost Calculation of Annual Accumulated *Net
price depreciation depreciation depreciation carrying
𝟐𝟎 amount
(a) × carrying amount* (b)
𝟏𝟎𝟎
(a) – (b)

May 31 R R R R
20.1
(End of financial year 1) 460 000 𝟐𝟎 𝟒𝟔𝟎 𝟎𝟎𝟎 92 000 92 000 a
368 000
×
𝟏𝟎𝟎 𝟏
20.2
(End of financial year 2) 460 000 𝟐𝟎 𝟑𝟔𝟖 𝟎𝟎𝟎 73 600 b
165 600 294 400
×
𝟏𝟎𝟎 𝟏
20.3
(End of financial year 3) 460 000 𝟐𝟎 𝟐𝟗𝟒 𝟒𝟎𝟎 58 880 224 480 235 520
×
𝟏𝟎𝟎 𝟏

a20.4
(End of financial year 4) 460 000 𝟐𝟎 𝟐𝟑𝟓 𝟓𝟐𝟎 47 104 271 584 188 416
×
𝟏𝟎𝟎 𝟏
20.5
(End of financial year 5) 460 000 𝟐𝟎 𝟏𝟖𝟖 𝟒𝟏𝟔 37 683 309 267 150 733
×
𝟏𝟎𝟎 𝟏

Total depreciation 309 267

* cost price – accumulated depreciation = net carrying amount

a
net carrying amount = cost – accumulated depreciation = R[460 000 – R92 000] = R368 000
b
R[92 000 (accumulated depreciation at the end of financial year 1) + 73 600 (accumulated depreciation at the
end of the financial year 2)] = R165 600

The carrying amount at the end of the fifth year (R150 733) is deemed to be the disposal
(scrap) value of the asset. According to this method, the carrying amount will, mathematically,
never become nil.
This method does not use the depreciable amount (cost less residual value) as the basis for
calculation, it is based on the cost price (cost less residual value) less accumulated
depreciation, or the carrying amount.

10
(2) JOURNAL ENTRIES FOR THE FIVE YEARS

ZAMOKUHLE
GENERAL JOURNAL
20.1 R R
May 31 Depreciation: machinery N10 92 000
Accumulated depreciation: machinery B8 92 000
Provision for depreciation at 20% under the diminishing
balance method (year 1)

Profit or loss account N11 92 000

Depreciation: machinery N10 92 000
Closing entry

20.2
May 31 Depreciation: machinery N10 73 600
Accumulated depreciation: machinery B8 73 600
Provision for depreciation at 20% under the diminishing
balance method (year 2)

Profit or loss account N11 73 600

Depreciation: machinery N10 +
Closing entry

20.3
May 31 Depreciation: machinery N10 58 880
Accumulated depreciation: machinery B8 58 880
Provision for depreciation at 20% under the diminishing
balance method (year 3)

Profit or loss account N11 58 880

Depreciation: machinery N10 58 880
Closing entry

20.4
May 31 Depreciation: machinery N10 47 104
Accumulated depreciation: machinery B8 47 104
Provision for depreciation at 20% under the diminishing
balance method (year 4)

Profit or loss account N11 47 104

Depreciation: machinery N10
47 104
Closing entry

20.5
May 31 Depreciation: machinery N10 37 683
Accumulated depreciation: machinery B8 37 683
Provision for depreciation at 20% under the diminishing
balance method (year 5)

Profit or loss account N11 37 683

Depreciation: machinery N10 37 683
Closing entry

11
(3)
ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr
20.1 R
Jun 1 Bank CPJ 460 000

Dr Accumulated depreciation: machinery B8 Cr

20.1 R 20.1 R
May 31 Balance c/d 92 000 May 31 Depreciation 20.1 GJ 92 000
20.2 20.1
May 31 Balance c/d 165 600 June 1 Balance b/d 92 000
20.2
May 31 Depreciation 20.2 GJ 73 600
165 600 165 600
20.3 20.2
May 31 Balance c/d 224 480 June 1 Balance b/d 165 600
20.3
May 31 Depreciation 20.3 GJ 58 880
224 480 224 480
20.4 20.3
May 31 Balance c/d 271 584 June 1 Balance b/d 224 480
20.4
May 31 Depreciation 20.4 GJ 47 104
271 584 271 584
20.5 20.4
May 31 Balance c/d 309 267 June 1 Balance b/d 271 584
20.5
May 31 Depreciation 20.5 GJ 37 683
309 267 309 267
20.5
June 1 Balance b/d 309 267

Dr Depreciation: machinery N10 Cr

20.1 R 20.1 R
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 92 000
machinery GJ 92 000
20.2 20.2
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 73 600
machinery GJ 73 600
20.3 20.3
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 58 880
machinery GJ 58 880
20.4 20.4
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 47 104
machinery GJ 47 104
20.5 20.5
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 37 683
machinery GJ 37 683

12
Dr Profit or loss account (extract) N11 Cr
20.1 20.1 Rr
May 31 Depreciation: machinery GJ 92 000 May Profit or loss 92 000
31
20.2 20.2
May 31 Depreciation: machinery GJ 73 600 May Profit or loss 73 600
31
20.3 20.3
May 31 Depreciation: machinery GJ 58 880 May Profit or loss 58 880
31
20.4 20.4
May 31 Depreciation: machinery GJ 47 104 May Profit or loss 47 104
31
20.5 20.5
May 31 Depreciation: machinery GJ 37 683 May Profit or loss 37 683
31

ZAMOKUHLE
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY (EXTRACT)

20.5 20.4 20.3 20.2 20.1

R R R R R
Non-current assets
Property, plant and equipment 150 733 188 416 235 520 294 400 368 000

ZAMOKUHLE
NOTES FOR THE YEAR ENDED 31 MAY 20.2

Property, plant and equipment Machinery Total

R R
Carrying amount:
Beginning of year 368 000 l) 368 000 l)
Cost 460 000) 460 000)
Accumulated depreciation (92 000) (92 000)

Depreciation (73 600)) (73 600) l

Carrying amount:
End of year 294 400 l 294 400))l
Cost 460 000) 460 000)
Accumulated depreciation (165 600) (165 600)

(c) Production unit method

In this case, the units produced by the machine are written off annually as a percentage of the
units the machine is expected to produce over its total life-span. Production for year 1 = 500

13
units, year 2 = 550 units, year 3 = 300 units, year 4 = 200 units and year 5 = 450 units.
Therefore, the total number of units expected to be produced by the machine = 2 000 units.

(1)
ASSET AND DEPRECIATION SCHEDULE: PRODUCTION VOLUME METHOD

Date Cost Calculation of Annual Accumulated Net

price depreciation* depreciation depreciation carrying
(a) (b) amount
(a) – (b)

May 31 R R R R
20.1 500
(End of financial year 1) 460 000 × 460 000 115 000 115 000 a
345 000
2 000

20.2 550
(End of financial year 2) 460 000 × 460 000 126 500 b
241 500 218 500
2 000
20.3 300
(End of financial year 3) 460 000 × 460 000 69 000 310 500 149 500
2 000

20.4 200
(End of financial year 4) 460 000 × 460 000 46 000 356 500 103 500
2 000

20.5 450
(End of financial year 5) 460 000 × 460 000 103 500 460 000 NIL
2 000

Total depreciation 309 267

Units produced during the year

* Formula for calculating depreciation = Expected number of units to be produced over life span
× Cost price
a net carrying amount = cost – accumulated depreciation = R[460 000 – 115 000] = R345 00
b
R[115 000 (accumulated depreciation at the end of financial year 1) + 126 500 (accumulated depreciation at
the end of financial year 2)] = R241 500

(2) THE JOURNAL ENTRIES ARE SIMILAR TO THOSE IN (b)(2) on page 11.

(3)
ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr
20.1 R
Jun 1 Bank CPJ 460 000

14
Dr Accumulated depreciation: machinery B8 Cr
20.1 R 20.1 R
May 31 Balance c/d 115 000 May 31 Depreciation 20.1 GJ 115 000
20.2 20.1
May 31 Balance c/d 241 500 June 1 Balance b/d 115 000
20.2
May 31 Depreciation 20.2 GJ 126 500
241 500 241 500
20.3 20.2
May 31 Balance c/d 310 500 June 1 Balance b/d 241 500
20.3
May 31 Depreciation 20.3 GJ 69 000
310 500 310 500
20.4 20.3
May 31 Balance c/d 356 500 June 1 Balance b/d 310 500
20.4
May 31 Depreciation 20.4 GJ 46 000
356 500 356 500
20.5 20.4
May 31 Balance c/d 460 000 June 1 Balance b/d 356 600
20.5
May 31 Depreciation 20.5 GJ 103 500
460 000 460 000
20.5
June 1 Balance b/d 460 000

Dr Depreciation: machinery N10 Cr

20.1 R 20.1 R
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 115 000
machinery GJ 115 000
20.2 20.2
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 126 500
machinery GJ 126 500
20.3 20.3
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 69 000
machinery GJ 69 000
20.4 20.4
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 46 000
machinery GJ 46 000
20.5 20.5
May 31 Accumulated depreciation: May 31 Profit or loss account GJ 103 500
machinery GJ 103 500

15
Dr Profit or loss account (extract) N11 Cr
20.1 R 20.1 Rr
May 31 Depreciation: machinery GJ 115 000 May 31 Profit or loss 92 000
20.2 20.2
May 31 Depreciation: machinery GJ 126 500 May 31 Profit or loss 73 600
20.3 20.3
May 31 Depreciation: machinery GJ 69 000 May 31 Profit or loss 58 880
20.4 20.4
May 31 Depreciation: machinery GJ 46 000 May 31 Profit or loss 47 104
20.5 20.5
May 31 Depreciation: machinery GJ 103 500 May 31 Profit or loss 37 683

ZAMOKUHLE
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY (EXTRACT)

20.5 20.4 20.3 20.2 20.1

R R R R R
Non-current assets
Property, plant and equipment NIL 103 500 149 500 218 500 345 000

ZAMOKUHLE
NOTES FOR THE YEAR ENDED 31 MAY 20.2

Property, plant and equipment Machinery Total

R R
Carrying amount:
Beginning of year 345 000 l) 345 000)l)
Cost 460 000) 460 000)
Accumulated depreciation (115 000) (115 000)

Depreciation (126 500) ) (126 500) l

Carrying amount:
End of year 294 400))l 294 400))l
Cost 460 000) 460 000)
Accumulated depreciation (241 500) (241 500)

16
11.8 ACQUISITION OF PROPERTY, PLANT AND EQUIPMENT DURING
THE FINANCIAL YEAR
Suppose a machine is purchased six months before the end of the year. The provision for
depreciation for the first year must be determined for a portion of the year, which in this case
6
is 10 or 50% of the year.
If the cost price of the machine is R460 000 and the depreciation rate is 20% per year, the
provision for depreciation for the first year will be as follows:

20 6
R460 000 × ×
100 12
= R46 000

11.9 DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT

GOLDEN RULE
According to IAS 16 the carrying amount of an item of property, plant and equipment must be
derecognised

- on disposal or
- when no future economic benefits are expected from its use or disposal

When an asset is no longer useful to an entity and is disposed of, it must be removed from
the books and the asset register.

There are different ways to dispose of an asset, namely,

• scrapping it
• selling it outright or
• trading it in as partial payment on the purchase of a new asset

The gain or loss arising from the derecognition of an item of property, plant and equipment
must be determined as the difference between the net disposable proceeds, if any, and the
carrying amount of the item.

If an asset is traded-in for another asset, or sold, the profit or loss made on the disposal of the
asset must be treated as other income or distribution, administrative and other expenses in
the statement of profit or loss and other comprehensive income for the current financial
period.

EXERCISE 11.2 Scrapping an asset that has been written off entirely

We will use the information provided in exercise 11.1.

Suppose that Zamokuhle used the straight-line method of depreciation and decided to scrap
the machine at the end of its useful life.

17
 REQUIRED
Show the journal entry and the ledger accounts to record the transaction.

SOLUTION: EXERCISE 11.2

ZAMOKUHLE
GENERAL JOURNAL – MAY 20.5
R R
31 Accumulated depreciation: machinery B8 460 000
Machinery (at cost) B5 460 000
Scrapped machine written off

ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr

20.1 R 20.5 R
Jun 1 Bank CPJ 460 000 May 31 Accumulated depreciation:
machinery GJ 460 000

Dr Accumulated depreciation: machinery B8 Cr

20.5 R 20.1 R
May 31 Machinery (at cost) GJ 460 000 May 31 Depreciation GJ 92 000
20.
May 31 Depreciation GJ 92 000
20.3
May 31 Depreciation GJ 92 000
20.4
May 31 Depreciation GJ 92 000
20.5
May 31 Depreciation GJ 92 000

460 000 460 000

As illustrated in this exercise, the asset was scrapped and was written off entirely. This means
there are no proceeds.

18
EXERCISE 11.3 Scrapping an asset (at the end of the financial year)
that has not been written off (depreciated entirely)

Suppose that Zamokuhle bought a machine costing R460 000 on 30 November 20.0. The
management of Zamokuhle decided to scrap the machine at the year ended 31 May 20.5
when the accumulated depreciation amounted to R402 500.

(Note that, in this exercise, the purchase date has changed, and the production unit
method of depreciation is used. The units of production for each year are given in
exercise 11.1.)

REQUIRED
(a) Show the journal entries and the ledger accounts to record the
transactions.
(b) Show the note regarding property, plant and equipment.

SOLUTION: EXERCISE 11.3

(a)
ZAMOKUHLE
GENERAL JOURNAL – MAY 20.5
R R
31 *Realisation of machinery N9 460 000
Machinery (at cost) B5 460 000
Transfer machinery at cost to realisation account

Accumulated depreciation: machinery B5 402 500

Realisation of machinery N9 402 500
Transfer depreciation to realisation account

Loss on scrapping of machinery N10 57 500

Realisation of machinery N9 57 500
Loss on scrapping of machine

*Note: The account "Realisation of machinery" is used to capture the entries regarding the
disposal of the machinery.

19
 ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr

20.0 R 20.5 R
Nov 30 Bank CPJ 460 000 May 31 Realisation of machinery GJ 460 000

Dr Accumulated depreciation: machinery B8 Cr

20.5 R 20.1 R
May 31 Realisation of machinery GJ 402 500 May 31 Depreciation: machinery
a
(part of year) GJ 57 500
20.2
May 31 Depreciation: machinery GJ 126 500
20.3
May 31 Depreciation: machinery GJ 69 000
20.4
May 31 Depreciation: machinery GJ 46 000
20.5
May 31 Depreciation: machinery GJ 103 500

402 500 402 500

Units produced during the year

* Formula for calculating depreciation: Expected number of units to be produced over life span
× Cost price
a 500/ x R460 000 x 6/12 = R57 500
2 000
Why 6/12? Zamokuhle bought the asset on 30 November 20.0. The financial year end for Zamokuhle is
31 May 20.1. Therefore, the number of months the asset is in use = 6.

Dr Realisation of machinery N9 Cr

20.5 R 20.5 R
May 31 Machinery (at cost) GJ 460 000 May 31 Accumulated depreciation:
machinery GJ 402 500
Loss on scrapping of
machinery GJ 57 500

460 000 460 000

Dr Loss on scrapping of machinery N10 Cr

20.5 R
May 31 Realisation of machinery 57 500

The loss on scrapping of machinery account will be closed off to the profit or loss account at the end of the
financial year.

20
(b)
ZAMOKUHLE
NOTES FOR THE YEAR ENDED 31 MAY 20.5

Property, plant and equipment Machinery Total

R R
Carrying amount:
Beginning of year 161 000 l) 161 000)l)
Cost 460 000) 460 000)
Accumulated depreciation *(299 000) (299 000)

Depreciation (103 500) ) (103 500) l

Disposals (57 500) ) (57 500) l

Cost (460 000) (460 000)

Accumulated depreciation 402 500) 402 500)

Carrying amount:
End of year –))l –)l
Cost – –
Accumulated depreciation – –

* R57 500 + R126 500 + R69 000 + R46 000 = R299 000

COMMENTS
• Please note that the disposals are at the carrying amount in the notes to
the financial statements because the gains and losses on realisation of
a non-current asset will be posted to the profit or loss account and
statement of profit or loss and other comprehensive income for the year
and will not be entered in the statement of financial position.
• Should you have land and buildings as non-current assets, the amounts
must, if possible, be determined separately. The reason for this is that
land is not depreciated but buildings can be depreciated. These
amounts have to be disclosed separately in the note to the financial
statements.

GOLDEN RULE
According to IAS 16, an entity must present and disclose information about the entity’s
investment in property, plant and equipment and the changes that occurred in such
investments.

The following information must be disclosed for each class of property, plant and equipment
in the notes to the financial statements:

- the measurement basis used for determining the gross carrying amount
- the depreciation methods used

21
 - the useful lives or the depreciation rates used
- the gross carrying amount and the accumulated depreciation at the beginning and the
end of the period
- a reconciliation of the carrying amount at the beginning and the end of the period,
showing
• additions
• depreciation
• disposals (at carrying value)
and
- the existence and amounts of restrictions on title, and property, plant and equipment
pledged as security for liabilities

EXERCISE 11.4 Scrapping an asset (at the end of the financial year)
that has not been written off (depreciated) entirely

Suppose that Zamokuhle bought a machine costing R460 000 on 30 November 20.0. The
management of Zamokuhle decided to sell the machine for R60 000 cash at the year ended
31 May 20.5 when the accumulated depreciation amounted to R402 500.

(Note that, in this exercise the purchase date has changed, and the production unit
method of depreciation is used. The units of production for each year are given in
exercise 11.1.)

REQUIRED
Prepare the journal entries and the ledger accounts to record this
transaction.

22
 SOLUTION: EXERCISE 11.4

ZAMOKUHLE
GENERAL JOURNAL – MAY 20.5
R R
31 Realisation of machinery N9 460 000
Machinery (at cost) B5 460 000
Transfer machinery at cost to realisation account

Accumulated depreciation: machinery B8 402 500

Realisation of machinery N9 402 500
Transfer depreciation to realisation account

*Bank B2 60 000
Realisation of machinery N9 60 000
Cash received for machinery

Realisation of machinery N9 2 500

Profit on sale of machinery N10 2 500
Sold machinery at a profit

*This entry is normally recorded in the cash receipts journal.

ZAMOKUHLE
GENERAL LEDGER
Dr Machinery (at cost) B5 Cr

20.0 R 20.5 R
Nov 30 Bank CPJ 460 000 May 31 Realisation of machinery GJ 460 000

Dr Accumulated depreciation: machinery B8 Cr

20.5 R 20.1
May 31 Realisation of machinery GJ 402 500 May 31 Depreciation: machinery GJ 57 500
20.2
May 31 Depreciation: machinery GJ 126 500
20.3
May 31 Depreciation: machinery GJ 69 000
20.4
May 31 Depreciation: machinery GJ 46 000
20.5
May 31 Depreciation: machinery GJ 103 500

402 500 402 500

23
 Dr Realisation of machinery N9 Cr

20.5 R 20.5
May 31 Machinery (at cost) GJ 460 000 May 31 Accumulated depreciation:
Profit on sale of machinery GJ 402 500
machinery GJ 2 500 Bank CRJ 60 000

462 500 462 500

The same information given in exercise 11.3 was used but, in this exercise the machine was sold for R60 000
cash instead of being scrapped.

Dr Profit on sale of machinery N10 Cr

20.5
May 31 Realisation of machinery GJ 2 500

The profit on sale of machinery account will be closed off to the profit or loss account at the end of the financial
year.

Dr Bank Cr

20.5 R
May 31 Realisation of machinery 57 500

Pro rata depreciation

When an asset is sold before the end of its expected life span and during the financial year,
the pro rata depreciation for the period from the beginning of the financial year up to the date
of sale must be taken into account as part of the accumulated depreciation. For example, if
you sell an asset on 30 September and the financial year end is 31 December, the asset has
3
been in use for nine months, or of the year. If the percentage for a full year is 20%, the pro
4
9
rata depreciation will be 12 × 20% for the last year.

SUMMARY
The following six steps should be followed when dealing with the disposal of an asset:

1. Record the depreciation of the current period up until the date of disposal
(general journal):
Debit: Depreciation
Credit: Accumulated depreciation

Now calculate the total accumulated depreciation of the disposed asset.

2. Transfer the total accumulated depreciation of the disposed asset to the

realisation account (general journal):
Debit: Accumulated depreciation
Credit: Realisation account

24
3. Transfer the cost price of the disposed asset to the realisation account (general
journal):
Debit: Realisation account
Credit: The particular asset account (vehicles, equipment, etc)

4. Record the amount earned on the realisation (note that the realisation account
is credited in all three cases):
4.1 Sold for cash (CRJ):
Debit: Bank
Credit: Realisation account

4.2 Sold on credit (general journal):

Debit: Debtor (and trade receivables control account)
Credit: Realisation account

4.3 Asset traded in (general journal):

Debit: The asset account (as part of the cost price of the new asset)
Credit: Realisation account

5. Determine the profit or loss on the disposed asset:

5.1 If the total of the debit side of the realisation account is bigger than that of the credit
side, the asset was disposed of at a loss.

5.2 If the total of the credit side of the realisation account is bigger than that of the debit
side, the asset was disposed of at a profit.

6. Transfer the profit or loss to the profit or loss account on disposal of that type
of asset (general journal):
6.1 Profit:
Debit: Realisation account
Credit: Profit on disposal of ... account

6.2 Loss:
Debit: Loss on disposal of ... account
Credit: Realisation account

GOLDEN RULE
Profits (gains) or losses on disposal of assets must be disclosed separately in the
statement of profit or loss and other comprehensive income.

25
11.10 REVISION EXERCISES AND SOLUTIONS

11.10.1 REVISION EXERCISE 1

Please attempt 11.10.1_REVISION EXERCISE 1 under the heading “CONTENT”. The
answer will be provided at a later stage.

11.10.2 REVISION EXERCISE 2

Please attempt 11.10.2_REVISION EXERCISE 2 under the heading “CONTENT”. The
answer will be provided at a later stage.

11.10.3 REVISION EXERCISE 3

Please attempt 11.10.3_REVISION EXERCISE 3 under the heading “CONTENT”. The
answer will be provided at a later stage.

11.10.4 REVISION EXERCISE 4

Please attempt 11.10.4_REVISION EXERCISE 4 under the heading “CONTENT”. The
answer will be provided at a later stage.

SELF-ASSESSMENT

Now that you have studied this study unit, can you:

• define a non-current asset?

• explain how the cost price of a non-current asset is determined?

•
• record the entries for the purchase of property, plant and equipment?

• record the entries for the disposal of property, plant and equipment?

• calculate the depreciation of items of property, plant and equipment

according to the three methods explained and record the related
entries?

26
 FAC3704
FAC1502
STUDY UNIT 12

OTHER NON-CURRENT
ASSETS

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

12
Other non-current assets

Learning outcome

You should be able to record transactions related to other non-current assets such as
investments.

Contents
Page
Key concepts
12.1 Introduction 3
12.2 Intangible assets 3
12.3 Financial instruments 6
12.4 Other financial assets and methods of recording them 7
12.4.1 Cash investments 7
12.4.2 Investments in shares 9
12.5 Revision exercise 9
Self-assessment 9

2
 KEY CONCEPTS
• Intangible assets
• Amortisation
• Other financial assets
• Cash investments
• Loans granted
• Investments in shares
• Ordinary shares
• Investment income

12.1 INTRODUCTION
Non-current assets are divided into tangible assets, intangible assets and other financial assets.
Tangible assets (property, plant and equipment) were discussed in study unit 11. Other non-
current assets (intangible assets and other financial assets) are discussed in this study unit.

12.2 INTANGIBLE ASSETS

IAS 38 defines intangible assets as identifiable non-monetary assets without physical
substance that are held for use in the production or supply of goods or services, for rental to
others or for administrative purposes and that are controlled by an entity as a result of past
events and from which future economic benefits are expected to flow to the entity.
An intangible asset is identifiable when it
- is capable of being separated from the entity and can be sold, transferred, licensed,
rented or exchanged, either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do so or
- arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations
Examples of intangible assets are as follows:
• patented technology, computer software, databases, and trade secrets
• trademarks, trade dress, newspapers, mastheads and internet domains
video and audiovisual material, like motion pictures and television programmes
• customer lists
• mortgage servicing rights
• licensing, royalty and standstill agreements
• import quotas
• franchise agreements
• customer and supplier relationships
• marketing rights

Internally generated goodwill is within the scope of IAS 38 but is not recognised as an asset
because it is not an identifiable resource.

Intangible assets can be acquired by separate purchase, as part of a business combination, by

a government grant, by exchange of assets or by self-creation (internal generation).

3
According to IAS 38, expenditure for an intangible asset is recognised as an expense, unless
the item meets the definition of an intangible asset and
- it is probable that future economic benefits will emanate from the asset and
- the cost of the asset can be reliably measured

INITIAL RECOGNITION OF AN INTANGIBLE ASSET

Intangible assets are initially measured at cost. However, the cost of generating an intangible
asset internally is often difficult to distinguish from the cost of maintaining or enhancing the
entity’s operations or goodwill. For this reason, internally generated brands, mastheads,
publishing titles, customer lists and similar items are not recognised as intangible assets. These
costs must always be recognised in the profit or loss account when they were incurred. The
costs of generating other internally generated intangible assets are classified according to
whether they arise in a research phase or a development phase. Research expenditure is
recognised as an expense in the profit or loss account. Development expenditure that meets
specified criteria is recognised as the cost of an intangible asset. This means the that the entity
must intend and be able to complete the intangible asset and either use it or sell it and be able
to demonstrate how the asset will generate future economic benefits.
Given the nature of intangible assets, subsequent expenditure after the initial cost will only
rarely meet the criteria for being recognised in the carrying amount of an asset and therefore
has to be recognised in the profit or loss account in the period in which it is incurred.

MEASUREMENT AFTER RECOGNITION

An entity must adopt either the cost model or the revaluation model as its accounting policy.
For FAC1502, we will discuss the cost model.
After initial recognition, an entity usually measures an intangible asset at cost less accumulated
amortisation and impairment losses. Amortisation is the systematic allocation of the depreciable
amount of an intangible asset over its useful life. In rare cases, an entity may choose to measure
an asset at fair value when fair value can be determined by reference to an active market.
An intangible asset with a finite useful life, that is, a limited period of benefit to the entity, is
amortised and is subject to impairment testing. An intangible asset with an indefinite useful life,
that is, no foreseeable limit to the period over which the asset is expected to generate net cash
inflows for the entity, is not amortised but is tested annually for impairment.
When an intangible asset is disposed of, the gain or loss on disposal is included in the profit or
loss account (statement of profit or loss and other comprehensive income).

DISCLOSURE OF INTANGIBLE ASSETS

An entity’s intangible assets are disclosed in the financial statements and the notes to the
financial statements.
A note for intangible assets is prepared in the same way as notes for property, plant and
equipment.
The total carrying amount of intangible assets at the end of the year is disclosed in the
statement of financial position of the entity.
Amortisation of intangible assets is disclosed in the statement of profit and loss and other
comprehensive income under distribution, administrative and other expenses.
Below is a basic illustration of how you would disclose intangible assets on the statement of

4
financial position.

XYZ TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED … (EXTRACT)
R
Distribution, administrative and other expenses
Amortisation of intangible assets xx xxx

XYZ TRADERS
STATEMENT OF FINANCIAL POSITION AS AT … (EXTRACT)
ASSETS Notes R
Non-current assets
Property, plant and equipment 3 xx xxx
Intangible assets 4 xx xxx

The notes and disclosure of intangible assets and amortisation of intangible assets are beyond the scope of this
module.

GOLDEN RULE
According to IAS 38.118, an entity must present and disclose the following information in the
notes to the financial statements for each class of intangible asset:

- the useful life or amortisation rate

- the amortisation method
- the gross carrying amount
- the accumulated amortisation and impairment losses
- line items in the statement of profit or loss and other comprehensive income in which
amortisation is included
- a reconciliation of the carrying amount at the beginning and the end of the period,
showing
• additions
• assets held for sale
• retirements and other disposals
• impairment losses
• amortisation
• foreign exchange differences

According to IAS 38.122, an entity must disclose

- the basis for determining that an intangible asset has an indefinite life
- a description and the carrying amount of individually material intangible assets
- certain special disclosures about intangible assets acquired by way of government

5
 grants
- information about intangible assets whose title is restricted
- contractual commitments to acquire intangible assets

According to IAS 38.126, an entity must disclose

- the amount of research and development expenditure recognised as an expense in the

current period

12.3 FINANCIAL INSTRUMENTS

Financial instruments are any assets that hold capital and can be traded in the market.
Examples of financial instruments are shares, stocks, bonds, futures and options contracts. A
financial instrument is therefore defined as a contract that gives rise to a financial asset of one
entity and a financial liability or an equity instrument of another. It is therefore a contract
between individuals/parties that holds a monetary value. Financial instruments can be created,
traded, settled or modified as per the requirements of the parties involved. IAS 32 outlines the
accounting requirements for the presentation of financial instruments, particularly as to the
classification of such instruments into financial assets, financial liabilities and equity
instruments. The standard also provides guidance on the classification of related interest,
dividends and gains/losses, and when financial assets and financial liabilities can be offset.

When an entity first recognises a financial asset, it classifies it based on the entity’s business
model for managing the asset and the asset’s contractual cash flow characteristics, as follows:
• Amortised cost – a financial asset is measured at amortised cost if both of the following
conditions are met:
- the asset is held within a business model whose objective is to hold assets in order
to collect contractual cash flows; and
- the contractual terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest on the principal amount
outstanding.
• Fair value through other comprehensive income – financial assets are classified and
measured at fair value through other comprehensive income if they are held in a business
model whose objective is achieved by both collecting contractual cash flows and selling
financial assets.
• Fair value through profit or loss – any financial assets that are not held in one of the two
business models mentioned are measured at fair value through profit or loss.
When, and only when, an entity changes its business model for managing financial assets it
must reclassify all affected financial assets [IFRS 9].

6
Financial instruments can primarily be classified into two types:
- Derivative instruments
Derivative instruments can be defined as instruments whose characteristics and value
can be derived from their underlying entities, such as interest rates, indices or assets,
among others. The value of such instruments can be obtained from the performance of
the underlying component. They can also be linked to other securities such as bonds
and shares/stocks.
- Cash instruments
Cash instruments, on the other hand, are defined as instruments that can be transferred
and valued readily in the market. Some of the most common examples of cash
instruments are deposits and loans where the lenders and borrowers are required to
be agreed upon.
In tems of IFRS 9, an entity must initially measure all financial instruments at fair value plus or
minus, in the case of a financial asset or a financial liability not at fair value through profit or
loss, transaction costs that are directly attributable to the acquisition or issue of the financial
asset or the financial liability.

12.4 OTHER FINANCIAL ASSETS AND METHODS OF RECORDING THEM

When a financial asset is acquired, the relevant financial asset account is debited and the bank
account credited. IFRS 9 requires and entity to recognise a financial asset or a financial liability
in its statement of financial position when it becomes party to the contractual provisions of the
instrument.

12.4.1 Cash investments

Every entity tries to invest its available cash in the most profitable way, that is, the entity tries
to
• obtain the highest yield or
• earn the best return on its investment

Although cash investments are not always the most profitable type of investment, entities often
have cash temporarily available that they want to invest for a relatively short period. The cash
may be required on a specific future date.
Such an investment may be in the form of a savings account, a call deposit or a fixed deposit.
This kind of investment usually yields interest at a fixed rate or a rate that does not change
often. The income will be disclosed in the profit or loss account (statement of profit or loss and
other comprehensive income).

7
 EXERCISE 12.1

SKY IS D LIMIT TRADERS

EXTRACT FROM THE LIST OF BALANCES AS AT 28 FEBRUARY 20.8

Fixed deposit: FAC Bank (12,10%) 800 000

Interest on fixed deposit 48 400

Additional information

On 1 June 20.7, SKY IS D LIMIT Traders invested money in a three-year fixed deposit account
with FAC Bank at 12,10% interest per annum. The interest is payable quarterly. Account for
any outstanding interest.

REQUIRED
Using the information given, show the disclosure of the fixed deposit in the
financial statements of SKY IS D LIMIT Traders for the year ended
28 February 20.8.

SOLUTION: EXERCISE 11.1

SKY IS D LIMIT TRADERS

STATEMENT OF PROFIT AND LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.8 (EXTRACT)
R
Other income
a72
Interest income: fixed deposit 600
a
Interest on fixed deposit = R800 000 x 12.10% x ¾ = R72 600

SKY IS D LIMIT TRADERS

STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.8 (EXTRACT)
ASSETS R
Non-current assets
Property, plant and equipment xx xxx
Financial assets : fixed deposit at FAC Bank 800 000

Current assets
Trade and other receivables (xxx + b24 200) xx xxx
b Accrued income = R72 600 – R48 400 = R24 200

8
12.4.2 Investment in shares
Dividends earned on investments in shares differ from interest in that interest is usually earned
at a fixed rate while dividends are received only if the company that issued the shares declares
a dividend. The rate at which dividends are to be paid out is decided annually. The accounting
procedure is basically the same as for interest.
As regards the extent of dividends declared, dividends are shown either as a percentage of the
nominal value of the shares or as cents per share. The dividend received will be entered in the
profit or loss account.
Exchange-traded derivatives, such as equity futures and stock options, also fall in this category.

SELF-ASSESSMENT

Now that you have studied this study unit, can you

• describe the form that an investment may take?

• explain how the cost price of an investment is determined?

• record the necessary entries regarding an investment in the accounting

records?

• calculate the net income on an investment and record the related

entries in the accounting records?

9
 FAC3704
FAC1502
STUDY UNIT 13

CURRENT LIABILITIES

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
TOPIC D
ACCOUNTABILITY FOR CURRENT AND NON-CURRENT LIABILITIES

Learning outcome

You should be able to explain, valuate and record transactions pertaining to current
and non-current liabilities and to explain how they are controlled.

CONTENTS

Study units
13 CURRENT LIABILITIES
14 NON-CURRENT LIABILITIES

2
STUDY UNIT

13
Current liabilities

Learning outcome

You should be familiar with the treatment of current liabilities in the books of an entity.

Contents
Page
Key concepts
13.1 Introduction 4
13.2 Trade payables 4
13.3 Sundry current liabilities 6
13.4 Disclosure in the statement of financial position 6
13.5 Trade payables control account 7
13.6 Revision exercises and solutions
13.6.1 Revision exercise 1 14
13.6.2 Revision exercise 2 14
13.6.3 Revision exercise 3 14
Self-assessment 14

3
 KEY CONCEPTS
• Trade payables
• Sundry current liabilities
• Value-Added Tax payable
• Instalments payable on interest-bearing borrowings
• Accrued expenses
• Provisions
• Dividends payable
• Profit share payable
• Settlement discount received

13.1 INTRODUCTION
A liability is a claim that a party other than the owner/s of an entity has on the assets of the
entity. It usually originates from a transaction in the past, but it can also be the result of legal
action. It is expected that the payment of a liability will lead to an outflow of resources.
Liabilities can be classified as current liabilities, indicating that payment will or should take
place within the next period of 12 months, or non-current liabilities for which payment should
take place after the next period of 12 months.
The following items are usually classified as current liabilities:
• trade payables
• accrued expenses
• income received in advance
• instalments payable on long-term borrowings
• Value-Added Tax payable to the SA Revenue Service
• bank overdrafts

13.2 TRADE PAYABLES

This type of creditor results from the purchase of goods and services on credit.

When an entity pays a creditor within a specific period according to an agreement, the entity
may get a discount on the outstanding account, which is referred to as settlement discount
received. Settlement discount received is deducted from purchases in determining the cost of
purchases.

EXERCISE 13.1

On 2 January 20.1, LM Traders purchased merchandise costing R500 from creditor Musa
Suppliers. On 30 January 20.1, LM Traders paid R495 to Musa Suppliers by EFT in full
settlement of its account.

4
The entries would be as follows:

LM TRADERS
TRADE PAYABLES LEDGER
Dr Musa Suppliers CL1 Cr

20.1 R 20.1 R
Jan 30 Bank CPJ 495 Jan 12 Purchases PJ 500
Settlement discount received GJ 5

500 500

LM TRADERS
GENERAL LEDGER
Dr Trade payables control B6 Cr

20.1 R 20.1 R
Jan 30 Bank R(xxx including 495) CPJ xx xxx Jan 2 Purchases R(xxx
Settlement discount received CPJ 5 including 500) PJ 500

Usually, the transactions on the debit side will be entered as one transaction when the totals of the trade payables
column are posted to the ledger. The entry will then be “bank, settlement discount received and VAT output”. The
entries have been done separately just to explain certain concepts.
The R(xxx including 495) and the R(xxx including 500) represent the totals of the trade payables column in the
purchases journal and the cash payments journal, respectively. These totals were posted to the trade payables
control account. The R495 and the R500 represent one of these entries in these two journals that have been
posted as totals to the trade payables control account.

Dr Settlement discount received N7 Cr

20.1 R 20.1
Dec 31 Purchases GJ 5 Jan 30 Musa Suppliers/trade
payables control GJ 5

COMMENTS
• Settlement discount received is deducted from purchases in
determining the cost of purchases.
• In this specific example, we show two entries on the debit side of the
creditors account. The total of the two amounts is normally recorded in
the trade payables column of the cash payments journal. Only one
posting, representing both accounts, is then necessary.
• Creditor: Musa Suppliers will be one of many creditors. A trade payables
control account in the general ledger will then be in use and will

5
 represent all individual creditors appearing in the trade payables ledger.
A debit to a creditor's individual account will be included in the debits to
the trade payables control account and vice versa.
• In study unit 6 we explained the influence of settlement discount
received on VAT. In this study unit we will be ignoring VAT.

13.3 SUNDRY CURRENT LIABILITIES

There are several types of current liabilities. At the end of the financial year an entity must
provide for accrued expenses. and VAT payable to the SA Revenue Service. Income received
in advance is also classified as a current liability.

To refresh your memory with regard to accrued expenses and income received in advance,
revise study unit 6, which deals with adjustments.

In the case where the VAT output amount (credit) is bigger than the VAT input amount (debit)
in the VAT control account you will have to pay the difference over to the SA Revenue Service.
This amount will then be disclosed under current liabilities in the statement of financial position.

GOLDEN RULE
The portion of a long-term loan or obligation to be repaid within the next 12 months must
be disclosed as a current liability in the statement of financial position.

13.4 DISCLOSURE IN THE STATEMENT OF FINANCIAL POSITION

According to International Financial Reporting Standards in South Africa, current liabilities are
disclosed as follows in the statement of financial position of an entity:

NAME OF ENTERPRISE
STATEMENT OF FINANCIAL POSITION AS AT ...........
ASSETS R
EQUITY AND LIABILITIES
Total equity
Current liabilities xxx xxx
Trade and other payables a
xx xxx
Income received in advance x xxx
Other financial liabilities x xxx
Current portion of long-term borrowings xx xxx
Current VAT payable x xxx

a
Trade and other payables include the trade payables control balance (refer to exercise 13.1) and all the accrued
expenses as at the date of the statement of financial position.

6
 EXERCISE 13.2

The following balances were taken from the post-adjustment trial balance of Picnic Traders as
at 31 December 20.1:
R
Trade payables control 221 000
Accrued interest on loan 1 500
Bank overdraft 34 600
VAT control 4 500
Income received in advance 13 000

Additional information

The credit side (VAT output) of the VAT control account is bigger than the debit side (VAT input)
of the VAT control account.

The layout in the statement of financial position with regard to the above information will be as
follows:

PICNIC TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1 (extract)
ASSETS R
EQUITY AND LIABILITIES
Total equity
Current liabilities 274 600
Trade and other payables R(221 000 + 1 500) 222 500
Income received in advance 13 000
Bank overdraft 34 600
Current VAT payable 4 500

COMMENTS

• Trade and other payables include the trade payables control balance
and the accrued expenses as at the date of the statement of financial
position.
• For this module income received in advance is not included in trade and
other payables but is shown separately on the face of the statement of
financial position under the heading “current liabilities”.

13.5 TRADE PAYABLES CONTROL ACCOUNT

The trade payables control account in the general ledger represents all the individual creditors
in the trade payables (subsidiary) ledger.
The trade payables control account reflects a summary of the individual creditors' transactions,

7
and the balance of the trade payables control account must be equal to the total of the individual
creditors' account balances.
Posting to the personal accounts of the creditors takes place on a daily basis. Once a month,
when the totals of all the trade payables control columns in all the subsidiary journals have been
determined, the amounts are posted to the trade payables control account.

The procedure can be summarised as follows:

Individual entries in the purchases are the personal accounts of creditors

journal posted to (credit side) in the trade payables
ledger on the days the transactions
take place.

The total of the trade payables control are the trade payables control account
column in the purchases journal posted to (credit side) on the last day of the
month.

Individual entries in the purchases are the personal accounts of creditors

returns journal posted to (debit side) in the trade payables
ledger on the days the transactions
take place.

The total of the trade payables control are the trade payables control account
column in the purchases returns journal posted to (debit side) on the last day of the
month.

Individual entries in the cash payments are the personal accounts of creditors
journal posted to (debit side) in the trade payables
ledger on the days the transactions
take place.

The total of the trade payables control are the trade payables control account
column in the cash payments journal posted to (debit side) on the last day of the
month.

GOLDEN RULE

The rules applicable to liabilities are applicable to the trade payables control account, that
is a credit entry in the T-account will increase the trade payables control account (we will
owe them more money) and a debit entry in the T-account will decrease the trade payables
control account (we will owe them less money). The same rules will be applied to the
individual accounts of creditors in the trade payables ledger. That means if we owe the
creditor more money the account of the creditor will be credited. If we owe the creditor less
money the account of the creditor needs to be debited.

8
GENERAL JOURNAL

Provision can be made in the general journal for analysis columns for the trade receivables and
trade payables control accounts. The entries made in the general journal that affect creditors
must also be posted to the personal accounts of the creditors on a daily basis and the totals of
the columns must be posted to the control accounts at the end of the month. We will not make
provision for these columns in FAC1502 because most of the packages that entities use
to do their books, for example, PASTEL or Quick Books do not make provision for them.

LEDGER

At the end of the month all the accounts in the general ledger and subsidiary ledgers must be
balanced and a list compiled of all the outstanding creditors' balances. The balance on the trade
payables control account must be equal to the total of the trade payables list. If not, an error
was made either when posting to an individual creditor's account in the trade payables ledger
or when posting the totals of the journals to the trade payables control account. The accountant
must then determine the reason/s for the difference/s and make the necessary corrections.

The trade payables control account is therefore a control measure built into accounting to
determine if the entries in the individual creditors’ accounts in the trade payables ledger are
correct.

DIFFERENT TYPES OF ERRORS

The following errors will result in a difference between the balance of the trade payables control
account and the list of individual creditors’ balances in the trade payables ledger:

• Error/s in posting to the control account and/or the trade payables ledger, for example, a
posting to the debit side of an account instead of the credit side, or the transposition of
figures (e.g., R123 instead of R231)
• Incorrect balancing of accounts
• Incorrect totalling of one or more columns in the journals
• Incorrect listing of a balance
• Omission of a posting, where an entry in a journal (or the total column) was not posted to
the ledger account/s

A reconciliation of the trade payables control account balance with the total of individual
creditors’ balances is explained in the following exercise:

9
 EXERCISE 13.3

The following information relates to Tip-Top Traders:

(1) List of creditors' balances as at 30 September 20.2 as per trade payables ledger:

R
L Brand 6 424
S Ismail 10 285
C Roux 19 426
J Zulu 4 048
40 183

(2) Balance of the trade payables control account in the general ledger as R
at 31 August 20.2 47 072

(3) Totals of subsidiary journals as at 30 September 20.2:

R
Purchases journal 96 282
Sales journal 138 195
Purchases returns journal 2 899
Sales returns journal 6 403
Cash receipts journal:
Bank column 210 818
Sales column 98 000
Trade receivables column 118 624
Settlement discount granted column 5 806
Cash payments journal:
Bank column 187 520
Purchases column 87 000
Trade payables column 105 358
Settlement discount received column 4 838

Additional information

(a) A credit note of R353 received from S Ismail in respect of goods returned was correctly
entered in the purchases returns journal but posted to the wrong side of S Ismail's
account.
(b) An invoice of R286 in respect of goods purchased from L Brand was erroneously
omitted from the purchases journal.

10
(c) According to the monthly statement received from J Zulu, interest of R45 has been
charged on the overdue account. No entry has as yet been made.
(d) According to the trade payables ledger, the correct balance on C Roux's account at
30 September 20.2 was R14 926.
(e) An amount of wages paid, R880, was analysed to the trade payables column in the
cash payments journal. No correction has as yet been made.
(f) The purchases journal was overcast by R1 000. ("Overcast" means that the total
amount is more than it should be. "Undercast" means that the total is less than it should
be.)

REQUIRED
(1) Prepare the trade payables control account in the general ledger for
September 20.2.
(2) Prepare the corrected accounts of the creditors in the trade payables
ledger.
(3) Prepare a list of the adjusted trade payables' balances as at
30 September 20.2.

SOLUTION EXERCISE 13.3

(NOT REQUIRED – ONLY INCLUDED FOR EXPLANATORY PURPOSES)

TIP-TOP TRADERS
GENERAL JOURNAL – SEPTEMBER 20.2 GJ
Date Details Fol Debits Credits
R R
30 S Ismail CL2 353
Cancellation of the wrong credit entry to
the account of S Ismail in the trade
payables ledger
S Ismail CL2 353
Correction of the wrong credit entry to the
account of S Ismail in the trade payables
ledger
Interest expenses N8 45
J Zulu/trade payables control CL4/B6 45
Interest charged on the overdue account
of J Zulu
Wages N6 880
Trade payables control B6 880
Correction of wages erroneously posted to
the trade payables control account

11
(1)
TIP-TOP TRADERS
GENERAL LEDGER
Dr Trade payables control B6 Cr

20.2 R 20.2
Sep 30 Purchases returns PRJ 2 899 Sep 1 Balance b/d 47 072
Bank and settlement Sep 30 Purchases R(96 282 –
discount received CPJ 105 358 1 000 + 286) PJ 95 568
Balance c/d 35 308 Interest expenses GJ 45
Wages GJ 880

143 565 143 565

20.2
Oct 1 Balance b/d 35 308

GOLDEN RULE
The trade payables control account is a summary of ALL transactions related to all the
individual creditors’ accounts in the trade payables ledger.

GOLDEN RULE
What was done (Dr or Cr) to the individual creditors’ accounts must be done IN TOTAL to the
trade payables control account.

(2)
TIP-TOP TRADERS
TRADE PAYABLES LEDGER
L Brand CL1

Debit Credit Balance

20.2 R R R
Sep 30 Account rendered b/d 6 424 Cr
Purchases PJ 286 6 710 Cr

S Ismail CL2

Debit Credit Balance

20.2 R R R
Sep 30 Account rendered b/d 10 285 Cr
Purchases returns (2 × R353) GJ 706 9 579 Cr

12
C Roux CL3

Debits Credits Balance

20.2 R R R
Sep 30 Account rendered b/d 14 926 Cr

J Zulu CL4

Debits Credits Balance

20.2 R R R
Sep 30 Account rendered b/d 4 048 Cr
Interest expenses GJ 45 4 093 Cr

(3)
TIP-TOP TRADERS
LIST OF ADJUSTED BALANCES PER TRADE PAYABLES LEDGER AS AT
30 SEPTEMBER 20.2:
R
L Brand 6 710
S Ismail 9 579
C Roux 14 926
J Zulu 4 093
35 308 Balance as per trade payables control account

GOLDEN RULE
The total of all the balances of the individual creditors’ accounts in the trade payables
ledger must equal the balance of the trade payables control account in the general ledger.

13
 COMMENTS
• If information was omitted or transferred incorrectly from the source
document to the purchases journal, both the trade payables control
account and the individual creditor's account will be affected by the
mistake.
• If information was entered correctly in the journal but a posting error
was made to the trade payables ledger, the individual creditor's
account must be corrected, and the trade payables list must be
adjusted to correct the error.
• If an adding mistake was made in one or more columns in the journals,
the correction must only be made in the trade payables control
account.
• In this exercise, the mistakes or omissions on the creditors' personal
accounts were corrected on their accounts and a new list (adjusted list)
that equalled the balance of the trade payables control account was
compiled at 30 September 20.2.
• If you receive an account from a creditor at the end of a month, it will
be in the vertical format, as in exercise 13.3. However, you can also
do the account of a creditor in the T-account format, as in exercise
13.1 (Musa Suppliers). Both methods are correct, and you can choose
the method you are the most confident with.

13.6 REVISION EXERCISES AND SOLUTIONS

13.6.1 REVISION EXERCISE 1

Please attempt 13.6.1_REVISION EXERCISE 1 under the heading “CONTENT”. The answer
will be provided at a later stage.

13.6.2 REVISION EXERCISE 2

Please attempt 13.6.2_REVISION EXERCISE 2 under the heading “CONTENT”. The answer
will be provided at a later stage.

13.6.3 REVISION EXERCISE 3

Please attempt 13.6.3_REVISION EXERCISE 3 under the heading “CONTENT”. The answer
will be provided at a later stage.

14
SELF-ASSESSMENT

Now that you have studied this study unit, can you, in respect of an entity,

• explain what a trade creditor is?

• explain what settlement discount received is?

• calculate the discount involved and record the appropriate entries?

• explain the different types of sundry current liabilities?

• show how current liabilities are disclosed in the statement of financial

performance?

• reconcile the balance of the trade payables control account in the

general ledger with the total of the list of individual creditors’ balances
in the trade payables ledger?

15
 FAC3704
FAC1502
STUDY UNIT 14

NON-CURRENT LIABILITIES

Financial Accounting I:

Financial Accounting
Concepts, Principles and
Procedures
STUDY UNIT

14
Non-current liabilities

Learning outcome

You should be able to describe an entity’s non-current liabilities, to record the

necessary entries in the books and to disclose them in the statement of financial
position.

Contents
Page
Key concepts 3
14.1 Introduction 3
14.2 Recording of non-current liabilities in the books and their disclosure
in the financial statements 3
14.2.1 Long-term loans and mortgages (Long-term borrowings) 3
14.2.2 Debentures 6
14.3 Revision exercises and solutions 8
14.3.1 Revision exercise 1 8
14.3.2 Revision exercise 2 8
Self-assessment 9

2
 KEY CONCEPTS
• Non-current liabilities
• Mortgage
• Debenture
• Registrar of Deeds
• Insured by
• Disclosure
• Long-term borrowings

14.1 INTRODUCTION
According to IAS 32, a financial liability is any liability that is

a contractual obligation

• to deliver cash or another financial asset to another entity or

• to exchange financial assets or financial liabilities with another entity under conditions
that are potentially unfavourable to the entity

A non-current liability is a liability that is payable at the end of the financial period, after a
period of more than one year. The entity usually provides security for this type of loan.

IFRS 9 requires an entity to recognise a financial liability in its statement of financial position
when it becomes party to the contractual provisions of the instrument. At initial recognition,
an entity measures a financial liability at its fair value plus or minus, in the case of a financial
liability not at fair value through profit or loss, transaction costs that are directly attributable
to the acquisition or issue of the financial liability.

14.2 RECORDING OF NON-CURRENT LIABILITIES IN THE BOOKS AND

THEIR DISCLOSURE IN THE FINANCIAL STATEMENTS
Long-term borrowings must be disclosed under non-current liabilities in an entity’s statement
of financial position. In this course we will concentrate on long-term borrowings, namely, long-
term loans, mortgages and debentures.

14.2.1 Long-term loans and mortgages (long-term borrowings)

EXERCISE 14.1

Africa Dealers buys a property for R114 000 on 1 January 20.1 by means of a first mortgage
in favour of ABC Bank. The interest rate payable is 17% per annum, and payment will take
place in four equal instalments every fifth year. The first payment will be on 1 January 20.6.
The entity's financial year end is 31 December.

3
 REQUIRED
Show the entries in the ledger accounts and the liability portion of
the statement of financial position of Africa Dealers.

SOLUTION EXERCISE 14.1

AFRICA DEALERS
LEDGER ACCOUNTS
Dr Land B4 Cr

20.1 R
Jan 1 Mortgage: ABC Bank GJ 114 000

Dr Mortgage: ABC Bank B10 Cr

20.1 R
Jan 1 Land GJ 114 000

AFRICA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1 (extract)

ASSETS R
EQUITY AND LIABILITIES
Non-current liabilities 114 000
Long-term borrowings 114 000
Long-term loan from ABC Bank 114 000

COMMENTS
• When an instalment on a loan is payable during the next financial
year, the instalment must be disclosed as a current liability in the
statement of financial position of the current year.
• In the statement of financial position as at 31 December 20.5, the
amount indicated as a long-term loan will be R85 500 R(114 000 –
114 000/ ) and under current liabilities an amount of R28 500 (R114 000/ )
4 4

4
 will be shown as the current portion of long-term borrowings.
• In the statement of profit or loss and other comprehensive income, an
expense of R19 380 (17% x R114 000) in respect of interest expense
will be shown annually for the first five years.
• The existence and amounts of restrictions on title, and property, plant
and equipment pledged as security for liabilities must be disclosed in
the notes to the financial statements.

An illustration of what is explained in the above comments

AFRICA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1 (extract)
ASSETS R
EQUITY AND LIABILITIES
Non-current liabilities 85 500
Long-term borrowings 85 500
Long-term loan from ABC Bank 85 500

Current liabilities
Current portion of long-term borrowings 28 500

ECO

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (extract)

R
Finance costs
Interest on loan (R114 000 x 17%) 19 380

5
 GOLDEN RULE
Proof of ownership of assets like land and buildings and vehicles takes the form of a legal
document that must be signed and notarised at the Office of the Registrar of Deeds. The
deed must be filed at the Deeds Office, which is responsible for the registration,
management and maintenance of the property registry of South Africa. The need for
registers of deeds arises when individuals or companies want to access important
information about a piece of property. You can get information from the deed’s registry in
respect of the following:
• the registered owner of a property
• the conditions affecting such property
• interdicts and contracts in respect of the property
• the purchase price of the property
• rules of a sectional title scheme
• a copy of an ante nuptial contract (ANC)
• deeds of servitude
• mortgage bonds

14.2.2 Debentures
Large companies that want to borrow money for a certain period at a fixed rate of interest will
issue debentures to raise capital to meet the expenses of an upcoming project or to pay for
a planned expansion in business. Debentures are medium to long-term unsecured debt
instruments, similar to bonds, that large companies issue in order to raise capital.
“Unsecured” means the debentures are not backed by physical assets or collateral.
Debentures are only backed by companies’ creditworthiness and reputation.
Although the money raised by the issue of debentures becomes part of the company’s capital
structure, it does not become share capital and it will be disclosed as a non-current liability.
A debenture is documented by an agreement called an indenture that stipulates the general
agreement between the company issuing the debenture and the investor buying the
debenture. This indenture will stipulate the interest rate, the maturity date and convertibility
(converted into shares at a pre-specified date on the indenture).
The debenture can be held until maturity. At maturity, or at the end of the agreement period,
the company (issuer) will return the money initially borrowed from the investor. The investor
can buy or sell the debenture on the stock exchange through a stockbroker.
The interest is paid to the investor, regardless of whether the issuing company makes a profit
or not. The interest paid will be disclosed as finance charges in the statement of profit or loss
and other comprehensive income of the issuing company for the financial period.
We are concentrating on the books and financial statements of sole traders, and sole
traders are not allowed to issue debentures. Only companies are allowed to issue
debentures. For the purposes of FAC1502, you don’t need to know the ledger
accounts, only that there is a non-current liability known as long-term borrowings
(debentures), what a debenture is and how to disclose debentures in the statement of
financial position of a company.

6
EXERCISE 14.2

A Company wishes to borrow R2 000 000 by means of debentures of R1 000 each at 15%
interest. The public are invited in an advertisement to buy the debentures. The debentures
will be redeemed on 31 December 20.9. Applications for 2 500 debentures are received and
2 000 debentures are allocated on 1 January 20.1.

REQUIRED
Show the entries in the ledger accounts and the statement of financial
position of A Company.

SOLUTION EXERCISE 14.2

A COMPANY
LEDGER ACCOUNTS

Dr Bank Cr

20.1 R 20.1 R
Jan 30 Applications for Jan 1 Applications for
debentures CRJ 2 500 000 debentures CPJ 500 000

Dr Applications for debentures Cr

20.1 R 20.1 R
Jan 1 15% debentures 2 000 000 Jan 1 Bank 2 500 000
Bank 500 000 Se

2 500 000 2 500 000

Dr 15% Debentures Cr

20.1
Jan 1 Applications for
debentures 2 000 000

7
A COMPANY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1 (extract)
ASSETS R
EQUITY AND LIABILITIES
Non-current liabilities 2 000 000
Long-term borrowings 2 000 000
2 000, 15% R1 000 debentures redeemable on 31 December 20.9 2 000 000

COMMENTS
• The amount received as a result of excess applications is repaid to
the unsuccessful applicants.
• The annual interest expense on the debentures will be shown in the
statement of profit or loss and other comprehensive income as finance
charges.
• On the statement of financial position as at 31 December 20.8, the
debentures will be shown as a current liability since they will be
redeemed within the next 12 months.

14.3 REVISION EXERCISES AND SOLUTIONS

14.3.1 REVISION EXERCISE 1

Please attempt 14.3.1_REVISION EXERCISE 1 under the heading “CONTENT”. The
answer will be provided at a later stage.

14.3.2 REVISION EXERCISE 2

Please attempt 14.3.2_REVISION EXERCISE 2 under the heading “CONTENT”. The
answer will be provided at a later stage.

8
SELF-ASSESSMENT
Now that you have studied this study unit, can you describe the following, record the
necessary entries and calculations in the books and show how they will appear in the
statement of financial position?

• long-term loans

• mortgages

• debentures

• interest on loans