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FEDERALUNIVERSITY OF LAFIA
FACULTY OF SOCIAL SCIENCES
DEPARTMENT OF ECONIMICS
2ND SEMESTER, 2018/2019 ACADEMIC SESSION

LECTURE NOTE

COURSE TITLE: BASIC ACCOUNTING FOR ECONOMISTS II

COURSE CODE: ACC 121
COURSE UNITS: 2

COURSE LECTURERS: (1) PROF. M.I. KIDA.

(2) LASISI, T.K,

ASSESSMENT
 Continuous assessment shall be 30% of final grade which comprised of mid semester
test, take home work, and attendance.
 Examinations:
Final, comprehensive (according to University schedule): 70% of final grade.

ACADEMIC ETHICS
 All class and home work must be done independently, unless explicitly stated
otherwise.
 You may discuss general approaches to problems, but must write up the solution
yourself and independently of any other person.
 No late home work is accepted:
 Turn in what you have at the time it’s due
 All home works are due at the start of class
 If you will be away, turn in the homework early
 All students should be seated in class ten (10) minutes before the commencement of
the class.
 No any form of distraction during lecture is allowed.

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COURSE OUTLINE

*Revision: The nature, scope and purpose of accounting, accounting conventions and double
entry book-keeping.
1. Basic financial statements (IAS 1)
2. Accounting for depreciation.
3. Accounting ratios.
4. Correction of errors.
5. Suspense account.
6. Manufacturing account.
7. Introduction to partnership account.
8. Introduction to accounts of registered companies.

RECOMMENDED STUDY MATERIALS

(1) ICAN Financial Accounting Study Text 2019.
(2) ACCA F3 EW Study Text 2018.
(3) ACCA F3 BPP Study Text 2018
(4) CIMA Certificate C2 Fundamental of Financial Accounting.

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REVISION

A. The Context and Purpose of Financial Reporting

1. What is accounting?
2. The objectives of financial accounting
3. The needs of users and stakeholders
4. The main elements of financial reports
5. The regulatory framework

1. What is accounting?
Accounting is the process of collecting, recording, summarising and communicating financial
information

2. The Objectives of Financial Accounting

There are many purposes of accounting. The following are considered as reasons for keeping
accounts.

i. Control over the use of resources

ii. Knowledge of what the business owes and owns
iii. Calculation of profits and losses
iv. Cash budgeting
v. Effective financial planning

3. Users of Financial Statements and Their Needs

Users Group Their Needs

Management People appointed by the company's owners to supervise the daily
activities of the company need information about the company's current
and expected future financial situation, to make planning decisions
Shareholders Want to assess how effectively management is performing and how
much profit they can withdraw from the business for their own use.
Trade contacts Suppliers want to know about the company's ability to pay its debts;
customers need to know that the company is a secure source of supply
and is in no danger of closing down.
Finance Lenders will want to ensure that the company is able to meet interest
providers payments, and eventually to repay the amounts advanced
Tax authorities Want to know about business profits in order to assess the tax payable
by the company
Employees Need to know about the company's financial situation because their
future careers and the level of their wages and salaries depend on it.
Financial Need information for their clients. For example, stockbrokers need
analysts information to advise investors, credit agencies want information to

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advise potential suppliers of goods to the company, journalists need

information for their reading public.
Government Interested in the allocation of resources and in the activities of
and their enterprises. Also require information in order to provide a basis for
agencies national statistics.
The public Want information because enterprises affect them in many ways, e.g. by
providing jobs and using local suppliers, or by affecting the environment
(eg pollution).

Financial statements
Financial statements present information about:
a. the financial position of an entity
b. its financial performance during an accounting period (‘reporting period’)
c. its cash flows and
d. changes in its financial position during the period.

4. Elements of Financial Statements

- assets
- liabilities
- equity
- income
- expenses
- cash flows

4.1 Assets
An asset is defined by the IASB Framework as ‘a resource controlled by the entity as a result
of past events and from which future economic benefits are expected to flow to the entity.’ A
resource will provide ‘future economic benefits’ if it will contribute directly or indirectly to the
inflow of cash to the business.

In the statement of financial position, assets are categorised into two main types:

4.1.1 Non-current assets (IAS 16)

Assets that have a long useful life and are expected to provide future economic benefits for the
entity over a period of several years.

Examples are property, plant and equipment. A machine, for example, might be expected to
have a useful life of five years. If so, it is classified as a non-current asset. Non-current assets
are sometimes referred to as ‘fixed assets’.

Non-current assets can be sub-divided into tangible and intangible assets

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i. Tangible assets: These are identifiable non-monetary assets with a physical substance
(literally assets which can be touched). Examples include factory buildings, machinery used to
make goods for sale and office computers. Tangible assets are also called property, plant and
equipment.

ii. Intangible assets (IAS 38): These are identifiable non-monetary assets without a physical
substance (i.e. have no physical presence). Examples include royalties, trademarks and patents.
They are also called intellectual property because they arise from discoveries or know-how.

4.1.2 Current assets

Assets that are expected to provide economic benefit in the short term. Examples of assets that
are owned are inventory and cash. An example of assets that are owed is money owed by
customers who have purchased goods or services on credit. These assets are called ‘receivables’
or ‘trade receivables’ (to identify the fact that the debt has arisen in the course of business
trading, and the money is therefore owed by customers).

4.2 Liabilities
A liability is defined by the IASB Framework as a ‘present obligation of the entity arising from
past events, the settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits.’

Examples of liabilities are amounts owed to suppliers for goods or services purchased (‘trade
payables’), amounts owed to a bank (bank loans and a bank overdraft) and taxation owed to
the government. It is usual to categorise liabilities in the statement of financial position into:

4.2.1 Non-current liabilities: These are amounts not payable within the next 12 months, for
example a long-term loan from a bank, debenture, deferred tax, long-term finance lease.

4.2.2 Current liabilities:

These are obligations payable within 12 months. Examples are trade payables, other payables,
bank overdraft, tax expense payable, finance cost payable.

4.3 Equity (or Owner’s Capital)

Equity is the residual interest in the business that belongs to its owner or owners after the
liabilities have been deducted from the assets.

Capital is the amount owed to the owner of the business by the business. Owners put in money
to start a business, and are owed any profits which are generated by the business.

Equity = Assets – Liabilities

Equity is therefore sometimes referred to as the ‘net assets’ of the business, in other words
assets minus liabilities.

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Equity might also be referred to as ‘owners’ capital’ because it represents, in accounting terms,
the amount of capital invested in the business by the owners.

However, equity consists not only of capital put into the business by its owners, but also profits
that the business has made and retained or reinvested within the business.

The accounting equation

The accounting equation demonstrates that the assets of a business are always equal to the
liabilities + capital

The accounting equation is that in a statement of financial position:

Assets = Capital + Liabilities

4.4 Income
Income consists of:
- revenue from the sale of goods or services
- other items of income such as interest received from investments
- gains from disposing of non-current assets for more than their ‘carrying value’ or ‘net book
value’.

The term ‘revenue’ means income earned in the course of normal business operations. In an
income statement, revenue and ‘other income’ are reported as separate items.

4.5 Expenses
Expenses consist of:
- expenses arising in the ordinary course of activities, including the cost of sales, wages and
salaries, the cost of the depletion of non-current assets, interest payable on loans and so on.
- losses arising from disasters such as fire and flood, and also losses from disposing of non-
current assets for less than their carrying value in the statement of financial position.

5. The Regulatory System for Financial Accounting

Accounting regulation and international accounting standards
Financial reporting is regulated and controlled. Regulations should help to ensure that
information reported in financial statements has the required qualities and content.

Countries have their own national laws and regulations about financial accounting. In addition,
the accountancy profession has developed a large number of regulations and codes of practice
that professional accountants are required to use when preparing financial statements. These
regulations are accounting standards.

Many countries and companies whose shares are traded on the world’s stock markets have
adopted International Financial Reporting Standards. These are issued by the International
Accounting Standards Board (IASB). Accounting standards are applied to companies and

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corporations, but are not necessarily used to prepare the financial statements of non-corporate
businesses, such as sole traders and partnerships.

IASC Foundation and IASB

The body with overall responsibility for international accounting is the International
Accounting Standards Committee Foundation or IASC Foundation. The members of the IASC
Foundation have no direct involvement in setting accounting standards, but they have oversight
of three bodies that do:
a. The International Accounting Standards Board (IASB)
b. The Standards Advisory Council (SAC)
c. The International Financial Reporting Interpretations Committee (IFRIC).

The IASB
The IASB develops new international accounting standards. These are called International
Accounting Standards (IASs) or International Financial Reporting Standards (IFRSs). An IAS
and an IFRS have equal status: both are international accounting standards.
The ‘new’ name IFRS was introduced when the current IASB structure was established.

- Previously, all standards were issued by a body called the International Accounting Standards
Committee or IASC. The IASC issued International Accounting Standards or IASs.

- In 2001, the IASB took over from the IASC as the body responsible for issuing international
accounting standards. Standards issued by the IASB are IFRSs.

- The existing IASs were adopted by the IASB and many have since been amended. All new
international accounting standards will now be an IFRS, but there will continue to be IASs as
well as IFRSs for the foreseeable future.

The Standards Advisory Council

The SAC consists of representatives from different countries. It gives advice to the IASB on
the development of new IFRSs. The IASB consults with the SAC, to obtain the views and

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opinions of its members, when new accounting standards or amendments to existing standards
are being considered.

IFRIC
Sometimes, when an accounting standard is issued, there is some uncertainty about what the
regulations actually mean, or how the standard should be applied to particular transactions.
When important questions about interpretation are asked, the matter is referred to IFRIC. When
uncertainty arises with the meaning of an accounting standard, IFRIC interprets the rules in an
IAS or IFRS, and publishes its official interpretation.

The role of International Financial Reporting Standards

International Financial Reporting Standards provide rules and guidelines for the preparation
and presentation of financial statements, but they do not cover every aspect of accounting and
every type of business transaction. Where there is no relevant accounting standard for particular
aspects of financial reporting, preparers of financial statements are expected to apply the
general principles and concepts of accounting that are set out in the IASB Framework.

A role of IFRSs is to encourage business entities in all countries to apply similar principles,
concepts and accounting methods, so that the financial statements of all companies can be
compared. Global accounting standards will help with the development of international
investment, because investors should be able to read and understand the financial statements
of companies in any country, and make comparisons.

The IASC Foundation and IASB have no power to enforce the International Financial
Reporting Standards and in this sense IFRSs are ‘voluntary’. The power to enforce the use of
international standards belongs to the governments of individual countries. Some countries
have adopted IFRSs and made them compulsory for some types of business entity. For example,
in the European Union, stock market companies are required to use IFRSs in preparing their
financial statements.

B. Qualitative Characteristics of Financial Information

1 Qualities of financial information

The IASB Framework also sets out the qualities that the information in financial statements
should have in order to make the financial statements useful to users.

There are four main qualitative characteristics:

1.1 understand ability
1.2 relevance
1.3 reliability
1.4 comparability.

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1.1 Understandability
The financial information should be readily understandable by its users. This might seem
obvious: financial information is of no use unless its users can understand it.
There is a potential problem that, for an ‘ordinary user’, financial statements might be too
technical or complex.

1.2 Relevance
Financial information should be relevant to the economic decision-making needs of users.
Financial statements can help users to evaluate past, present or future events, in order to:
- predict the future financial position and performance of the organisation, or
- confirm or correct the evaluations and forecasts they have made in the past.
The relevance of information is affected by its materiality.
- Information is of little or no relevance if it is insignificant (immaterial).
- However, information is relevant if it is material.
Deciding what is material and what is not material can be a matter of judgement.

1.3 Reliability
Financial information must also be reliable. Users must be able to have trust in it, so that they
can use the information to make their economic decisions with confidence that it is not
misleading or too inaccurate.

Information is reliable if it is free from material error and bias. In order to be reliable,
information must have the following qualities:
- Faithful representation
- Substance over form
- Neutrality
- Prudence
- Completeness.

Faithful representation
The information must represent faithfully the transactions or other events that it is supposed to
represent. For example a statement of financial position should faithfully represent the
transactions and other events that have resulted in assets, liabilities and equity.

Substance over form

The information should represent the substance or economic reality of the financial transactions,
even if the economic reality is not consistent with the legal position. An example of ‘substance
over form’ arises when an entity effectively controls the use of an item of equipment even
though it is not the legal owner. An example is a long-term lease in which an entity pays lease
rentals for an item over most of its economic life, controlling the use of the item without
becoming the legal owner. The concept of ‘substance over form’ is that an item should be
accounted for as an asset in such a situation, even though the entity is not its legal owner.

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Neutrality
The information must be free from bias.

Prudence
Financial statements must sometimes recognise the uncertainty in business transactions. For
example, if a business is owed ₦1,000,000 by a number of its customers, there will be some
uncertainty as to whether all the money will actually be collected. Prudence involves allowing
for some caution in preparing financial statements, by making reasonable and sensible
allowances in order to avoid overstating assets or income and to avoid understating expenses
or liabilities.

Completeness
To be reliable, information should be complete, subject to materiality and cost.
(There is no need to include information if it is not material, and greater accuracy is not required
if the cost of obtaining the extra information is more than the benefits that the information will
provide to its users.)

1.4 Comparability
Financial information should enable the users of financial statements to make comparisons:
- with the financial statements of other business entities, and
- with the entity’s own financial statements for previous years.
Proper comparisons are only possible if the information that is being compared has been
prepared on the same basis, in a consistent way.

An important implication of the need for comparability is that an entity should disclose the
accounting policies that it has used to prepare the financial information.

1.5 Constraints on relevant and reliable information

Some of the desirable characteristics of financial information are inconsistent with each other.
For example, it is not possible for information to be completely neutral if there is some element
of prudence in the figures (such as an allowance for bad debts, which is an assessment based
on judgement).

1.6 True and fair view/faithful representation

Financial statements should give a ‘true and fair view’ of the financial position, financial
performance and changes in financial position of an entity. Another way of saying this is that
financial statements should provide a ‘faithful presentation’ of the financial position, financial
performance and changes in financial position of an entity.

Accounting Concepts: Underlying Assumptions

a. The business entity concept
b. The money measurement concept
c. The realisation concept

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d. Accruals basis (matching concept)

e. Going concern assumption
f. Prudence Concept
g. Consistency Concept
h. Materiality Concept

a. The business entity concept

A concept used in financial reporting is that a business entity is an entity that is separate from
its owners. In other words, the business entity and its owners are different.
For example, suppose that John Smith sets up a sole trader business as a builder, and he calls
the business ‘J Smith, Builder’. For the purpose of financial reporting, the business (J Smith,
Builder) and John Smith, the owner of the business, are different and separate from each other.

The owner of the business is someone who has contributed capital to the business, and who
owns the profits that have been made and retained and re-invested in the business. The equity
capital of a business can be thought of as an amount that the business entity owes to its owners.

- Financial statements must not mix the assets and liabilities of the business with the personal
assets and liabilities of the individual owners. For example, the money in a bank account for a
business is an asset of the business, but money in the personal bank account of the business
owner is money belonging to the owner.

- If an owner takes money from the business, for example by taking out some of the profits in
cash, the capital of the business is reduced. The business pays out its cash to the owner. (The
owner is not taking his personal cash, but the cash of the business).

- When an owner invests new money in a business, there is an increase in the equity capital.

b. The money measurement concept

The money measurement concept in financial reporting is that an item should not be
‘recognised’ and included in the financial statements unless it has a money value that can be
measured reliably and objectively.

For example land can be included in the financial statements because its value can be measured
objectively, either at its original cost or at its current market value (which can be determined
objectively from a professional valuation).

c. The realisation concept

The realisation concept is that a transaction should not be ‘recognised’ and included in the
financial statements until it has actually happened and has ‘been realised’. For example, it is
inappropriate to include the profit on a transaction in the financial statements if the transaction
has not happened yet, even if it will happen in the future.

As a general rule, revenue from sales is not ‘recognised’ until the sale transaction has been
realised by the delivery of the goods or service to the customer.

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d. Accruals basis (matching concept)

The accruals basis of preparing financial statements, which is also called the ‘matching
concept’, is based on the following assumptions.

- The cost of sales in the income statement (or within profit and loss in the statement of
comprehensive income) must be matched with the sales. Sales income and ‘matching’ expenses
must be reported in the same financial period.

- Other expenses should be charged in the period to which they relate, not the period in which
they are paid for.

- Income, such as sales, should be reported in the period when the income arises.
This might not be the same as the period when the cash is received.

e. Going concern basis

The going concern basis of accounting is that all the items of value owned by a business, such
as inventory and property, plant and equipment, should be valued on the assumption that the
business will continue in operation for the foreseeable future. The business will not close down
or be forced to close down and sell off all its items (assets). This assumption affects the value
of assets and liabilities of an entity, as reported in the financial statements.

f. Prudence Concept
Prudence is the concept that specifies, in situations where there is uncertainty, appropriate
caution is exercised in recognising transactions in financial records.

For example, inventory should be stated in the statement of financial position at cost rather
than their selling price so as to take into account the uncertainty of disposal.

g. Consistency Concept
The consistency concept states that in preparing accounts consistency should be observed in
two respects.
(a) Similar items within a single set of accounts should be given similar accounting treatment.
(b) The same treatment should be applied from one period to another in accounting for similar
items. This enables valid comparisons to be made from one period to the next.

h. Materiality Concept
A matter is material if its omission or misstatement would reasonably influence the decisions
of a user of the accounts. In preparing accounts it is important to decide what is material and
what is not, so that time and money are not wasted in the pursuit of excessive detail.

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Recording Transactions
Source Documents These are initial documentation which shows the source of
information needed to record financial information. Examples
include invoices, sales order, purchase order, payslip etc.
Books of Prime Entry This is where the source documents are recorded at the first
stage of accounting system. Examples include sales day book,
purchases day book, cash book, sales return day book,
purchases return day book.
Ledger Account (Nominal The ledger contains the account for assets, liabilities, capital,
or General) income, and expenditure. These individual account records all
transactions.

Ledger Accounting
The general ledger is the heart of the accounting system. It contains a separate account for each
item that appears in the statement of profit or loss and statement of financial position.

Basic Rules of Double Entry Book-Keeping

Every transaction will give rise to two accounting entries, a debit and a credit. Because of this
basic fundamental rule, it means that all the debits and all the credits in the ledger will be equal.

- Debit and credit entries, and T accounts

Financial transactions are recorded in the accounts in accordance with a set of rules or
conventions. The following rules apply to the accounts in the main ledger (nominal ledger or
general ledger).

� Every transaction is recorded twice, as a debit entry in one account and as a credit entry in
another account.
� Total debit entries and total credit entries must always be equal. This maintains the
accounting equation.

It therefore helps to show accounts in the shape of a T, with a left-hand and a right hand side.
By convention:
� debit entries are made on the left-hand side and
� credit entries are on the right-hand side.

By convention, the terms ‘debit’ and ‘credit’ are sometimes shortened to ‘Dr’ and ‘Cr’
respectively.

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A Useful Matrix May Help in Understanding the Double Entry System

Event Financial Statement Debit or Credit
Increase in asset Statement of Financial Position Debit
Decrease in asset Statement of Financial Position Credit
Increase in liability Statement of Financial Position Credit
Decrease in liability Statement of Financial Position Debit
Increase in capital Statement of Financial Position Credit
Decrease in capital Statement of Financial Position Debit
Increase in revenue Statement of Profit or Loss Credit
Decrease in revenue Statement of Profit or Loss Debit
Increase in expense Statement of Profit or Loss Debit
Decrease in expense Statement of Profit or Loss Credit

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TOPIC ONE: BASIC FINANCIAL STATEMENTS (IAS 1)

CONTENTS
1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Content
3.1 Objectives, Scope and Definitions of IAS 1
3.2 Purposes of Financial Statements
3.3 Components of Financial Statements
3.4 Non Financial Statements
3.5 Presentation of Financial Statements
3.6 Assignment

1.0 Introduction
At the end of an accounting period, a trial balance is extracted from the main ledger. End-of-
year adjustments are made to the balances to include depreciation and amortisation charges for
non-current assets, accruals and prepayments, opening and closing inventories, bad debts and
the allowance for irrecoverable debts.

After making all these end-of-year adjustments, the amounts in the ‘extended’ trial balance for
income and expenses can be used to prepare an income statement for the accounting period,
and calculate the profit or loss for the period. In the financial statements of a sole trader, there
is no tax charge on profits.

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Understand the financial statements
(b) Identify the components of financial statements
(c) Preparing a sole trader’s financial statements

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3.0 Main Content

3.1 Objectives, Scope and Definitions of IAS 1

The purpose of financial statements is to provide information about financial position, financial
performance and cash flows.

The objective of IAS 1 is to set out the basis for the presentation of financial statements and to
ensure comparability with previous periods and with other entities. The standard identifies a
minimum content of what should be included in a set of financial statements as well as
guidelines as to their structure, although rigid formats are not prescribed.

A financial statement is any report summarising the financial condition or financial results of
a business on any date or for any period.

IAS 1 requires that the financial statements should be presented at least annually. If, for
example, the entity changes its year end and therefore reports a shorter or longer period, the
entity should explain why such a change has been made. Where a shorter or longer period is
reported, comparative information will not be entirely comparable and it is important that this
is clearly highlighted.

3.2 Purposes of Financial Statements

i. To provide information about:
- Financial position (e.g. solvency)
- Financial performance (e.g. profitability)
- Cash flows

ii. To show the results of management's stewardship (i.e. management's accountability for the
resources entrusted to it).

iii. To meet this objective of stewardship, financial statements provide information about:*
Assets
Liabilities
Equity
Revenue and expenses
Cash flows

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3.3 Components of Financial Statements

i. Statement of financial position (also called balance sheet)
ii. Statement of comprehensive income
iii. Statement of changes in equity
iv. Statement of cash flows
v. Accounting policies and explanatory notes

3.4 Non Financial Statements

These may be included in a company's annual report alongside the financial statements:
(a) Financial review (by management)
(b) Chairman’s statement
(c) Director’s report
(d) Employee report
(e) Five-year financial record
(f) Analysis of commercial properties
(g) Environmental report
(h) Value added statement

3.5 Presentation of Financial Statements

3.5.1 Statement of financial position (also called balance sheet): a financial statement which
reports the assets, liabilities and equity of an entity as at a particular date. Also called a
statement of financial condition or balance sheet.

Description
The statement of financial position is a statement, at a particular date, of the book value or
carrying amount (i.e. the amount which is carried in the books) of all of an entity's:*
Assets (resources controlled);
Liabilities (obligations owed); and
Owners' capital or equity (the difference between assets and liabilities).

Presentation
To facilitate meaningful analysis, assets and liabilities are grouped according to classifications
which are generally accepted or legally required. Comparability is an essential quality which
makes information useful to users.

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IAS 1 Presentation of Financial Statements sets out minimum requirements for all general
purpose financial statements presented in accordance with International Financial Reporting.

XY Enterprises
Statement of Financial Position as at 31 December, 200X
₦
ASSETS
Non-Current Assets
Property, plant and equipment xxx
Intangible assets xxx
Biological assets xxx
Available-for-sale investments xxx
xxx
Current Assets
Inventories xxx
Trade receivables xxx
Other receivables (advance, prepaid expenses) xxx
Cash xxx
Short term investment xxx
xxx
Total Assets xxx

EQUITY AND LIABILITIES

Equity
Capital xxx
Net Profit xxx
Drawings (xx)
xxx
Non-Current Liabilities
Long-term borrowings xxx
Debenture xxx
Deferred tax xxx
Finance lease xxx
Long-term provisions xxx
xxx
Current Liabilities
Trade payables xxx
Other payables (owing, accrual, due, arrears expenses) xxx
Bank overdraft xxx
Short term provision xxx
Current tax payable xxx
xxx
Total equity and liabilities xxx

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3.5.2. Statement of comprehensive income: a summary of transactions and events over a

period of time. It includes:
- a statement of profit or loss;* and
- other comprehensive income (e.g. gains and losses)

RAKUNMI SAUDI ENTERPRISES

Statement of Profit or Loss for the Year Ended 31 December, 2017
₦ ₦ ₦
Revenue (Sales) XX
Sales Returns (X)
Net Sales XX

Cost of Sales:
Opening inventory XX
Purchases XX
Purchases returns (X)
Net purchases XX
Goods withdrew for personal use (X) XX
Carriage inward XX
Cost of goods available XX
Closing inventory (X)
(XX)
Gross Profit XX
Other Income:
Discount received X
Profit on disposal of non-current asset X
Investment Income (rent received, dividend received etc.) X
Decrease in allowance for receivables X XX
XX
Operating Costs:
Wages and salaries X
Rent and rates X
Insurance premium X
Discount allowed X
Carriage Outwards X
Office expenses X
Bad debts written off X
Increase in allowance for receivables X
Depreciation X
Advertisement X
Postages and stationery X
Utility bills X
Loss on disposal of non-current assets X (XX)
Operating Profit XX
Finance cost (Interest on loan) (X)
XX
Tax expense (X)
Profit f or the year (Net Profit) XX

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Illustration 1
The following trial balance was extracted from the ledger of Stephen, a sole trader, as at 31
May 2001.
Dr Cr
₦ ₦
Property, at cost 120,000.00
Equipment, at cost 80,000.00
Provisions for depreciation (as at 1 June 20X0)
– on property 20,000.00
– on equipment 38,000.00
Purchases 250,000.00
Sales 402,200.00
Inventory, as at 1 June 20X0 50,000.00
Discounts allowed 18,000.00
Discounts received 4,800.00
Returns outward 15,000.00
Wages and salaries 58,800.00
Irrecoverable debts 4,600.00
Loan interest 5,100.00
Other operating expenses 17,700.00
Trade payables 36,000.00
Trade receivables 38,000.00
Cash in hand 300.00
Bank 1,300.00
Drawings 24,000.00
Allowance for receivables 500.00
17% long-term loan 30,000.00
Capital, as at 1 June 20X0 121,300.00
667,800.00 667,800.00

The following additional information as at 31 May 2001 is available.

(a) Inventory as at the close of business has been valued at cost at ₦42,000.
(b) Wages and salaries need to be accrued by ₦800.
(c) Other operating expenses are prepaid by ₦300.
(d) The allowance for receivables is to be adjusted so that it is 2% of trade receivables.
(e) Depreciation for the year ended 31 May 2001 has still to be provided for as follows.
(i) Property: 1.5% per annum using the straight line method
(ii) Equipment: 25% per annum using the reducing balance method
Required
Prepare Stephen's statement of profit or loss for the year ended 31 May 2001 and his statement
of financial position as at that date.

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Suggested Solution
STEPHEN
Statement of Profit or Loss for the year ended 31 May, 2001
₦ ₦ ₦
Sales 402,200
Cost of Sales:
Opening inventory 50,000
Purchases 250,000
Return outwards (15,000) 235,000
285,000
Closing inventory (42,000) (243,000)
Gross profit 159,200
Other income: Discount received 4,800
164,000
Operating Costs:
Discount allowed 18,000
Wages and salaries 58,800
Accrued wages 800 59600
Irrecoverable debts 4,600
Other operating expenses 17,700
Prepaid operating exp. (300) 17,400
Increase in allowance for receivables 260
Depreciation:
Property 1,800
Equipment 10,500 (112,160)
Operating profit 51,840
Interest on loan (5,100)
Profit for the year 46,740

STEPHEN
Statement of Financial Position as at 31 May, 2001.
ASSETS Notes ₦
Non-Current Assets
Property 1 98,200
Equipment 2 31,500
129,700
Current Assets
Trade receivables 3 37,240
Inventory 42,000
Cash in hand 300
Bank 1,300
Prepaid other operating expenses 300

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81,140
Total Assets 210,840
Equity:
Capital 121,300
Profit for the year 46,740
Drawings (24,000)
144,040
Non-Current Assets
17% long term loan 30,000
30,000
Current Liabilities
Trade payables 36,000
Wages and salaries accrued 800
36,000
210,840

NOTES:
₦
1. Property 120,000
Accumulated depreciation (20,000)
Depreciation for the year (1,800)
98,200

₦
2. Equipment 80,000
Accumulated depreciation (38,000)
Depreciation for the year (10,500)
31,500

₦
3. Trade receivables 38,000
Closing allowance for receivable (760)
37,240
Working
a. Closing allowance for receivable = 2% x ₦38,000 = ₦760
b. Increase in allowance for receivable = ₦760 - ₦500 = ₦260
c. Depreciation for the year:
Property = 1.5% x ₦120,000 = ₦1,800
Equipment = 25% x (₦80,000 - ₦38,000) = ₦10,500

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3.6 Assignment
Q1. On 1 April 2014 Gandalf started a business with capital of ₦20,000 which he paid into a
business account.
The following is a summary of the cash transactions for the first year:
₦
Amounts from customers 34,628
Salary of assistant 4,000
Cash paid to suppliers for purchases 20,700
Purchase of motor van on 31 March 2015 8,000
Gandalf’s drawings during the year 4,800
Electricity payments 1,120
Rent for the year 2,200
Postage and stationery 700
The following further information is relevant:
(1) At the end of the year Gandalf was owed ₦8,512 by his customers and owed ₦11,344 to
his suppliers.
(2) Gandalf promised his assistant a bonus of ₦800. At 31 March 2015 this had not been paid.
(3) At 31 March 2015 there was inventory of ₦8,514 and Gandalf owed ₦340 for electricity
for the last quarter of the year.
(4) As the van was acquired in the last day of March, Gandalf has decided not to charge any
depreciation for the year.
Required:
Prepare a statement of profit or loss for the year ended 31 March 2015 and a statement
of financial position at that date.

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Q2. The following information relates to the business of Maria for the year ended 31 December
2014:
$ $
Capital account, 1 January 2014 13,640
Freehold properties at cost 7,500
Furniture and fittings at cost 2,000
Motor cars at cost 6,300
Accumulated depreciation to 1 January 2014:
Freehold properties 450
Furniture and fittings 800
Motor cars 2,370
Inventory 1 January 2014 6,740
Purchases 54,520
Sales 79,060
Salaries 8,760
Rent 1,170
Office expenses 3,950
Motor expenses 3,790
Drawings 4,800
Allowance for receivables 1 January 2014 600
Loan 4,000
Trade receivables 9,240
Trade payables 10,040
Bank balance 2190
110960 110960
You are also supplied with the following information:
(1) Inventory at 31 December 2014 was $7,330.
(2) Rent paid in advance at 31 December 2014 amounted to $250.
(3) Allowance for trade receivables is to be made equal to 5% of accounts receivable at
31 December 2014.
(4) Depreciation is to be charged for the year at the following annual rates calculated on cost
at the year end:
Freehold properties 1%
Furniture and fittings 10%
Motor cars 20%
(5) Interest on the loan at 5% per annum is to be provided.
Required:
Prepare a statement of profit or loss for the year ended 31 December 2014 and a statement
of financial position at that date.

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TOPIC 2: DEPRECIATION OF NON CURRENT ASSETS

CONTENTS
1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Content
3.1 Definition of Depreciation
3.2 Causes of Depreciation
3.3 Factors consider in arriving at the depreciation charged.
3.4 Methods of Depreciation
3.5 Accounting for Depreciation
3.6 Disposal of Non current assets
3.7 Accounting Entries
3.8 Assignment

1.0 Introduction
A non-current asset is acquired with a view to earning profits. Its life extends over more than
one accounting period, and so it earns profits over more than one period. With the exception
of land held on freehold or very long leasehold, every non-current asset eventually wears out
over time. Machines, cars and other vehicles, fixtures and fittings, and even buildings do not
last for ever. When a business acquires a non-current asset, it will have some idea about how
long its useful life will be. Its policy may be one of the following.

• Use the non-current asset until it is worn out, useless, and worthless
• Sell off the non-current asset at the end of its useful life as second-hand or as scrap

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Understand and explain the purpose of depreciation.
(b) Calculate the charge for depreciation using straight line and reducing balance methods.
(d) Illustrate how depreciation expense and accumulated depreciation are recorded in ledger
accounts.
(e) Calculate depreciation on a revalued non-current asset, including the transfer of excess
depreciation between the revaluation reserve and retained earnings.

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(g) Record depreciation in the income statement and statement of financial position.

3.0 Main Content

3.1 Definition of Depreciation

IAS 16 requires the depreciable amount to be allocated on a systematic basis to each
accounting period during the useful life of the asset.

IAS 16 defines depreciation as ‘the measure of the cost or revalued amount of the economic
benefits of the tangible non-current asset that has been consumed during the period’.

Depreciation can also be defined as the systematic allocation of the depreciable amount of an
item of property, plant and equipment over its estimated useful life.

Consumption includes the wearing out, using up or other reduction in the useful life of a
tangible non-current asset whether arising from use, effluxion (passing) of time or obsolescence
through either changes in technology or demand for the goods and services produced by the
asset.

3.2 Causes of Depreciation

i. Physical deterioration
ii. Wear and Tear: An asset may depreciate in quantity, quality and value as a result of
constant usage. Physical factors like erosion, dampness, rust and decay can cause an asset to
reduce in value;
iii. Obsolescence: An asset can become obsolete due to changes in technology. When this
occurs, it is due for replacement. A very good example is the steam engine train;
iv. Passage of time: Depreciation occurs in some assets with the effusion of copy rights;
v. Depletion: Some natural resources like gold, oil or tin deposits become worthless when the
deposits have been depleted. They are called wasting assets. The more they are extracted, the
less the reserve;
vi. Inadequacy: As a result of expansion in the productive capacity of a company, an asset
may become too small an inadequate and thus require replacement for bigger ones.

3.3 Factors consider in arriving at the depreciation charged

The following are the factors which should be taken into consideration in arriving at the
depreciation charged on a non-current asset:

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i) The cost (or revalued amount) of the non-current asset.

ii) The estimated residual value of the non-current asset.
iii) The estimated useful economic life of the non-current asset.
iv) The method of depreciation considered appropriate for the business by management (i.e.
Straight line, Reducing balance, Sum of the year digit etc.)
v) Nature of the non- current asset.
vi) The legal norms relating to such non- current asset, where such is application.
vii) The chance of the asset becoming obsolete

3.4 Methods of Depreciation

There are several different methods of depreciation which are stated below:
i. Straight-line method
ii. Reducing balance method (Diminishing Balance Method)
iii. Sum of the year digit method
iv. Units of production method
v. Revaluation Method

3.4.1 Straight line method

The straight line method means that the total depreciable amount is charged in equal
instalments to each accounting period over the expected useful life of the asset.

The straight line method is a fair allocation of the total depreciable amount, if it is reasonable
to assume that the business enjoys equal benefits from the use of the asset throughout its life.

The annual depreciation charge is calculated as:

Annual Depreciation = Cost of asset minus residual value

Expected useful life of the asset

Since the depreciation charge per annum is the same amount every year, it is often stated that
depreciation is charged at the rate of x per cent per annum on the cost of the asset.

3.4.2 Reducing balance method

The reducing balance method of depreciation calculates the annual charge as a fixed percentage
of the net book value of the asset, as at the end of the previous accounting period.

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With the reducing balance method, the annual charge for depreciation is higher in the earlier
years of the asset's life, and lower in the later years. Therefore, it is used when it is considered
fair to allocate a greater proportion of the total depreciable amount to the earlier years. The
assumption is that the benefits obtained by the business from using theasset decline over time.

Determination of Depreciation Rate using the Reducing Balance Method

Where r = rate of depreciation

n= expected useful life in years
s = estimated scrap value
c = cost of asset

Annual Depreciation = Net book value of asset of the asset × X%.

Illustration 1.
A lorry bought for a business cost ₦17,000. It is expected to last for five years and then be sold
for scrap for ₦2,000.

Required
Work out the depreciation to be charged each year under the following methods.
(a) The straight line method
(b) The reducing balance method (using a rate of 35%)

SUGGESTED SOLUTION
(a) Using straight line method

Annual depreciation = Cost – Residual value

life span

Annual depreciation = ₦17,000-₦2000

5
= ₦3,000

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₦
Year 1. Cost 17,000
Depreciation (3,000)
Carrying value 14,000
Year 2. Depreciation (3,000)
Carrying value 11,000
Year 3. Depreciation (3,000)
Carrying value 8,000
Year 4. Depreciation (3,000)
Carrying value 5,000
Year 5. Depreciation (3,000)
Residual value 2,000

(b) Using reducing balance method

₦
Year 1. Cost 17,000
Depreciation (35% x ₦17,000) (5,950)
Carrying value 11,050
Year 2. Depreciation (35% x ₦11,050) (3,868)
Carrying value 7,182
Year 3. Depreciation (35% x ₦7,182) (2,513)
Carrying value 4,669
Year 4. Depreciation (35% x ₦4,669) (1,634)
Carrying value 3,035
Year 5. Depreciation (35% x ₦3,035) (1,062)
Residual value 1,973

3.4.3 Sum of the year digit method

This method like the diminishing balance method, also seeks to accelerate the accumulation of
depreciation. Under this method, a decreasing depreciation is computed by a simple
mathematical procedure relating to arithmetical progression. Each year of an asset’s life should
be represented by a digit. Add these digits and charge fraction of the asset cost to the years in
a reverse order.

Illustration 2
Assuming machine ‘X’ costs ₦10, 000 and has an estimated useful life of 5 years, what will be
the depreciation for at least the first three years using SYD method.

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SUGGESTED SOLUTION
Year Units
1 5
2 4
3 3
4 2
5 1
Total 15

Year 1, Depreciation = 5/15 x ₦10, 000 = ₦3,333

Year 2, Depreciation = 4/15 x ₦10, 000 = ₦2,667
Year 3, Depreciation = 3/15 x ₦10, 000 = ₦2,000
Year 4, Depreciation = 2/15 x ₦10, 000 = ₦1,333
Year 5, Depreciation = 1/15 x ₦10, 000 = ₦667

3.4.4 Units of production method

The amount of annual depreciation to be charged can be arrived at by using the volume of
production for that year.

Illustration 3
On March 1, 2010, Enbelenbe Enterprises acquired a machine with the following information:
Initial cost ₦100,000
Installation cost ₦25,000
Estimated useful life 5 years
Estimated production capacity in units
2010 - 7,500
2011 - 6,500
2012 - 10,500
2013 - 11,500
2014 - 12,000
Calculate the annual depreciation charge for Enbelenbe enterprises for 2010, 2011, 2012,
2013and 2014 using units of production method

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SUGGESTED SOLUTION
Total capitalisation cost of machine = ₦100,000 + ₦25,000 = ₦125,000
Total production units = 7,500+6,500+10,500+11,500+12,000 = 48,000

Year 2010, Depreciation = 7,500/48,000 x ₦125,000 = ₦19,531

Year 2011, Depreciation = 6,500/48,000 x ₦125,000 = ₦16,927
Year 2012, Depreciation = 10,500/48,000 x ₦125,000 = ₦27,344
Year 2013, Depreciation = 11,500/48,000 x ₦125,000 = ₦29,948
Year 2014, Depreciation = 12,000/48,000 x ₦125,000 = ₦31,250

3.4.5 Revaluation Method

During a period of high-inflation, the value of non-current assets may be well in excess of their
net book value.

In this situation a company may choose to show the current worth of such assets on their
Statement of Financial Position.

Any profit resulting from such revaluation is an unrealised profit (in that the asset has not been
sold and therefore no real profit has actually been made). As a result, the profit is shown
separately from the Statement of Profit or Loss in a revaluation reserve. (For a limited company
this must be the case. For a sole trader, where the owner has unlimited liability, this is not a
rule even though it is good practice.)

IAS 16 Property, Plant and Equipment requires that when an item of property, plant or
equipment is revalued, then the entire class of property, plant and equipment to which the asset
belongs must be revalued.

When a non-current asset has been revalued, the future charge for depreciation should be based
on the revalued amount and the remaining economic life of the asset.

The depreciation charge will be higher than it was before the revaluation, and then excess of
the new charge over the old charge should be transferred from the revaluation reserve to
accumulated profits.

After a revaluation, depreciation is calculated using the following formula:

Annual depreciation = Revalued amount − residual value (if any)

Remaining useful life

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3.5 Accounting for Depreciation

The modern practice of recording depreciation treats depreciation as a contra to the non current
asset account. The non current asset account is maintained at its original cost. A ledger account
called “accumulated provision for depreciation account” is opened and all depreciation
calculations are credited to that account, the corresponding entry being passed into the
depreciation charge account as a debit.

(a) The double entry is as follows:

DEBIT - Depreciation expense account

CREDIT - Provision for depreciation account

(b) The depreciation charge for an accounting period is a charge against profit and is recorded
as:
DEBIT – Statement of Profit or Loss
CREDIT - Depreciation expenses account

(c) The balance on the provision for depreciation account is the total accumulated depreciation.
This is always a credit balance.

(d) The non-current asset accounts are unaffected by depreciation. Non-current assets are
recorded in these accounts at cost (or, if they are revalued, at their revalued amount).

(e) In the statement of financial position of the business, the accumulated depreciation is
deducted from the cost of non-current assets (or revalued amount) to arrive at the net book
value of the non-current assets.

Illustration 5
Brian Box set up his own computer software business on 1 March 20X6. He purchased a
computer system, at a cost of ₦16,000. The system has an expected life of three years and a
residual value of ₦2,500.

Using the straight line method of depreciation, produce the non-current asset account, provision
for depreciation account, income statement (extract) and statement of financial position (extract)
for each of the three years, 28 February 20X7, 20X8 and 20X9.

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SUGGESTED SOLUTION
Annual Depreciation = ₦16,000 - ₦2,500
3
= ₦4,500

Non-Current Asset Account (Carrying Value Method)

₦ ₦
1/3/20X6 Cash 16,000 28/2/20X7 Depreciation 4,500
28/2/20X7 Balance. c/d 11,500
16,000 16,000
1/3/20X7 Balance b/d 11,500 28/2/20X8 Depreciation 4,500
28/2/20X8 Balance. c/d 7,000
11,500 11,500
1/3/20X8 Balance b/d 7,000 28/2/20X9 Depreciation 4,500
28/2/20X9 Balance. c/d (residual) 2,500
7,000 7,000

Depreciation Account
₦ ₦
28/2/20X7 Provision for Depreciation 4,500 28/2/20X7 Profit or loss a/c 4,500
28/2/20X8 Provision for Depreciation 4,500 28/2/20X8 Profit or loss a/c 4,500
28/2/20X8 Provision for Depreciation 4,500 28/2/20X9 Profit or loss a/c 4,500

Provision for Depreciation Account

₦ ₦
28/2/20X7 Balance. c/d 4,500 28/2/20X7 Depreciation 4,500
4,500 4,500
28/2/20X8 Balance c/d 9,000 1/3/20X8 Balance b/d 4,500
28/2/20X8 Depreciation 4,500
9,000 9,000
28/2/20X9 Balance c/d 13,500 1/3/20X9 Balance b/d 9,000
28/2/20X9 Depreciation 4,500
13,500 13,500

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Income Statement (Extract)

₦
20X7 Depreciation 4,500
20X8 Depreciation 4,500
20X9 Depreciation 4,500

Statement of Financial Position (Extract)

₦
Non-Current Asset:
20X7 Computer system 11,500
20X8 Computer system 7,000
20X9 Computer system 2,500

3.6 Disposal of Non-Current assets

An organization can dispose of its non-current assets by either selling it for cash, exchanging
it for a similar asset or a different one, or merely by discarding the asset. In all these three
situations, you must remember to take out the disposed asset from the main non-current asset
account. This is done by opening an account for the purpose of the disposal. Into this account
is entered the cost of the non-current asset and its associated accumulated depreciation
provision. A profit or loss may arise from the disposal of the non-current asset depending on
the outcome of the non-current asset disposal account.

3.7 Accounting Entries

When depreciation has been carried to a provision for depreciation account, it is best dealt with
by opening the disposal account to which the original cost of the asset and the accumulated
depreciation are transferred.

The procedures are:

(a) DEBIT - Disposal Account (with the cost of the asset sold)
CREDIT- Asset Account (with the cost of the asset sold)

(b) DR - Accumulated Depreciation Account (with accumulated depreciation on the asset sold)
CR - Disposal Account (with accumulated depreciation on the asset sold)

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(c) DR – Cash Account (with the proceeds of sale)

CR - Disposal Account (with the proceeds of sale)

(d) DR – Disposal Account (with profit on sale of asset)

CR – Statement of Profit or Loss (with profit on sale of asset)

(e) DR – Statement of Profit or Loss (with loss on sale of asset)

CR – Disposal Account (with loss on sale of asset)

Illustration 4
A motor car was bought for N 300,000. It is to be depreciated at 25% on cost for 3 years and
was sold for N 100,000 at the end of the 3rd year.
Prepare:
(a) Motor car account
(b) Bank account
(c) Motor car disposal account
(d) Statement of Profit or Loss. Using the straight line method

SUGGESTED SOLUTION
(a)
Motor Car Account (Cost Value Method)
₦ ₦
Year 1 Cash 300,000 Balance. c/d 300,000
300,000 300,000
Year 2 Balance b/d 300,000 Balance. c/d 300,000
300,000 300,000
Year 3 Balance b/d 300,000 Disposal a/c 300,000
300,000 300,000

(b)
Bank Account
₦ ₦
Year 3 Motor car disposal a/c 100,000 Year 1 Motor car a/c 300,000
Balance c/d 200,000
300,000 300,000

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(c)
Motor Car Disposal Account
₦ ₦
Motor car a/c 300,000 Bank 100,000
Income statement (Gain on disposal) 25,000 Accumulated depreciation 225,000
325,000 325,000
(d)
Statement of Profit or Loss
₦ ₦
Gain on disposal 25,000

3.8 ASSIGNMENT
1. On January 1, 2013 Ajanaku Enterprises bought a motor vehicle for ₦1,850,000 with the
estimated life span of four years and residual value of ₦50,000.
(i). Determine the depreciation rate, using the reducing balance method.
(ii). Using the rate of depreciation derived in (i) above, calculate the amount of depreciation
for years 2013 and 2014 respectively. Also disclose the carrying amount of the asset at the end
of December 31, 2014.

2. On January 1, 2013, Daraju Enterprises acquired a machine with the following information:
Initial cost ₦200,000
Installation cost ₦50,000
Estimated useful life 5 years
Estimated production capacity in units
2013 - 15,000
2014 - 17,000
2015 - 21,000
2016 - 23,000
2017 - 24,000
Calculate the annual depreciation charge for Daraju enterprises for 2013, 2014 and 2015, using:
i. Units of production method
ii. Sum-of-the-years-digit method
iii. Prepare a statement showing the carrying amount of the assets for each of the three years:
2013, 2014 and 2015 using units of production method

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TOPIC 3: ACCOUNTING RATIOS

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Contents
3.1 Definition of Accounting Ratio
3.2 Uses of Accounting Ratios
3.3 Categories of Accounting Ratios
3.4 Calculation of Accounting Ratios
3.5 Limitations of Accounting Ratios
3.6 Assignment

1.0 Introduction
Financial statements are prepared to assist users in making decisions. They therefore need
interpreting, and the calculation of various ratios makes it easier to compare the state of a
company with previous years and with other companies.

In this chapter we will look at the various ratios that you should learn for the examination.

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Understand and explain the purposes of accounting ratios
(b) Identify the categories of accounting ratios
(c) Calculate different accounting ratios
(d) Understand the limitations of accounting ratios

3.0 Main Contents

3.1 Definition of Accounting Ratio

3.1.1 Ratio
A ratio is a relationship between two numbers of the same kind

3.1.2 Financial Ratios

A financial ratio is a measure of the relative magnitude of two selected numerical values taken
from a company’s financial statements.

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3.1.3 Ratio Analysis

Ratio analysis is the calculation of ratios from a set of financial statements which is used for
comparison with either earlier years or similar businesses to provide information for decision-
making.

Ratios are of no use in isolation. To be useful, a basis is needed for comparison, e.g.
i. Previous years
ii. Other companies
iii. Industry averages
iv. Budgeted v actual (for management use)

3.2 Uses of Accounting Ratios

(a) To summarise and present financial information in a more understandable form.
(b) To compare results over a period of time
(c) To measure performance against other organisations
(d) To compare results with a target
(e) To compare against industry averages
.
3.3 Categories of Accounting Ratios
i. Performance (or Profitability) Ratios
ii. Efficiency Ratios
iii. Short Term Liquidity Ratios
iv Long Term Solvency (or Leverage) Ratios
v. Investors Ratios

Types of users
Investors – look at the risk of their investment, profitability and future growth.
Managers / employees– have access to more information and will want to know the stability
of the company and profitability.
Creditors – are interested in the liquidity, as they just want to be paid on time.
Banks – are interested in the performance and liquidity of organisations for lending purposes
Government departments - have various uses.
Other groups including the local community on green issues, jobs etc.

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1. PERFORMANCE (PROFITABILITY) RATIOS

Return on capital employed (ROCE) Profit before interest & tax (PBIT) X 100%
Capital employed (CE)
Return on shareholders' funds Profit before tax x 100
(ROSF) Equity (Share capital + reserves) 1
Turnover (number of times)
Asset turnover
Total assets
Gross profit x 100
Gross profit percentage
Sales 1
PBIT X 100%
Operating profit margin
Turnover
Overheads/Sales Percentage Overhead x 100
Sales 1
2. EFFICIENCY (WORKING CAPITAL) RATIOS
Trade receivables days Trade receivable x 365 days
Sales
Average trade payables x 365 days
Trade payables days
Credit Purchases (or Cost of Sales)
Inventory days Av. Inventory (or Closing inventory) x 365 days
Cost of Sales

Working capital cycle Trade receivable days + inventory days – trade

payable days
3. SHORT TERM LIQUIDITY RATIOS
Current assets
Current ratio
Current liabilities
Current assets minus closing inventory
Quick ratio (or Acid test ratio)
Current liabilities
4. LONG TERM LIQUIDITY (SOLVENCY) RATIOS
Debt capital X 100%
Debt to equity ratio (Equity Gearing)
Equity (shareholders’ funds)
Capital gearing ratio Debt capital X 100%
Debt + equity (total capital)
Interest cover Profit before interest and tax
Interest paid
5. INVESTORS RATIOS

Earnings per share (EPS) Profit after tax

Number of shares
Price earnings ratio (P/E ratio) Market share price
Earnings per share
Dividend yield Dividend per share X 100%
Market share price
Dividend cover Earnings per share
Dividend per share

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Financial Ratios in Detail

3.1.1. Performance (or Profitability) Ratios

Performance ratios measure rate of return earned on capital employed, and analyse this into
profit margins and use of assets. These ratios are frequently used as the basis for assessing
management effectiveness in utilising the resources under their control.

Performance ratios are divided into:

i. Return on capital employed (ROCE)
ii. Return on shareholders' funds (ROSF)
iii. Gross profit percentage
iv. Operating profit percentage
v. Overheads/sales percentage

3.1.1.1. Return on capital employed (ROCE): Measures overall efficiency of company in

employing resources available to it.

Profit before interest and tax x 100

ROCE = Equity + non current liability 1

Where:
Equity = Ordinary shares + all reserves (share premium, retained earnings, revaluation reserve)
Non- current liability = Preference shares + Debenture + Long term loan + finance lease

3.1.1.2 Return on shareholders' funds (ROSF): Measures how efficiently company is

employing funds that shareholders have provided.

ROSF = Profit after tax x 100

Equity (Share capital + reserves) 1

3.1.1.3 Gross profit percentage: Measures margin earned by company on sales.

Gross Profit Percentage = Gross profit x 100

Sales 1

3.1.1.4 Operating profit percentage: Measures earnings earned by company on sales.

Operating Profit Percentage = Profit before Interest and Tax x 100
Sales 1

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3.1.1.5 Overheads/Sales Percentage

Measures margin of overheads (distribution costs + administrative expenses) to sales.

Overheads/sales percentage = Overhead x 100

Sales 1

3.1.2. Efficiency (Working Capital) Ratios

Working capital ratios are an important indicator of management's effectiveness in running the
business efficiently, as for a given level of activity, it is most profitable to minimise the level
of working capital employed in the business.

Efficiency (Working Capital) ratios are divided into:

i. Trade Receivables Days
ii. Trade Payables Days
iii. Inventory Days
iv. Working capital cycle (operating/trading/cash cycle)

3.1.2.1 Trade Receivables Days: This is the average length of time taken by customers to pay.

A long average collection means poor credit control and hence cash flow problems may occur.
The normal stated credit period is 30 days for most industries.

Changes in the ratio may be due to improving or worsening credit control. Major new customer
pays fast or slow. Change in credit terms or early settlement discounts are offered to customers
for early payment of invoices.

Average trade receivables (or Closing receivables) x 365 days

Trade Receivables Days = Credit Sales (or Sales Revenue)

Note: Average trade receivables = (Opening receivables + Closing receivables) ÷ 2

3.1.2.2 Trade Payables Days: This is the length of time taken to pay the suppliers.

The ratio can also be calculated using cost of sales, as credit purchases are not usually stated
in the financial statements.

High trade payable day’s is good as credit from suppliers represents free credit. If it’s too high
then there is a risk of the suppliers not extending credit in the future and may lose goodwill.

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High trade payable days may also indicate that the business has no cash to pay which indicates
insolvency problems.
Average trade payables (or Closing payables) x 365 days
Trade Payables Days = Credit Purchases (or Cost of Sales)

Note: Average trade payables = (Opening payables + Closing payables) ÷ 2

3.1.2.3 Inventory Days: This ratio shows how long the inventory stays in the company before
it is sold. The lower the ratio the more efficient the company is trading, but this may result in
low levels of inventories to meet demand.

A lengthening inventory period may indicate a slow down in trade and an excessive build up
of inventories, resulting in additional costs.

Average Inventory (or Closing inventory) x 365 days

Inventory Days = Cost of Sales

Average inventory can be arrived by taking this year’s and last year’s inventory values and
dividing by 2 i.e. (Opening inventories + closing inventories) ÷ 2

Inventory turnover is the reciprocal of inventory days

Inventory turnover = Cost of sales (number of times)

Average inventory

It shows how quickly the inventory is being sold. It shows the liquidity of inventories, the
higher then figure the quicker the inventory is sold.

3.1.2.4 Working capital cycle (operating/trading/cash cycle)

This is the time between paying for goods supplied and final receipt of cash from their sale. It
is desirable to keep the cycle as short as possible:

The working capital cycle therefore should be kept to a minimum to ensure efficient and cost
effective management.

Working capital cycle = Trade receivable days + inventory days – trade payable days

- The shorter the cycle, the better it is for the company

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- Moving inventories rapidly

- Collecting debts quickly
- Taking the maximum credit possible
- The shorter the cycle, the lower the company’s reliance on external supplies of finance like
bank overdrafts which is costly.
- Excessive working capital means too much money is invested in inventories and trade
receivables.
- This represents lost interest or excessive interest paid and lost opportunities (the funds could
be invested elsewhere and earn a higher return).
- The longer the working capital cycle, the more capital is required to finance it.

3.1.3 Short Term Liquidity (or Short term Solvency) Ratios

Short term liquidity ratios are used to assess a company's ability to raise cash to meet payments
when due. In practice, information contained in the cash flow statement is often more useful
when analysing liquidity.

Liquidity is the amount of cash a company can put its hands on quickly to settle its debts (and
possibly to meet other unforeseen demands for cash payments too).

Short term liquidity ratios are divided into:

i. Current ratio
ii. Quick ratio (or Acid test ratio)

3.1.3.1 Current ratio: Measures adequacy of current assets to cover current liabilities.
Current ratio = Current assets (times)
Current liabilities

The normal current ratio is around 2:1 but this varies within different industries. Low current
ratio may indicate insolvency. High ratio may indicate not maximising return on working
capital. Valuation of inventories will have an impact on the current ratio, as will year end
balances and seasonal fluctuations.

3.1.3.2 Quick ratio (or Acid test ratio): It measures real short-term liquidity by eliminating
closing inventory from total assets.

Quick ratio = Current assets minus closing inventory

Current liabilities
3.1.4 Long Term Solvency (or Leverage) Ratios

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Gearing ratios examine the fmancing structure of a business. They indicate to shareholders the
degree of risk attached to the company and the sensitivity of profits and dividends to changes
in profitability and activity level.

Long term solvency ratios can be divided into:

i. Gearing ratio
ii. Interest cover

3.1.4.1 Gearing ratio: Measures relationship between company's borrowings and its share
capital and reserves. A company is highly geared if it has a substantial proportion of its capital
in the form of preference shares, debentures or loan stock.

There are two ways that the gearing ratio can be calculated are:
- Equity gearing = debt capital vs equity capital
- Total gearing = debt capital vs total capital

Total gearing ratio = Debt

Debt + Equity

Equity gearing (Debt to equity ratio) = Debt

Equity

3.1.4.2 Interest cover: Measures the security of the interest payments.

Interest cover = Profit before interest and tax

Annual interest charged

Consider accounting policies which affect profit before interest and interest payable.

3.1.5. Investors Ratios

Investors' ratios help to establish characteristics of ordinary shares in different companies e.g.
- Earnings per share will be important to those investors looking for capital growth
- Dividend yield, dividend cover and dividends per share will be important to those investors
seeking income.
Investors ratios can be divided into:
i. Earnings per share
ii. Price earnings ratio
iii. Dividend yield
iv. Dividend cover

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3.1.5.1 Earnings per share: Measures the amount of net profit for the period that is attributable
to each ordinary share which is outstanding during all or part of the period.

Earnings per share = Profit after tax minus preference dividend

Weighted number of ordinary shares

3.1.5.2 Price/Earnings (P/E) ratio: Measures the number of years earnings which pay back
the price of the share.

Price/Earnings (P/E) ratio = Market price per share

Earnings per share

3.1.5.3 Dividend yield: Measures the dividend per share relative to price. It measures dividend
policy rather than performance. It is useful to income seekers.

Dividend yield = Dividend (ordinary) per share x 100%

Market share price

3.1.5.4 Dividend cover: Measures the security of the dividend payment.

Dividend cover = Earnings per share
Dividend per (ordinary) share

Exam Technique for Analysing Performance

Step 1 Review figures as they are and comment on them.

Step 2 Calculate relevant ratios according to performance, position and potential (if possible)

Step 3 Add value to the ratios by:

Interacting with other ratios and giving reasons
a) State the significant fact or change (i.e. increase or decrease)
b) Explain the change or how it may have occurred by looking at the business activities and
other information.
c) Explain the significance of the ratio in terms of implications for the future and how it fits
in with the user’s needs.
d) Limitations of the ratio analysis. Look at the 2 figures used to compute the ratio and criticise
them. Also look at other factors which may distort the information (creative accounting,
seasonal fluctuations etc.)

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3.4 Calculation of Accounting Ratios

Illustration 1

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Required:
(a) Calculate the following ratios for both years:
(i) Current ratio
(ii) Quick ratio;
(iii) Inventory days;
(iv) Receivables days;
(v) Payables days;
(vi) Gross profit percentage;
(vii) Return on shareholders fund;
(viii) Return on capital employed (ROCE)
(ix) Gearing ratio.

SUGGESTED SOLUTION

SOLO
Computation of Financial Ratios for the Years 2014 And 2013
Formula 2014 2013
i. Current ratio = Current assets 30500 = 1.32 28500 = 1.47
Current liabilities 23050 19400
ii. Quick ratio = Current assets - inventory 30500-14000 = 0.72 28500-13000 = 0.80
Current liabilities 23050 19400
iii. Inventory days = Inventory x 365 14000x365=121days 13000x365=139days
Cost of Sales 42000 34000
iv. Receivable days = Receivable x 365 16000x365=97days 15000x365=109days
Revenue 60000 50000
v. Payable days = Payable x 365 23050x365=200days 19400x365=208days
Cost of Sales 42000 34000
vi. Gross Profit Ratio = Gross profit x 100 18000x100 = 30% 16000x100 = 32%
Sales 1 60000 1 50000 1
vii. ROSF = Profit after tax x 100 -50 x 100 = -35% 1100 x 100 = 7.5%
Equity 1 13950 1 14600 1
viii ROCE = Profit before int. & tax 100 2500 x100 = 12.53% 3000 x100 = 14.93%
Capital Employed 1 19950 1 20100 1
ix Total gearing ratio = Debt X 100 6000 x100 = 30.08% 5500 x100 = 27.36%
Debt + Equity 1 19950 1 20100 1

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3.5 Limitations of Accounting Ratios

(i) Different Accounting Policies: Comparisons of ratios between entities’ can be very
difficult because ratios may be distorted by differences in accounting policies and also by the
use of creative accounting techniques.

(ii) Historical Data: Ratios use historic data which may not be predictive as this ignores future
actions by management and changes in the business environment.

(iii) Not Similar Size: The companies may not be of similar size. One may be part of a large
group and therefore have access to economies of scale, which result in lower costs.

(iv) Different Market: The companies may be operating in the same industry, but they may
have different markets, and therefore different product ranges and sales mix. Segmental
accounts are useful in this respect.

(v) Capitalisation of Expense: Capitalising of expenses as non current assets. This will lead
to increased profits.

(vi) Off balance sheet finance: This is where the company undertakes finance but excludes it
from the statement of financial position.

3.6 Assignment
Q1.

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Required:
(a) Calculate, for each year, TWO ratios for each of the following user groups, which are of
particular significance to them:
(i) suppliers;
(ii) internal management.
(b) Comment briefly on the changes, between the two years, in the ratios calculated in (a) above.

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Q2.

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Calculate and comment on the following ratios for Umar plc

1 ROCE
2 Gross profit margin
3 Asset turnover
4 Current ratio
5 Quick ratio
6 Inventory turnover ratio
7 Inventory days
8 Trade receivable days
9 Trade payable days
10 Equity gearing
11 Total gearing
12 Interest cover
13 Dividend cover
14 EPS
15 PE if market value of ordinary shares is 240p in 20X2

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TOPIC 4: CORRECTION OF ERRORS

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Content
3.1 Definition of Error
3.2 Errors Where the Trial Balance Still Balance
3.3 The Correction of Errors

1.0 Introduction
This chapter continues the subject of errors in accounts. Here we deal with errors that may be
corrected by means of the journal. Finally we look at the correction of material errors from a
prior period in IAS 8.

2.0 Chapter learning objectives

Upon completion of this chapter you will be able to:
(a) Identify the types of error which may occur in book-keeping systems.
(b) Identify errors which would be highlighted by the extraction of a trial balance.
(c) Prepare journal entries to correct errors.
(d) Calculate and understand the impact of errors on the income statement, statement of
comprehensive income and statement of financial position.

3.0 Main Content

3.1 Errors: are unintentional mistakes that occurred when recording financial items to
appropriate ledgers.

3.2 Errors Where the Trial Balance Still Balances

i. Errors of omission
An error of omission means failing to record a transaction at all, or making a debit or credit
entry, but not the corresponding double entry. e.g. a cash sale of ₦100 was not recorded.

ii. Error of commission: A transaction has been recorded in the wrong personal account, e.g.
purchase of goods from Taiwo on credit of ₦500 has been credited to Tayo’s account.

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iii. Error of principle: A transaction has conceptually been recorded incorrectly, e.g. a
noncurrent asset purchase of ₦1,000 has been debited to the repair expense account rather than
an asset account.

iv. Compensating error: Two different errors have been made which cancel each other out,
e.g. a rent bill of ₦1,200 has been debited to the rent account as ₦1,400 and a casting error on
the sales account has resulted in sales being overstated by ₦200.

v. Error of original entry/ Transposition Error: The correct double entry has been made but
with the wrong amount. An error of transposition is when two digits in an amount are
accidentally recorded the wrong way round. e.g. a cash sale of ₦76 has been recorded as ₦67.

vi. Reversal of entries: The correct amount has been posted to the correct accounts but on the
wrong side, e.g. a cash sale of ₦200 has been debited to sales and credited to bank.

3.3 The Correction of Errors

Errors which leave total debits and credits in the ledger accounts in balance can be corrected
by using journal entries. Otherwise a suspense account has to be opened first, and later cleared
by a journal entry

NOTE: When correcting these errors, a good approach is to consider:

(1) What was the double entry?
(2) What should the double entry have been?
(3) Therefore what correction is required?
Always assume that if one side of the double entry is not mentioned, it has been recorded
correctly

Illustration 1
Provide the journal to correct each of the following errors:
(i) A cash sale of ₦100 was not recorded in the books.
(ii) Rates expense of ₦500, paid in cash has been debited to the rent account in error.
(iii) A rent bill of ₦1,200 paid in cash has been debited to the rent account as ₦1,400 and cash
account was credited with ₦1,400
(iv) A cash sale of ₦76 has been recorded as ₦67 in the books.
(v) A cash sale of ₦200 has been debited to sales and credited to cash.
(vi) A non-current asset purchase of ₦1,000 on credit has been debited to the repairs expense
account.

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SUGGESTED SOLUTION

JOURNAL ENTRY
Date Particulars Dr Cr
₦ ₦
i. Cash A/C 100
Sales A/C 100
Being the correction of error of omission
ii. Rates A/C 500
Rent A/C 500
Being the correction of error of commision
iii. Cash A/C 200
Rent A/C 200
Error of compensation is being corrected
iv. Cash A/C 9
Sales A/C 9
Correction of error of original entry
v. Cash A/C 400
Sales A/C 400
Being the correction of error of original entry
vi Non- current asset A/C 1000
Repair expenses A/C 1000
Error of principle is being corrected

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TOPIC 5: SUSPENSE ACCOUNT

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Content
3.1 Definition of Suspense Account
3.2 Errors Leading to the Creation of a Suspense Account
3.3 Errors Where the Trial Balance Does Not Balance
3.4 Assignment

1.0 Introduction
The trial balance should balance, and if it does not then there must be errors somewhere that
need to be found. However, it is likely that the difference on the trial balance is the net result
of several errors. In practice, we would have to start checking the bookkeeping entries until we
found an error. A common way of doing this is to open a t-account called the Suspense Account
(or Difference Account) with a balance equal to the trial balance difference. This is in some
ways an artificial account, in that had the double entries all been correct then there would be
no trial balance difference.

However, it does provide a useful check when finding errors. Every time we find an error in
the book keeping, we will correct it and at the same time make an entry in the Suspense Account
to show that part of the difference had been found. When all the errors have been found, the
balance on the Suspense Account will fall to zero.

2.0 Chapter learning objectives

Upon completion of this chapter you will be able to:
(a) Understand the purpose of a suspense account.
(b) Identify errors leading to the creation of a suspense account.
(c) Record entries in a suspense account.
(d) Make journal entries to clear a suspense account.

3.0 Main Content

3.1 Suspense Account
A suspense account is an account showing a balance equal to the difference in a trial balance.

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Suspense account is a temporary account which can be opened for a number of reasons. The
most common reasons are as follows.

(a) A trial balance is drawn up which does not balance (i.e. total debits do not equal total credits).

(b) The bookkeeper of a business knows where to post the credit side of a transaction, but does
not know where to post the debit (or vice versa).

For example, a cash payment might be made and must obviously be credited to cash. But the
bookkeeper may not know what the payment is for, and so will not know which account to
debit.

Suspense accounts, as well as being used to correct some errors, are also opened when it is
not known immediately where to post an amount. When the mystery is solved, the suspense
account is closed and the amount correctly posted using a journal entry.

3.2 Errors Leading to the Creation of a Suspense Account

The suspense account is created when the trial balance failed to agree. The difference between
the debit side and credit side of the trial balance is as a result of errors committed in the ledger
accounts. Therefore, these errors are then moved to suspense account.

3.3 Errors Where the Trial Balance Does Not Balance

1. Single sided entry – a debit entry has been made but no corresponding credit entry or vice
versa.
2. Debit and credit entries have been made but at different values.
3. Two entries have been made on the same side.
4. An incorrect addition in any individual account, i.e. miscasting.
5. Opening balance has not been brought down.
6. Extraction error – the balance in the trial balance is different from the balance in the relevant
account.

Illustration 1
The trial balance of Ohio Plc. failed to agree. The total of the credit column exceeded the total
of the debit column by ₦20,500. On investigation, the following errors were discovered:
(i) The cost of motor vehicle repairs of ₦55,000 recorded in the cash book but was not reflected
in the motor vehicle repairs account.

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(ii) A credit sale of goods for ₦64,000 was recorded correctly in the sales day book but posted
as ₦46,000 to the customer’s personal account.
(iii) A rental income of ₦42,000 was correctly recorded in the cash book but omitted from the
rental income account.
(iv) The receivables control account has a debit entry of ₦54,000 for a transaction instead of
₦90,000.
(v) The return inwards account was overcast by ₦45,000.
(vi) Discount of ₦23,000 received from a supplier was correctly recorded in his account but
omitted from the other account.
(vii) A purchase invoice of ₦34,500 was correctly recorded in the cash book but the other
account was not captured.
(viii) Cost of stationery of ₦13,000 in cash was correctly recorded in the printing and stationery
account but not reflected in the other account.

Required: Prepare the journal entries and the suspense account to effect corrections as
appropriate.

SUGGESTED SOLUTION
Date Particulars Dr Cr
₦ ₦
i. Motor vehicle repair A/C 55,000
Suspense A/C 55,000
ii. Receivables A/C 18,000
Suspense A/C 18,000
iii. Suspense A/C 42,000
Rental income A/C 42,000
iv. Receivable control A/C 36,000
Suspense A/C 36,000
v. Suspense A/C 45.000
Return inward A/C 45.000
vi Suspense A/C 23.000
Discount received A/C 23.000
vii Purchases A/C 34.500
Suspense A/C 34,500
viii Suspense A/C 13,000
Cash A/C 13,000

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SUSPENSE ACCOUNT
₦ ₦
As per trial balance 20,500 Motor vehicle repairs 35,000
Rental income 42,000 Receivables 18,000
Return inward 45,000 Receivable Control 36,000
Discount received 23,000 Purchases 34,500
Cash 13,000
143,000 143,000

3.4 Assignment
The account of Shakol enterprises for the year ended September 30, 2016 has just been prepared.
The profit for the year was ₦224,500 but the following errors were later discovered.
(i) Sales of ₦3,200 was posted as ₦320 to a customer’s account, the correct amount was
included in the day book.
(ii) Additional plant purchased during the year for ₦48,000 was posted to purchases account.
(iii) The sum of ₦4,850 representing wages paid to technicians who installed the plant was
debited to wages account.
(iv) To obtain the total in the returns outwards book, a total of ₦6,887 was carried forward as
₦8,876.
(v) The total of the sales account had been overcast by ₦8,190.
(vi) Furniture which cost ₦36,000 was posted to repairs account.
(vii) Goods valued at ₦4,470 were returned but the returns were not entered in the books.
(viii) A sales invoice for ₦6,000 was completely omitted from the books.
(ix) N2,500 overdraft in the cash book was omitted in the trial balance.
(x) The amount of ₦3,200 paid to a supplier was correctly entered in the cash book but debited
in the personal account as ₦2,300.
(xi) The debit side of wages account was under-cast by ₦8,005.
Depreciation is provided on plant at 20% of cost and furniture at 25% of cost.

Required:
a. Prepare Journal entries to correct the errors.
b. Prepare the suspense account showing the amount by which the trial balance did not agree.
c. Prepare a statement of the adjusted profit for the year ended September 30, 2016.

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TOPIC 6: MANUFACTURING ACCOUNT

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Content
3.1 Definition of Manufacturing Account
3.2 Direct Factory Costs
3.3 Production Overhead or Indirect factory costs
3.4 Prime Costs
3.5 Cost of Goods Sold
3.6 Work in progress
3.7 A pro-forma manufacturing account
3.8 Assignment

1.0 Introduction
The manufacturing account is needed to calculate the cost of finished goods. This figure is then
carried forward into the income statement to replace purchases in the cost of sales calculation.

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Understand the meaning of manufacturing account
(b) Identify the components of production costs
(c) Understand the meaning of work – in progress
(d) Preparing manufacturing account

3.0 Main Content

3.1 Definition of Manufacturing Account
Manufacturing account is an account in which the costs of producing finished goods are
calculated. It is prepared for internal use.

3.2 Direct factory costs: are factory costs which change every time an extra unit is made. For
example, direct factory wages are wages paid to production workers who are paid per unit made.

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3.3 Production overheads or indirect factory costs: are factory costs which do not change
every time an extra unit is made. For example, indirect factory wages are wages paid to
production managers who are paid the same each month regardless of how many units are made.

3.4 Prime cost is raw material costs plus direct factory costs.

3.5 Cost of goods sold: A company's trading account will usually include a cost of goods sold
derived as the total of opening inventory plus purchases, less closing inventory. This is
particularly suitable for a retail business which buys in goods and sells them on to customers
without altering their condition. But for a manufacturing company it would be truer to say that
the cost of goods sold is as follows.

₦
Opening inventory of finished goods X
Plus cost of finished goods produced in the period X
X
Less closing inventory of finished goods X
Cost of finished goods sold X

3.6 Work in progress

At the reporting date, there will be work in progress in the production departments, i.e. work
which has been partly converted but which has not yet reached the stage of being finished
goods.

The value of this work in progress is the cost of the raw materials, the wages of employees who
have worked on it plus a share of overheads. To arrive at the cost of finished goods produced,
an increase in work in progress must be deducted from the total production costs. Of course,
if the value of work in progress had fallen during the period, this fall would be an increase in
the cost of finished goods produced.

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3.7 A pro-forma manufacturing account

XYZ ENTERPRISES
MANUFACTURING ACCOUNT
FOR THE YEAR ENDED 31 DECEMBER 20XX
₦ ₦
Raw materials:
Opening inventory X
Purchases (net of returns) X
X
Less closing inventory X
X
Direct factory wages X
Prime cost X
Production overhead:
Factory power X
Plant depreciation X
Plant maintenance X
Rent and insurance X
Light and heat X
Sundry expenses X
Factory manager's salary X
Building depreciation X
X
Production cost of resources consumed X
Work in progress:
Opening inventory X
Closing inventory (X)
(X)
Production cost of finished goods produced XX

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Illustration 1

A manufacturing company has its factory and offices at the same site. Its results for the year to
31 December 20X5 were:
₦
Sales 179,000
Purchases of raw materials 60,000
Direct labour 70,000
Depreciation of equipment 10,000
Rent 5,000
Depreciation of building 2,000
Heating and lighting 3,000
Telephone 2,000
Other manufacturing overheads 2,300
Other administration expenses 2,550
Other selling expenses 1,150
Shared overhead costs are to be apportioned as follows:
Manufacturing Administration Selling
Depreciation of equipment 80% 5% 15%
Rent 50% 30% 20%
Depreciation of building 50% 30% 20%
Heating and lighting 40% 35% 25%
Telephone – 40% 60%

The values of inventories are as follows.

At At
1 January 20X5 31 December 20X5
₦ ₦
Raw materials 5,000 3,000
Work in progress 4,000 3,000
Finished goods 16,000 18,000

Required
Prepare the manufacturing account and income statement of the company for the period to 31
December 20X5.

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SUGGESTED SOLUTION

A MANUFACTURING COMPANY
Manufacturing Account for the year ended 31 December, 20X5
₦ ₦
Opening Inventory of Raw Material 5,000
Purchases of Raw Material 60,000
65,000
Closing Inventory of Raw Material (3,000)
62,000
Direct labour 70,000
Prime Cost 132,000
Factory Overhead Costs:
Depreciation of equipment (wk1) 8,000
Rent (wk2) 2,500
Depreciation of building (wk1) 1,000
Heating and lighting (wk3) 1,200
Other factory overhead 2,300
15,000
Production cost of resources consume 147,000
Opening Work-in- Progress 4,000
Closing Work-in- Progress (3,000) 1,000
Production Cost of Finished Goods 148,000

Income Statement for the year ended 31 December, 20X5

₦ ₦
Revenue 179,000
Cost of Sales:
Opening inventory of finished goods 16,000
Production cost of finished goods 148,000
164,000
Closing inventory of finished goods (18,000) (146,000)
Gross Profit 33,000
Administrative expenses:
Depreciation of equipment (wk1) 500
Rent (wk2) 1,500
Depreciation of building (wk1) 600
Heating and lighting (wk3) 1,050
Telephone (wk4) 800
Other administrative expenses 2,550 (7,000)
Selling expenses:
Depreciation of equipment (wk1) 1,500
Rent (wk2) 1,000
Depreciation of building (wk1) 400
Heating and lighting (wk3) 750
Telephone (wk4) 1,200
Other selling expenses 1,150 (6,000)
Profit for the year 20,000

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Workings

1. Depreciation of equipment:
₦
Factory = 80% x ₦10,000 = 8,000
Administrative = 5% x ₦10,000 = 500
Selling = 15% x ₦10,000 = 1,500
10,000
Depreciation of building:
₦
Factory = 50% x ₦2,000 = 1,000
Administrative = 30% x ₦2,000 = 600
Selling = 20% x ₦2,000 = , 400
2,000

2. Rent:
₦
Factory = 50% x ₦5,000 = 2,500
Administrative = 30% x ₦5,000 = 1,500
Selling = 20% x ₦5,000 = 1,000
5,000

3. Heating and lighting:

₦
Factory = 40% x ₦3,000 = 1,200
Administrative = 35% x ₦3,000 = 1,050
Selling = 25% x ₦3,000 = 750
3,000

4. Telephone:
₦
Administrative = 40% x ₦2,000 = 800
Selling = 60% x ₦2,000 = 1200
2,000

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3.8 Assignment

The following information has been extracted from the books of account of the Marsden
Manufacturing Company for the year to 30 September 20X4.
₦
Advertising 2,000
Depreciation for the year to 30 September 20X4:
Factory equipment 7,000
Office equipment 4,000
Direct wages 40,000
Factory: insurance 1,000
heat 15,000
indirect materials 5,000
power 20,000
salaries 25,000
Finished goods (at 1 October 20X3) 24,000
Office: electricity 15,000
General expenses 9,000
Postage and telephones 2,900
Salaries 70,000
Raw material purchases 202,000
Raw material inventory (at 1 October 20X3) 8,000
Sales 512,400
Work in progress (at 1 October 20X3) 12,000
Notes
(a) At 30 September 20X4 the following inventories were on hand.
₦
Raw materials 10,000
Work in progress 9,000
Finished goods 30,000

(b) At 30 September 20X4 there was an accrual for advertising of ₦1,000, and it was estimated
that ₦1,500 had been paid in advance for electricity. These items had not been included in the
books of account for the year to 30 September 20X4.
Required
Prepare Marsden's manufacturing account and income statement for the year to 30 September
20X4.

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TOPIC 7: INTRODUCTION TO PARTNERSHIP ACCOUNTS

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Contents
3.1 Definition of Partnership
3.2 Partnership Agreements
3.3 Financial Statements for a Partnership
3.4 Solving of Partnership Questions
3.5 Assignment

1.0 Introduction
You have learnt about the preparation of final accounts for a sole proprietary concern. As the
business expands, one needs more capital and larger number of people to manage the business
and share its risks. In such a situation, people usually adopt the partnership form of organisation.
Accounting for partnership firms has its own peculiarities, as the partnership firm comes into
existence when two or more persons come together to establish business and share its profits.

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Define a partnership
(b) Explain the typical contents of a partnership agreements
(c) Explain the contents when there is no partnership agreements
(d) Explain the:
– partners’ capital accounts
– partners’ current accounts
– Statement of division of profits
(e) Explain and illustrate how to record partners’ shares of profits/losses and their drawings in
the accounting records and financial statements
(f) Explain how to account for loans from partners

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3.0 Main Contents

3.1 Definition of Partnership

A partnership is an unincorporated business owned by more than one person. Partnership is
‘the relationship which subsists amongst persons carrying on a business in common with a
view of making profit’.
• Therefore a partnership is a business which has two or more joint owners.
• As in the case of a sole trader, the profits of the business are owed to the owners.
• It is therefore necessary to share the profits of the business amongst the partners

3.2 Partnership Agreements (or Partnership Deed)

The partnership agreement is a written agreement in which the terms of the partnership are set
out, and in particular the financial arrangements as between partners.

3.2.1 Contents of Partnership Deed

(a) Capital. Each partner puts in a share of the business capital. If there is to be an agreement
on how much each partner should put in and keep in the business, as a minimum fixed amount,
this should be stated.

(b) Profit-sharing ratio. Partners can agree to share profits in any way they choose. For
example, if there are three partners in a business, they might agree to share profits equally but
on the other hand, if one partner does a greater share of the work, or has more experience and
ability, or puts in more capital, the ratio of profit sharing might be different.

(c) Interest on capital. Partners might agree to pay themselves interest on the capital they put
into the business. If they do so, the agreement will state what rate of interest is to be applied.

(d) Partners' salaries. Partners might also agree to pay themselves salaries. These are not
salaries in the same way that an employee of the business will be paid a wage or salary, because
partners' salaries are an appropriation of profit, and not an expense in the income statement of
the business.

(e) Drawings. Partners may draw out their share of profits from the business. However, they
might agree to put a limit on how much they should draw out in any period. If so, this limit
should be specified in the partnership agreement. To encourage partners to delay making

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withdrawals from the business until the financial year has ended, the agreement might also be
that partners should be charged interest on their drawings during the year

3.2.2 When There Is No Partnership Agreement

i. Partnership profit should be shared equally.
ii. No interest should be charged on partners’ capital.
iii. No interest should be charged on partners’ drawings.
iv. No interest should be charged on partners’ current accounts.
v. No salary should be paid on active partners.
vi. 5% interest should be paid on loan introduced by partner.

3.3 Financial Statements for a Partnership

Like a proprietorship, the income statement of a partnership or proprietorship is similar to that
of a corporation, except that there is no income taxes expense. Income taxes are paid personally
by partners on all sources of income, including their amounts of partnership income allocated
each year.
i. Partnership Income Statement
ii. Statement of Division of Profit
iii. Partners Current Accounts
iv. Partners’ Capital Accounts
v. Statement of Financial Position

3.3.1 Partnership Income Statement

The income statement for a partnership is exactly the same as that for a sole trader. A
partnership income statement also does not record any salaries expense paid to partners.

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SULEIMAN AND BALA

Statement of Profit or Loss for the Year Ended 31 December, 2017
₦ ₦
Revenue (Sales) XX
Sales Returns (X)
Net Sales XX

Cost of Sales:
Opening inventory XX
Purchases XX
Purchases returns (X)
Net purchases XX
Goods withdrew for personal use (X) XX
Carriage inward XX
Cost of goods available XX
Closing inventory (X)
(XX)
Gross Profit XX
Other Income:
Discount received X
Profit on disposal of non-current asset X
Investment Income (rent received, dividend received etc.) X
Decrease in allowance for receivables X XX
XX
Operating Costs:
Wages and salaries X
Rent and rates X
Insurance premium X
Discount allowed X
Carriage Outwards X
Office expenses X
Bad debts written off X
Increase in allowance for receivables X
Depreciation X
Advertisement X
Postages and stationery X
Utility bills X
Loss on disposal of non-current assets X
Interest on loan - Suleiman X
(XX)
Profit f or the year (Net Profit) XX

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3.3.2 Statement of Division of Profit (or Appropriation Account)

The net profit of a partnership is shared out between them according to the terms of their
agreement. This sharing out is shown in an appropriation account, which follows on from the
income statement. This is extra statement in which the profit from the income statement is
shared between the partners. This is referred to as a statement of division of profit or
appropriation account.

SULEIMAN AND BALA

STATEMENT OF DIVISION OF PROFIT 31 DECEMBER, 2017

₦ ₦ ₦
Net Profit b/f XX
Add:
Interest on Drawings:
Suleiman XX
Bala XX XX
XX
Less:
Interest on Capital:
Suleiman XX
Bala XX XX
Interest on Current Accounts:
Suleiman XX
Bala XX XX
Partners Salary:
Suleiman XX
Bala XX XX XX
Profit to share XX
Share of Profit / (Loss):
Suleiman XX
Bala XX (XX)
Nil

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3.3.3 Partners Current Accounts

A current account is used to record the profits retained in the business by the partner. The
profits allocated to each partner are credited to the partners’ current account. Drawings are also
recorded in this account. The current account is a sort of capital account, which increases in
value when the partnership makes profits, and falls in value when the partner whose current
account it is makes drawings out of the business.

SULEIMAN AND BALA

PARTNERS CURRENT ACCOUNTS. 31 DECEMBER, 2017.
Suleiman Bala
₦ ₦
Balance b/f (Opening Current) XX XX
Add:
Interest on Capital XX XX
Interest on Current Accounts XX XX
Partners Salary XX XX
Interest on loan – Suleiman XX XX
Share of profit/ (loss) XX XX
XX XX
Drawings (XX) (XX)
Interest on Drawings (XX) (XX)
Balance c/d (Closing Current) XX XX

3.3.4 Partners’ Capital Accounts (Fixed)

Each partner has an individual account that is credited with capital contributions to the
partnership. The partners’ capital account records the initial capital invested in the business by
each partner...
SULEIMAN AND BALA
PARTNERS CAPITAL ACCOUNTS. 31 DECEMBER, 2017.
Suleiman Bala
₦ ₦
Balance b/f (Opening Capital) XX XX
Balance c/d XX XX

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3.3.5 Statement of Financial Position

The partnership statement of financial position will therefore consist of:
(a) the capital accounts of each partner; and
(b) the current accounts of each partner, net of drawings

SULEIMAN AND BALA

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER, 2017.
₦ ₦ ₦
ASSETS:
Non- Current Assets Cost Acc. Depr. Carrying Value
Plant, and Equipment XX (X) XX
Furniture & Fittings XX (X) XX
Leasehold Premises XX (X) XX
Motor Vehicles XX (X) XX
XX (X) XX
Current Assets
Inventory (Closing) XX
Trade receivables XX
Allowance for receivables (X) XX
Bank or Cash XX
Bills Receivable XX
Other receivables (Prepayments, advance exp,) XX
Short term investment XX
XX
Total Assets XX

EQUITY:
Capital Accounts:
Suleiman XX
Bala XX XX
Current Accounts:
Suleiman XX
Bala XX XX
XX
Non- Current Liability
Loan – Suleiman XX
Finance lease XX
XX
Current Liabilities
Trade payables XX
Bill payables XX
Other payables (owing, due, accrual, arrear, outstanding exp.) XX
Bank overdraft XX
XX
Total Equity and Liabilities XX

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3.4 Loans by Partners

In addition, it is sometimes the case that an existing or previous partner will make a loan to the
partnership in which case he becomes a creditor of the partnership. If a partner makes a loan
to the business, he will receive interest on it in the normal way. On the statement of financial
position, such a loan is not included as partners' funds, but is shown separately as a non-current
liability (unless repayable within twelve months in which case it is a current liability). This is
the case whether or not the loan creditor is also an existing partner. However, interest on such
loans will be credited to the partner's current account.

3.4 Illustration 1
Alhaji, Pastor and Oluwo are in partnership with an agreement to share profits in the ratio 3:2:1.
They also agree the following terms.
(a) All three should receive interest at 12% on capital.
(b) Oluwo should receive a salary of ₦6,000 per annum.
(c) Interest will be charged on drawings at the rate of 5%
(d) The interest rate on the loan by Alhaji is 5%.
The statement of financial position of the partnership as at 31 December 20X5 revealed the
following
₦ ₦
Capital accounts
Alhaji 20,000
Pastor 8,000
Oluwo 6,000
34,000
Current accounts
Alhaji 3,500
Pastor (700)
Oluwo 1,800
4,600
Loan account (Alhaji) 6,000
Capital employed to finance net long-term assets and working capital 44,600

Drawings made during the year to 31 December 20X6 were as follows.

₦
Alhaji 6,000
Pastor 4,000
Oluwo 7,000

The net profit for the year to 31 December 20X6 was ₦24,530 before deducting loan interest.

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Required
Prepare the appropriation account for the year to 31 December 20X6, and the partners' capital
accounts, and current accounts.

SUGGESTED SOLUTION
(a)
ALHAJI, PASTOR AND OLUWO
Appropriation Account for the year ended 31 December, 20X6
₦ ₦
Net Profit 24,530
Interest on Partners’ Drawings:
Alhaji (wk1) 300
Pastor (wk1) 200
Oluwo (wk1) 350 850
25,380
Interest on Partners’ Capital:
Alhaji (wk2) 2,400
Pastor (wk2) 960
Oluwo (wk2) 720 (4080)
Patners’ Salary:
Oluwo (6000)
Interest on Partners’ Loan:
Alhaji (300)
Profit to share 15,000
Alhaji (wk3) 7,500
Pastor (wk3) 5,000
Oluwo (wk3) 2500 (15,000)
-
(b)
Fixed Partners Capital Account
Alhaji Pastor Oluwo
₦ ₦ ₦
Balance b/d 20,000 8,000 6,000
Balance c/d 20,000 8,000 6,000

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Partners’ Current Account

Alhaji Pastor Oluwo
₦ ₦ ₦
Balance b/d 3,500 (700) 1,800
Interest on capital 2,400 960 720
Partner salary - - 6,000
Partner’ interest on loan 300 - -
Share of profit 7,500 5,000 2,500
13,700 5,260 11,020
Partners drawings (6,000) (4,000) (7,000)
Interest on drawings (300) (200) (350)
Balance c/d 7,400 1,060 3,670

Workings

1. Interest on partners’ drawings:

Alhaji = 5% x ₦6,000 = ₦300
Pastor = 5% x ₦4,000 = ₦200
Oluwo = 5% x ₦7,000 = ₦350

2. Interest on partners’ capital:

Alhaji = 12% x ₦20,000 = ₦2,400
Pastor = 12% x ₦8,000 = ₦960
Oluwo = 12% x ₦7,000 = ₦720

3. Share of Profit:
Alhaji = 3/6 x ₦15,000 = ₦7,500
Pastor = 2/6 x ₦15,000 = ₦5,000
Oluwo = 1/6 x ₦15,000 = ₦2,500

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3.5 Assignment

The following notes are relevant to the accounts:

i. Inventories at 30 April 2013 are valued at N258,000
ii. The investments are measured at fair value through profit or loss. At 30 April 2013, the
market value of the investment was N666,000

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iii. The depreciation policy is as follows:

Building, plant, equipment and machine at 10% per annum
Motor vehicle at 20% on the carrying value
iv. Interest on capital and partners‟ loan is at 10% per annum
v. Provision for doubtful debts should be reduced to N28,000

You are required to: Prepare the Statement of Profit or Loss of the partnership for the year
ended 30 April 2013, in a vertical format.

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TOPIC 8: INTRODUCTION TO ACCOUNTS OF REGISTERED COMPANY

1.0 Introduction
2.0 Chapter Learning Objectives
3.0 Main Contents
3.1 Definition of Company
3.2 Capital structure of a limited liability company and their accounting treatment
3.3 The preparation of final accounts of limited liability companies
3.4 Assignment

1.0 Introduction
You have learnt about the preparation of final accounts for a sole proprietary concern. There
is need to learn the preparation of registered company’s financial statements. A registered
company is regarded as artificial person empowered by law to carry on the specific line of
business. Therefore, it is necessary to maintain its financial records.

2.0 Chapter Learning Objectives

Upon completion of this chapter you will be able to:
(a) Understand the capital structure of a limited liability company:
(b) Record movements in the share capital and share premium accounts
(c) Identify and record the other reserves which may appear in the company statement of
financial position.
(d) Define a bonus (capitalisation) issue and record a bonus issue in ledger accounts and show
the effect in the statement of financial position.
(e) Define a rights issue and record a rights issue in ledger accounts and show the effect in
the statement of financial position.
(g) Prepare company’s financial statements.

3.0 Main Contents

3.1 Limited liability Company

Limited liability companies offer limited liability to their owners. This means that the
maximum amount that an owner stands to lose in the event that the company becomes insolvent

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and cannot pay off its debts, is his share of the capital in the business. So, unlike sole traders,
the owners (shareholders) of a company do not have to use their own, private, finances to pay
payables if there are insufficient funds in the business.

Unlimited liability means that if the business runs up debts that it is unable to pay, the
proprietors will become personally liable for the unpaid debts and would be required, if
necessary, to sell their private possessions to repay them.

3.2 Capital Structure of a Limited Liability Company

3.2.1 Authorised (or legal) capital: is the maximum amount of share capital that a company
is empowered to issue. The amount of authorised share capital varies from company to
company, and can change by agreement.

For example, a company's authorised share capital might be 5,000,000 ordinary shares of ₦1
each. This would then be the maximum number of shares it could issue, unless the maximum
were to be changed by agreement.

3.2.2 Issued capital: is the par amount of share capital that has been issued to shareholders.
The amount of issued capital cannot exceed the amount of authorised capital.

Continuing the example above, the company with authorised share capital of 5,000,000
ordinary shares of ₦1 might have issued 4,000,000 shares. This would leave it the option to
issue 1,000,000 more shares at some time in the future

When share capital is issued, shares are allotted to shareholders. The term 'allotted' share capital
means the same thing as issued share capital.

3.2.3 Called-up capital: When shares are issued or allotted, a company does not always expect
to be paid the full amount for the shares at once. It might instead call up only a part of the issue
price, and wait until a later time before it calls up the remainder.

For example, if a company allots 400,000 ordinary shares of ₦1, it might call up only, say, 75
cents per share. The issued share capital would be ₦400,000, but the called-up share capital
would only be ₦300,000.

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3.2.4 Paid-up capital. Like everyone else, investors are not always prompt or reliable payers.
When capital is called up, some shareholders might delay their payment (or even default on
payment). Paid-up capital is the amount of called-up capital that has been paid.

For example,
If a company issues 400,000 ordinary shares of ₦1 each, calls up 75 cents per share, and
receives payments of ₦290,000, we would have:
₦
Allotted or issued capital 400,000
Called-up capital 300,000
Paid-up capital 290,000
Capital not yet paid-up 10,000

The statement of financial position of the company would appear as follows.

₦
Assets
Called-up capital not paid 10,000
Cash (called-up capital paid) 290,000
300,000
Equity
Called-up share capital
(400,000 ordinary shares of ₦1, with 75k per share called up) 300,000

3.2.5 Bonus issues

A company may wish to increase its share capital without needing to raise additional finance
by issuing new shares. For example, a profitable company might expand from modest
beginnings over a number of years. Its profitability would be reflected in large balances on its
reserves, while its original share capital might look like that of a much smaller business.
It is open to such a company to re-classify some of its reserves as share capital. This is purely
a paper exercise which raises no funds. Any reserve may be re-classified in this way, including
a share premium account or other statutory reserve. Such a re-classification increases the
capital base of the company and gives creditors greater protection.

A bonus (or capitalisation or scrip) issue is: the issue of new shares to existing shareholders in
proportion to their existing shareholding. No cash is received from a bonus issue.

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Example: bonus issue

Bubbles Co
Statement of financial position (extract)
₦'000 ₦'000

Equity
Share capital:
₦1 ordinary shares (fully paid) 1,000
Reserves:
Share premium 500
Undistributed profit (retained earnings) 2,000
2,500
Shareholders' funds 3,500

Bubbles decided to make a '3 for 2' bonus issue (ie 3 new shares for every 2 already held). So
shares with a nominal value of ₦1,500,000 need to be issued.
The double entry is
₦'000 ₦'000
DEBIT Share premium 500
Retained earnings 1,000
CREDIT Ordinary share capital 1,500

After the issue the statement of financial position is as follows

₦'000
Share capital:
₦1 ordinary shares (fully paid) 2,500
Reserves:
Retained earnings 1,000
Shareholders' funds 3,500

1,500,000 new ('bonus') shares are issued to existing shareholders, so that if Mr X previously
held 20,000 shares he will now hold 50,000. The total value of his holding should theoretically
remain the same however, since the net assets of the company remain unchanged and his share
of those net assets remains at 2% (ie 50,000/2,500,000; previously 20,000/1,000,000).

3.2.6 Rights issues

A rights issue (unlike a bonus issue) is an issue of shares for cash. The 'rights' are offered to
existing shareholders, who can sell them if they wish.

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A rights issue is the offer of new shares to existing shareholders in proportion to their existing
shareholding at a stated price (normally below market values).

Example: rights issue

Bubbles Co (above) decides to make a rights issue, shortly after the bonus issue. The terms are
'1 for 5 @ ₦1.20' (ie one new share for every five already held, at a price of ₦1.20). Assuming
that all shareholders take up their rights (which they are not obliged to) the double entry is:
₦'000 ₦'000
DEBIT Cash 600
CREDIT Ordinary share capital 500
Share premium 100

Mr X who previously held 50,000 shares will now hold 60,000, and the value of his holding
should increase (all other things being equal) because the net assets of the company will
increase. The new statement of financial position will show:
₦'000 ₦'000
Share capital
₦1 ordinary shares 3,000

Reserves:
Share premium 100
Retained earnings 1,000
1,100
Shareholders' funds 4,100

The increase in funds of ₦600,000 represents the cash raised from the issue of 500,000 new
shares at a price of ₦1.20 each.

Rights issues are a popular way of raising cash by issuing shares and they are cheap to
administer. In addition, shareholders retain control of the business as their holding is not
diluted.

The disadvantages of a rights issue is that shareholders are not obliged to take up their rights
and so the issue could fail to raise the money required. For this reason companies usually try
to find a broker to 'underwrite' the issue, ie who will buy any rights not taken up by the
shareholders.

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3.2.7 Ordinary Shares and Preference Shares

The two types of shares most often encountered are preference shares and ordinary shares.

Preference shares carry the right to a fixed dividend which is expressed as a percentage of
their nominal value: e.g. a 6% ₦1 preference share carries a right to an annual dividend of 6k.

Preference dividends have priority over ordinary dividends. If the directors of a company wish
to pay a dividend (which they are not obliged to do) they must pay any preference dividend
first. Otherwise, no ordinary dividend may be paid.

Ordinary shares are by far the most common. They carry no right to a fixed dividend but are
entitled to all profits left after payment of any preference dividend. In most companies only
ordinary shares carry voting rights.

Should the company be wound up, any surplus is shared between the ordinary shareholders.

Illustration
At the year-end, the trial balance for KT shows a debit balance of ₦20,000 in respect of
dividends. The Share Capital account of ₦1m comprises 200,000 5% preference shares of ₦1
with the balance made up of 50k ordinary shares. The dividends account represents a half-
year's preference dividend and an interim ordinary dividend. A final dividend of 5k per ordinary
share was proposed before the trial balance was prepared.
Calculate the interim and final dividends for each category of share.

SUGGESTED SOLUTION
A full year's dividend on the preference shares is 200,000 @ 5% = ₦10,000, therefore a half-
year's dividend was ₦5,000, with a final dividend of the same amount.

The interim ordinary dividend was therefore ₦15,000 (₦20,000 – ₦5,000).

As the share capital account amounts to ₦1m, ₦800,000 (₦1m – ₦200k) must relate to
ordinary shares. However, the ordinary shares are only 50k each, meaning that there are 1.6
million of them. The final dividend is therefore ₦80,000 (1.6m × 5k)

3.2.8 Reserves
Reserves are profits that have not been distributed (paid out) to shareholders.

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The ordinary shareholders' total investment in a company is called the equity and consists of
ordinary share capital plus reserves.

A distinction should be made between the two types of reserves.

Statutory reserves are reserves which a company is required to set up by law and which are
not available for the distribution of dividends.

Non-statutory reserves are reserves consisting of profits which are distributable as dividends,
if the company so wishes.

This is the most significant non-statutory reserve, and it is described in many different ways.
• Revenue reserve
• Retained profits
• Retained earnings
• Undistributed profits
• Unappropriated profits
Under IAS 1 (revised), it is called retained earnings

The share premium account

The share premium account is a statutory reserve created if shares are issued for more than
their nominal value. The excess received over nominal value is credited to the share premium
account.

When a company is first incorporated (set up) the issue price of its shares will probably be the
same as their nominal value and so there would be no share premium. If the company does well
the market value of its shares will increase, but not the nominal value. The price of any new
shares issued will be approximately their market value. The difference between cash received
by the company and the nominal value of the new shares issued is transferred to the share
premium account.

A share premium account only comes into being when a company issues shares at a price in
excess of their nominal value. The market price of the shares, once they have been issued, has
no bearing at all on the company's accounts, and so if their market price goes up or down, the
share premium account would remain unaltered.

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Example
X Co issues 1,000 ₦1 ordinary shares at ₦2.60. What entries record this issue?

Solution
₦ ₦
DEBIT Cash 2,600
CREDIT Ordinary share capital 1,000
CREDIT Share premium account 1,600

Revaluation reserve
A revaluation reserve is a statutory reserve which must be created when a company revalues
its non-current assets.

Revaluations frequently occur with freehold property, as the market value of property rises.

The directors might wish to show a more 'reasonable' value of the asset in their statement of
financial position to avoid giving a misleading impression about the financial position of the
company.
When an asset is revalued the revaluation reserve is credited with the difference between the
revalued amount of the asset, and its net book value before the revaluation took place.
Depreciation is subsequently charged on the revalued amount.

Example:
X Co bought freehold land and buildings for ₦20,000 ten years ago; their net book value (after
depreciation of the buildings) is now ₦19,300. A professional valuation of ₦390,000 has been
given, and the directors wish to reflect this in the accounts. Show the entries to record this
revaluation.

Solution
The revaluation surplus is ₦390,000 – ₦19,300 = ₦370,700. The entry to be made is thus.
₦ ₦
DEBIT Freehold property 370,700
CREDIT Revaluation reserve 370,700

The statement of financial position will then include the following.

Reserves:
Revaluation reserve 370,700

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Non-current assets:
Freehold property (at valuation) 390,000

An unrealised capital profit (such as the ₦370,700 above) is generally not distributable,
whereas a realised capital profit (ie if the property is actually sold for ₦390,000) usually is
distributable

Distinction between reserves and provisions

A reserve is an appropriation of distributable profits for a specific purpose (eg plant
replacement) while a provision is an amount charged against revenue as an expense.

A provision relates either to a diminution in the value of an asset (eg allowance for receivables)
or a known liability (e.g. audit fees), the amount of which cannot be established with any
accuracy. Provisions (for depreciation, allowance for receivables etc.) are dealt with in
company accounts in the same way as in the accounts of other types of business.

Question
(a) A public company has 10,000,000 25c shares in issue and their current value on the stock
market is ₦4.97 per share. What is the value of share capital in the company's nominal ledger?
(b) The retained profits of a limited liability company the same thing as the trading account of
a sole trader. True or false?
(c) A freehold property is revalued from ₦180,000 to ₦500,000. What is the balance on the
revaluation reserve after this revaluation?

Answer
(a) ₦2.5m.
(b) False. The reserve is for retained profits, not profits of the current year only.
(c) ₦320,000 (i.e. ₦500,000 – ₦180,000).

3.2.10 Dividends
Profits paid out to shareholders are called dividends.
• An interim dividend is a dividend paid part-way through the year
• At the end of the year, the company might pay a further final dividend.

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The total dividend for the year is the sum of the interim and final dividends. (Not all companies
pay an interim dividend. Interim dividends are commonly paid by public limited companies.)
Usually, at the end of an accounting year, a company's directors will propose a final dividend
payment, but this will not yet have been paid. This means that the final dividend will be shown
as a note to the financial statements. It is not a liability until the dividend is approved at the
Annual General Meeting (AGM).

3.3 THE FINAL ACCOUNTS OF LIMITED LIABILITY COMPANIES

The preparation and publication of the final accounts of limited liability companies is governed
by IAS 1.

IAS 1 (revised) format

ABC CO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X2
20X2 20X1
₦'000 ₦'000 ₦'000
₦'000
Assets
Non-current assets:
Property, plant and equipment X X
Goodwill X X
Other intangible assets X X
X X
Current assets
Inventories X X
Trade and other receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X
Equity and liabilities
Equity:
Share capital X X
Retained earnings X X
Other components of equity X X
X X

Non-current liabilities:
Long-term borrowings X X
Long-term provisions X X
Preference shares X X
Deferred tax X X

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X X
Current liabilities:
Trade payables X X
Other payables X X
Short-term borrowings X X
Bank overdraft X X
Current tax payable X X
X X
Total equity and liabilities X X

ABC CO
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31
DECEMBER 20X2
20X2 20X1
₦'000 ₦'000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Profit before tax X X
Income tax expense (X) (X)
Profit for the year X X
Other comprehensive income:
Gains on property revaluation X X
Total comprehensive income for the year X X

Illustration 1
You have been asked to prepare the financial statements of Tanimose Limited for the year
ended 31 December, 2018. A trial balance as at that date is shown below.
DR CR
N’000 N’000
Revenue 53,000
Purchases 32,200
Property, plant and equipment - cost 59,000
Property, plant and equipment - accumulated depreciation 25,000
Inventories as at 1 January, 2018 7,800
Interest expense 200

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Accrued expenses 400

Distribution expenses 8,900
Administrative expenses 7,000
Retained earnings 23,500
Trade receivables 9,000
Cash at bank 200
8% bank loan repayable in 2021 5,000
10 Million Ordinary share capital at N1 each 10,000
Share premium 5,000
Trade payables 2,400
124,300 124,300

The following information is also available:

(i) The revenue figure in the trial balance includes sales made on credit to Mr. Abdullahi
amounting to N3,100,000 on 30 October, 2017.

(ii) Closing inventory value was N8,400,000. Included in this figure are inventories that cost
N500,000 but which can be sold for only N250,000.
(iii) Carriage inwards amounting to N157,000 was not included in the trial balance.

(iv) Interest on bank loan for the past six months remained unpaid as at 31 December, 2018.
This was not included in the trial balance.

(v) Depreciation of property, plant and equipment, for the year was charged at 10% using
straight line method.

(vi) Accrued distribution expenses amounted to N150,000 at 31 December, 2018.

You are required to prepare:

a. Statement of profit or loss and other comprehensive income for the year ended 31 December,
2018.
b. Statement of financial position as at 31 December, 2018.

SUGGESTED SOLUTION

TANIMOSE LIMITED
Statement of profit or loss and other comprehensive income for the year ended December
31, 2018
N’000 N’000
Revenue (53,000-3,100) 49,900
Cost of sales
Opening Inventory 7,800
Purchases 32,200
Carriage inward 157

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Closing inventory (8400 - 250) (8150) (32,007)

Gross profit 17,893
Distribution costs (8900+150) 9,050
Administrative expenses (7,000+(10% x 59,000) 12,900 (21,950)
Loss from operations (4,057)
Finance costs (200+200) (400)
Loss before tax (4,457)
Tax expense -
Loss for the year (4,457)

Statement of financial position as at December 31, 2018

Assets N’000 N’000
Non-current Assets
Property, plant and equipment (59,000-25,000-5900) 28,100
Current Assets
Inventories (8,400-250) 8,150
Trade receivables 9,000
Cash at bank 200 17,350
45,450
Equity
Share capital 10,000
Share premium 5,000
Retained earnings (23,500-4,457 + 3,100) 22,143 37,143
Liabilities
Non-current liabilities
8% bank loan 5,000
Current liabilities
Trade payables 2,400
Accrued expenses (400+200+150+157) 907 3,307
45,450

3.4 Assignment
The following balances remained in the books of Lagbaja Plc at December 31, 2014 after
determining the gross profit:
N’000
Share capital, authorised and issued:
200,000,000 ordinary shares of N1 each 200,000
Cash at bank and in hand 500
Inventory at December 31, 2014 61,200
Trade receivables 18,005
Trade payables 15,009
Gross profit at December 31, 2014 128,942

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Retained earnings 25,000

Salaries & Wages 28,430
Prepayments 600
Bad debts 500
Accrued expenses 526
Director]s account (credit) 2,500
Finance cost on loan note (½ year to June 30, 2014) 600
Sundry expenses 4,100
Rates & insurance 1,520
6% Loan notes 20,000
Lighting & cooling 1,310
Postage, telephone and telegrams 800
Motor vehicle (cost N25million) 15,000
Office fittings and equipment (cost N65.5million) 42,350
Profit at January 1, 2014 22,300
Land and buildings at Cost 239,362

The following additional information is relevant:

(i) Office fittings and equipment are to be depreciated at 15% of cost, and Motor vehicle at
20% of cost.
(ii) Provisions are to be made for:
Directors’ fees N6,000,000
Audit Fees N2,500,000
(iii) The amount of insurance includes a premium of N600,000 paid in September 2014 to
cover the company against fire for the period September 1, 2014 to August 31, 2015.

(iv) A bill for N548,000 in respect of electricity consumed up to December 31, 2014 has not
been posted to the ledger.

Required:
a. Prepare the Statement of profit or loss for the year ended December 31, 2014; and
b. the Statement of financial position as at December 31, 2014.

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