FUNDAMENTALS OF ACCOUNTING: (BAF 111)

STUDY MATERIAL

BAF 1101: FUNDAMENTALS OF ACCOUNTING

BACHELOR OF BUSINESS ADMINISTRATION

AND

BACHELOR OF SCIENCE IN ACCOUNTING AND

FINANCE

@TU

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 FUNDAMENTALS OF ACCOUNTING: (CODE BAF 1101)

Table of Contents
PREFACE......................................................................................................................................5
Course Description........................................................................................................................5
COURSE OUTLINE.....................................................................................................................6
1.0 INTRODUCTION...................................................................................................................9
1.1 Financial Accounting.....................................................................................................10
1.2 Cost accounting...............................................................................................................10
1.3 Management accounting.................................................................................................11
1.4 Book Keeping and Accounting.......................................................................................12
1.5 Users/interested parties in accounting information.......................................................13
1.9. FORMS OF BUSINESS:......................................................................................................37
CHAPTER TWO:........................................................................................................................38
PRINCIPLES OF DOUBLE ENTRY AND ACCOUNTING SYSTEM................................38
2.3 DOUBLE-ENTRY ACCOUNTING....................................................................................54
CHAPTER THREE.....................................................................................................................65
THE PREPARATION OF BOOKS OF ACCOUNTS.............................................................65
3.3 JOURNALS............................................................................................................................69
3.3.5 BANK STATEMENT:......................................................................................................78
3.3.6 PETTY CASH:..................................................................................................................78
3.4 THE MAIN BOOK OF ACCOUNTS..................................................................................81
3.4.1 THE LEDGER...................................................................................................................84
3.5 Posting transactions from the Journals to the Ledgers......................................................93
CHAPTER FOUR.....................................................................................................................105
ADJUSTMENTS IN ACCOUNTS:.........................................................................................105
4.2 ACCRUALS AND PREPAYMENTS:...............................................................................119
4.3 BAD(IRRECOVERABLE) DEBTS..................................................................................121
4.4. Provisions and contingencies: (IAS 37).............................................................................124
CHAPTER FIVE.......................................................................................................................127
PREPARATION OF A TRIAL BALANCE...........................................................................127
5.1 Definition of a trial balance................................................................................................127
5.2 Preparing a trial balance.....................................................................................................127
5.3 EXTRACTION OF TRIAL BALANCE...........................................................................133
5.4 Errors detected by a trial balance......................................................................................142
CHAPTER SIX..........................................................................................................................145
BANK RECONCILIATIONS..................................................................................................145
6.1 Preparing Bank Reconciliation Statements........................................................................145
6.2 Agreement of the cash and bank balances..........................................................................147
6.3 Steps to follow reconciling account balances:....................................................................150
6.4 Relevance of Bank reconciliation.......................................................................................152
CHAPTER SEVEN...................................................................................................................155
PREPARATION OF FINANCIAL STATEMENTS OF SOLE TRADERS.......................155
7.1 FINAL ACCOUNTS OF A SOLE TRADER...................................................................156
PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS162
8.1 INCOMPLETE RECORDS:..............................................................................................162

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8.1.3 Purchases and trade accounts payable:............................................................................166

8.1.5 Stolen goods or goods destroyed:....................................................................................168
8.1.7 Accruals and prepayments:..............................................................................................169
CHAPTER NINE.......................................................................................................................173
PREPARATION OF FINANCIAL STATEMENTS OF PARTNERSHIPS:......................173
9.1 Definition of a partnership..................................................................................................173
9.2.1 Advantages in comparison to sole trading......................................................................174
9.2.2 Advantages in comparison to a company........................................................................174
9.2.3 Disadvantages of partnerships.........................................................................................174
9.3 Partnership agreements.......................................................................................................174
9.4 Preparation of final accounts of partnerships.....................................................................179
9.5 CHANGES IN PARTNERSHIPS;.....................................................................................181
CHAPTER TEN.........................................................................................................................191
PREPARATION OF FINANCIAL STATEMENTS OF LIMITED COMPANIES:.........191
10.1 Definition of a limited company.......................................................................................191
10.1 Types of companies..........................................................................................................192
10.2 IAS 1 Presentation of financial statements:......................................................................192
10.8 IAS 18 Revenue:...............................................................................................................204
CHAPTER ELEVEN................................................................................................................207
PREPARATION OF FINANCIAL STATEMENTS OF NON PROFIT MAKING
ORGANISATIONS...................................................................................................................207
11.1 Definition of nonprofit making organization...................................................................207
11.2 Accounts prepared by non-trading organization..............................................................208
Required prepare the relevant accounts..................................................................................215
CHAPTER TWELVE...............................................................................................................216
STATEMENT OF CASH FLOWS..........................................................................................216
12.1 IAS 7 Statement of Cash flows:.......................................................................................217
12.2 Presentation of a statement of cash flows:.......................................................................218
12.3 Reporting cash flows from operations:.............................................................................219
12.4 Advantages of cash flow accounting:...............................................................................225
REFERENCES:.........................................................................................................................229
1.0 INTRODUCTION...................................................................................................................7
1.1 Financial Accounting.........................................................................................................7
1.2 Cost accounting...................................................................................................................8
1.3 Management accounting....................................................................................................9
1.4 Book Keeping and Accounting........................................................................................10
1.5 Users/interested parties in accounting information.......................................................11
1.6 OBJECTIVES OF FINANCIAL STATEMENTS........................................................16
1.7 ACCOUNTING PRINCIPLES/CONCEPTS/CONVENTIONS..................................17
1.8. Accounting Regulatory Framework:..............................................................................30
1.9. FORMS OF BUSINESS:......................................................................................................35
CHAPTER TWO:........................................................................................................................36
PRINCIPLES OF DOUBLE ENTRY AND ACCOUNTING SYSTEM................................36
2.1 The Accounting equation:.....................................................................................................38

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2.3 DOUBLE-ENTRY ACCOUNTING....................................................................................52

2.4 Accounts..................................................................................................................................53
CHAPTER THREE.....................................................................................................................63
THE PREPARATION OF BOOKS OF ACCOUNTS.............................................................63
3.1 Subsidiary books and sources of information.....................................................................64
3.2 Sources of information..........................................................................................................65
3.3 JOURNALS............................................................................................................................67
3.4 THE MAIN BOOK OF ACCOUNTS..................................................................................79
3.5 Posting transactions from the Journals to the Ledgers......................................................90
CHAPTER FOUR.......................................................................................................................96
ADJUSTMENTS IN ACCOUNTS:...........................................................................................96
4.0 Depreciation of non-current assets.......................................................................................96
Fixed assets are those assets of monetary and material value bought for use in business over
their life span. When fixed assets are used in business they lose value therefore the
monetary costs in a fixed assets is termed as depreciation......................................................96
Example......................................................................................................................................96
Solution.......................................................................................................................................96
Example......................................................................................................................................96
Example......................................................................................................................................96
Solution.......................................................................................................................................96
4.1.3 Accumulated depreciation:................................................................................................96
Annual depreciation charge = 1,600,000 – 250,000 = shs 450,000...........................................96
Example........................................................................................................................................96
Solution.........................................................................................................................................96
4.2 ACCRUALS AND PREPAYMENTS:.................................................................................96
4.3 BAD(IRRECOVERABLE) DEBTS.....................................................................................96
4.4. Provisions and contingencies: (IAS 37)...............................................................................96
CHAPTER FIVE.........................................................................................................................96
PREPARATION OF A TRIAL BALANCE.............................................................................96
5.1 Definition of a trial balance..................................................................................................96
5.2 Preparing a trial balance.......................................................................................................96
5.3 EXTRACTION OF TRIAL BALANCE.............................................................................96
5.4 Errors detected by a trial balance........................................................................................96
5.5. Errors not detected by the trial balance.............................................................................96
CHAPTER SIX............................................................................................................................96
BANK RECONCILIATIONS....................................................................................................96
6.1 Preparing Bank Reconciliation Statements..........................................................................96
6.2 Agreement of the cash and bank balances............................................................................96
6.3 Steps to follow reconciling account balances:......................................................................96
6.4 Relevance of Bank reconciliation.........................................................................................96
CHAPTER SEVEN.....................................................................................................................96
PREPARATION OF FINANCIAL STATEMENTS OF SOLE TRADERS.........................96
7.1 FINAL ACCOUNTS OF A SOLE TRADER......................................................................96
7.1.1Points to note about the Income Statement.......................................................................96

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We shall study the preparation of final accounts of a sole trader by looking at an example.
.......................................................................................................................................................96
Example:.......................................................................................................................................96
Trial Balance of Sarah Kagezi on 31/12/2010...........................................................................96
Total..............................................................................................................................................96
Additional Information...............................................................................................................96
Treatment of Depreciation in Final Accounts...........................................................................96
Total..............................................................................................................................................96
Additional Information...............................................................................................................96
Required: Prepare.......................................................................................................................96
Treatment of Bad Debts Provisions in Final Accounts............................................................96
Total..............................................................................................................................................96
Total..............................................................................................................................................96
CHAPTER EIGHT......................................................................................................................96
PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS. 96
8.1 INCOMPLETE RECORDS:................................................................................................96
CHAPTER NINE.........................................................................................................................96
PREPARATION OF FINANCIAL STATEMENTS OF PARTNERSHIPS:........................96
9.1 Definition of a partnership....................................................................................................96
9.2.1 Advantages in comparison to sole trading........................................................................96
9.2.2 Advantages in comparison to a company..........................................................................96
9.2.3 Disadvantages of partnerships...........................................................................................96
9.3 Partnership agreements.........................................................................................................96
9.3.1 Rules in the absence of an agreement............................................................................96
9.3.6 Interest on capitals..............................................................................................................96
9.3.7 Interest on drawings...........................................................................................................96
9.3.9...............................................................................................................................................96
Salaries to partners......................................................................................................................96
9.4 Preparation of final accounts of partnerships.......................................................................96
Example........................................................................................................................................96
9.5 CHANGES IN PARTNERSHIPS;.......................................................................................96
Good will.......................................................................................................................................96
Example :......................................................................................................................................96
Locke 3,500.................................................................................................96
Partners Current accounts..........................................................................................................96
DR CR................................................................................................................................96
CHAPTER TEN...........................................................................................................................96
PREPARATION OF FINANCIAL STATEMENTS OF LIMITED COMPANIES:...........96
10.1 Definition of a limited company.........................................................................................96
10.1 Types of companies............................................................................................................96
10.2 IAS 1 Presentation of financial statements:........................................................................96
Types of shares...........................................................................................................................96
10.3 Profit or loss for the period:................................................................................................96
10.3.2 Statement of financial Position format:..........................................................................96

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10.3.3.............................................................................................................................................96
Format: Statement of comprehensive income:.........................................................................96
ABC Co.........................................................................................................................................96
2010 2009................................................................................................................................96
10.4 Notes to financial statements:.............................................................................................96
10.5 Items in the statement of comprehensive income:............................................................96
10.6 Items in the statement of financial position:.......................................................................96
Required :Prepare relevant accounts for its internal and external use....................................96
10.8 IAS 18 Revenue:.................................................................................................................96
CHAPTER ELEVEN..................................................................................................................96
PREPARATION OF FINANCIAL STATEMENTS OF NON PROFIT MAKING
ORGANISATIONS.....................................................................................................................96
11.1 Definition of nonprofit making organization.....................................................................96
11.2 Accounts prepared by non-trading organization................................................................96
Example........................................................................................................................................96
Required to prepare relevant accounts......................................................................................96
Solution.........................................................................................................................................96
Assets.............................................................................................................................................96
Income........................................................................................................................................96
Expenditure.................................................................................................................................96
Required prepare the relevant accounts....................................................................................96
CHAPTER TWELVE.................................................................................................................96
STATEMENT OF CASH FLOWS............................................................................................96
12.1 IAS 7 Statement of Cash flows:.........................................................................................96
12.2 Presentation of a statement of cash flows:.........................................................................96
12.3 Reporting cash flows from operations:...............................................................................96
12.4 Advantages of cash flow accounting:.................................................................................96
REFERENCES:...........................................................................................................................96

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PREFACE
Course Description
This course offers an introduction to the basic principles underlying the logic of Accounting,
students will undertake an analysis of business transactions and preparation of financial
statements. the purpose and function of financial reporting and its impact on the various users
such as management, owners, creditors and other external users will be examined. Students
develop an understanding of the fundamentals of financial Accounting relating to
bookkeeping and preparation of financial statements.

Course Objectives
1) To classify forms of business organizations
2) Record transitions on books using double entry system
3) Prepare books of prime entry
4) Getting to know the role of reporting frame work
5) Learn to prepare simple financial statements for a business organization and non-profit
making organizations
6) Construct a trial balance

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7) Apply some international financial reporting standards.

8) Introduction to international Accounting Standards

Course Learning Outcomes

Upon successful completion of this course, students will have demonstrated ability to:
1) Explain the role of Accounting and accountants
2) Describe the financial reporting framework
3) Explain the qualitative characteristics of financial information
4) Prepare accounts and financial statements from incomplete records
5) Explain the different forms of business organizations
6) Reconcile financial transactions
7) Record transactions in the books of prime entry and ledgers using double entry bookkeeping

COURSE OUTLINE
Detailed Course Description;
UNIT 1: Introduction
a) Definition of Financial Accounting
b) Branches of Accounting
c) Users of Accounting information and their information needs
d) Accounting concepts/principles/conventions 4hrs
UNIT 2: Forms of Business
a) The entity concept
b) Categories of business organizations their characteristics, benefits and limitations
c) Partnerships
d) Limited companies 4hrs
UNIT 3: Principles of Double Entry and Accounting System
a) Accounting equation
b) Double entry book keeping
c) Books of prime entry

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d) Types of Ledgers and their purpose

e) Extraction of trial balance from ledgers
f) Types of errors in a trial balance
g) Correction of errors 6hrs
UNIT 4: Preparation of Financial statements for Sole traders
Adjustments in Accounts
a) Prepayments
b) Accruals
c) Depreciations
d) Provisions
e) Bad debts
f) Preparation of income statement, balance sheet and cash flow statements
10hrs

UNIT 5: Manufacturing Accounts

a) Introduction
b) Elements of costs
c) Product cost and period cost
d) Stock in trade of a manufacturing firm
e) Market value of goods manufactured
f) Unrealized profit in stock
g) Work in progress
h) Preparation of income statement and balance sheet 8hrs
UNIT 6: Preparation of financial statements for non-profit making organizations
a) Identify the entity and purpose of the organization
b) Compare receipts and payment accounts with income statement
c) Prepare the receipts and payment accounts
d) Income statement and balance sheet for non-profit making organizations 6hrs
UNIT 7: Partnerships Accounts

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a) Contents of a partnership deed

b) Treatment of good will
c) Accounts for changes in partnership on admission and retirement of partners
d) Preparation of income statement and balance sheet
e) Dissolution of a partnership 6hrs
UNIT 8: Bank Reconciliation
a) Causes of differences in cashbook balance and bank statement balance
b) Methods of reconciling the balances
c) Preparation of bank reconciliation statement 4hrs
UNIT 9: Preparation of Financial Statements from incomplete records
a) Definition of single entry Accounting system and its advantages
b) Opening position statements
c) Analysis of cash and bank transactions
d) Derive missing figures
e) Prepare control accounts
f) Prepare financial statements. 6hrs

UNIT 10: International Financial Reporting Standards (IFRS’s)

Application of IFRS’s dealing with
a) Presentation of Financial Statements
b) Inventories
c) Cash flow statements.
d) Accounting policies, changes in Accounting estimates and errors
e) Property, Plant and Equipment, disposal, impairment and evaluation
f) Revenue
g) Provisional
h) Intangible assets
i) Taxation 6hrs
Total Lecture hours 60

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Mode of assessments
Take-home assignment 10%
Course work test2 30%
Final exam 60%
Total 100%
Teaching methods
Face to face lectures, group and class discussions

REFERENCES
Serwanga A (2005) Introduction to Financial Accounting 1 st Edition. Wide link services
Kampala.
Frank Wood and Alan Sangster Business Accounting 1 (10the Ed). Prentice Hall.
H. Johnson & Whitman A Practical Foundation in Accounting. Routledge.
IASB International Financial Reporting Standards. IASB.
Government of Uganda. Laws of Uganda: The Companies Act, Capital markets Acts,
Financial Institutions Act, and Insurance Act.
N.A Saleemi-Foundation of Accounting

TEAM INSTITUTE OF BUSINESS MANAGEMENT

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BBA & BSAF EXTERNAL

FUNDAMENTALS OF ACCOUNTING I

DEPARTMENT OF UNDERGRADUATE STUDIES

[OCTOBER NOVEMEBR 2011]

[.]

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This reading material is published by;

Team Institute of Business Management

P.O Box 8128

Kampala.

Tel: 256 414 346139

Email: info@teamibme.ac.ug

Copy right by: Team Institute of Business Management

All rights reserved.

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PREFACE:

COURSE DESCRIPTION:

This course offers an introduction to the basic principles underlying the logic of accounting. Students will

undertake an analysis of business transactions and preparation of financial statements, the purpose and

function of financial reporting and its impact on the various users such as management, owners, trade

payables and other external users will be examined.

COURSE OBJECTIVES:

By the end of the course, the student should be able to;

1. Classify forms of business organizations

2. Develop knowledge and understanding of the underlying principles and concept relating to financial

accounting

3. Acquire proficiency in the use of double entry accounting techniques.

34. Understand the nature, principles and scope of financial reporting.

45.. Prepare the main types of financial statements

65. Understand and identify the purpose of each of the financial statements.

67. Define and identify elements in the financial statements

COURSE ChapterOUTLINE Outline:

CHAPTER ONE:

- Introduction

- Definition of financial accounting, book keeping, cost and management accounting

- Their similarities and differences

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- Users of financial accounting information

-Objectives of financial statements

- Accounting principles/concepts

-and Regulatory framework

CHAPTER ONE
1.0 INTRODUCTION
This chapter defines the different sub systems of the accounting systems which include; cost accounting,

management accounting and financial accounting system. The financial accounting system that

constitutes the process of book keeping is our main focus in this course. We shall also look at the

different forms of business and highlight the stakeholders of any business pointing out their needs. The

chapter will also deal with accounting concepts that are behind preparation of financial statements

Learning Objectives:

By the end of this chapter you should be able to;

 Define cost accounting, management accounting and financial accounting.

 Compare and contrast the three sub systems of the accounting system

 Identify and define types of business entities and recognize their legal requirements

 Identify the users of financial statements and state and differentiate between their

information needs.

 Explain the different accounting conventions on which preparation of financial statements is

based

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1.1 Financial Accounting

Financial Accounting is the art and science of recording and classifying financial transactions

summarizing and communicating financial information through production of financial

statements/reports, and interpretation of the operating results portrayed in financial statements/

reports to facilitate decision-making (Omonuk, 1999).

Financial Accounting is the process of identifying, measuring and communicating economic information

to permit informed and rational decisions to be made. Rational decisions made by the organization

include for example; working capital decisions, capital budgeting decisions, investment decisions, etc. It

is beyond the scope of this book to go into details of these decisions.

Without limiting accounting to finances, in general use, accounting means explaining and defending or

justifying actions or results of those actions. All those who have been entrusted with safe custody of

others resources are usually required to account or submit accountability to the owners of the

resources.

1.2 Cost accounting

It is primarily concerned with cost determination and allocation of costs to products and services in

accordance with costing principles, methods and techniques. Determining product costs and assigning

costs to products is called costing.

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In many organizations, cost accounting is concerned with ascertainment and analysis of product costs.

Costs should determine the least price (floor) to be charged for a product unless the environment is too

competitive. Costing products with-a view to setting a selling price is very crucial.

A cost accountant will also analyze costs into their behavior patterns ie. fixedFixed, variable or semi fixed

and semi variable. This analysis will help management on how to control and minimize costs and Plan for

profits. Cost accounting developed and gained prominence during the industrial revolution when

business activity grew and there was need to control costs.

Financial accounting though it predates cost accounting became inadequate in providing information for

cost control. Key costing techniques for cost control are, standard costing and variance analysis, target

costing and budgeting and budgetary control. Key techniques for planning are, marginal costing also

called Cost Volume Profit analysis or break even analysis and budgeting. Costing methods such as job

costing, contract costing, process costing, service costing are also major areas of study. Cost accounting

is taught as a separate course or subject usually in the third year of study for students majoring in

accounting.

1.3 Management accounting

The emphasis of management accounting is providing information to management for execution of their

functions. It was observed earlier that management is in dire need of information for planning, control

and decision making.

Management accounting is primarily concerned with data gathering, processing, analysis, interpretation

and communication of the resulting information to management so that they can more effectively plan,

control operations and make decisions.

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A management accountant must be knowledgeable of managerial processes so that he/she can provide

relevant information for facilitation of that process.

However, there is no clear dividing line between cost accounting and management accounting. Cost

accounting is an important source of data for management accounting purposes. Most of the

information that management needs is cost related. For this reason the two are sometimes taught as

one course called cost and management accounting.

In organizations, there is no need for both positions of a cost accountant and management accountant

because it will lead to duplication of functions. Though management accounting draws heavily on cost

accounting, its scope is a bit wider it also borrows from other disciplines such as financial management,

financial accounting, operations research economics etc. as long as the information so generated is

relevant for management decisions.

Management accounting uses more advanced techniques than cost accounting; Management

accounting is more recent compared with cost accounting. It arose when there was need to bring an

accountant closer to management i.e to sit in a table where management's strategies and various

decisions are being made. Expert advice from an accountant is important in such meetings.

Management accounting is taught at Masters Level in many universities after studying cost accounting at

undergraduate level.

1.4 Book Keeping and Accounting

These two words are often taken to be one and the same thing but this is far from being true.

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Book keeping is the record-making phase of accounting. It is a subset or a component of accounting.

Described more clearly, it is the clerical part of accounting. It includes the preparation of books of

account such as cashbooks and ledgers. It is usually said that the work of a bookkeeper ends at the

preparation of the trial balance from where the accountant takes over.

Accounting is broader, though it encompasses bookkeeping; its scope extends to financial reporting i.e

preparation of financial reports. It also involves analysis and interpretation of financial statements.

Unlike bookkeepers, accountants authorize financial transactions. Bookkeepers simply record financial

transactions that have been completed. Accountants also design accounting systems but book keepers

have no capacity to do this.

Book keeper’s posses lower academic or professional qualifications than accountants.

Usually after earning a university degree one is not supposed to work as a bookkeeper.

Activity

Refer to the organization where you work.

-What kind of jobs do accountants do?

1.5 usersUsers/interested parties in accounting information

Every organization whether profit making or not has people or parties interested in it. These interested

parties (stakeholders) have to make decisions connected with the organisation. Accounting information

is very necessary if decisions are to be made accurately and rationally. Various parties are interested in

accounting information about the activities of a business to facilitate their decision making. Accounting

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information is provided in form of financial statements/reports, entries in books of accounts and other

business documents.

Accounting is user-oriented thus an accountant needs to identify the user and target him/her with the

relevant information for the decision. In other words a business should produce information about its

activities because there are various groups of people who need information about the business.

The users or decision makers interested in accounting information are broadly divided into two groups,

internal users (parties) and external users (parties).

1.5.1 Internal parties (users)

They are involved in the day to day running of the organization. They are insiders so to speak and

include management and employees.

Management

An organization’s management team may comprise inter alia, directors, senior executives and managers

at various levels especially top managers. These people run the organization on behalf of the owners

(shareholder). They are entrusted with safe custody or stewardship of the shareholders resources. They

have to ensure that shareholders resources are well managed and invested.

They are charged with the duty of increasing the shareholders wealth and making sure that the owners

get dividends from their investments. To be able to run the organization profitably and give

shareholders return on their investment, they have to plan for profits, control activities/operations and

take timely decisions. Key decisions to be made could be what markets to enter, what prices to charge,

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how to minimize costs and how to formulate strategies for beating off competitors. For all these

activities, management requires accounting information. In fact they require services of an accountant

all the time if they are to execute their roles successfully. Such an accountant who is relied on by

management is called a management accountant.

Accounting reports or statements also indicate to management whether they are making profits or

losses and whether they are in the right business. Management must also submit accountability to the

owners. The accountability that they submit is in form of financial statements/reports backed by books

of account and underlying documents.

Employees and trade unions

They need accounting information about the company’s finance situation for two major reasons.

They want to support their claim or agitation for salary and wage increments using accounting

information. The profit and loss account shows how much profit the company made. They use it to judge

whether their remuneration was commensurate with the profits earned. If they did not par take a due

share, they use the profit and loss account as a base for bargaining salary and wage increase.

Trade unions leaders agitate for better pay for their members after examining financial statements and

getting convinced that the employing organization has capacity to pay.

Another reason why employees require accounting information is to assess and judge their job security

or continued tenure. If the employing organization is perpetually making losses, it is definitely not a

going concern and any time it can collapse. When the organization is in poor financial health there are

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often last minute attempts to save the organization from total collapse. Cost cutting reviews are

normally instituted, among which, is to down size the work force by retrenching staff. If the organization

is not a going concern employees start searching for alternate employments before they are retrenched

or before the organization finally succumbs..

1.5.2 External parties

They are external in the sense that they are not involved in the day-to-day running of the organization

but they are stakeholders or interested parties. They view the organization from outside the fence with

keen interest. These parties make decisions that have a bearing on the organization. These parties

include shareholders (investors), Trade payables, donors and other external financiers, Government,

competitors, general public etc.

Shareholders (investors)

They are primary stakeholders of the business because they contributed capital by subscribing to shares

or are contemplating to invest. They are the company’s owners. Existing investors or shareholders are

interested in knowing how their business is performing i.e. whether the organization is well managed,

expanding and whether they receive dividends.

They examine management's accountability statements, books of accounts and documents through

their auditors and evaluate management's performance. They are particularly interested in knowing

whether management is not misusing financial resources through abuse or vices such as embezzlement

and fraud. Shareholders have the power to change management if they feel that management is not

measuring up to their expectations. Potential or prospective investors need accounting information in

order to able to decide whether investing in a company is worthwhile.

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Prospective investors analyse the company's past and projected financial performance before they can

buy shares in it. Financial analysts usually perform financial analysis for them. They examine financial

statements and other information disclosed in the company’s prospectus before buying shares.

Today, analysis has gone beyond financial or accounting figures to include examining managerial

capacity for sustaining the organization. Suppose for instance, the current management delivers but are

old or are said to be sick from incurable diseases. If such management did not groom effective managers

to take over from them, there would be managerial vacuum and you would not want to buy shares from

such a company. Studies have shown that poor management has accounted for the bankruptcy and

collapse of many companies.

Trade Contacts

This includes suppliers who provide goods to the company on credit and customers who purchase goods

and services provided by the company.

Trade payables (suppliers) are individuals and financial institutions that extend credit to company. Trade

payables(suppliers) are interested in getting paid for goods and services that they extend on credit.

Financialcredit. Financial institutions like banks that extend loans to the company are interested in

making sure that the loans are serviced and do not become nonnone performing. Before loans or any

credit facility is granted, the credit worthiness of the applicant is analysedanalyzed. Credit analysis can

only be possible if accounting information in form financial statements exists.

Donors/ funding agencies

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Non profit making organizations like Non-Governmental Organizations (NGO's) get- funding from donor

agencies abroad. These agencies are always interested in making sure that the money they donate

achieves the objectives for which it was released. Most of their objectives are societal. Donors rigorously

monitor utilization of their money by examining accounting records-financial reports/statements, books

and documents of the organizations that they support.

Government

Government is another external user of accounting information. Through tax authorities like URA,

government collects tax revenue from companies and individuals for financing public expenditures. The

government of Uganda finances its recurrent budget from tax revenue. Tax authorities are interested in

companies filing income tax returns for tax assessments. Returns submitted for tax assessments are

statements showing operating performance especially profitability of the business. Failure to file returns

to form a basis for tax assessments could result into more tax liability through estimated assessments or

penalties.

In mixed economies like that of Uganda where there are state owned public business enterprises

existing alongside private ones, government monitors the performance of its public enterprises

(parastatals) by examining their accounts.

Furthermore, every government must provide policy ingredients for businesses to thrive. Government

collects accounting data from companies to enable it analyze the effect its policies have on businesses.

This enables formulation of policies that promote private sector development which is the motor of

economic development.

Competitors

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Competitors are interested in accounting information of firms in the same industry with them so as to

judge whether they are doing badly or fairly in comparison with other players in the same business.

Some competitors also require information for market intelligence purposes. In order to be able to

develop competitive strategies for beating other participants in the market place. For this reason very

few companies will provide detailed information regarding their business operations to non entitled

persons. Students doing research do get considerable difficulty in getting data from companies.

General public

The public includes individuals and organizations which ensure that businesses make their profits in a

socially acceptable manner without damage to the environment and consumers health. Environmental

pressure groups advocate for minimization of "pollution which degrades the environment. Consumer

groups or associations try to ensure that businesses offer safe and not adulterated products to their

consumers and should not charge very high prices for poor quality products. This group attempts to

mitigate extreme consumer exploitation. This action aimed at protecting the consumer is known as

consumerism and is gaining prominence in many countries including Uganda.

Even ordinary members of society questions the contribution made by an organization operating in their

locality to the enhancement or improvement of the quality of their lives or welfare. If an organization

does not contribute to local developmental initiatives or efforts by people in the area in which it

operates, that organization will not be rated well by that community. Social responsibility of businesses

is gaining attention.

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1.6 OBJECTIVES OF FINANCIAL STATEMENTS

When accounts are prepared and incomes and expenditures recorded, profits/losses can be ascertained

and thus helps in planning the way forward. Every business organization is formed with the view to

making profits (Peter Drucker might disagree). Profits have to be planned for.

Preparation of accounts helps shareholders to monitor management and other stakeholders to evaluate

the performance of the organization. The relationship between shareholders and management is that of

agency. The shareholders are principals and managers are agents. The shareholders (principals) should

always monitor management (agents)

Accounts make tax assessment easy and advantageous to both the organization and the Tax Authority.

Over taxation due to estimated assessments will be avoided.

Monitoring of trade receivables and trade payables is easy if accounts are prepared. Without a record of

trade receivables or trade payables, it will be difficult to tell who owes you money and to whom you owe

money.

1.7 ACCOUNTING PRINCIPLES/CONCEPTS/CONVENTIONS

They have already been defined as ground rules and basic assumptions that govern the preparation and

presentation of financial accounts. It is important at this point to explain them in some detail. These

concepts/conventions/principles are very many; hereunder all of them are examined. It is however the

responsibility of the enforcing or overseeing institutions to spell out in the accounting standards the

fundamental concepts/principles to compel practicing accountants under their jurisdiction to observe.

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Some of these conventions are basic while others are procedural that distinction is however of

consequence. Hereunder the concepts/conventions are discussed without an attempt being made to

categorize them as basic or procedural. They include the following;

-Fair presentation - Going concern - Accruals or matching

- Consistency - Prudence - Materiality

-Substance over form - Relevance - Reliability

- Faithful representation - Neutrality - Completeness

- Comparability - Understandability - Business entity concept

International Accounting Standard (ISA 1) identifies four fundamental concepts when preparing

statements

- Fair presentation - Going concern - Accruals - Consistency

- It also considers other concepts like prudence, substance over form and materiality which

should govern the selection and application of accounting policies.

The main objective of IAS 1 Presentation of financial statements is to;

- Prescribe the basis for presentation of general purpose financial statements, to ensure

comparability both with the entity’s financial statements of previous periods and with financial

statements of other entities.

1.7.1 Fair presentation and compliance with IAS/IFRS

Financial statements should present fairly the financial position, financial performance and cash flows of

an entity. IAS 1 help to expand on this principle;

- Compliance with IAS/IFRS should be disclosed

- All relevant IAS/IFRS’s should be followed

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- Use of inappropriate accounting treatment cannot be rectified by either disclosure of accounting

policies or notes

There are few occasions where management decides that compliance with a requirement of IAS/IFRS

would be misleading and any departure to achieve fair presentation should be disclosed.

1.7.2 Business entity

This concept requires recognition and recording of transactions relating to the entity (organization) in

question and excludes private transactions of the owners or those running it. Record is only made for

what the entity owes the owner (capital) and what the owner owes the entity (drawings). When an

organization is set up and is fully incorporated under the law, it becomes a separate legal person (entity)

capable of transacting on its own including the power to borrow and lend.

In writing or preparation of accounts this concepts is important because it filters transactions by

isolating business from non-business private transactions. For instance if the owner purchases a suit for

himself for Shs.600,000, it is not a business cost and should therefore not be charged to the businesses

trading and profit and loss account. If the resources to buy the suit came from transacting business, it

should be recorded as the owner borrowing from the business termed as a drawing. Drawings reduce

owner's capital. For this reason private expenses should not be regarded as business expenses and

likewise private incomes should not be recorded as business incomes. The aim is to report accurate

financial performance of the entity. There is normally a temptation to increase expenses in order to

declare lower profits and thereby minimize tax liability. This might involve increasing expenses by

including those of a private nature or not declaring all incomes of the entity. These actions are illegal and

outlawed, tax assessors are aware of this and they usually have to restate profits to be taxed by

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removing private expenses of the owners or management of the entity that are unallowable deductions

according to the income tax law.

The limitation of this concept can be appreciated from the perspective of a humble business

man/woman like a sole trader or a family run business. The owner and the business are actually

inseparable. For instance if a sole trader sells but also dwells in the same premises, rent and utilities

paid on those premises will be difficult to apportion between the owner and the business especially if

there are no clear apportionment bases.

1.7.3 Monetary / Money measurement.

According to this concept or convention all transactions to be recorded must be quantified in monetary

terms or language of money. Money is a common denominator for all transactions. Let alone being an

objective measure, money is also a unit of account and store of value. This convention assumes money

has stable value over time and it is a source for one of its criticisms.

This concept limits recognition of business transactions to those that can be expressed in monetary

terms. Even where goods are exchanged for goods (barter trade), value must be attached to the items in

question. Whatever, cannot be monetized is not recorded. Money is favored because it is an objective

measure as pointed out above.

This concept has the following shortcomings;

a. It assumes that money has stable value over time and yet it is common knowledge that

money loses value with time a phenomenon referred to as inflation. Under inflationary

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circumstances, money ceases to an objective measure of value b. There are certain events or things that

cannot be expressed in monetary terms, thus not recorded, and yet they materially impede or enhance

business operations. For instance if the manager is ill or the accountant has poor working relationship

with say the production manager, business will not flow smoothly. These are both costs to the business

but cannot be recorded since they cannot be expressed in monetary terms. Furthermore, there are

some intangible assets like goodwill, brand name, patent etc which lead to increased turnovers and

profits but cannot be recorded as assets because they are difficult to quantify in financial terms.

Attempts are being made to value intangible assets for inclusions in the statement of financial position.

1.7.4 Going Concern

This concept states that the business entity is assumed to continue in operational existence in the

foreseeable future. The business is not on the verge of collapse unless there are indications to suggest

so. This assumption is very fundamental to preparation of accounts.

Accounts are written on the assumption and understanding that the business will continue in operation.

This concept makes it possible for accountants to project or prepare estimates for a long period into the

nature for example preparing cash flow projections or forecasts for five years or preparing budget

estimates for many years into the future. Fixed assets are depreciated knowing that they will last for

many years. All these can be done if the going concern assumption is upheld otherwise it would be

senseless to prepare budget. Estimates,Estimates make cash flow forecasts or depreciate fixed assets

when you are aware that the business will cease operating. The assets in the statement of financial

position would be recorded at liquidating (saleable) values. The statement of financial position and

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profit and loss account are written on the assumption that there is no intention or necessity to liquidate

or scale down business operations.

There is almost no challenge against the going concern assumption and has been embraced and

enshrined in accounting standards of many countries as a fundamental assumption or concept. However

this assumption is at times farfetched or makes accountants and managers complacent. The business

will be there any way! Good management is necessary for a business to be a going concern. What about

those many companies that have collapsed and many other business failures, didn't they make the going

concern assumption?

1.7.5 Historical cost (sometimes shortened as cost)

This concept requires accountants to record assets and liabilities at historical costs of their acquisitions.

Assets are recorded at their acquisition (invoice) costs even if the value today is more than the historical

cost. Likewise liabilities are recorded at amounts they were incurred though the true value of the liability

might have changed due to foreign exchange fluctuations and other macro economicmacroeconomic

issues such as inflation, devaluation, currency reform etc. However the focus of the historical cost

convention is on recording of assets since there is more temptation of over valuing assets in the

statement of financial position in order to portray a sound financial stand.

A big shortcoming of this concept is that during inflation, historical cost will not reflect the true value of

the asset to the business. The true value is not reflected. For instance if an asset was bought for Shs.

1,000,000 at the beginning of the year and the annual inflation rate is 90%, its value at the end of the

year will be Shs. 1,900,000. The historical cost concept will require 1,000,000 and not 1,900,000 to be

recorded. There has been debate on the validity of the historical cost concept. Those in favour of it

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argue that departing from the historical cost will open room for subjectivity in valuing assets. According

to them, no other value is verifiable and objective like the historical cost. Verification of historical cost is

possible by examining purchase documents such as invoices, vouchers etc. Those against the historical

cost of course point out its inadequacy during inflation because it will not reflect the true value of the

asset. The compromise position is that the historical cost should be converted to current cost using price

or inflation indices.

Current Cost Accounting (CCA) statements are then disclosed side by side with historical cost statements

in order to afford users better evaluation. Historical cost statements being primary disclosure and

current cost supplementary disclosure.

Specific accounting standards have been developed for preparing accounts and reporting under

inflationary environment. Details of inflation accounting standards are taught in the third year of

student majority in accounting.

1.7.6. Realization

This concept demands that accountants recognize income as earned only when a sale has been made

and the goods have been accepted by the customer or services have been offered and enjoyed by

customers or where value has been created by a transaction and legal rights and obligations have

resulted. Gains that result from operations like selling goods and services are called operating gains and

are recorded as income in the income statement. Income is recognized when the customer has accepted

the goods/services and is obliged to pay for them. Holding gains that arise from an asset that has

appreciated but is not sold is not realized income and should not be recorded in the income statement.

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It should be separate from operating gains. The aim is to deter accountants from exaggerating incomes

by adding those not realized or distorting reporting of actual operating income by mixing extra ordinary

items.

There is no major problem with the realization concept, however question debated is that which point in

time should income be recognized as earned'. The majority argue that income should be recognized

when a sale has been made and title has passed. Others argue that income should be recognized when

the goods have been shipped or dispatched to the customer and he/she has been invoiced and there is a

strong likelihood of amounts being collected i.e absence of bad debts. To them recognizing income

immediately a credit sale is made without money actually being received or the prospect of receiving it

being high is deceptive and gives a false cash flow position of the business. In accounting, those who

push for income to be recognized when a sale has been made prevail over those who want it recognized

when cash has been received or strong certainty income existing. This is reinforced by the accrual

concept.

1.7.7 Accrual

According to this concept, income is recorded as earned even though it might have not been received

cash provided there is right to income (see realization concept). The portion of income that has not been

received cash is recorded as an asset (accrued income or trade receivables). Likewise expenses or costs

should be recorded and recognized as incurred although cash might have not been paid in respect of

those expenses or costs in case those expenses were not paid cash they should be recorded as liabilities

(accruals or accrued expenses). Accrual concept does bring out the view that there is no exact

coincidence between the right to receive income and the actual receipt of that income cash and likewise

there is no exact coincidence between the obligation to pay an expense and the actual cash payment.

Transactions occur but cash payments or receipts may be deferred.^ Accrual is one of the most

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fundamental ones in many countries accounting standards. Accrual basis accounting whereby both

incomes and expenses are recognized without cash necessarily changing hands is upheld and prevails

over cash basis accounting where only transactions involving cash movement are recognized and

recorded. Lack of observing the accrual concept will narrow the scope of accounting to preparing the

cashbook. Trade receivables and trade payables ledgers for example will not be prepared and to assume

that only cash and not credit transactions will result is farfetched. .

There is no major criticism of this concept just like the realization concept, however when preparing a

cash flow statement which shows the actual or expected cash flow position of the enterprise, accrued

items should be eliminated. Investment decisions are based on the available or expected cash, accrued

items will falsify the actual cash position.

1.7.8 Matching (sometimes combined with accrual)

This concept requires accurate matching of expenses against incomes by writing off only those costs or

expenses that were incurred in generating specific income for the period ended. Costs or expenses paid

should be adjusted for any part-period that does not relate to the overall period. For instance if income

of Shs. 50,000,000 was earned during a particular financial year and rent of 1,800,000 had been paid for

one and half years. Not all Shs.1,800,000 should be written off or subtracted from 50,000,000 because

part of the rent is for another financial year. Since the rent was paid for 18 months, monthly rent is

100,000. For one financial year (12 months) the rent is 1,200,000. The correct amount to be subtracted

from income of 50,000,000 is 1,200,000 and not 1,800,000. The difference of 600,000 is recorded as

prepaid rent. Likewise if electricity expense paid was 500,000 but some electricity equivalent to 200,000

was used but not paid, that amount should as well be matched against that income. The amount of

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electricity to be subtracted from income of 50,000,000 should be 700,000 (500,000+200,000). The

unpaid 200,000 is an accrual and is recorded as a liability. /

The matching concept and indeed the accrual concept are very important in the preparation of the

income statement (trading and profit and loss account).

1.7.9. Conservatism (or prudence)

Preparation of accounts involves estimations, measurements and valuations, according to the

conservatism or prudence concept it is good practice to follow a procedure that tends to understate

things. This concept has two principle rules;

a) An accountant should not anticipate revenues and profits until realized but should provide, for

all possible losses. Provisions for bad debts are created and written off from profits for: this reason.

Provisions are also made for all known contingent liabilities in order to be prudent or conservative.

b) If there are two or more methods of valuing an asset, an accountant should choose a method or

base that leads to a lower value. Rules 'like the lower of cost or market value' stem from this

concept i.e you record an asset either at cost or market value whichever is lower. This would of

course contradict the historical cost concept that insists that assets must be recorded at historical

costs. Let us assume for example, though it rarely occurs that, market values are lower than the

historical costs, the statement of financial position would carry market values. There would be a

direct conflict between conservatism and historical cost concepts.

Other than being inconsistent with the historical cost concept, conservatism concept has also been

criticized for discourages optimism, ambition, creativity and innovation because it requires accountants

to behave in a conservative manner. Even in ordinary use of the word, being conservative means sticking

to old ways of doing things, intransigence ie. Reluctant to embrace change etc. If somebody tells you

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that you are conservative, you will not have a good taste for that and will not filter in-well within you .

This concept has been criticized for discouraging ambition and challenging of existing literature and has

undermined evolution of concepts that would respond to contemporary business environment. •

This concept is also at fault because it gives the impression that while overstatement of assets or

earnings is bad, understatement is not bad and may be a positive virtue. Deliberate misstatement in

either direction i.e on the higher or lower sides should not be condoned. Unwarranted conservatism in

financial reporting is as bad as overstatement and contravenes objectivity concept.

1.7.10. Consistency

It states that once a particular accounting method or base has been selected and has become

accounting policy, it must be applied continuously or consistently from year to year. Changes in

accounting methods or policies are permitted only if there are justifiable reasons for doing so for

instance if the old ones have become inappropriate for the present circumstances. When a change is

made, the effect of the change on the reported net profit and statement of financial position if material

must be disclosed as foot notes in the accounts.

Many accounting bases are allowed for instance in valuing inventory, FIFO, LIFO, weighted average cost

etc may be used and in the depreciation of fixed assets, straight line, declining balance, sum of years

digits etc may be applied what the consistency concept requires is that once management has chosen

one of those methods and has become an accounting policy, it must be applied on a consistent basis.

Switching from one method to another will cause distortions in financial reporting.

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This will prevent accurate analysis of a company's accounts over time. Inter period comparisons and

intercompany comparisons will be difficult if some companies keep changing their accounting policies.

The consistency concept also requires that similar items should have the same treatment.

Consistency is one of the most fundamental concepts required by UK and international accounting

standards. There is no serious challenge of this concept.

1.7.11. Periodicity and disclosure

This concept makes financial reporting mandatory and is enshrined in the Companies Act of Uganda and

of many other countries. At the end of an accounting or financial year (may not be a calendar year but

twelve months), a company must prepare and disclose financial statements. Publishing annual accounts

is made an obligation by this concept. Disclosure can be made more than once a year if the accountant

so wishes. If interim accounts are to be published, it is n6"t discouraged. Non disclosure even once a

year is illegal. All material information must be disclosed, an accountant must not be seen to be hiding

some vital information.

1.7.12. Materiality

It requires recognition of only material items and excluding immaterial or trivial items or matters.

Information is material if it is able to influence the decision. For instance if the cost of recording certain

items is not justifiable, then they should be left out. Take an example of buying a razor blade at Shs.50

for the business from your own money, it is immaterial to record that amount in the cashbook or as your

asset. Some assets like good will and some low value assets are written off in the profit and loss account

rather than being included as assets in the statement of financial position because of materiality

consideration. Departures from good accounting practice that are not material should also be ignored.

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The concept of materiality has to be applied with some caution because there is no threshold or

quantitative guidelines for judging whether an asset is material or not. Materiality is a matter of

opinion and judgment, abuses should be guarded against.

1.7.13. Objectivity

It states that whatever figure is recorded in accounting books and financial statements must have clear

criteria or yardstick for its measurement. Figures must have a basis for arriving at them but not simply

planted into financial statements. Accountants must be able to defend figures in financial statements

using objective evidence, empirical or otherwise.

This concept aims at eliminating subjectivity and free accounting information from bias. The entire

regulatory framework of accounting aims at emphasizing objectivity of accounting information. This

concept is reflected in all the others and other forms of accounting regulations. The preparation of

accounting statements however involves a considerable amount of individual discretion especially on

judging the materiality of amounts or issues. While personal discretion cannot be done away with

completely, accounts should be prepared with minimum amount of bias and the maximum amount of

overall objectivity.

1.7.14. Duality (also called Dual aspect)

It requires a transaction to be recorded twice (dual recording). The rule is a recognition that every

transaction involves giving and receiving effect. When somebody gives something another must receive

it. This is in effect a requirement for double entry book keeping. Double entry is a principle rule or

principle in accounting and is thoroughly explored in later chapters. For now it suffices to mention that

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the receiving account is debited while the giving account is credited. Double entry therefore means that

one account is debited while another is credited. The meaning of debit and credit are also explained in

later chapters.

1.7. 15. Substance over form

It states that transactions and other events should be accounted for and presented in accordance with

their substance and financial reality and not merely with their legal form. For instance if you buy a motor

vehicle for your business on hire purchase, when you make a down payment you can be given the

vehicle to use as you continue making installment payments. The registration book, which is evidence of

ownership, will not be released to you until you make the last installment payment. The lawyers say that

title passes on fully paying up. The question then is, how do you account for such a vehicle, should you

make it off-statement of financial position i,e not to record in your statement of financial position.

Substance over form gives the answer as follows. The substance and reality is that you are using the

vehicle in your business so it's a business asset and should be recorded in its books and statements. You

should stop worrying about legalities of title passing after all you will complete installment payments

and documents of ownership will be surrendered to you.

1.7.16. Relevance

According to this concept the overall message that the accounts are trying to relay may be obscured if

too much information is presented. Accounting statements should contain only information that

complies strictly with the specific requirements of the user. This concept is at times combined with

materiality concept.

Activity

Explain each of the following concepts;

Relevance, Reliability, neutrality, completeness, comparability, understandability

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1.8. Accounting Regulatory Framework:

This looks at a number of factors that have shaped development of financial accounting.

Having looked at the accounting principles, qualitative characteristic, users and so forth, we now have to

summarize a number of rules that underlie accounting practice.

Accounting rules are imposed on accountants in order to make sure that their reporting is free from

bias. Accounting legislation requires financial accounts be prepared and presented in conformity with

GAAP (Generally Accepted Accounting Principles). GAAP refers to accounting principles or practices that

are regarded permissible by the accounting profession. The rule may be derived from national company

legislation (company’s Act), National and international accounting standards, statutory requirements in

other countries, inventory exchange etc. The key terms used in accounting regulatory framework

include:

 Accounting principles/ concepts/conventions

 Accounting bases

 Accounting policies

 Accounting standards

1.8.1. Accounting principles

Also known as accounting concepts, conventions or postulates, are basic ground rules which must be

followed when financial accounts are being prepared and presented. They are also referred to as

assumptions or prepositions that underlie the preparation and presentation of financial reports. Most of

these have already been discussed earlier.

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1.8.2. Accounting bases

"These are methods developed for applying fundamental concepts to financial transactions and items

for the purpose of final accounts and in particular:

• For determining the accounting periods in which revenue and costs should be recognized in the profit

and loss account.

• For determining the amounts at which material items should be stated in the statement of financial

position.

1.8.3. Accounting policies

These are the specific accounting bases selected and consistently followed by a business enterprise as

being in the opinion of management, appropriate to its circumstances and best suited to present fairly

its results and financial position.

1.8.4. Accounting standards

These are guideline statements or rules issued by professional accounting bodies governing accounting

practice, relating to how accounts should be prepared and presented. These may be developed both at

local level and international level. In Uganda the professional body responsible for issue of accounting

standards is the Institute of Certified Public Accountants of Uganda (ICPAU) and internationally there is

the International Accounting Standards Board (IASB ). The IASB develops IFRS’s (International Financial

Reporting Standards) through an international process which involves the world wide accountancy

profession, preparers, users of financial statements and national standard setting bodies. Prior to 2003

standards were issued as International Accounting Standards (IAS) and all new standards issued

thereafter are now designated as IFRS’s.

The objective of the IASB include;

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 To develop in the public interest, a single set of high quality, understandable and enforceable

globalenforceable global accounting standards that can help in easy comparability of

information.

 To promote the use and rigorous application of those standards

 To bring about convergence of national accounting standards and IFRS’s.

Below is a list of the full range of that are currently in use and examinable at your level, as you proceed

with accounting you will meet other several IAS’s and IFRS’s;

IAS 1- Presentation of financial statements

IAS 2-Inventories

IAS 7- Statement of cash flows

IAS 8- Accounting policies, changes in accounting estimates and errors

IAS 10- Events after the reporting period

IAS-18 Revenue

IAS-37 Provisions, contingent liabilities and contingent assets

Much as accounting concepts are credited with ensuring reliability of accounting information, they fall

short of ensuring comparability of accounting information. Accounting concepts/conventions allow a

variety of methods or bases. It is therefore possible for accountants to prepare different statements

(content) from the same data while conforming to the concepts mentioned above.

Accounting standards ensure uniformity and therefore comparability of accounting statements, which is

very important to the users. This is because practicing accountants who must be members of a

professional accountancy bodies are obliged to adopt the same accounting practice/treatment.

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Accounting standards harmonize accounting policies and accounting treatments or practices that would

allow variations. For instance, in order to value inventory, you could use FIFO, LIFO, weighted average

cost method etc. These methods lead to different values of inventorys. In order to discourage

differences in value of the same inventory, an accounting standard on inventory valuation will specify

the method that all members must use.

If accounting standards are not in force it is possible for less efficient firms using less rigorous accounting

methods to present accounts overstating their financial performance and therefore divert capital to

themselves at the expense of those companies that have adopted more rigorous accounting methods.

Users of accounts such as prospective shareholders or investors examine the accounts of companies

that they want to invest in or subscribe to their shares. Accounts of companies must therefore be

comparable so that the differences will only be on financial performance and not due to the accounting

methods or bases used. For this reason inventory exchanges require companies that quote on it to apply

rigorous accounting standards. Governments also in order to protect its citizens from doctored accounts

require companies to adopt proper accounting standards and accounting methodology specified in

Companies Acts.

1.8.5. Accounting standards relevant for selection of accounting concepts

Accounting standards specify the accounting concepts to be regarded as fundamental. You can observe

from the above that accounting concepts are very many. Requiring members to observe all of them will

be expecting too much. Accounting standards focus on some core concepts that members are obliged to

apply while preparing and presenting financial statements and in disclosing their accounting policies.

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IAS 1- presentation of financial statements identifies four fundamental principles that must be

observed in preparation and presentation of financial statements.

 Going concern.
 Accrual
 Consistency
 Conservatism (prudence)

IAS I also recognizes Conservatism (Prudence), Substance over form and Materiality as important

concepts especially in the selection and application of accounting policies.

It should be noted that the above mentioned concepts do not constitute Generally Accepted Accounting

Principles (GAAP). Those concepts are only fundamental in countries where those standards are

enforced. In fact those standards are criticized for limiting recognition of accounting concepts to only a

few and yet there are many others.

Besides the accounting standards mentioned above, there are many others on specific items. A more

detailed treatment of these standards is handled in the third year of study for accounting students.

Activity:
1. Which IAS deals with accounting assumptions?
2. Outline the assumptions included in IAS 1.
3. What is meant by the following?
- Going concern
- Prudence
4. Making an allowance for receivables is an example of which concept?
5. Why is the regulatory framework necessary?

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1.9. FORMS OF BUSINESS:

There are three main types of business entity

 Sole traders

 Partnerships

 Limited liability companies.

Sole traders are people who work for themselves e.g local shopkeeper, plumber, hair dresser etc. The

term sole trader refers to the ownership of the business and sole traders can have employees.

Partnerships occur when two or more people decide to run a business together e.g an accountancy

practice, a medical practice, a legal practice.

Limited liability companies are incorporated to take advantage of limited liability of their owners

(shareholders). This means that while sole traders and partners are personally responsible for the

amounts owed by the business, the shareholders of a limited liability company are only responsible to

the amount to be paid for their shares.

In law sole traders and partnerships are not separate entities from their owners but a limited liability

company is legally a separate entity from its owners and it can issue contracts in the company’s name.

For accounting purposes, all three entities are treated as separate from their owners.

Advantages of trading as a limited liability company:

a) Limited liability makes investment less risky

b) It is easier to raise finance.

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c) A company can continue to exist regardless of the identity of its owners

d) The company is taxed as a separate entity from its owners and the tax rate on companies may be

lower than tax rate for individuals.

e) It is relatively easy to transfer shares from one owner to another.

Disadvantages of trading as a limited liability company:

 They have to publish annual financial statements so anyone including competitors can see how

how well or badly they are doing.

 Their financial statements have to comply with legal and accounting requirements

 Financial statements have to be audited, this can be inconvenient, time consuming and

expensive.

 Share issues are regulated by law so it is difficult to reduce the share capital.

CHAPTER TWO:

PRINCIPLES OF DOUBLE ENTRY AND ACCOUNTING SYSTEM

LEARNING OBJECTIVESChapter Outline:

- Introduction

- Accounting equation

- Double entry accosting

- Accounts

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- Recording transactions under double entry

LEARNING OBJECTIVES

By the end of this chapter, the learner should be able to;

1. Understand and demonstrate knowledge of the accounting equation

2. Define the elements of the accounting equation.

2.0 Introduction

In the last chapter, we saw the framework within which accountants are supposed to present financial

accountability. In this chapter, we will ably show that the whole of financial accounting is based on a

very simple idea - the accounting equation. We shall pay attention to the way business transactions are

recorded in different books up to drafting financial statements.

The statement of financial position of an enterprise is a statement of the financial position of that

enterprise at a given date. It represents the assets and liabilities of that business. The accounting

equation emphasizes the equality between assets and liabilities.

The accounting equation is the elementary presentation of the statement of financial position. It

consists of three elements: the assets, liabilities and owners equity. The assets are the resources that are

owned by the business while liabilities and owners equity represent who supplied the resources.

We shall start by showing how to account for business transactions from the time trading begins.

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In business where the equity (capital) is contributed by the owner solely the resources owned will be

equal to what the owner invested. (Assets = Equity). However most business concerns have liabilities

and therefore, resources are supplied by the owner and liabilities Like Trade trade payables/ Accounts

payable.

Owner's equity represents the resources that are invested by the owner. It variously means claims from

the business by the owners. It is Capital introduced in the business by owners and is intended to remain

in the business for as Long as it continues to exist (see Going Concern Principle in Chapter 1).

We define capital as that wealth which is set aside to assist in the creation of further wealth. In the sole

proprietorship business owners equity comprises of the individual funds contributed while in the

company owners equity comprises of preference and ordinary share capital, reserves (retained earnings,

revaluations and general reserves)

2.1 The Accounting equation:

We present the accounting equation is mathematically as;

Assets
Anything that is= Liabilities + Owners equity
owned by the What the business Owner’s funds
business owes others invested in the
business

Capital + Liabilities = Assets

OR

Capital = Assets - Liabilities

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OR

Capital = Net Assets

IllustrationExample

Mukasa is a sole trader who set up his business in Kisenyi. The following were the transactions that took

place in the month of January. Amounts are in UGX

i) Started business with cash of 10,000,000 and cash at bank of 20,000,000

ii) Purchased inventory of goods an credit of 3,000,000

iii) Bought a Motor vehicle for business operations using the cash at bank of 2,000,000

iv) Sold goods to James for 600,000 cash which had cost-him 500,000

v) Paid the shopkeeper 50,000 cash as salary

vi) Bought more inventory of goods for 500,000 cash.

vii) Used business cash of 300,000 to buy for hi's wife and children Christmas clothes

Required Construct an accounting equation for each of the transactions above and extract prepare a

simple statement of financial position at the end.

i)

Assets = Liabilities + Owners equity

Bank 20,000,000 Capital 30,000,000

Cash 10,000,000
30,000,000 30,000,000

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ii)

Assets= Liabilities + Owners equity

Inventory Trade trade payables Capital 30,000,000
3,000,000 3,000,000
Bank 20,000,000
Cash 10,000,000
33,000,000 33,000,000

iii)

Assets = Liabilities + Owners equity

M/vehicle 2,000,000
Inventory 3,000,000 Trade trade payables Capital 30,000,000
3,000,000
Bank 18,000,000
Cash 10,000,000
33,000,000 33,000,000

iv)
Assets = Liabilities + Owners equity
M/vehicle 2,000,000
Inventory 2,500,000 Trade trade payables Capital 30,000,000
Bank 18,000,000 3,000,000 Profit 100,000
Cash 10,600,000
33,100,000 33,100,000
V)
Assets = Liabilities + Owners equity
M/vehicle 2,000,000
Inventory 2,500,000 Trade trade payables Capital 30,000,000
Bank 18,000,000 3,000,000 Profit 50,000
Cash 10,550,000
33,050,000 33,050,000

VI)

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Assets = Liabilities + Owners equity

M/vehicle 2,000,000
Inventory 3,000,000 Trade trade payables Capital 30,000,000
Bank 18,000,000 Profit 50,000
Cash 10,050,000 3,000,000 f

33,050,000 33,050,000

vii)

Assets = Liabilities + Owners equity

M/vehicle 2,000,000
Inventory 3,000,000 Trade trade payables Capital 30,000,000
, Bank 18,000,000 Profit 50,000
Cash 9,750,000 3,000,000 Drawings
32,750,000 32,750,000
(300,000)

Mukasa's Statement of financial position as at.

Non Current Assets Shs Equity and liabilities Shs

Motor vehicle 2,000,000 Capital 30,000,000
Current assets Profit 50,000
Inventory 3,000,000 less drawings (300,000)
Bank 18,000,000 Current liabilities
Cash 9,750,000 Trade trade payables 3.000,000
Total Assets 32,750,000 Total Equity & Liabilities 32 ,750.00

Illustration TwoExample

Mukwano is a businessperson dealing in general merchandise .Below is the transactions for the month

of January .Show the accounting equation and the balance-sheet for the transactions below,

i) He started business with a lorry of 30,000,000and cash at bank of 20,000,000.

ii) A motor vehicle of 10,000,000 was bought on credit from Lonhro ltd

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iii) He bought inventory of 6,000,000 using a cheque

iv) Bought furniture of 4,200,000 from Hwan Sung on credit

v) He used his salary to buy a shirt of 80,000 –

vi) He sold 2/3 of the inventory for 3,000,000 cash

vii)Secured a DFCU loan of 5,000,000, which was deposited on his bank account to be paid within one

year.

viii) Paid Hwan sung 2,200,000 cash.

ix) Paid utilities of 800,000 by cheque

x) He used the business debit card to withdraw 1,000,000 for buying, a mobile phone for his girl friend.

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Solution

i)

Assets Liabilities + Owners equity

Lorry 30,000,00 + Capital 50,000/000

Bank 20,000,000
50,000,000 50,000,000

ii)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,0.00,000 + .. Capital 50,000,000
M/ vehicle 10,000,000
Bank 20,000,000
60,000,000 60.000,000

iii)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000
Inventory 6,000,000
Bank 14,000,000
60,000,000 60,000,000

iv)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 4,200,000 .
Furniture 4,200,000
Inventory 6,000,000
Bank 14,000,000
64,200,000 64,200,000

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V)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 4,200,000
Furniture 4,200,000
Inventory 6,000,000
Bank 14,000,000
64,200,000 64,200,000

vi)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 4,200,000 Loss (1,000,000)
Furniture 4,200,000
Inventory 2,000,000 •
Bank 14,000,000
Cash 3,000,000
63,200,000 63,200,000
vii)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 4,200,000 Loss (1,000,000)
Furniture 4,200,000 DFCU loan 5,000,000
Inventory 2,000,000
Bank 19,000,000
Cash 3,000,000
68,200,000 68,200,000
viii)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 2,000,000 Loss (1,000,000)
Furniture 4,200,000 DFCU loan 5,000,000
Inventory 2,000,000
Bank 19,000,000
" Cash 800,000
66,000,000 66,000,000
ix)

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Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 2,000,000 Loss (1,800,000)
Furniture 4,200,000 DFCU loan 5,000,000
Inventory 2,000,000
Bank 18,200,000
Cash 800,000
65,200,000 65,200,000

x)

Assets = Liabilities + Owners equity

Lorry 30,000,000 Lonhro ltd 10,000,000 + Capital 50,000,000
M/ vehicle 10,000,000 Hwan sung 2,000,000 Loss (1,800,000)
Furniture 4,200,000 DFCU loan 5,000,000 Drawings (1,000,000)
Inventory 2,000,000
Bank 17,200,000
Cash 800,000
64,200,000 64,200,000

Mukwano's Statement of financial position as at.

Non Current Assets Equity and Liabilities

Lorry 30,000,000 Capital 50,000,000
Motor 10,000,000 Loss (1,800,000)
vehicle
Furniture 4,200,000 Drawings (1000,000)
44,200,000
Current Assets Current liabilities
Inventory 2,000,000 Lohro ltd ./ 10,000,000
Bank 17,200,000 Hwan Sung / 2,000,000
Cash 800,000 20,000,000 DFCU Loan 5,000,000
Total Assets 64,200,000 Total Equity & Liabilities 64,200,000

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Conclusion

In the foregoing chapter, we have been able to demonstrate the fundamental accounting equation

that is the pivotal of the statement of financial position. It is a fact that the totals of each side of the

statement of financial position will always equal one another, and this will always be true no matter

how many transactions there may be! The actual assets, capital and liabilities may change, but the

total of the assets will always equal the total of capital and liabilities.

Example 1:

John starts a business. The business starts by owning the cash that John has put into it, if its say shs

2,500,000. The business is a separate entity from John so it owes shs 2,500,000 to John as capital

Capital is an investment of money with intention of earning a return. In the above example capital

invested (liability) is shs 2,500,000 and cash(asset) is shs 2,500,000.

The accounting equation is ASSETS = CAPITAL + LIABILITIES

Example 2:

From example 1 above, If john purchases a market stall at shs 1,800,000 and also some flowers at

shs 650,000. This leaves a balance of Shs 50,000 in cash after paying for these items. This alters the

assets and liabilities as;

Assets: = Capital + Liabilities

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Stall 1,800,000 2,500,000 + 0

Flowers 650,000

Cash 50,000

If John sells the flowers for shs 900,000 cash, he earns a profit of (900,000 – 650,000 = 250,000). If

this profit is not used to pay anything out to John it is called retained profits and is an addition to the

proprietor’s capital.

Assets will be stall Shs 1, 800,000,Cash 950,000 = shs 2,750,000

Capital will be shs 2,500,000 + 250,000 = shs 2,750,000

Drawings are amounts taken out of the business by the owner. Since John made a profit of shs 250,000,

he may withdraw shs 180,000 for himself, this is not an expense, it just reduces the retained profit. The

accounting equation now becomes;

Assets: Stall (1,800,000) + Cash (950,000-180,000) = 2,570,000

Capital: Original investment (2,500,000) + Retained profit (250,000- 180,000) = 2,570,000

NOTE: You should now know that when business transactions are accounted for it should be possible to

restate the assets and liabilities after the transaction has taken place and in all cases the accounting

equation is always true.

Payables and receivables:

Trade accounts payables are liabilities and trade accounts receivables are assets. A payable is a person

to whom a business owes money. In accounts of a business debts still outstanding from the purchase of

materials, components or goods for resale are called trade accounts payable

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Just as a business might buy goods on credit, so too might sell goods to customers on credit. A customer

who buys goods without paying for them cash straight away is a receivable. So the amounts owed by

receivables are called trade accounts receivables.

Activity:

From example of john above; if he realizes that he is going to need more money in the business and

makes the following arrangements

i) Invests a further shs 250,000 of her own capital

ii) He persuades his uncle Henry to lend him shs 500,000 immediately

iii) He decides to buy a van to pick up flowers from his supplier and bring them to the stall at Shs

700,000 which he can pay after 1 month.

Required: State the accounting equation in each of the three cases above.

2.2.1 Definitions of elements in an accounting equation

Assets: are defined as economic resources which are owned by the business and are expected to benefit

future operations. Assets are also defined as anything of value that is owned by the organization

excluding human resources (at least the purpose of this text).

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The assets may exist in their physical form such as the buildings and machinery while other assets may

not physically exist for example investments in the treasury bills amounts due to customers.

We classify assets as

 Noncurrent assets or fixed assets

 Current assets

Noncurrent assets/ Fixed Assets: are assets which will be used in the business for a number of years

specifically for not more than one year. Examples of noncurrent assets are Motor vehicles. Buildings,

Plant and Machinery, Equipments, Land, Fixtures and Fitting etc.

Current assets: are assets that will be easily realized (turned into cash) or are quickly consumed in the

operation of the business. The current assets have a short Life and are expected to be consumed within

a period of one year. Current assets are short-term assets. Examples of current assets include A/Cs

receivables /Trade trade receivables, Inventory/inventory, Bank, Prepaid expenses. Accrued Income,

Cash at hand.

Liabilities: These obligations transfer out organization's economic benefits. They are amounts owed or

debts to other organizations - in short, the financial obligations of a business .Liabilities are classified

according to their settlement period. Liabilities are classified as

 Current liabilities

 Non current or long term liabilities

Current liabilities: These are obligations, which have to be settled within a period of one year. They are

payable by the business within one year of the statement of financial position date. Examples include

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A/Cs payable/ Trade trade payables, prepaid incomes, accrued expenses, short-term loans and bank

overdrafts.

Non-current /long-term liabilities: are obligations that have to be settled within a period of more tfian

one year. So they are payable by the business at a date more that one year from the statement of

financial position date. Examples include long-term bank loans, capital, debentures, and so on.

Exercises.

Multiple-choice questions

1) The following are not Liabilities except

a) Trade payables for goods

b) Machinery

c) Cash at bank

d) Motor vehicles,

e) None

2) One of the statements is incorrect. Which one is it?

(a) Assets - Capital = Liabilities (b) Assets,- Liabilities = Capital

(c) Liabilities + Assets = Capital (d) Liabilities + Capital = Assets (e) None

3) One of the following is incorrect. Which one is it?

Assets (UGX) Liabilities (UGX) Capital (UGX)

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a) 6,540,000 1,120,000 5,420,000

b) 7,850,000 1,250,000 6,600,000

c) 8,200,000 1,150,000 8,200,000

d) None 2,800,000 5,400,000

4) Given the following, what is the amount of capital? Assets: Premises UGX.20M, Inventory UGX.8.5M,

Cash UGX.0.1M. Liabilities>Trade payables UGX.3M, Loan from a Cousin UGX.4M

(a) None (b) UGX.21.1M (c) UGX.21.6M (d) UGX.32.4M (e) UGX.35.6M

The following are incorrect except; ffcfy a Profit increases capital (c) Profit reduces capital

(b) Profit does not alter capital (d) Capital only comes from profit.

6) The following should be called sales except;

(a) Goods sold on credit (b) Sale of an item previously included in purchases,

-(c) Purchases by Peter from us (d) Office fixtures sold (e) None

7. How would each of the following affect the accounting equation?

a). Purchasing Shs 800,000 worth of inventory

b). Paying the telephone bill Shs 25,000

c). Selling Shs 450,000 worth of inventory for shs 650,000

d). Paying shs 800,000 to a supplier

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 78) In the sole proprietorship business, owner's equity comprises of the individual funds contributed

while in the company owner's equity comprises of preference and ordinary share capital, and

reserves (retained earnings, revaluations and general reserves).

(a) This is a true statement (b) This statement is untrue

(c) This statement is somehow true

d) It is correct only that we should remove preference (e) Me, I do not know

89) The accounting equation is the elementary presentation of the statement of financial position. It

consists of

the following elements except:

(a) Assets ' (b Revenue (c) liabilities (d) Equity interest (e) None

9) Non-current/long term liabilities are obligations that have to be settled within a period of more than

one year. So they are-payable by the business at a date more that one year from the statement of

financial position date. The following are examples except (a) Long-term bank loans (b) capital (c)

debentures (d) Preference shares (c) None

10) In business where the equity (capital) is contributed by the owner solely the following will

not be true;

(a) Resources owned will be equal to what the owner invested

(b) Assets = Capital + Liabilities (c) Assets = Equity Interest

(d) None (e) Owner will bear all the risks

11). Which of the following is not an asset?

(a) Motor vehicle (b) Incomes . (c) Rent (d) (a) (e) (b) & (c)
 Other Questions

1. Newton is a businessperson in Masaka. The following were transactions that transpired in the

month of April. Amounts are in UGX

i) Started business with cash of 10,000,000

11) Bought inventory of goods using 3,000,000 cash

!
iii) He bought land using a bank loan of 4,000,000 to be repaid in 2 years

iv) Sold inventory, of goods 40.0,000 cash which had cost him 300,000

v) Paid water and electricity bills of 60,000 cash

vi) He sold goods on credit of 1,000,000

vii) To ease the transportation of inventory he bought a motor vehicle using cash 3,000,000

Required: Construct an accounting equation for each the above transactions and the statement of

financial position extract.

2. Muggaga is an Entrepreneur owning a manufacturing firm in the industrial area .The following

are the enterprises transactions for the month of October.

i)Started business with 100,000,000 on his bank account obtained as a retirement benefit.

ii) Bought a building of 60,000,000 by cheque

iii) Rent out part of the of the building and received 4,000,000 cash

iv) He bought a computer from Copy cat ltd for storing the company's records paying 2,000,000 cash and

promising to pay the balance later of 500

v) The company's assets were depreciated at 10% on cost

vi) vi) He withdrew 600,000 to shop for his concubine in the Garden city vii) Obtained a mortgage from

Housing finance of 22,000,000 cash viii) Paid fuel of 200,000 cash and parking tickets of 40,000 cash

vii)Paid Copy cat ltd its outstanding balance using cash

viii) Invested a cheque of 20,000,000 in treasury bills

Required Construct an accounting equation for each of the above transactions and extract a Statement

of financial position at the end

2.3 DOUBLE-ENTRY ACCOUNTING

The fundamental principle of the transactions is the concept of double entry. The two-fold aspect of

business transaction has been evolved to provide the arithmetic check regarding the accurate and complete

record of these transactions. We state that every business transaction requires two entries, which are

named as a debit and credit entries. These two entries are made in the ledger, which has two sides - the left

hand side being the debit and the right hand side being the credit.

In a transaction, the total amounts on the credit side must equal the total amounts on the debit side. If

double entry rule is not complied with the account will not balance and finally the statement of financial

position. Double entry book keeping is based on the idea that each transaction has equal but opposite

effect.

At this moment always, remember that,

• The elements of accounting are assets, liabilities, and owner's equity.

• Every business transaction has at least two effects on the accounting elements. This dual effect

provides the basis for double-entry accounting records.

• In double-entry accounting, both effects of a transaction are recorded in the accounting records.

Example:
 A firm buys equipment on credit. The asset Equipment increases, and the liability Accounts payable/

trade payables increase. In double-entry accounting, it is necessary to record both the increase in the

asset equipment and the increase in the liability accounts payable.

2.3.1 Rules of double entry book keeping:

A debit entry will

 Increase an asset

 Decrease a liability

 Increase an expense

A credit entry will

 Decrease an asset

 Increase a liability

 Increase income

The basic rule which must always be observed is that every financial transaction gives rise to two

accounting entries, one a debit and the other a credit.

2.4 Accounts
Definition: A separate record that is kept of the increase and decrease in each asset, each liability, and

each aspect of owner's equity.

2.4.1 Why do we need accounts?

• A firm must have a well-organized accounting system with detailed Information about the effects of

transactions so that financial reports and statements can be prepared.

• The effects of transactions can be recorded by updating the accounting equation. However, this is

not practical as it is highly tedious.

May be kept by hand in a bound book or tooseloose-leaf binder, or they may be part of a computer

system.
 There are various forms used for ledger (to be explored later in detail) accounts, A common

type is the standard form of account.

Accounts Standard Form

 Account title and number are located at the top and identify each account as an asset, liability, or aspect

of owner's equity.

 Debit side - left side

 Credit side - right side

The debit side and the credit side of an account contain the following columns:

 Date column - record date of transaction

 Item column - record description, if necessary

 P.R/folio column - record posting reference

 Debit or credit column - record amount

T- Accounts:

Simplified version of the standard form of account for learning purposes. Looks like the capital letter T.

Contains title, debit and credit side

Title of Account

Debit side Credit side

Left side Right side

Debits and credits

The left side of any account is the debit side, and the right side is the credit side.
 * To debit an account is to enter an amount on the left, or debit side.

* To credit an account is to enter an amount on the right, or credit side. * Dr used for debit

*Cr used for credit.

The rule of debit and credit are based on the location of assets, liabilities, and owner's equity. Recall;

Assets = Liability +0wner's Equity

Assets:

Assets appear on the left side of the accounting equation

* Accounts increase on the left, or debit, side.(To record an increase in an asset)

* Accounts decrease on the right, or credit side.(To record a decrease in an asset)

Assets Account

Debit Credit

+ -

Liability and Owner's equity

Liabilities and owners equity appear on right side of the accounting equation.

* Accounts increase on the right, or credit side.( To record an increase in Liabilities and owners equity)

* Accounts decrease on the left, or debit side. .( To record a decrease in Liabilities and owners equity)

Liability Account Owner's Equity

Debit Credit Debit Credit

- + - +

Note: Debit and credit do not necessarily mean increase and decrease. They mean Left and right.

 A debit can be either an increase or a decrease, depending on the type of account.

 A credit can be either an increase or decrease, depending on the type of account.

Recording transactions

a) Ali Musa starts a traveL agency with an investment of UGX25, 000 in cash. The owner's investment

increases the assets cash by UGX25, 000. Assets accounts are debited to record an increase. Thus, the

cash account must be debited for UGX25, 000.

(a) Entry

Cash Ali Musa, Capital

+ - -+

(a) 25,000 a) -25,000

Ali Musa buys a computer and other office equipment for the business for UGX 9,000 on credit. The

asset office equipment increased by UGX9, 000 and Asset accounts are debited to record an increase.

Thus, the office equipment account must be debited for UGX9, 000. The liability accounts payable

increases by UGX9, 000. Liability accounts are credited to record an increase. Thus, the accounts

payable account must be credited for UGX9, 000.

(b) Entry

Office Equipment Accounts Payable

+ - +-

(b) 9,000 (b) 9,000

Ali Musa buys offices supplies for the business for UGX 300 in cash. The assets office supplies are

debited to record an increase. Thus, the office supplies account must be debited with UGX, 300.

The asset office supplies increases by UGX 300 and cash reduces by UGX 300

( c ) Entry

Office supplies Cash

+ - +-

(c) 300 (c) 300

Ali Musa pays UGX 3000 of the amount her business owes for office equipment previously brought on

credit. The liability payable decreases by UGX3000. Thus, the account payable must be debited for

UGX3000. The asset cash decreases by UGX3000. Assets accounts are credited to record a decrease.

Thus, the cash account must be credited for UGX3000.

(d) Entry

Accounts Payable Cash

3000 -+

3000

Debits and credits

The Shilling amounts of the debits and credits must be equal when transactions are recorded.

Checking that the same sides of the accounting equation are equal is a way of verifying the

mathematical accuracy of the transactions that have been recorded. In double-entry accounting, a debit

recorded in one account must be matched by a credit record in another account. Making equal debit

and credit entries for each transaction keeps the accounting equation in balance.

Effects on owner's equity

Owners' equity increases with revenue or reduces when the owner withdraws cash or other assets and

when the business incurs expenses.

Owner's Capital Account

Revenue is the income earned from carrying out the main activities of the business, such as Selling

goods or services.

Expenses are the costs of operating the business.

Temporary owner's equity

Definition: accounts whose balance will be transferred to the owner's capital account at the end of the

accounting period.

Includes;
 Expense account

 Revenue account

 Owner's Drawing account

Why use temporary owner's equity

It is not practical to mix the owner's investment together with revenue, expenses, and withdrawal in

one account. A better practice is to enter only transactions involving the owner's investment in the

owner's capital account and use separate accounts to record other owner's equity transactions.

The rules of debiting and crediting revenue and expense accounts are based on the relationship of these

accounts to the owner's capital account.

Revenue accounts

Like an investment by the owner, revenue increases owner's equity. The rules are the same as the rules

for debiting and crediting the owner's capital account. Increase on the credit side and decrease on the

debit side.

Expenses account

An expense decreases owner's equity. The rules are the opposite of those for debiting and crediting

owner's capital account. Increase on the debit side and decrease on the credit side.

The increase and decrease sides of the revenue accounts are the same as those of the owner's capital

account.

Owner's capital Account Revenue Account

Debit Credit Debit Credit

- + -+
The increase and decrease sides of the expense accounts are opposite of the owner's capital account.

Owner’s Capital Account Expenses Account

Debit Credit Debit Credit

- + + -

Revenue transactions

(e) Ali Musa receives fees of UGX 4, 000 in cash during the first month of her firm's operations.

The asset cash increases by UGX 4, 000. Asset accounts are debited to record an increase. Thus, the cash

account must be debited for UGX 4, 000.

The revenue of the business increases by UGX 4, 000.

Revenue accounts are credited to record an increase. Thus, the fees earned or whatever form of

Revenue (we shall later call this sales revenue) account must be credited for UGX4, 000.

(e) Entry

Cash Fees Earned

Debit Credit Debit Credit

- + -+

(e) 4000 4,000

Expense transactions

(f) Ali Musa pays the monthly rent of UGX700 for her office.

The expenses of the business increase by UGX700. Expense account must be debited for UGX700.

Expense accounts are debited to record an increase. Thus the rent expense account must be debited for

UGX 700
The asset cash decreases by UGX700. Asset accounts are credited to record a decrease. Thus, the cash

account must be credited for UGX700.

(f) Entry

Rent Expense Cash

Debit Credit Debit Credit

+ - +-

700 700

Recording withdrawals

When the owner withdraws cash or other assets for personal use, it is possible to record the

transactions in capital account.

However, it is better to use a separate temporary owner's equity account called a drawings account.

Because withdrawals by the owner decrease owner's equity, the drawing account increases on the debit

side. The rule for increasing the owner's drawing account is the opposite of the rule for increasing the

owner's capital account.

Ali Musa withdraws UGX1, 000 for her personal use during the first month of her firm's operations. The

withdrawal by the owner results in a UGX1, 000 increase in the drawings account The drawings account

is debited to record an increase. Thus, Ali Musa, drawing must be debited for UGX1, 000. The assets

cash decreases by UGX 1,000. Assets accounts are credited to record a decrease. Thus, the cash account

must be credited for UGX 1, 000.

Remember in double-entry accounting, the total debits in the ledger accounts must always equal the

total credits. For that matter, this equality in form a trial balance will be illustrated in the next chapter.
Chart of account balance

An account usually has more increases than decreases. Thus, the normal balance of an account is on the

increase side of the account.

Example: assets accounts increase on the debit side and their normal balance is a debit balance.
Type of account

Asset accounts, Liability account, Owner's capital account, Owner's drawing

account, Revenue accounts, Expenses account

+ - Normal
Side Side Balance
Debit Credit Debit
Credit - Debit Credit
Credit Debit* Credit
Debit Credit Debit
Credit Debit Credit
Debit Credit Debit
Conclusion

As a learner, you must master the double entry principle. This chapter is, in fact, key to the following

chapters.

Exercise

1. Show the following transactions, as they are entered in the double entry system

a) Sold goods for cash UGX 8,000

b) Bought Furniture for UGX 5,000 and paid by cheque

c) Bought goods in trade for UGX 3,000 on credit

d) Part payment of UGX 1,000 cash was made to a creditor

e) Tom was paid UGX 2,000 cash

f) Some furniture, which had cost UGX 3,000, sold for cash at cost.
 CHAPTER THREE

THE PREPARATION OF BOOKS OF ACCOUNTS

Chapter Outline:

- Introduction

- Subsidiary books and sources of information

- The journal

- Bank statement

- Petty cash

- Main books of accounts

- Posting transactions from journals to ledgers

Learning objectives

By the end of the chapter, the learner should be able to;

1. Classify accounts

2. Explain the subsidiary books and sources of accounting information

3. Understand the term posting and balancing off accounts

4. Be able to enter transactions using the double entry system

5. Prepare a trial balance and a simple statement of financial position there from.

6. Record business transactions in the respective source documents.

3.0 Introduction

All business transactions will be ultimately recorded in a main book of accounts. In this chapter, we

introduce the books kept by an enterprise and economic transactions recorded there. We shall

acknowledge and illustrate that the ledger is the main book accounts.
3.1 Subsidiary books and sources of information
As transactions occur; business papers are prepared as evidence of the transactions. We call these

business papers source documents. All entries made in the ledger (the use of which we shall come to

shortly) accounts are first recorded in some other books which are known as subsidiary books, B

3.1.2 Books of original (prime) entry.

These books are used to reduce the bulk of the work in the" ledger. This procedure also enables

different staff members to work simultaneously as they can work on different books. We post the

transactions recorded in the subsidiary books to the ledger accounts at the end of every month and in

case of some transactions, only total amounts are posted. The books used to record all transactions of a

particular category prior posting to the ledgers are the books known as subsidiary books or books of

prime entry. They include;

 The purchase daybook or journal; this book records the details of all goods purchased on credit.

 Sales daybook or journal; this book records the details and amounts of all goods sold on credit.

 Purchases return book or returns outwards journal; this book records the details and amounts of

goods returned to the trade payables

 Sales return book or return inwards journal; this books records the details and amounts of goods

returned by the trade receivables

 Petty cash book; this book records the small cash receipts or payments. This books is also used to

analyze the expenses the expenses paid in cash

 Journal or diary; the journal is that daybook in which we can record the details of any transaction that

cannot be recorded in any other subsidiary book. We call all other books of original entry the
 division of journal for recording specific type of transactions. The main uses of the journal are the

following.

 To record purchases or sales of assets

 To correct the errors

 To record opening and closing entries

 Writing off of bad debts; etc

3.2 Sources of information

As Earlier mentioned when transactions occur; business papers are prepared as evidence of the

transactions and we call these business papers source documents. Source documents should be the

basis for recording transactions and this conforms to the principle of objective evidence. Documentary

evidence must support all entries in the books of account. We use the following documents for this

purpose.

1) Invoice - Shows the claim of money regarding the goods sold on credit. They are of two types

a) Incoming invoices - These are received from trade payables

b) Out going invoices - These are sent to the trade receivables

We write up the purchases daybook from the incoming invoices and the sales daybook from the

outgoing invoices. Then we post entries made in the purchase and sales daybooks in the ledger accounts

at the end of every month (usually). The term 'posting' means to record a transaction in a ledger account

from a book of original entry. We make the double entry as- under:-

Purchase day book

i) Dr. Purchase's a/c in total

ii) Cr. The accounts of trade payables

iii) Sales day book

iv) Dr. The accounts of trade receivables

v) Cr. Sales account in total

2) Credit note - This shows the decrease in a claim of money. It is issued when part of the goods sold or

purchased are returned or price over-charged is reduced at a later stage. Credit notes may be of two kinds.

(i) Out going credit notes - These are sent to trade receivables

(ii) In coming credit notes - These are sent by trade payables

The returns out ward daybook is written up from the incoming credit notes and return in wards daybook

from the outgoing credit notes. We make the double entry as under;

a) Return out ward book

i) Dr. the accounts of creditor

ii) Cr, Returns outwards account in total

b) Return inwards book

i) Dr. Returns inwards account in total

ii) Cr. The accounts of trade receivables

At the end of the accounting period, the balances in returns account are transferred to the, trading

account (to been seen later in the text). In this case:

i) Dr: Trading account

ii) Cr. Returns inwards account

3) Debit note or supplementary invoice - The seller sends this document to the buyer to correct for

under under-charge on the original invoice. Treat the Debit note in exactly the same way as an invoice.

4) Statement of account - the seller sends the statement of account to the buyer at the end of the

every month and it indicates the amount due from the buyer. He/she sends this statement to remind to

the buyer for the payment of his outstanding amount.

5) Remittance advice note - This is a note sent by the buyer to the seller together with a cheque at the

end of the month and shows the details of the items against which that payment is made.

These documents provide data for the journal.

3.3 JOURNALS
A journal may also be defined as a book of original entry where transactions are first recorded when

they occur. Businesses maintain several types of journals and the nature of operations determine the

number and the types of journals needed. The journal was once the most used book in bookkeeping, but

today entries in the journal are limited to records of 'unusual' transactions, which are improperly

recorded in any of other books of original entry that will be described. Such transactions are those which

do not purely involve the receipt or payment of money (whether in cash or through the bank), and which

are not credit sales or purchases or returns inwards or returns. However the types of Journals are;

a) General journal

b) Sales day book/sales journal

c) Purchases day book/purchases journal

d) Cash book -,

e) Returns inwards day book

f) Returns outward day book

Before looking at the Journals in details, it is important that we understand the place of the journal-in

the accounting process. After the occurrence and documentation of the business transaction it is

recorded in the books of account. Transactions are first recorded in the journal and then posted to "the

ledger. Recall that a business transaction is defined as an event, which can be expressed in money form

and must be recorded in the accounting books. The relationship between the transactions of a business,

the journal and the ledger can be discerned from the following diagram.
 All business transactions

Classify - put some types of transactions together

Credit Credit Returns Returns Cash receipts Other

purchas sales inwards Outwar and payments types
es ds
Enter
Enter in Enter Enter Enter in
purchase in sales in out Enter general
s journal journal Returns Returns in cash journal
journal journal book
inwards
Enter in double entry accounts in the various ledgers
Sales ledger
Purchases ledger
General leader
 A3.3.1 General Journal

We can also use this journal for all types of transactions with two money columns, although in the

diagram above we have said it used to record other types of transaction other than those specifically

identified with other journals. We also call it a journal proper.

Procedural steps for recording transactions in the General journal:

a) Recording the date on which the transaction occurred.

b) Write the name of the account to be debited and record -the amount in the first money column

c) Write the name of the account to be credited in the second money column

d. A brief explanation is given about the transaction immediately after the account is credited

e. Journals have a Ledger page column .This column provides a convenient cross-reference with the

ledger.

Let us now illustrate the operation of the general journal using the following transactions

IllustrationExample

The following were the transactions of XYZ ltd for the month of January

i) On January 1st XYZ ltd started business with cash of UGX 2,000,000 and money at the bank of UGX

3,000,000

ii) 3rd Jan Purchased goods for UGX 600,000 cash

iii) 6th Jan Bought a Motor vehicle for UGX 1,500,000 by cheque >

iv) 7th Jan Sold goods for UGX 300,000 cash.

v) 15th Jan Purchased more goods on credit from TK Ltd

vi) 20th Jan obtained a bank loan of UGX 3,000,000cash.

vii) 23rd Jan Sold goods for UGX 200,000 on credit to Mary

viii) 25th Jan Mary paid UGX 80,000 cash.

ix) 26th Jan Sold goods on credit to Peter for UGX 100,000.

x) 29th Jan purchased goods from John on credit for UGX 300,000

Required Enter the above transactions in the General Journal

XYZ LTD GENERAL JOURNAL FOR THE MONTH OF JANUARY

Date Account title & explanations LP/ Debit Credit

1st Cash A/C Folio
01 02 2,000,000
Jan 03 3,000,000
Bank A/C

Capital A/C For starting the business 5,000,000

rd
3 Purchases A/C 04 01 600,000
Cash A/C Being purchase of goods using
cash 600,000
6th . Motor vehicle A/C 05 02 1,500,000
1,500,000
Bank A/C

Being for purchase of a motor vehicle

using cash
7th Cash A/C 01 300,000
06 300,000
Sales A/C

Being sale of goods for cash

th
20 Cash A/C 01 07 3,000,000
3,000,000
Loan A/C

23rd Mary A/C(Debtor's A/c) 08 200,000

06 200,000
Sales A/C

To record sale of goods on credit to Mary

th
25 Cash A/C -Mary A/C (Trade receivables 01 08 80,000
A/c) To record receipt of cash 80,000 .

26th Peter A/C (Debtor's A/C) 09 06 100,000

100,000
Sales A/C

To record sold of goods to Peter on credit

 29th Purchases A/C 04 10.
John A/C ( Creditor's A/C) To record
purchase of goods from John on credit 300,000

3.3.2 B. Sales Day Book (Sales Journal)

In almost all businesses sales will be made on credit .The sales day book is used for recording the credit sales

.The sales day book contains the following:

 Date on which the transaction occurred

 Name of the customer .The person who bought the goods on credit (individual or company)

 Invoice number .The number on the sales invoice. A sales invoice is a document showing details of goods

sold and the prices at which they have sold

 Folio column

 Amounts or Prices at which goods have been sold

IllustrationExample

The company sold goods on credit to the following people.

i) On May 1st soLd goods to Jackie of UGX 400,000 and the invoice number was Oil

ii) On May 4th sold goods to James of UGX 300,000, invoice number 016

iii) On 7th sold goods to Peter UGX 700,000, invoice number 018

iv) On 10th sold goods to Meyer UGX 500,000 invoice number 020

Required: Prepare a Sales daybook

 SALES DAY BOOK

Date Name of Invoice number F Amount (UGX)

customer ol

io

May 1st Jackie 011 400,000

4th James 016 300,000

7th Peter 018 700,000

10th Meyer 020 500,00a

1,900,000

C)3.3.3 Purchases Day Book

The purchases daybook is book of original entry for recording goods bought on credit. The purchases

daybook contains the following

• Date

• Name of creditor

• Invoice number

• Folio column

• Amount

Another illustrationexample

The company bought the following goods on credit in the month of May.

i) On May 3rd bought goods from Stephen for UGX l,5QO,000, invoice number 10.

ii) On 7th purchased from Brian for UGX 3,000,000/invoice number 14.

iii) On 20th purchased from Derrick for UGX 2,000,000,invoice number 18.

iv) On 22nd bought goods from Adrian for UGX 700,000 ,invoice number 20.

Required: Record the above transactions in the purchases daybook

 PURCHASES DAY BOOK

Date Name of creditor Invoice Foli Amount (UGX)

number o

May Stephen 10 1,500,000

3rd

7th Brian 14 3,000,000

20th Derrick 18 2,000,000

22nd Adrian 20 700,000

- 7,200,000

D)3.3.4 Cashbook

Although this is a major topic (Chapter 8) in its own right, it is introduced here as one of the specialized

journals. The cashbook is a book of original entry for recording cash and bank transactions. It shows the

business receipts and payments. It is also a day book used to keep a record of money received and money

paid out by the business. We also classify a cashbook as a ledger. A cashbook can have two columns or three

columns.

i) Two-column cashbook

The two-column cashbook has the bank and cash column both on the debit and credit side. The

cashbook therefore is a combination of the bank and the cash account.

Format of a two-column cashbook

Title
 Date Particulars Cash Bank Date Particulars Cash Bank

Using the illustrationexample of XYZ ltd prepare a 2 column .cashbook

XYZ two-column cashbook

Date Particulars Cash Bank Date Particulars Cash Bank

3an Capital 2,000,000 Jan Purchases 600,000

1st 3rd

Jan 1st Capital 3,000,000 Jan M. vehicle 1,500,000

6th

7th Sales 300,000

20th Loan 3,000,000 Bal c/d 4,780,000 1,500,000

25th Mary 80,000

5,380,000 3,000,000 5,380,000 3,000,000

Use of folio columns in the cashbook

The particulars column of the cashbook just contains the name of the other accounts and tracing such

accounts may be difficult .Folio columns will indicate where we find such accounts when we need more

information.

ii) The three-column cashbook

The three-column cashbook has additional columns of discount received and discount allowed column in

addition to the cash and the bank columns.

Discount allowed. This is the discount (reduction in the prices) that is given to customers by the

business. It reduces the amount paid by the customer. We enter the discounts allowed in the discount

column on the debit side of the cashbook

Discount received. This is a discount received by the business from its suppliers. It reduces the amount

paid to suppliers. The discounts received are entered in the discounts column on the credit side of the

cashbook.

IllustrationExample

The company purchased goods on credit from Man/ for UGX2, 000,000.

i) The company was able to pay on 4 May (in time) using a cheque and therefore qualified for a

discount of 5%. ii) The company has a debtor 3ohn whose balance was 1)0X200,^000. He paid cash on

10 April (in time) and this made him qualify for discount of 2%.
 Required: Show how the above transactions will appear in the cashbook

i, Discount received

2,000,000*5/100 = 100,000 (To be entered on the credit side of the cashbook)

The amount of money that the company paid to Mary amounted to 2,000,000-100,000 =1,900,000

Discount allowed 2/100*200,000 = 4,000

The discount allowed is UGX 4,000 (will appear in the discount column on the debit side of the cash

book)

The amount received from John a debtor was 200,000-4,000 = 196,000

Three-column cashbook

Date Details Discount Cash Bank Date Details Discount Cash Bank

10/ Joh 4,000 196,000 4/05 Mary 100,000 1,900,000

4 n

Exercise: Refer to the General Journal of Kyeswa Ltd and prepare a Cash book Note: we shall come to a

detailed operation of the cash book in the next chapter.

3.3.5 BANK STATEMENT:

This can be received by a business either weekly or monthly. It is used to check that the amount shown

as a balance in the cash book agrees with the amount on the bank statement and that no cash has gone

missing. We shall discuss this reconciliation in the coming chapter.

3.3.6 PETTY CASH:

Most businesses keep petty cash on the premises which is topped up from the main bank account under

the imprest system. This is where an agreed sum is kept so that each topping is equal to the amount paid

out in the period. The recording is done in a petty cash book which is a cash book for small claims. The

petty cash system is subject to strict controls such as;

 - Payment is made only with respect to authorized claims

- All claims are supported by evidence e.g receipts of expenditure

3.3.7 RETURNS DAY BOOKS/JOURNALS

The returns day books record goods, which have been returned to and by the business These books are:

 Return inwards day book

 Return outwards day book

Return inwards day book/Journal

Return inwards refers to goods which have been sold but have been returned to the business .When the

goods are returned and the amounts are refunded, a credit note is issued to the customer .It is called a

credit note because the customer’s account will be credited. The returns on the credit notes will be

recorded in the:

 The return inwards account

 Sales ledger (Trade receivables subsidiary ledgers) by crediting the individual customers accounts

IllustrationExample

The following customers returned goods to the company:

i) On 3rd September David returned goods for UGX50,000 ,credit note number 012

ii) On 8th September Isaac returned goods for UGX80,000 ,credit note number 019 iii) On

iii) 20th September Deborah returned goods for UGX100,000, credit note number 020

Required: Record the above transactions in return in wards daybook

Return in wards daybook

Date Details Credit note number Folio Amount (UGX)

 3rd September David 012 50,000

8th " Isaac 019 80,000

20th " Deborah 020 100.000

Amounts to be transferred to the return inwards account 230,000

Return outwards account

The return outwards day book records the goods which have returned by the business to its suppliers.

When goods are returned, the business issues a debit note to the supplier and gives reasons for their

return.

The amounts of the debit note will be recorded thus;

 Return out wards account

 Purchases ledger by debiting in the individual accounts

IllustrationExample

The company returned goods to the following suppliers

i) On 4th May returned goods to peter of UGX80,OQO,debit note number 013 ii) On 28th May

returned goods to Ivan of UGXl30,000,debit note number 015 iii) On 30th May returned goods to Mark

of UGX200,000,debit note number 018

Required: Record the above transactions in the return outwards daybook

Return outwards daybook

Date Details Debit note FolioAmou

4th May Peter 013 80,00
28th May Ivan number
015 nt
130,0
30th May Mark 018 200,0
Amounts to be transferred to the return outwards account 00
410,0
00
00 We sometimes refer to a
After recording transactions in the journals, we post them to the ledgers.
ledger as the book of secondary entry. A ledger is a group of accounts (A/C) and in the manual

accounting system the ledger is a book where the accounts are kept.

Activity:

1. Name four pieces of information shown on the invoice.

2. What is the difference between a cash book and petty cash book?

3. What is the source document for petty cash?

4. What is the use of the purchase returns day book?

3.4 THE MAIN BOOK OF ACCOUNTS

The recording function of accounting is called preparation of books of accounts/book keeping.

The purpose of bookkeeping is to provide an accurate and detailed record of every transaction involving

the exchange of money or money's worth between the-enterprise and others, whether they are

individuals or organizations.

Before looking at the ledger however, it is important that the specialized meaning of certain words and

terms commonly used in bookkeeping and accounting be clearly understood. At this stage, the following

explanations should be thoroughly learnt to ensure that progress in learning will be rapid and easy; any

'skipping' through the explanations or an "I know it already" attitude at this stage can lead to

misunderstanding or difficulty in learning other topics in this text.

Assets: these are the possessions of an enterprise, that is, what it owns. Assets include actual cash

(currency notes and coins). They also include money in bank accounts; investment and, depending on

the type and size of an enterprise, land and buildings; plant, equipment and machinery. They include

furniture; inventorysinventories of goods for sale and/or inventorysinventories of materials to be utilized

in manufacturing goods; and anything else owned by the enterprise, which has monetary value,

including money owed to it by individuals, and other enterprises, and often called book debts.

What are called Non-current assets are items, which an enterprise acquires in order to be able to carry

out its activities, and they are usually acquired with the intention of their being retained for some time,

perhaps many years. The variety of such items is great and, depending on the type and size of the

particular enterprise, may range from desk to chair, type writers and other office equipment, to factory

buildings, machinery and plant, motor vehicles, etc; in fact any material item large or small in size or

value which assists the enterprise to run effectively and profitably. In some countries non-current assets

are called working assets because they enable the enterprise to perform its 'work'.
All other assets of an enterprise are called current assets, and their total value is constantly changing or

fluctuating with the day-to-day operations of the enterprise. Current assets include

inventorysinventories of goods and / or raw materials, cash and bank balances, debts owing to the

enterprise, etc, whose total values change daily as purchases and sales are made, as bills are paid and as

customers pay their debts.

Liabilities: those are any sums, measured in monetary value, which an enterprise owes to others? that

is, they are the debts of the enterprise. Liabilities may include the values of goods, materials or services

paid for by customers but not yet provided to them; as well as bank overdrafts, and loans made to the

enterprise by banks and other financial institutions, etc.

Trade receivables: are people and organizations who owe money or money's worth to the enterprise.

Trade receivables are mainly customers who have been supplied with goods or services 'on credit'. That

is, without having to pay for them at the time of sale; but can also be those to whom the enterprise has

loaned money and those who have been paid in advance for goods or services not yet provided (eg

insurance cover is usually-paid in advance for a whole year). Those who incur debts to a business as the

result of its normal business activities are commonly called 'trade trade receivables'. As mentioned

earlier, debts owing to an enterprise are assets; and sums owed by trade receivables (book debts) are

therefore classed as current assets.

Trade payables: are people and organizations to which an enterprise owes money or money's worth.

Trade payables may be suppliers who have supplied goods, materials or services on credit. That is,

without demanding payment at the time of supply, or may be people who have paid in advance (e.g.

rent paid in advance to a land lord); both groups of whom are commonly referred to as trade payables.

They may also be banks or other financial institutions, which loaned money to the enterprise, or banks

which have permitted the enterprise to 'overdraw 1 its current account (a matter that is dealt with fully in
 a later chapter). As already stated, all sums owed to trade payables are liabilities of an enterprise.

Capital is an essential prerequisite of any business enterprise; whatever it's intended or eventual size it

will require initial capital to enable it to commence its operations. Initial capital requirements will, vary

considerably, but money will be needed to acquire the necessary fixed assets as well as the relevant

current assets - inventorysinventories of raw materials and/or goods for sale.

Sufficient capital - 'working capital' - will also be required to finance the enterprise, that is, to meet all

the expenses which will be incurred (e g rent, salaries, electricity, advertising, etc) until sufficient income

from initial production and/or sakes is generated.Thegenerated. The amount of an enterprise's working

capital at any point in time is the total value of its current assets less the total value of its current

liabilities.

Income and expenditure: income is all the money, in whatever form, received by an enterprise; whilst

'expenditure' is all the money, in whatever form, paid out by the enterprise to enable it keep running -

its expenses.

Profit: enterprises - often called 'businesses' in the private sector- are started and run to make profits or

gains for their owners. Some people do not hold the 'profit motive' in esteem, and it is therefore worth

considering what profit is and how it arises. This will be dealt with later in the text. For now, we return to

the Ledger.

3.4.1 THE LEDGER

The books that are the subject of bookkeeping are referred to as the "books of accounts". The main book of

accounts is the ledger. In a summarized form it records andrecords and can provide all the following
information:-

(a) The total income of the business, and in general the different sources from which it is derived;

(b) The amounts involved in meeting each type of expense, and the total expenditure incurred by the

business;

(c) What assets are owned by the business, the values of each general type and the total value of all its

assets;

(d) The values of the different liabilities of the business, and the total value of all its liabilities;

(e) Who its trade receivables are, how much they owe to the business, and the total amount owed to the

business;

(f) Who the trade payables of the business are, how much is owed to each by the business, and the total

amount owed by the business;

(g) Whether the business has made a profit or a loss during a given period of time, and the amount of that

profit or loss;

(h) The amount of working capital available to the business at the point in time

(i) A ledger comprises many different sections, each of which is called an account. In a ledger book, there

will usually be one account on each page of it; in a large business, each account may have its own card or

sheet - all the account - cards or account - sheets together jointly make up the business' ledger.

The following important points must be noted about ledger accounts:

1. Each individual account is headed by a name or by a title. That name or title may be the name of a person

or an organization or a type of assets, a type of liability, a type of expense or a source of income.

2. Only information about the transactions concerning the person, organization or item named

at its head may be recorded in that account.

3. Each account must be kept separate, or treated separately, from all the other accounts in the Ledger, and

there must be only one account in the Ledger for any one particular person,

organization or item.
4. Each ledger account is divided into two sides by a Line - or by two close parallel (although for purposes of

this book, we one line) Lines - drawn down the middle of it, from top to bottom

5. The Left-hand side of an account is called its debit side, and it records all values received by

the person, organization or item named at the head of it.

6. The right-hand side of an account is called its credit side, and it records all values given (or

paid out by) the person, organization or item named at its head.

In addition to a name or title, each account also has a number located to it; that number is called a folio or

an account number.
A specimen ledger account

Debit side (receipt) CLARENDON HOTEL credit side (value given out)

10 ___ MGX 10 ______

May 2 SB7 May 4 returns Rl 3 14.00

UV3A
8 purchases SB7 339.40 15 payment CB 800.00
purchases
12 purchases SB7 162.50 Balance c/d 458.70
14 purchases 5B7 296.20 43
:L27^20_ J^THO
16 balance b/d • 458.70 27 returns R14 21.00-

25 purchases SB7 113.10 31 balance c/d 551.10

572.10 572.10
June l balance b/d 551.10

The transactions - or entries - are rarely recorded direct into the Ledger account. Generally, information

is first recorded in one of the 'subsidiary books' or 'day books' - which are collectively often called 'the

books of original entry. The information is then transferred, or 'posted', as the process is called in

bookkeeping to the appropriate ledger accounts in a summarized form.

The most commonly used subsidiary books are the cashbook, the sales book, the purchases book and

the returns inwards and outwards book, which have all been described in this chapter already.

Now let us turn to an examination of the specimen ledger account and note the meaning of the
 following abbreviations used in the specimen account, and which will frequently be met with in

bookkeeping and accounting;-

c/f - this is the abbreviation for "carried forward" and means that the figure, total or balance against

which it appears has been transferred to another place, for example from the bottom of one page to

the top of another, or to one book or account to another.

b/f - this abbreviation stands for "brought forward" and means that the figure, total or balance

alongside which it appears was transferred from another place, e.g. to the top of one page from the

bottom of another, or to another book or account from another.

c/d - this is the abbreviation for "carried down" and indicates that the balance alongside which it is

written has been transferred to a lower position on the same page

b/d - this abbreviation stands for "brought down" and means that the balance against which it is

written has been transferred from a higher position on the same page.

bal - this is the common abbreviation for the word "balance", which is the difference between the

total value of the debit entries in an account and the total value of the credit entries in it.

3.4.2 Balancing a Ledger

After making the entry for the payment from Clarendon on the 15th, Mr. Trader needed to know how

much was still owed to his business by Clarendon. To obtain that information, he carried out a process,

called balancing. What he did was first to add up the values of the entries on the debit side of
Clarendon's account in the ledger; their total amount to UGX 1,272.70. He wrote that total below the

fourth entry - remember that fig. 1/1 shows an 'historical record, and that on the 14th the other entries

shows in the account had not yet been made.

Next, he added up the value of entries on the credit side of the account - their total, which was UGX.

814, was deducted from UGX 1,272.70 to give the balance - the amount still owing by Clarendon - of

UGX 458.70. that amount was entered on the credit side, making the totals of the entries on both sides

equal, and so the total was entered on the credit side, on the same line as the total of the debit entries;

and both - equal - totals are neatly underlined, or 'ruled off as the process is called. Finally, the balance

was carried down from the credit side to the debit side, showing that Clarendon had received an excess

value of UGX 458.70 over what it had been given out.

Balancing is an easy process and can be carried out on any account at any time it is considered

necessary to do so. It is generally carried out on the account of all trade receivables and trade payables

at the end of each month, and on each account at the end of a financial or trading year or other

accounting period and you will learn why that is done as you progress with your studies. Before we

proceed, it is important to look at the classification of accounts.

3.4.3 Classification of accounts

An account may be defined as a record of transactions of a particular type or with a particular person

usually expressed in financial terms and maintained in a ledger. Each page of a ledger is given a heading

or title and it is used to record transactions of a similar nature. For example, all sales of goods are

recorded on one page and it is known as sales account and so on. In a ledger, we classify various

accounts as under;
 ACCOUNT
S

IMPERSONAL ACCOUNTS PERSONAL ACCOUNTS

NORMAL ACCOUNTS REAL ACCOUNTS

Adopted from: Saleemi (1982)

We explain these as under;

Personal accounts - These accounts contain the name of a business, person or firm. In a ledger,

there may be three types of personal accounts.

 Capital account; this account records the transactions between the proprietor and the business. Any

amount invested or withdrawn by the proprietor is recorded in this account. ,

 Trade payables' account; the persons to whom money is owed by the business are called trade

payables.Thepayables. The goods purchased on credit basis from suppliers create a Liability of the business.

These amounts owing to trade payables are recorded in their personal accounts, which are opened

separately for each creditor.

 Trade receivables' account; trade receivables are the persons owing money to the business. This

money is owed to the business against goods sold to the customers on credit basis. A separate account is

opened for each debtor.

Impersonal accounts - The accounts, which do not contain the name of any person or business, are called

impersonal accounts. They may be of two kinds;

 Real accounts; these relate to tangible items. These accounts always represent something we can

see, touch, or move. The accounts of assets like land and buildings, plant and machinery, motor vehicles,

furniture and fittings and cash are real accounts.

 Nominal accounts; these relate to intangible items. These accounts record transactions for which

we have nothing tangible to show; for example, purchases, rent, sales, wages and salaries, electricity,

printing and stationery and so on.

Accounts and the dual (double entry) concept

The classification of accounts enables us to establish rules for making double entry (we saw double

entry principle in operation in the previous chapter) in case of different transactions. When faced with

any transaction, the following three points must be considered.

1) What two accounts are affected?

2) What type of accounts are they?

3) Which account is to be debited and which one to be credited?

Nominal Personal accounts

Accounts Real Accounts

DR. CR.
ACCOUNTS The The
DR. CR. Recei Give
Expenses Incomes ver r
and Losses and Gains
DR. What CR. What
comes in goes out
Adopted from: Saleemi (1982)

We divide all the many accounts, which will jointly make up the ledger of a business, into these three

classes – Real accounts, Personal accounts and nominal accounts.

Let us return to the ledges details. We noted earlier that source documents provide information for the

journal, which in turn will be posted to the ledger. The following diagram can help once again to explain

this relationship.
 All business transactions

Classify - put some types of transactions together

Credit Credit Returns Returns Cash receipts Other

purchas sales inward Outwar and payments types
es s ds
Enter
Enter in Enter Enter Enter in
purchase in sales in out Enter general
s journal journal Returns Returns in cash journal
journal journal book
inward
s various ledgers
Enter in double entry accounts in the
Sales ledger
Purchases ledger
General leader

The above diagram suggests that ledgers divide into;

 General, ledger

 Subsidiary ledger that includes the cashbook, sales ledger, purchases ledger, etc

Let us look at each in turn.

General ledger

It is a ledger for all accounts in an organisationorganization .In an organisationorganization the general

ledger will contain accounts such as cash account, bank account, purchases account etc but on different

pages. It is important to note that the general ledger will not contain individual accounts for the trade

receivables and trade payables. For example, the account for Mary as a debtor will not appear in the

general ledger but the trade receivables account will appear having information about all the trade
 receivables.

Subsidiary ledgers

Businesses have so many customers and suppliers therefore it is necessary to have each individual

debtor or trade payables account separate to determine each one's balance.

We call these individual accounts subsidiary ledgers because they support and general ledger controls

them.

Types of subsidiary ledgers

• Trade receivables subsidiary ledger

• Trade payables subsidiary ledger

• Private ledger

• Cash book

Trade receivables' subsidiary ledger

This is a summary of an individual debtor's transaction. The general ledger shows information

concerning all the trade receivables but does not bring out the details about each individual debtor. The

subsidiary ledger brings out these details. For example, Mary who is a debtor will have transactions

concerning her alone summarized in Mary's account.

Trade payables1 subsidiary ledger

This is a summary of individual creditor's transactions. The general ledger will show information

concerning all the trade payables but will not details of each individual creditor. In the trade payables

subsidiary ledger each creditor will have their account.

Private ledger

The private ledger columns contain accounts that the proprietors wish to keep secret from other people
 .These accounts may include: capital A/C, drawings A/C, income A/C depending on-the organization etc

3.5 Posting transactions from the Journals to the Ledgers

The transfer of transactions from the journals to the ledgers is referred to as posting. The transactions

that appear in the debit column of the general journal will be posted to the debit side of the respective

ledger.The transactions that appear in the credit column of the general journal will posted on the credit

side of the respective ledger account.

Letaccount. Let us look at a few entries in Kyeswa's General journal and post them to the general

ledger.

Date Account titles& Explanations Fo Dr. (UGX) Cr.(UGX)

Mar Bank A/C Capital 50,000,000
lio
1 A/C To record capital used to start 50,000,000
Mar Purchases A/C 10,000,000
business.
2 A/C Payable (Bridgestone /C)

Being purchase of goods on credit 1-0,000,000

Bank account
UGX

Mar, 1 Capita Account 50,000,000

 Capital account

UGX
Mar.1 Bank account 50,000,000
Purchase account

UGX
Mar.2 A/C Payable (Bridgestone account 10,000,000
A/C Payable (Bridgestone account)

UGX
Mar.2 Purchases account 10,000,000

The arrows show the direction of the posting.

The process continues like that until all entries made in the journal are posted to their respective

ledgers. You will see later that all the entries of XYZ General Journal have been posted both in the

General Ledger and the subsidiary Ledger. You can also at this moment continue with posting the

entries of Kyeswa General Journal in their respective ledgers.

Balancing off the ledger accounts (you may wish to refer to the specimen of ledger account of

Clarendon Hotel)

There, we noted that the ledger accounts are balanced off to determine the balance by the end of

the financial period. Balancing off the accounts involves the following stages:

i) Adding both sides of the account to determine the total for each side

ii) For example the debit side of the account below adds up to 5,000,000 while the credit side to

700,000 [in)

iii) Leave space after all the transactions have been posted for inserting in the end of period balances.

iv) The Larger amount after adding both sides will become the total for both sides.
v) Subtract the smaller total from the larger total ( e.g. 5,000,000-700,000= 4,300,000).

vi) Enter the difference (4, 300,000) on the side with the smaller amount and it is represented as

balance carried down (bal c/d).

vii)Now both the debit and credit side will have the same total.

viii) Double entry of the balances should be fulfilled by carrying down the balance to the beginning of

the next period.

ix) If the balance carried down is on the credit side of the account then the balance brought down will

be on the debit side of the same account.

Normal Balances

Liabilities, capital and revenue accounts should have credit balances. Assets (apart from the bank

overdraft), expenses and drawings account should have a debit balance. If these accounts have

different balances from the normal then the accounts were not properly prepared.

With this in mind, the ledger accounts for XYZ Ltd now appear as follows

Cash account

Jan 1 capital 2,000,000 Jan 3 purchases 600,000

7 sales 300,000

20 Loan 80,000

31 Bal c/f 4,780,000

5,380,000 5,380,000

Feb 1 Bal b/f 4,780,000

 Bank A/C

Jan 1 capital 3,000,000 Jan 6 M.Vehicle 600,000

31 Bal c/f 1,500,000

3,00,000

3,000,000

Feb 1 Bal b/f 1,500,000

Capital A/C

Jan 31 c/f 3,000,000 Jan 1 Cash 2,000,000

1 Bank 1,500,000

5,000,000 5,000,000

Feb 1 Bal b/f 3,000,000

Capital A/C

Jan 3 Cash 6,000,000 Jan 31 Bal c/f 1,400,000

15 Trade payables (Tk) 500,000

29 Trade payables (John) 300,000 5,000,000

1,400,000 1,400,000

Feb 1 Bal b/f 1,400,000

M. Vehicle A/C

Jan 6 Bank 1,500,000 Jan 31 Bal c/f 1,500,000

1,500,000 1,500,000

Feb 1 Bal b/f 1,500,000

Trade receivables A/C

Jan 23 Sales 200,000 Jan 25 Cash 80,000

26 Sales 100,000 31 Bal c/f 220,000

300,000 300,000

Feb 1 Bal b/f 220,000

Trade payables A/C

Jan 31 Bal c/f 800,000 Jan 15 Purchases 500,000

29 Purchases 300,000

800,000 800,000

Feb 1 Bal b/f 300,000

 Loan A/C

Jan 31 Bal c/f 3,000,000 Jan 20 Cash 3,000,000

3,000,000 3,000,000

Feb 1 Bal b/f 3,000,000

Sales A/C

Jan 31 c/f 600,000 Jan 7 Cash 300,000

23 Debtor(Mary) 200,000

000,000 26 Debtor (Peter) 100,000

600,000 600,000

Feb 1 Bal b/f 600,000

XYZ subsidiary ledgers

Trade receivables' subsidiary ledgers

The trade receivables for XYZ Ltd are Mary and Peter .We are going to have Mary and Peter

accounts separately.

Mary’s A/C

Jan 23 Sales 200,000 Jan 25 Cash 80,000

_______ 31 Bal c/f 120,000

000,0200,000 200,000

Feb 1 Bal b/f 120,000

Peter’s A/C

Jan 23 Sales 100,000 Jan 31 Bal c/f 100,000

100,000 100,000

Feb 1 Bal b/f 000,0100,000

Note that the balance in the trade receivables' account (220,000) should always be equal to the

total of all individual balances. In this example the total of individual balances (for Mary and Peter

is 120,000 + 100,000 = 220,000

Trade payables' subsidiary ledgers

The trade payables for XYZ Ltd are John and TK ltd

TK Ltd A/C

Jan 31 Bal b/f 500,000 Jan 15 Purchases 500,000

500,000

000, Feb 1 Bal b/f 500,000

Johns A/C

Jan 31 Bal b/f 300,000 Jan 29 Purchases 300,000

300,000 300,000

000, Feb 1 Bal b/f 300,000

Similarly, the balance in the trade payables account in the General ledger (800,000) should always

be equal to the total of all individual trade payables (i.e. of TK Ltd and John in this example)

(500,000+300,000 =800,000))

An example concerning the use of Subsidiary books

Enter up the sales, purchases and returns daybooks from the following details. Then post the

individual items to the relevant accounts in the sales and purchases ledger and transfer the totals

of the various

May books to the accounts in the general ledger.

May 1 Credit purchases; R. Burton UGX.250, C. Malthus UGX.145, M. Adleman UGX.355

May 5 Credit sales; S. 'David UGX.410, T. White UGX.340, P. Black UGX.270

May 7 Credit Purchases; A. Thomas UGX.147, R. Burton UGX.100, C. Malthus UGX.190 May 9

Go.ods returned by us to; R. Burton UGX.35, C. Malthus UGX.50

May 10 Goods returned to us by; T. White UGX.25, P. Black UGX.30

May 12 Credit purchases, A. Thomas UGX.186, R. Burton UGX.250, C. Malthus UGX.80

May 15 Credit sales; T. White UGX.150, S. David UGX.220

May 18 Goods returned by us to; A. Thomas UGX.20, C. Malthus UGX.10

May Goods returned to us by T. White UGX.18

Solution

Sales Day book/Journal

Date Particulars Invoice number Folio/ledger paqe Amount

May 5 S. David 571 SL- 1 410
‘’ 5 T. White 572 SL- 2 340
‘’ 5 P. Black 573 SL- 3 270
‘’ 15 T. White 574 SL-2 150
‘’ 15 S. David 575 SL- 1 220
SL- 16 1390

Purchases day book/Journal

Date Particulars Invoice Number Folio/Ledger Amount

May R. Burton 681 PL- 1 250
1 C. Malthus 715 PL- 2 145
1
1 M. 350. PL- 3 355
7 A. Thomas 817 PL -4 147
7 Adleman
R. Burton 815 PL- 1 —
100
7 C. Malthus 850 PL- 2 190
12 A. Thomas 980 PL -4 186
12 R. Burton 940 PL- 1 250
12 C. Malthus 948 PL -2 80
L-15 1703
Returns outward book

lDate Particulars Credit note Folio Amount

lay R. Burton C- 215 PL- 1 35
9 C. Malthus number
C-410 PL -2 50
18 A. Thomas C- 530 PL -4 20
18 C. Malthus C- 560 PL- 2 10
L- 17 115

Returns Inwards book

Date Particular Credit note No. Folio Amount

May T. White C- 151 SL-2 25
10 s Black
P. C- 152 SL-3 30
25 T. White C- 153 SL -.2 18
L- 18 73

PURCHASES LEDGER

R. B URTON PL-1

May 9 Credit note 35 May 1 Invoices 250

May 31 Closing Balance 565 May 7 Invoices 100

_ May 12 Invoices 250

___

600 600

C. MALTHUS PL-2

May 9 Credit note 50 May 1 Invoices 145

May 18 Credit note 10 May 7 Invoices 190

May 31 Closing Balance 355 May 12 Invoices 80

 415 415

A. THOMAS PL-3

May 31 Closing Balance 355 May 1 Invoices 355

S. DAVID PL-4

May 9 Credit note 20 May 1 Invoices 147

May 31 Closing Balance 313 May 12 Invoices 186

333 333

SALES LAGER

C. MALTHUS SL-1

May 5 Invoices 410

May 15 Invoices 220 May 31 Closing Balance 630

630 630

P. WHITE SL-2

May 5 Invoices 340 May 5 Credit note 25

May 15 Invoices 150 May25 Credit note 18

630 May 31 Closing Balance 447

490 490
 P. BLACK SL-3

May 5 Invoices 270 May 10 Credit note 30

220 May 31 Closing Balance 240

270 270

GENERAL LEDGER

Purchases account L-15

May 31 Invoices 1703

Sales account L-16

May 31 Invoices 1390

Returns outwards account L-17

May 31 Credit notes 115

Returns outwards account L-18

May 31 Credit notes 73

 CHAPTER FOUR
ADJUSTMENTS IN ACCOUNTS:
Chapter Outline:

- Introduction

- Depreciation of noncurrent assets

- Accruals and prepayments

- Bad(irrecoverable) debts

- Provisions and contingencies

4.0 Introduction

This chapter highlights the adjustments required in final accounts of different items including

depreciation, provisions, bad debts, accruals and prepayments. It also shows how different transactions

and events are recorded in the accounts. The chapter will describe the different methods of calculating

depreciation and how to account for it when there is revaluation or disposal of noncurrent assets. It

shows the effect of accruals and prepayments, provisions and contingencies and bad debts on financial

statements of a business.

Learning objectives

By the end of this chapter you should be able to;

  Calculate the charge for depreciation using different methods

 Calculate the depreciation on revaluation of an asset

 Record depreciation in the income statement and statement of financial position.

 Understand how matching principle applies to accruals and prepayments

 Identify and calculate adjustments needed for accruals and prepayments

 Understand the impact on profit and net assets of accruals and prepayments

 Identify the impact of bad debts on the income statement and statement of financial position

4.0 Depreciation of non-current assets

Fixed assets are those assets of monetary and material value bought for use in business over their life span.

When fixed assets are used in business they lose value therefore the monetary costs in a fixed assets is

termed as depreciation.

Depreciation is a monetary loss in fixed assets due to use, wear and tear, passage of time running out of

date (obsolescence) Erosion for hard, decay for machinery depletion for quarries, etc.

Depreciation is part of the original cost of the fixed assets consumed during its period of use by the firm

therefore it is an expense for services consumed in the same way as expenses for items such as salaries and

wages, rent electricity etc it is charged against profit.

It is also deducted from the value of noncurrent assets in the statement of financial position.

With the exception of land held on free hold or very long leasehold, every noncurrent asset eventually wears

out over time. Machines, fixtures and fittings and even buildings to not last forever.

Since an asset has a cost, a limited useful life and its value eventually declines, it follows that a charge should
be made in the income statement to reflect the use that is made of the asset. This charge is what we call

depreciation.

Accounting for depreciation is governed by IAS 16 Property, Plant and equipment which spells out the

following definitions.

 Depreciation is the allocation of depreciable amount of an asset over its estimated useful life.

Depreciation for the accounting period is charged to the net profit or loss for the period.

 Depreciable assets are assets which;

- Are expected to be used for more than one accounting period

- Have limited useful life

- Are held by an enterprise for production or supply of goods and services etc

 Useful life is the period over which a depreciable asset is expected to be used by the enterprise.

 Depreciable amount is the historical cost less the estimated residual value.

IAS 16 requires the depreciable amount to be allocated on a systematic basis to each accounting period

during the useful life of the asset.

The following factors should be considered when estimating the useful life of a depreciable asset;

- Expected physical wear and tear

- Obsolescence

- Legal or other limits on the use of the assets

This should be reviewed periodically.

Residual value in most cases is immaterial and if it is likely to be material it should be estimated based

on current situation.

4.1.1.Depreciation methods:

Consistency is important ie the depreciation method selected should be applied consistently from period to

period unless circumstances justify a change. If changed the effect should be quantified and reason for the
change disclosed.

IAS 16 requires disclosure of the following;

- Depreciation method used

- Useful lives or depreciation rates

- Total depreciation allocate for the period Gross amount of depreciable assets and the related

accumulated depreciation.

Two methods of depreciation are specified for your level;

- Straight line method

- reducing balance method

We have already seen that when a non current asset is depreciated, the charge for depreciation is an

expense of the accounting period and the reduction in the value of the asset is shown by reducing the

asset in the statement of financial position by the depreciation charge to get the net book value.

1. Straight line method/fixed instalment method.

This is the most commonly used. It assumes equal amount of depreciation charge each year over the

life span of a fixed asset. It is calculated by-

Depreciation = Cost of asset – residual value

Expected useful life of the asset

Where a fixed asset has no disposal value at the end of its life span the formula changes to

Depreciation = cost of asset

Expected useful life of the asset

Example

A motor vehicle is bought for 10,000,000/= and has an expected lifespan of 4 years after which
 disposed at 2,000,000/= Calculate depreciation on the motor vehicle.

Solution

a) Depreciation= Cost - Residual value

lifespan

= 10,000 ,000 - 2,000,000

= 8,000,000

= 2,000,000/= depreciation charge each year for 4 years

b) Depreciation = cost

life span

if the fixed asset is assumed where no disposal value

Depreciation = 10,000,000

= 2,500,000/= depreciation charge each year for 4 years

If noncurrent assets are acquired during the year, then its fair to charge an amount for depreciation which

reflects the limited use the business has from the asset in that period.

Activity:

A business which has an accounting year which runs from 1 January to 31 December purchases a new

noncurrent asset on 1 April 2010 at a cost of shs 24,000,000. The expected life of the asset is 4 years and it

has a nil residual value. What shoud be the depreciation charge for 2010?

Solution:

Annual depreciation charge = 24,000,000/4 = Shs 6,000,000 per year

But since the asset was acquired on 1 April, the business has only benefited from the use of the asset for 9
months instead of 12 months. So it would be fair to charge depreciation in 2010 only 9/12 * 6,000,000 = shs

4,500,000.

2. Reducing Balance Method/Diminishing

Reducing balance method where a fixed rate of percentage for depreciation is applied on costing. In the first

year and subsequent, years the rate is applied on the reducing balance i.e cost less depreciation charge in

the 4 years.

Example

A motor van is bought at 10,000,000/= and depreciate charge 20% is to be applied.

Shs
Cost 10,000,000
Depreciation (1st yr) 20% x 10,000 2,000,000
Balance c/f 8,000,000
Depreciation (2nd yrs) 20% x 8,000,000 1,600,000
Balance c/f 6,400,000
Depreciation (3rd yr)20% x 6,400,000 1,280,000
Balance c/f 5,120,000
Depreciation (4th yr) 20% x 5,120,000 1,024,000
Balance c/f 4,096,000
Depreciation (5th yr) 20% x 4,096,000 819,200
Balance c/f 3,276,800

The percentage rate may not be given therefore the rate can be calculated by use of:-

R = 1 - n s

where n = lifespan of the asset

s = residual value
 c = cost of the asset

r = rate of depreciation

Example

A machine is bought for 8,000/= and estimated to have a lifespan of 4 years after which be disposed at

500/=. Show the depreciation charge over the lifespan of asset.

Solution

Shs

Cost 8,000

1st yr (Depreciation) 50% x 8,000 4,000

Balance c/f 4,000

2nd yr Depreciation 50% x 4,000 2,000

Balance c/f 2,000

3rd yr Depreciation 50% x 2000 1,000

Balance c/f 1,000

4th yr depreciation 50% x 1,000 500

Balance c/f 500

4.1.2 Fall in market value of a non current asset:

When the market value of a non current asset falls and the fall is expected to be permanent, the asset

should be written down to its new low market value. The charge in the income statement for the

diminution in the value of the asset during the period should be

Shs

Carrying Value at beginning of period xx

Less new reduced value (xx)

Charge for diminution in asset value xx

 Change in expected useful life or residual value of an asset:

If the useful life of an asset changes, the depreciation charge will also change and the new charge is

calculated as below;

New depreciation = Net Book Value – residual value

Revised useful life

You should note that depreciation is not a cash expense.

Activity:

1. What are the purposes of providing for depreciation?

2. In what circumstances is the reducing balance method more appropriate than the straight line

method?

4.1.3 Accumulated depreciation:

This is the amount set aside as charge for wearing out of noncurrent assets. You should remember that the

depreciation charge is made posted to the income statement in each accounting period and the total

accumulated depreciation on a non current asset builds up as the asset gets older. The following entries are

made;

DR: income statement (depreciation expense)

CR: Accumulated depreciation account (statement of financial position) with depreciation charge for the

period.

The balance on the statement of financial position depreciation account is the total accumulated

depreciation. The non current asset account is unaffected by depreciation. In the statement of financial

position, the total balance on the accumulated depreciation account is set against the value of non

current assets to derive the carrying value (Net book value) of the non current asset.

Example:

ABC ltd set up a computer software business on business on 1 March 2006. He purchased a computer

system on credit from a manufacturer at a cost of shs 1,600,000. The system has an expected life of 3
 years and a residual value of shs 250,000. Using straight line method of depreciation. Prepare the non

current asset account, accumulated depreciation account and an extract of income and expenditure and

statement of financial position.

Solution

Noncurrent asset: Computer equipment

Shs Shs

1.3.06 Accounts payable 1,600,000 28.2.07 Bal c/d 1,600,000

1.3.07 Bal b/d 1,600,000 28.2.08 Bal c/d 1,600,000

1.3.08 Bal cb/d 1,600,000 28.2.09 Bal c/d 1,600,000

Accumulated depreciation

28.2.07 Bal c/d 450,000 28.2.07 I &E 450,000

28.2.08 Bal c/d 900,000 1.3.07 bal b/d 450,000

28.2.08 I & E 450,000

28.2.09 Bal c/d 1,350,000 1.3.08 Bal b/d 900,000

28.2.09 I & E 450,000

1.3.09 Bal b/d 1,350,000

Annual depreciation charge = 1,600,000 – 250,000 = shs 450,000

Income statement:

28.2.07 depreciation 450,000

28.2.08 depreciation 450,000

28.2.09 depreciation 450,000

Statement of financial position (Extract)

 2007 2008 2009

Computer equipment at cost 1,600,000 1,600,000 1,600,000

Less accumulated depreciation (450,000) (900,000) (1,350,000)

Carrying Value 1,150,000 700,000 2,500,000

4.1.4 Revaluation of noncurrent assets:

When a non current asset is revalued depreciation is charged on the revalued amount. Revaluation gain

cannot go to the income statement as it has not be realized and it is recognized in the statement of

comprehensive income by transferring to a revaluation reserve. The accounting entries are;

DR: Noncurrent assets

CR: Revaluation reserve.

After revaluation depreciation will be charged as follows;

Revalued amount

Remaining useful life

4.1.5 Disposal of noncurrent asset

When a non current asset is sold, there is likely to be a profit or loss on disposal. On disposal of a fixed

asset, the following entries are necessary

i) An asset disposal account is opened where the cost price of the asset is posted to thus

Dr. Asset disposal account with the cost price

Cr. Non current asset account

ii) Dr. Accumulated depreciation accounts

Cr. Non current Asset account

With the cost of asset disposed off.

iii) Dr. Accumulated depreciation account

Cr. Disposal of non current asset account

With the accumulated depreciation on the asset as at the date of sale

 iv). Dr. Receivable account/ Cash book

Cr. Disposal of non current asset with the sale price of the asset.

Example

A machine is bought on 01-01-19x5 for shs 1000 and another machine is bought on 01-01-19x6 for shs 1200.

The first machine is sold on 30-06-19x7 for 720. the firm policy is to depreciation machinery at 10% using the

straight line method and the financial year end on 31-12-19xx. Show the required accounts.

Solution

Machine a/c

19x5 19x5

Jan 01 Cash 1000 Dec 31 Bal c/f 1000

19x6 19x6

Jan 01 Bal b/f 1000 Dec 31 bal c/f 2200

Oct 01 Cash 1200

2200 2200

19x7 19x7
Jan 01 Bal b/f 2200 J un 30 Machinery 1000
Disposal a/c
____ Dec 31 Bal c/f 1200
2200 2200
19x8

Jan 01 Bal c/f 1200

Machinery Disposal account

19x7 19x7

Jan 30 Machinery a/c 1000 Jan 30 Prov. for Dep 200

 Jun 30Cash 720

____ Dec 31 P & L a/c 80

1000 1000

Provision for depreciation account

19x5 19x5

Dec 31 Bal c/f 100 Dec 31 P & L a/c 100

19x6 19x6

Dec 31 Bal c/f 320 Jan 01 Bal b/f 100

___ P & L a/c 220

320 320

19x7 19x7

Jun 30 Machinery Jan 01 Bal b/f 320

Disposal a/c 200 Dec 31 P&L 120

Dec 31 Bal c/f 240 ___

440 440

19x8
Jan 01 Bal b/f 240

Cashbook

19x7

Jun 30 Disposal 720

 Profit and loss account (Extract)

Shs
Less
19x5
Dec 31 Provision for Depreciation (machinery) 100
19x5
Dec 31 Provision for Deprecation (machinery) 220
19x7
Dec 31 Provision for Depreciation (machinery) 120
Loss on disposal (machinery) 80

Statement of financial position (Extract)

Shs Shs
19x5
Machinery (Cost) 1,000
Less Depreciation 100 900
19x6
Machinery (Cost) 2,200
Less Depreciation 320 1,880
19x7
Machinery (cost) 1,200
Less Depreciation 240 960
IAS 16 covers all aspects of accounting for property, plant and equipment. This represents a bulk of items

which are tangible noncurrent assets.

Recognition of property, plant and equipment depends on two criteria

a) Its probable that future economic benefits associated with the asset will flow to the entity

b) The cost of the asset to the entity can be measured reliably.

Please note that an item that qualifies as property plant and equipment is initially measured at cost and the

following entry is made;

DR Noncurrent asset- cost

Cr Cash/payable

The cost of an item of property, plant and equipment is comprised of;

 Purchase price

 Initial costs of dismantling and removing the items and restoring site on which it is located

 Directly attributable costs e.g site preparation, initial delivery and handling costs,installation costs,

professional fees.

The Asset register

This is used to record all noncurrent assets and is an internal check on the accuracy of the nominal ledger.

The following data detail is kept in the asset register.

 Reference number

 Manufacturers serial number

 Description of the asset

 Location of the asset

 Department which owns the asset

 Purchase date (for calculation of depreciation)

 Cost

 Depreciation method and estimated useful life

 Carrying value (Net Book Value

From time to time the asset register should be checked to the accounting records. Any discrepancies

must be investigated and records corrected.

Activity:

1. In a statement of financial position prepared in accordance with IAS 16, what does carrying value

represent?
4.2 ACCRUALS AND PREPAYMENTS:
We shall start by defining what the above terms mean.

Accrued expenses (accruals) are expenses which relate to an accounting period but have not been paid

for. They are shown in the statement of financial position as a liability.

Prepaid expenses (prepayments) are expenses which have already been paid but relate to a future

accounting period. They are shown in the statement of financial position as an asset.

Accruals and prepayments might seem difficult at first but the example below will help us clarify the

principal involved, that expenses must be matched against ttthe period to which they relate.

Example:

Ford motor spares end its financial year on 28 February each year. His telephone was installed on 1 April

2006 and he receives his telephone account quarterly at the end of each quarter. On the basis of the

following data calculate the telephone expense to be charged to the income statement for the year

ended 28 February 2007.

Ford motors telephone expense for three months

Shs

30.6.2006 23,500

30.9.2006 27,200

31.12.2006 33,400

31.3.2007 36,000

Solution

The telephone expenses for the year ended 28 February 2008 are

Shs
1 March-31 March 2006 0

1 April-30June 2006 23,500

1 July- 30 Sept 2006 27,200

1 October- 28 December 2006 33,400

1 January- 28 Feb 2007 24,000

108,100

The charge for 1 January -28 February 2007 is two thirds of the quarterly bill received on 31 March As at

28 February 2007 no telephone has been received because it is not due to another month. Telephone

charge of shs 24,000 is accrued which is two thirds of the bill for the quarter. This will appear in the

statement of financial position as a current liability.

Example: prepayments

Gatsby garage pays fire insurance annually in advance on 1 June each year. Its financial year ends 28

February. The following recording of insurance payments has been provided. You are required to

calculate the charge to the income statement for the financial year to 28february 2008

Insurance paid

1.6.2006 shs 600,000

1.6.2007 Shs 700,000

Insurance costs for

a) The three months 1 march-31 May 2007 (3/12 x 600,000) 150,000

b) The 9 months 1 june2007 to 28 February 2008 (9/12 x 700,000) 525,000

Insurance cost for the year charged to the income statement 675,000

At February 2008 there is a prepayment covering the period 1 March-31 May 2008. This insurance

premium was paid on 1 June 2007 but inly 9 months of full annual costis chargeable to the accounting

period ended 28 February. The prepayment of 3/12 x 700,000) Shs 175,000as at 28 February 2008 will
 appear as a current asset in the statement of financial position.

The prepayment of 3/12 x 600,000= 150,000 will appear in the statement of financial position as at 28

February 2007.

The table below shows us how accruals and prepayments affect the profit and net assets:

Effect on income/ Effect on profit Effect on

expenses assets/liabilities

Accruals Increases expenses Reduces profit Increases liabilities

Prepayments Reduces expenses Increases profit Increases assets

Prepayments on income Reduces income Reduces profit Increases liabilities

4.3 BAD(IRRECOVERABLE) DEBTS

These are specific debts owed to a business which it decides are never going to be paid. Ther are written

off as an expense in the income statement. The following entry is passed.

DR irrecoverable debts

CR receivable control account

Irrecoverable debts are accounted for as follows;

 Sales are shown at their invoice value in the income statement

 Irrecoverable debts written off are shown as an expense in the income statement

 The credit entry removes the receivable from the receivables account.

Irrecoverable debts written off and subsequently paid:

If this happens the following entry is made

DR Cash account

CR irrecoverable debts expense

Allowances for receivables may be specific or simply a percentage allowance based on past experience
of irrecoverable debts. An increase in the allowance for receivables is shown as an expense in the

income statement.

The receivables in the statement of financial position are shown net of any receivables allowance.

At the end of the accounting period, the balance on the irrecoverable debts accounts is transferred to

the I & E ledger account.

DR I & E account

CR Irrecoverable debts account

However if the irrecoverable debt is subsequently recovered, the accounting entries will be

DR Cash account

CR Irrecoverable debts account (expense)

Example:

At 1 October 2005 a business had a total outstanding debt of shs 8,600,000. During the year to 30

September 2006 the following transactions took place.

a) Credit sales amounted to shs 44,000,000

b) Payments from various customers amounted to Sh 49,000,000

c) Two debts for shs 180,000 and 420,000 were declared irrecoverable and the consumers are no longer

purchasing goods from the company. These are to be written off.

Required:

Prepare the trade account receivable and the irrecoverable debts account for the year.

Solution:

Trade accounts receivable

Shs 000 Shs000

Bal b/f 8,600 Cash 49,000

Sales 44,000 irrecoverable debt 180

Irrecoverable debt 420

 Bal c/f 3,000

52,600 52,600

Irrecoverable debts

Receivables 180 I & E a/c 600

Receivables 420

600 600

4.3.1 Allowance for receivables:

Only movement on the receivable allowance is debited or credited to irrecoverable debts in the income

statement. In subsequent years adjustments mnay be needed to the amount of the allowance and the

procedure to follow is as follows;

a) Calculate new allowance required

b) Compare it with existing balance on allowance account

c) Calculate increase or decrease

If a higher allowance is required now;

CR Allowance for receivable

DR Irrecoverable debt with amount of the increase

If a lower allowance is needed now than before

DR allowance for receivables’

CR irrecoverable debts expense with amount of the decrease

4.4. Provisions and contingencies: (IAS 37)

A provision should be recognized;
 - When an entity has incurred a present obligation

- When it is probable that transfer of economic benefits will be required to settle it

- When a reliable estimate can be made to the amount involved

IAS 37 views a provision as a liability of uncertain timing or amount. It distinguishes provisions form

other liabilities on the basis that for a provision there is uncertainty about timing or amount of the

future expenditure. A provision is accounted for as follows;

DR Expense account

CR Provision account.

Example:

A business has been told by its lawyers that it is likely to pay shs 10,000,000 damages for a product that

failed. The business duly set up the provision on 31 december 2007. But in the following year the

lawyers found that the damages were morelikely to be shs 50,000,000. How is the provision treated in

the account at 31 december 2007 and 31 december 2008.

Solution:

The business needs to set up a provision as follows;

DR Damages (IS) 10,000,000

CR Provision (SOFP) 10,000,000

In the income statement under expenses we have provision of shs 10,000,000 and in the statement of

financial position this figure appears under noncurrent liabilities.

At 31 December 2008

The business needs to increase the provision

DR Damages 40,000,000

CR Provision 40,000,000

So statement of financial position will show noncurrent liability (provision for damages at 50,000,00) and

in the income statement the expense will be shs 40,000,000.

A provision is made when there is a legal and constructive obligation. Examples include warranties,

guarantees and sale returns.

4.5.1 Contingent liability

An entity should not recognize a contingent asset or liability but it should disclose it.

IAS 47 defines a contingent liability as a possible obligation that arises from past events and whose

existence will be confirmed only by the occurrence or non occurrence of one or more uncertain future

events or a present obligation that arises from past events.

4.5.2 A contingent asset

This is a possible asset that arises from past events and whose existence will be confirmed by the

occurrence of one or more uncertain future events not wholly within the enterprises control. A brief

description of these must be provided including the estimate of their financial effect and details of any

uncertainties. Contingent assets must only be disclosed in notes if they are probable.

Review Questions

1. A business purchases two machines on 1 January 2005 at a cost of Sh 15,000,000. Each had an

estimated life of five years and nil residual value. The straight line method is used. On 31 March 2007

one machine was sold for shs 8,000,000 on credit because of reduction in activity. Later in the year

production was abandoned altogether and the second machine was sold on credit to a buyer at shs

2,500,000 cash on 1 December 2007.

Required:

Prepare the machinery account, depreciation of machinery account and disposal of machinery account

for the year to 31 December 2007.

2. When Dan commenced trading as a car dealer on 1 January 2001, he purchased business premises at

a cost of shs 50,000,000.

For purposes of calculating depreciation, he decided the following;

a) The land part of the business premises was worth shs 20,000,000 (not to be depreciated)
 b) The building part of the premises was worth the remaining shs 30,000,000. This would be depreciated

by straight line method to nil residual value over 30 years.

After 5 years of trading on 1 January 2006, Dan decides that the business premises are now worth shs

150,000,000 divided as Land 75,000,000 and building 75,000,000. He estimates that the building still has

a further 25 years of useful life remaining.

Required:

Calculate the annual charge for depreciation in each of the 30 years in its life, and the statement of

financial position value of land and building at the end of each year.

CHAPTER FOURFIVE
PREPARATION OF A TRIAL BALANCE
Chapter Outline:

-Introduction

- Trial balance defined

-Steps in preparing a trial balance

-Extraction of the trial balance

- Balancing off ledgers

- Error detected and not detected by the trial balance

5.0 Introduction:

In the previous chapter we learnt how to post different transactions to the ledger accounts. In this

chapter we shall look at how to prepare a trial balance from the ledgers and eventually how to prepare

simple financial statements from the trial balance.

Learning Objectives:

By the end of this chapter, you should be able to;

  Extract ledger balances into a trial balance

 Prepare simple financial statements from the trial balance.

 Identify errors which are detected and those not detected by the trial balance

5.1 TRIAL BALANCEDefinition of a trial balance

A trial balance is a listing of the accounts in the ledger and their balances as of a certain date.

A trial balance is prepared periodically to test the equality of the debits and credits in the ledge

accounts. A trial balance is usually prepared at the end of each month. However, it can be prepared at

any time.

5.2 Preparing a trial balance

(Refer to Ali Musa's accounts in chapter one section 1.3.1)

Step 1: find the balance of each ledger account Footing (adding) the amount on the debit side of the

account Footing the amounts on the credit side When calculating the difference between the total

debits and the total credits

Total debits is UGX29, 000

Total credits is UGX5, 000

Account debit balance is UGX24, 000 (or 29,000 - UGX5, 000.

Cash

(a) 25,000 (c) 300

(e) 4,000 (d) 3,000
(f) 700
(g) 1,000
24,000 29,000 5,000
(Debit (debit (credit
balance footing) footing)

)
Step 2: prepare the trial balance

Write heading that shows who, what, when.

List account titles on the left.

List debit and credit balances

Confirm totals are equal

Remember;

The trial balance is not a final statement or report It is simply a working paper that is used to prove the

equality of the debits and credits in the ledger.) Now assuming that Ali Musa was operating a business

called Ali travel agency, then the trial balance would look thus;

AM Travel Agency

Trial Balance

January 31, 20x1

Account Title Debit Credit

Cash 24,000

Office Equipment 9,000

Office Supplies 300

Accounts Payables 6,000

Ali Musa, Capital 6,000

Ali Musa, Drawings 1,000

Fees Earned 4,000

Rent Expenses 700

Total 35,000 35,000

Remember;

Since the debits and credits are equal, we can draw up a simple statement of financial position from our

example, thus;
AH travel agency statement of financial position

Assets UGX
Office equipment 9,000
Office supplies 300
Cash 24,000
Total assets 33,300
Owner's Equity and Liabilities Capital
Ali Musa, Capital (25,000 - 1,000 (note 1) - 700 (note 2))) 23,300
Fees earned (note 3) 4,000
Liability
Accounts payable 6,000
Total owner's equity and liabilities 33,300
Note 1
That was Ali Musa's drawing of cash for private use. As earlier mentioned it has to

reduce the capital of the owner.

Note 2

That was rent expense. As earlier mentioned, these expenses must reduce owner's

equity, so capital has been reduced accordingly. The alternative would have been to

reduce the fees earned with the rent expense (you may recollect that expenses must

be matched with revenues earned - matching concept). This would have given us a

profit - a concept we shall revisit later in chapter 7.

Note 3

These incomes belong to the owner of the business and thus form part of the owner's

equity.

The Trial Balance of XYZ Ltd for the month of January can also be drawn; thus

Account title Debit Credit

Cash 4,780,000
Bank 1,500,000
Capital 5,000,000
Purchases 1,400,000
Motor vehicle 1,500,000
Trade 220,000
Trade payables 800,000
Loan 3,000,000
Sales 600,000
Total 9,400,000 9,400,000
XYZ Ltd STATEMENT OF FINANCIAL POSITION

Assets
1,500,000
Motor vehicle
220,000
Trade receivables
1,500,000
Bank
4,780,000
Cash
8,000,000
Total assets

Owner's Equity and Liabilities 5,000,000

Capital (800,000)

Profit (loss) (Sales 600,000 - Purchases 1,400,000)

3,000,000
Noncurrent liability

Loan 800,000

Current liabilities
8.00,000
Trade payables

Total owner's equity and liabilities

 Exercise

Refer to journal of Kyeswa Ltd, post to the Ledgers including the general ledger and extract a trial

balance

The trial balance always has to balance that is the debit side always has to be equal to the credit

side as shown in the XYZ Ltd trial balance above.

Failure of the trial balance to agree implies that:

 Arithmetical errors may have been committed while balancing off the accounts

 The double entry rule was not properly observed .For example if goods were sold for cash,

the cash account has to be debited while the sales account credited. If the cash account is debited

but the sales account is not credited the trial balance will not agree. However the trial balance can

agree when there are still errors that have been committed. These are referred to as errors that

cannot be detected by the trial balance .

Activity

Multiple Choice questions

1) Which of the following errors will affect the agreement of the trial balance?

a) Cash sale of the motor van credited to the sales

a) Sales returns of UGX.l, 500, correctly entered in the sales return account but posted to the

credit side of Zake's account instead of Zaka's account.

b) A sale of UGX.540, 000 to Ali debited to the sales account by the same amount

c) Purchase of UGX.60, 000 credited to Jimmy instead of Jenny

d) None.

___________collects information about particular liabilities of a business.

(a) A debt collector (b) A Liability account

(c) A credit collector (d) A trade payables' account. (e) None

3)______________A_____________collects information about particular liabilities of a business.

(a) A debt collector (b) A Liability account

(c) A credit collector (d) A trade payables' account. (e) None

4) Which of the following are correct?

iv) Paid a creditor, Arthur by cash Arthur Cash

(a) i), ii) & iii) only (b) i) & iv) Only (d)
(e) None
(c) i), ii) & iv) Only ii), iii) & iv) Only
5. i) Which of the following are incorrect?

ii) Returned some of office equipment to Office equipment Supliers Ltd

suppliers
iii) RepaidLtdpart of loan from Nkunda by Loan from Nkunda Bank

cheque
iv) Bought Machinery on credit from NCBS NCBS Machinery
(a) ii) & iv) ) b) ii) & iii) c) i) & iii)

Only d) iii) & iv) Only e) None Only

Only
1. Which of the following is/are incorrect?

w) Motor van bought for cash Purchases Cash

a) i) and iii) Only b) iii) Only c) ii) and i) Only d) iv) Only e) None

7) Which of the following are correct?

iv) Received refund of insurance by

Insurance Bank
cheque
a) i) & ii) Only b) ii), i) and iii) Only c) iv), iii) and iv) Only d) iv), i) and ii) Only

8) Which of the following are incorrect?

iii) Took Cash out of business for private

Cash Drawings
use

iv) Paid general expenses by cheque General expenses Bank

a) ii) & iv) only b) i) & ii) Only c) i) & iii) Only d) ii) & iii) Only e) None.
 9) Which of the following best describes a trial balance?

a) It is a special account

b) Shows the statement of financial position of the enterprise

c) Shows all the entries in the books

d) It is a list of balances on the books

10) Examples of journals include the following but c) Purchasesday

a) The general journal b) Sales day book book

d) Cash book e) none

 11) It is important to note that the general ledger will not contain individual accounts for the

trade receivables and trade payables.

a) This statement will always be true b) This statement will never be

true

c) True except when they are personal accounts

d) True only when they are personal accounts e) May be true in future

12) The sales day book must contain the following except

a) Date on which the transaction occurred

b) Name of the customer .Any person who bought the goods

c) Invoice number if invoice is sent with the goods .The number on the sales invoice.

d) Folio column

e) Monetary amounts

12) David obtained a loan of 2M to be paid in 2 years. It was transferred on his bank account.

What at is the double entry?

a) DR Bank, Cr David

b) Dr Bank, Cr Loan

c) Dr Cash, Cr David

d) Dr Loan, Cr Bank

13). Duncan started business with cash of 1M. On 3rd June he bought inventory of goods for

0.3M Cash. He sold the inventory of goods which had cost 0.1M for 0.15M. He bought more

inventory on credit from TK Ltd for 0.2M

Which of the following accounting equations best describes the above transactions?
 Assets = Liabilities + Owner's equity

1M Nil 1M

1.5M 0.5M 1M

1.25M 0.2M 1.05M

1.2M 0.2M 1M

14) Which of the following error(s) affect the agreement of the trial balance?

a) Commission b) Principle c) Compensation d) Arithmetic

15) The sales daybook is a book of original entry used for recording;

a) Sales for the day b) Cash sales

c) Credit sales d) Payment from trade receivables for credit sales

16) A cash book is a;

a) Journal b) Ledger c) Both a ledger and Journald) Journal proper

 17) The accounting process involves the following stages;

a) Documentation - Ledgers - Journal - Trial balance - Adjustments - Financial statements

preparation - Interpretation

b) Documentation - Journal - Ledgers - Trial balance - Adjustments - Financial statements

preparation - Interpretation

c) Documentation - Ledgers - Trial balance - Journal - Adjustments - Financial statements

preparation - Interpretation

d) Documentation - Journals - ledgers - Adjustments - Trial balance - Financial Statements

preparation - Interpretation

18) Irene Ltd Purchased a motor vehicle for the company work. They paid for the car by cheque.

What is the appropriate double entry in this case?

a) Dr Purchases, Cr Bank b) Dr Motor vehicle, Cr Bank

c) Dr Bank, Credit Purchases d) Dr Purchases, Cr Motor vehicle e) None

19) Another name for the trade receivables' subsidiary ledger is;

a) Receivables account b) Sales ledger c) Private ledger d) general Ledger e) none

20) Nalukenge Ltd sold goods on credit to Edwin Ltd for UGX.400, 000. Edwin Ltd Paid UGX.200,000

cash as part payment for the clearance of the outstanding amount. Edwin Ltd then obtained more

goods on credit from Nalukenge Ltd for UGX.300, 000. Edwin Ltd Paid UGX.50,000 later for the

goods. What is the balance on Edwin Ltd's account?

Other questions

1. The following are the transactions of DK Ltd for the month

September 3rd Started business with cash of 10,000,000

9th Bought computers of 2,000,000 to help in the efficient running of the business 16th Purchased

goods of 700,000using a cheque

20th Okello bought goods from the company for 50,000 on credit

22nd Purchased more goods on credit from XY ltd for 2,000,000

24th The goods which were bought from XY Ltd were returned because they were damaged,

25th Sold goods for 200,000

26th Paid 700,000 cash to XY ltd

28th Sold one of the Computers which had cost 500,000 by cheque

Required: Enter the above transactions in the General journal, cash book, post to the ledger and

extract a trial balance

2. Ronaldino started a Sports Centre on September 1 with UGX. 30 million cash

September 2 Bought a business Pick-up for 10 million on credit from Toyota Uganda.

4 Deposited 12 million cash onto the bank account.

6 Bought equipment of 1.3 million cash

8 Acquired an interest free loan from his uncle of 75 million, which was deposited on his account

10 Repaired the Pick-up at 100,000 cash.

 12 Withdrew Imillion from the bank to pay his child's fees in Aga Khan Primary School

14 Bought an incomplete building in the City centre at 50 million by cheque

16 Paid Mama Boy 80,000 Cash for the Katogo food supplied to business employees.

18 Received 800,000 Cash as rental income.

20 Paid Electricity bills of 50,000 cash

22 Agreed with Roko Constructors to extend and complete the building at 20 million. He made an

initial payment of 10 million by cheque and promising to pay the balance later.

24 Received a cheque of 3,000,000 from his Trade receivables.

26 Paid a cheque of 5 million to Toyota Uganda.

28 Paid weekly wages to the Trainers of 1,200.000 by cheque.

30 Paid for MTN Uganda 500,000 cash for Internet services.

Required: Prepare Enter the above transactions in the books of original entry, post to the ledger and

prepare a trial balance at the end of the month.

5.3 EXTRACTION OF TRIAL BALANCE

5.3.1 Closing or Balancing Off Accounts and Extraction of the Trial Balance

At the end of a specified period most often a month, all ledger accounts including the cash book are

closed or balanced off. The purpose of doing this is to obtain the net balances on each account at

the end of the month.

After the accounts have been closed, a trial balance is extracted. You might wonder what a trial

balance means. It is simply a list of debit and credit balances that are extracted from the ledger and

plays the following roles:

1. It checks whether the rules of the double entry were observed when transactions were

being entered into the books of account. If there was non-conformance to the rules of the

double entry, the trial balance will not balance.

2. The trial balance also checks whether no arithmetic errors of additions or subtractions

were made in the ledger, especially at the time of closing or balancing off accounts. If

arithmetic errors were made, the trial balance will not balance.

It could be summarized that the trial balance checks the accuracy of the accounts though when it

balances it does not always mean that there was total accuracy. This is because there are certain errors

that the trial balance cannot detect. These errors will be discussed later.

5.3.2 Procedure for Balancing or Closing an Account

Step 1: -

Draw two lines below each side of an account. The upper line should be single and the bottom lines

should be double. Remember to leave one blank line between the last figure and the first line closing

the account. This blank line is where the balance carried forward (c/f) or carried down (c/d) will be put.

Step 2:

Add up all the figures on both the debit and credit sides without inserting the totals. Having ascertained

the side with the greater total, that total is put on both sides of the account.

Step 3:

Determine the difference by which the two sides were not previously agreeing and insert it on the

deficient side and call that difference the balance carried down or carried forward. You should

remember that the difference you obtain ie. the balance carried down is put on the blank line which you

had reserved.
Step 4:

In order to complete the double entry recording of the balances, the balance brought down or brought

forward is put on the opposite side of the account below the totals. The date to be indicated is the

opening date of the following month.

Note: Bal. c/f and Bal. c/d mean the same thing and are used interchangeably. They mean balances at

the end of the period. Likewise Bal. b/f and Bal. b/d are used interchangeably and mean the opening

balances.

With the above knowledge, we are now ready to close or balance off the ledger accounts for Ltd. and

PTC Ltd and there after extract trial balances at the end of the month.

Closing or balancing off ABCs ledger accounts

Cash A/C

Shs Shs

Oct. 1 Capital 20,000,000 Oct. 2 Land 3,000,000

20 Land 500,000 17 Vehicle 10,000,000

5,380,000 30 Drawings 800,000

Feb 1 Bal b/f 20,500,000 31 Bal. c/d 6,700,000

Nov 1 Bal. b/d 6,700,000 20,500,000

Capital A/C

Shs Shs

31 Bal. c/d 20,000,000 Oct. 1 Cash 20,000,000

20 Land 20,000,000 20,000,000

Nov 1 Bal. b/d 20,000,000

Land A/C

Shs Shs

Oct. 2 Cash 3,000,000 Oct. 20 Cash 500,000

31 Bal. c/d 2,500,000

5,380,000 3,000,000

3,000,000

Nov 1 Bal. b/d 2,500,000

Office Equipment A/C

Shs Shs

Oct. 4 Equipment Supplies Ltd 2,000,000 31 Bal. c/d 2,000,000

2,000,000 2,000,000

Nov 1 Bal. b/d 2,000,000

Equipment Suppliers A/C

 Shs Shs

Oct. 15 Bank 1,500,000 Oct. 4 Office Equipment 2,000,000

31 Bal. c/d 500,000 2,000,000

2,000,000 2,000,000

Nov 31 Bal. b/d 500,000

Bank A/C

Shs Shs

Oct. 5 Loan 8,000,000 Oct. 15 Equipment Supplies 1,500,000

Ltd

17 Vehicle 3,000,000

5,380,000 25 Spear Motors 2,000,000

8,000,000 31 Bal. c/d 1,500,000

Oct 5 Bal. b/d 1,500,000 8,000,000

Loan A/C

Shs Shs

Oct. 31. Bal c/d 8,000,000 Oct. 15 Bank 8,000,000

8,000,000 8,000,000

Nov 1 Bal. c/d 8,000,000

Motor Vehicle A/C

 Shs Shs

Oc. 17 Cash 10,000,000

Bank 3,000,000

Spear Motors 2,000,000 Oct. 31. Bal c/d 15,000,000

15,000,000 15,000,000

Nov 1 Bal. b/d 15,000,000

Spear Motors A/C

Shs Shs

Oct. 25 Bank 2000,000 Oct. 17 Vehicle 2,000,000

Drawings A/C

Shs Shs

Oc. 30 Cash 800,000 Oct. 31. Bal c/d 800,000

800,000 800,000

Nov 1 Bal. b/d 800,000

ABC Ltd Cash Book

Date Particulars R Cash Bank Date Particulars Ref. Cash Bank

e (Details)
Oct. 1 Capital 20,000, Oct. 2 Land 3,000,00

000 0
Oct. 5 Loan 8,00 Oct. Equipment 1,500,0

0,00 15 Suppliers 00
Oct.20 Land 500,000 Oct. Vehicle 10,000,0 3,000,0
0
 Oct. Spear 2,000,0

25 Motors 00
Oc Drawings 800,000
Oc Bal. c/d 6,700,00 1,500,0
20.500, 8.00 20.500.0 8,000,0
No Bal b/d 6,700,0 1,50
As mentioned above, a trial balance is a list of debit and credit balances extracted from the ledger aimed

at checking the accuracy of the accounting process. Accounts with net debit balances ie. beforeBefore

closing the account, the total on the debit side was more than the total on the credit side. Meaning Bal.

c/d is on the credit side and Bal. b/d on the debit side, will appear on the debit side of the trial balance.

Likewise accounts with net credit balances will appear on the credit side of the trial balance.

All asset accounts (except bank in case of bank overdraft), expense accounts and drawings account are

expected to have debit balances. If you get credit balances on these accounts, it means your working

was wrong. Similarly all liability accounts, revenue or income accounts, capital account and reserve

accounts are expected to have credit balances. If you get a debit balance on any of those accounts, then

it means you are wrong.

With the above knowledge, we can now prepare ABC's trial balance.

ABC LTD

TRIAL BALANCE

AS AT 31ST COCTOBER

Accounts titles Debit (Dr) Credit (Cr)

Shs Shs

Cash 6,700,000
 Bank 1,500,000

Office equipment 2,500,000

Motor vehicle 2,000,000

Drawings 15,000,000

Capital 800,000

Equipment Suppliers Ltd 20,000,000

Loan 500,000

8, 000,000 8,000,000

28,500,000 28,500,000

Note: Spear Motor’s A/C is completely closed ie has a nil balance and therefore does not appear in

the trial balance.

Mukasa’s

Trial balance

For the month ended 30.06.99

Accounts titles Debit (Dr) Credit (Cr)

Shs (000) Shs (000)

 Purchases 6,500

Trade receivables 7,800

Cash 7,050

Bank 1,000

Returns inwards 100

Rent 1,700

Electricity 550

Drawings 800

Trade payables 7,200

Sales 8,000

Returns outwards 300

Capital 8, 000,000 1,000

25,000 25,000

2. Connie commenced a stationery business on 1st January 2010 with her salary savings of Shs. 50,000

which she was keeping with Crane bank. She transformed her personal account into a business account

and thereafter the salary had to be channeled to her account with Cairo bank. She also took on her

sister as her assistant in the business and she was to be paid a salary of Shs. 5,000 per month. During the

month of January, she carried out the following transactions

Jan. 1 She withdrew Shs. 10,000 for use in the day-to-day operations of the business.

2 Bought2 Bought stationery worth Shs. 15,000 from ABC Stationers on credit, and also transferred her

furniture worth Shs. 10,000 from home for use in the business.
3 Bought further inventory of stationery at Shs. 18,000 and paid by cheque. She also paid Shs.

1,500 for transporting the stationery to the place of work paying cash.

5 Cash sales were Shs. 8,000. She also sold stationery to Katwe Primary School at Shs.

14,000 on credit.

7 Paid ABC Stationers Shs. 9,000 by cheque for stationery previously bought, and returned some

spoilt stationery worth Shs. 700 on the same day.

10 Bought stationery worth Shs. 20,000 from Kim Investments Ltd. On credit.

13 Katwe Primary School paid Shs. 6,000 by cheque and returned some items worth Shs. 800

which had not been ordered for.

20 Sold books worth Shs. 23,000 to Kibuye School on condition that payment is made before the

end of the month.

25 Paid salary to her assistant, by cheque.

30 She agreed with Picfare Industries Ltd to purchase stationery worth Shs. 20,000 per month and

delivery would begin early February.

These were the only transactions of the month.

Required:

i) To record transactions into the books of original entry (ignore returns books)

ii) To post the entries in the ledgers

ii) To extract a trial balance as at 31 January 1999

A REMINDER ON5.4 errors Errors detected by a trial balance

You will recall that the purpose of the trial balance is to check the accuracy of the books. It

specifically detects the following errors:

(a) Where the principles or rules of the double entry were not observed eg. if goods were

sold cash for 500,000/=, the cash A/C is debited but the sales A/C is not credited. Or

if the cash A/C is debited with 500,000/- but the sales account is credited with a

different figure say 5,000,000/=. The trial balance will detect such errors by failing to

balance.

(b) The trial balance also detects arithmetic errors in the balancing off the ledger accounts

ie. wrong additions or subtractions. The trial balance will fail to balance if such

arithmetic errors were made.

5.5ERRORS. Errors not detected by the trial balance

When a trial balance balances or agrees, it is not a guarantee that no errors were committed.

Certain errors may be committed but evade detection by a trial balance. A trial balance will balance

in a deceptive manner. Readers should know that balancing the trial balance does not mean that all

was okay.

Errors which cannot be detected by the trial balance include:

(a) Errors of Original entry

These errors originate from source documents eg. Invoices, vouchers, receipts, bank paying slips etc.

These errors are carried throughout the accounting process ie. from the journal through the ledger

to the trial balance and eventually to the final accounts. For instance goods were sold to John on

credit for 2,300,000/7= but was recorded hfif the sales invoice as 3,200,0007=, a wrong figure will be

journalised, posted to the ledger and will end up in the trial balance. Since double entry is effected
though with a wrong figure, the trial balance will still balance and cannot detect such an error.

(b)Errors of Omission

These are errors of omitting transactions from all books of account. If a transaction occurs and is not

recorded anywhere, the trial balance cannot detect such an error. For instance, if goods were

bought cash for 300,000/= and entries were not made in both the cash account and purchases

account, the trial balance cannot detect such an error. Fraudulent individuals always attempt to

omit recording transactions.

(c) Errors of Commission

These errors are committed when an entry is made on a wrong person's account or account title but

the double entry properly effected. For instance, goods worth 2,000,000 were sold to Jane on credit

but Jone's account was debited instead of the correct account of Jane. The sales account being

properly credited. The trial balance is not too intelligent to know that the name should have been

Jane and not Jone. It only tests whether the figure debited was also credited.

Errors of Principle

These are errors of making entries on wrong classes or types of accounts. For if a capital expenditure

for say purchase of a motor vehicle is made, and it is debited to the purchases account instead of

the correct motor vehicle account. Or if an old fixed asset was disposed off and the proceeds from

that disposal or sale is entered into the sales account.

Compensating Errors

These are errors that cancel out in the trial balance. They get concealed because £he error on one

side of the trial balance is compensated by a similar error on the other side of the trial balance. For

instance, if an item that appears on the debit side of the trial balance eg. Purchases is overcast by

200,0007= and by coincidence another account that appears on the credit side of the trial balance
say the sales account is also overcast by 200,000/=. These errors will neutralise each other and the

trial balance will still balance as if no errors ; were made.

(f) Errors of Complete Reversal of Entries

These errors are committed when entries are made on wrong sides of the accounts. For instance,

Wages totaling 5,000,000/= were paid cash and the bookkeeper debits the cash account and credits

the wages account. Such an action completely reversed what should have been done ie. debit wages

account and credit cash account.

 CHAPTER FOURSIX
BANK RECONCILIATIONS
Chapter Outline:

 Introduction

 Preparing bank reconciliations

 Agreement of cash and bank balance

6.0 Introduction:

This chapter explains why we need bank reconciliation and the sort of differences that have to be

reconciled. It will also high light errors made in the cash book.

Learning Objectives:

By the end of this chapter, you should be able to;

 Understand the purpose of bank reconciliations

 Identify the main reasons for the differences between the cash book and the bank statement.

 Correct cash book errors

 Prepare bank reconciliation statements.

6.1 Preparing Bank Reconciliation Statements

The cashbook records all transactions with the bank. The bank statement records all the bank's

transactions with the business. It is a summary of transactions between the account holder and the

bank. The transactions include deposit and withdrawals to and from the account respectively.

The bank statement also shows the running balance after every transaction. Banks prepare bank

statements for their account holders at the end of each month or any time on request. A moment's

thought will suggest that the contents of the cashbook are the same as the record provided by the
 bank in the form of a bank statement, and therefore our records should correspond with the bank

statement. This is in fact so, but with two important provisions;

 The ledger account maintained by the bank is the opposite way round to the cashbook. This is

because the bank records the balance in favour of an individual as a credit balance that is a liability of

the bank to the individual. From the individual's point of view it is, of course, an asset, that is a debit

balance in his cash book (or bank control account in the general ledger)

 Timing differences must inevitably occur. A cheque payment is recorded in the cashbook when the

cheque is dispatched. The bank only records such a cheque when it is paid by the bank, which may be

several days later.

The existence of the bank statement provides an important check on the most vulnerable of a

company's assets - cash. However, the timing differences referred to above make it essential to

reconcile the balance on the ledger account with that of the bank statement. This reconciliation

takes the form of a bank reconciliation statement.

In this chapter the relationship between the balance in the cashbook (or cash account), and the

balance on the bank statement will be considered. The likely reasons for any differences wilt be-

investigated and a statement reconciling the two balances prepared.

Bank reconciliation is the process of bringing cashbook and bank statement balances into agreement

by adjusting an account balance reported by a bank to reflect transactions that have occurred since

the reporting date.

The process by which you compare the information in the company's records with the statements

provided each month by the bank for the bank account and deal with the difference so that the

bank's records and the company's records balance.

 Banks furnish a depositor with a bank statement once each month. Included with the statement are

usually the canceled cheques and any debit or credit memos that have affected the amount. The

cheques returned are called canceled cheques because they are canceled by stamping to show that

the bank has paid them. During any month, besides the cheques drawn, the bank may deduct from

the account amounts for service charges, returned cheques and for errors. The bank notifies the

depositor of each deduction with a debit memo. The bank may also add amounts to the depositor's

account for errors and interest. A credit memo is used to notify of any additions. A copy of each

memorandum should be included with the monthly statement.

Entries on the customer's bank account in the bank

When a cheque or cash is deposited, the customer account will be credited in the bank. When the

customer withdraws cash or when payments are made out of the customer's account, the account is

debited.

Entries in the customer's cashbook (bank column)

The bank column of the cashbook shows the transactions of the customer with its bankers. A,

customer who deposits money debits his cashbook and when a withdrawal is made, the cashbook is

credited.

6.2 Agreement of the cash and bank balances

When all receipts are deposited intact and all payments are made by cheque, the bank statement

becomes a device for proving the cash in bank account. The proof normally begins with the
preparation of a reconciliation of the bank balance. To simplify this process, request the cutoff date

of the bank statement to be the Last working day of the month. Thus, if all credits in the bank were

also debited to the cashbook and all debits in the bank were credited in the cashbook and vice-

versa, the two balances would agree and there would be no need of bank reconciliation. However,

this is not aiways the case. The balance as per bank statement rarely agrees with the balance as per

cashbook and thus the need to prepare a bank reconciliation statement.

6.2.1 Numerous things may causeWhy the bank statement balance to differ from the cash balance

in the general ledger

i) Outstanding Cheques/ Un-presented cheques:

These are cheques that have been written and are listed on the cash disbursement journal but have

not cleared through the bank. They are drawn and credited in the cashbook but not presented to

the bank for payment. These cheques are not debited to the bank statement.

ii) Unrecorded Deposits/un-credited cheques (also called Deposits in Transit):

Often deposits are made on the day following the Last day of the month; consequently, these

deposits do not appear on the bank statement for that month but they appear on the cash receipts

journal. Deposited to the bank and debited to the cashbook but not credited by the bank.

iii) Direct debits. Charges for Services and Non-Collectable Items:

A bank often deducts amounts from a depositor's account for services rendered and for returned

cheques. The bank notifies you of each deduction with a debit memo. These deductions should be

recorded as soon as they are received. They are debits in the bank statement not credited to the

cashbook and payments effected by the bank without requiring a cheque to be issued by the
account holder. Since cheques are not issued for such payments, they are not recorded in the

cashbook yet debited in the bank statement. They include the following.

Bank charges,

The bank, for services offered to the account holder, Levies these charges; they include ledger fees,

commission and many others.

Standing orders (SO)

These are arrangements where the account holder instructs the bank to make certain routine and

fixed type of payments directly to the payees on behalf of the account holder. The account holder

does not issue cheques for these types of payments. Such transactions include; insurance premiums,

paying utility organizations such as water bills and telephone charges. Others include paying interest

and amortizing fixed installment loans. If the deduction occurs close to the end of the month, it may

not show on the bank statement. The standing orders usually appear in the bank statement but not

in the cashbook.

iv) Direct credits and Interest earned: (credits in the bank statement not debited to the cashbook)

These are receipts that are directly credited to the bank statement without having been debited to

the cashbook. For instance, some trade receivables may clear their indebtedness by paying directly

to the payee's bank account and some accounts earn interest that is posted to the account by the

bank at the end of the month making the bank statement the only notification.

Credit advice notes (credit memo) and debit advice notes

 A credit advice note (credit memo) and a direct debit note for direct credits and direct debits are

sent to the account holder and may not be included in the cashbook.

v) Clerical errors

Errors made in recording amounts or wrong postings in the cashbook or bank statement make the

cashbook and bank statement balances disagree. Regardless of care and systems of internal control,

both the bank and the depositor may make errors that affect a bank balance. These errors are not

discovered until the balance is reconciled.

vi) Dishonoured cheques

When a bank refuses to pay or recognize a cheque as an instrument for transferring money from

one person to another, such a cheque is a dishonoured cheque.

6.2.2 Why are cheques dishonoured?

 Lack of sufficient funds on the account

 Amount in words differing from amount in figures

 Drawer's signature differing from specimen signatures held by the bank.

 Expired cheques (cheques get stale or expire six months from the date on the cheque),

 Alterations on the cheque not counter signed.

 If there is no account title on the cheque

 Where drawer's confirmation is required by contract and cheques are not confirmed.

 When the payee's identity is doubted

 For some cheques, if payment vouchers are required and are not presented
6.3 Steps to follow reconciling account balances:
STEP ONE: Compare the deposits listed on the bank statement with deposits recorded in the cheque

register and the cash receipts journal. Identify any differences and determine which is correct. List the

deposits in transit for each account on the reconciliation form.

STEP TWO: Compare the cancelled cheques listed on each bank statement. Note any discrepancies.

Review the previous month's reconciliation and check off the cheques that cleared during the current

month that were outstanding last month. List any cheques that are still outstanding. Verify all deposits

in transit that were listed Last month to assure that they have been recorded by the bank on the current

statement.

STEP THREE: Compare each of the cheques with its entry in the cash disbursement journal. Identify any

corrections or discrepancies. List any outstanding cheque on the reconciliation form.

STEP FOUR: Determine if any debits or credits appearing on the bank statement need to be recorded in

the cheque register. Make general journal entries to record them. Any corrections to deposits or

cheques noted should be made by general journal entries. Do not go back and change the cash

disbursement or cash receipts journals. Changes to those records must be made in the following month

through general journal entries. The purpose of reconciling the bank statement is to verify balances per

your cheque book and to resolve discrepancies. If discrepancies or bank errors are found, notify the

bank immediately.
STEP FIVE: Compare each of the cheques with its entry in the cash disbursement journal. Identify any

corrections or discrepancies. List any outstanding cheques on the-reconciliation form. Determine if any

debits or credits appearing on the bank statement need to be recorded in the cheque register. Make

general journal entries to record them. Any corrections to deposits or cheques noted should be made by

general journal entries. Do not go back and change the cash disbursement or cash-receipts journals.

Changes to those records must be made in the following month through general journal entries. The

purpose of reconciling the bank statement is to verify balances per your cashbook and to resolve

discrepancies. If discrepancies 01 bank errors are found, notify the bank immediately.

6.4 Relevance of Bank reconciliation

Bank reconciliation strengthens an organizations internal control system through detection and

prevention of fraud. When bank transactions are involved, manipulations in the cashbook can

discovered.

It enhances accuracy of records. A mistake in either the cashbook or the bank statement can be is

covered and corrected during the process of bank reconciliation.

Methods of bank reconciliation

There are three major methods of bank reconciliation.

i) You can begin with the cashbook balance, adjusting, updating or correcting the cashbook and then

preparing a bank reconciliation statement. The aim of this method is to arrive at the bank statement

balance.

ii) Beginning with the bank statement balance and working towards the cashbook balance.

iii) Adjusting the cashbook balance and adjusting the bank statement balance. The aim is to show

whether the two adjusted balances agree.

As are a number of methods or ways by which bank reconciliation can be prepared the method adopted

by this book is that of preparing an adjusted cashbook (Bringing the cash book up to date) id then

proceeding to prepare a reconciliation statement.

Example:

At 30th September 2010, the balance in the cashbook of Reco ltd was shs 805,150 debit. A bank

statement on the same date showed Reco ltd to be in credit by shs 1,112,300. On investigation of

the difference between the two sums it was established that;

a) The cash book had been undercast by shs 90,000 on the debit side

b) Cheques paid in not yet credited by the bank amounted to shs 208,200

c) Cheques drawn not yet presented to the bank amounted to shs 425,350

Required

a) Show a correction to the cashbook

b) Prepare a statement reconciling the balance pre bank statement to balance per cash book.

Solution:

a) shs

Cash book balance brought forward 805,150

Add: correction of under cast 90,000

Corrected balance 895,150

b) Shs

Balance per bank statement 1,112,300

Add: outstanding lodgements 208,200

1,320,500

Less: Unpresented cheques (425,350)

Balance per cash book 895,150

Activity

Activity:

 Name three categories in which differences between the cash book and bank statement fall.

 What are the common reasons for the differences between the cashbook and the bank

statement

 Why is it necessary to compare the cash book and bank statement?

Review questions:

1. On 31st January 2008 a company’s cash book showed a credit balance of shs 150,000 on its

current account which did not agree with the bank statements balance. In performing the

reconciliation the following points were noted

Shs

Not recorded in the cashbook:

Bank charges 36,000

Transfer from deposit account to current a/c 500,000

Note recorded in the bank statement

Unpresented cheques 116,000

Outstanding lodgements 630,000

 It was also discovered that the bank had debited the comoany’s account with a cheque for shs

400,000 in error. What was the original balance on the bank statement?

2. A company’s bank statement shows shs 715,000 direct debits and shs 353,000 investment income

not recorded in the cash book. The bank statement does not show a customer cheque for shs

875,000 entered in the cash book on the last day of the accounting period. If the cash book shows a

credit balance of shs 610,000. What balance will appear on the bank statement?

CHAPTER FIVE:SEVEN
CHAPTER
PREPARATION OF FINANCIAL STATEMENTS OF SOLE TRADERS
Chapter Outline:

-Introduction

- Points to note about final accounts of a sole trader

-Preparation of final accounts of a sole trader.

7.0 Introduction:

This chapter deals with preparation of financial statements of a sole trader beginning from the trial

balance and making some adjustments. From the information covered so far you should be able to

prepare a set of final accounts for a sole trader after incorporating some adjustments.

Learning objectives:
 By the end of this chapter, you should be able to;

 Prepare extracts of the statement of financial position from given information

 Prepare extracts of an income statement from the given information

 Prepare a set of final accounts for a sole trader from a trial balance

7.1 FINAL ACCOUNTS OF A SOLE TRADER

The Expression Final Accounts normally refers to the Income Statement, and Statement of financial

position.

7.1.1Points to note about the Income Statement

i) The title of the Income Statement must be with the words for the period/year ended ……

ii) All revenue/income relating to the period covered by the Income Statement must be included,

whether already received or not. Similarly all revenue/income not belonging to that period must

be excluded.

iii) All expenses belonging to the period covered by the Income Statement must be included, whether

already paid or not. Similarly, all expenses not relating to that period must be excluded.

iv) Carriage inwards must be included in the cost of sales when calculating Gross Profit/Loss.

v) Carriage Outwards is included in expenses considered when calculating Net Profit/Loss

vi) Generally, wages, when not combined with salaries, are treated as part of Cost of Sales.

We shall study the preparation of final accounts of a sole trader by looking at an illustrationexample.

We have already covered extraction of financial statements from the trial balance and this is no different

for the sole trader. You are therefore required to try the following examples.
Example: Trial Balance of Sarah Kagezi on 31/12/2010

DR CR
Shs. Shs.
000 000
Purchases and sales 586,500 614,800
Inventory on 1.1.2010 24,500
Motor van at cost 70,000
Salaries 6,150
Rent 4,950
Electricity 1,800
Sales Returns and Purchases Returns 2,300 3,200
Carriage in 1,600
Carriage out 2,400
Furniture and Equipment at cost 5,000
Trade Receivables/Creditors 15,000 18,000
Cash at Bank 9,800
Drawings 4,200
 Bad Debts 750
Advertising 1,350
Discounts 1,900 2,200
Capital 100,000
Total 738,200 738,200

Additional Information

i) Inventory on 31/12/2010 was valued at cost of shs 18,500,000

ii) Salaries includes shs 1,200,000 paid for January 2011.

iii) A water bill of shs 600,000 is due for 2010 but unpaid, while electricity of shs 400,000 is

outstanding for 2010.

Required

a) An income statement for Sarah Kagezi for the year ended 31 December 2010

b) A statement of financial position as at 31/12/2010.

Treatment of Depreciation in Final Accounts

Example:
 Trial Balance of Amos Baguma on 30/6/2010

DR CR
Shs. Shs.
000 000
Salaries 8,200
Purchases 646,800
Sales 700,400
Inventory 1.7.2010 18,500
Capital 47,000
Trade Receivables/Creditors 12,500 17,000
Motor Van (cost 80m) 48,000
Furniture at cost 4,000
Rent 3,800
Accum. Depreciation on Furniture 600
Drawings 3,500
Cash at bank 15,500
Cash on hand 1,200
Equipment at cost 3,000
Total 765,000 765,000

Additional Information

i) Depreciate M/Van by 10% on cost, Furniture by 5% on cost and equipment by 4% on cost

ii) Inventory on 30/6/2010 was valued at 20,500,000/=

iii) Rent includes shs 500,000 paid in advance.

Required: Prepare

a) An income statement for Amos Baguma for the year ended 30/6/2010

b) A statement of financial position as at 30/6/2010

Treatment of Bad Debts Provisions in Final Accounts

EExample

When the provision is created for the first time.

Trial balance of Faith Aceng on 31/12/2010.

DR CR
Shs. Shs.
000 000
M/Van – at cost 70,000
- Cumulative depreciation 21,000
Salaries 7,500
Purchases/Sales 528,500 600,600
Trade Receivables/Creditors 12,000 15,000
Capital 56,000
Inventory 1.1.2010 42,000
Rent 4,600
Cash at bank 17,500
Drawings 2,400
Furniture and equipment (cost 9m/=) 8,100
Total 692,600 692,600

Additional Information

i) Inventory was valued at cost of shs 36,500,000 on 3/12/2010

ii) Depreciate M/Van by 10% of cost and furniture and equipment by 5% on cost
iii) Make a provision for bad debts at 5% on trade receivables
 Required: Prepare

a) An Income Statement for the year ended 31/12/2010

b) A statement of financial position on 31/12/2010

Example 2

When the Provision Increases

Trial Balance of Gloria Mataama on 31/12/2010

DR CR
Shs. Shs.
000 000
Purchases and sales 724,500 802,800
Trade Receivables/Creditors 15,000 16,120
Provision for Bad Debts 480
Motor Van at costs 60,000
Drawings 2,800
Inventory 1.1.2003 25,000
Capital 35,000
Cash at bank 16,500
Salaries 6,400
Rent 4,200
Total 854,400 854,400
 Additional Information

i) Inventory on 31/12/2010 was valued at cost of shs 27,500,000

ii) Depreciate Motor Van by 8% on cost

iii) Make a provision for bad debts of 4% on trade receivables.

Required: Prepare

a) An income statement for the year ended 31/12/2010

b) A statement of financial position as at 31/12/2010

Treatment of Discounts Allowed in Final Accounts

Example

Matovu & Sons Ltd is a wholesale business.

Matovu & sons ltd prepares final accounts on 31/12 every year. For the year ended 31/12/2010, with

awith total receivables at shs 16,000,000, they decided to provide for bad debts at 31/12/2010 on trade

receivables and at 2% on receivables for discounts allowed.

Required

a) An extract of the Income Statement for the year ended 31/12/2010

b) An extract of a statement of financial position as at 31/12/2010

ADJUSTMENTS IN NOMINAL ACCOUNTS

Unpaid expenses

Denis prepares end of year final accounts on every 31st December each year.

He pays rent in advance for every quarter at shs 360,000. As on 31 st December 2009, he had paid rent up

to 30th September 2009.

Required

Show the Rent Account, duly balanced for 2009.

Example 2

Expenses paid in advance

Given: As in example 1, above, except that as on 31 st December, Denis had paid rent for the period from

1st January 2009 to 31st March 2010.

Required:
Show the Rent Account for 2009, duly balanced

Example 3

Income received in advance

Sarah is in business; she sublets part of her premises for shs 150,000 per month. She prepares her end

of year final accounts every 31st December every year. As on 31st December 2009, Sarah had received

rent income covering the period 1st January 2009 to 31st March 2010.

Required

Show the Rent Income Account, duly balanced for 2009.

Example 4

Income earned not yet received

Given: As in example 3, except that as on 31 st December 2009, Sarah had received up to 31 st October

2009.

Required

Draw up the Rent Income Account, duly balanced for 2009.

CHAPTER EIGHT
PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS
Chapter Outline:

-Introduction

-Incomplete records

-Credit sales and receivables

-Purchases and trade account payables

- Establishing cost of goods sold, stolen or destroyed

- Accruals and prepayments

8.0 Introduction:

In preparation of accounts for a sole trader we have assumed that a full set of records are kept but

in practice many sole traders do not keep a full set of records and some techniques have to be used
 to arrive at necessary figures. This chapter looks at incomplete records and highlights the techniques

used to prepare financial statements from incomplete records.

Learning objectives:

By the end of this chapter you should be able to;

 Understand and apply techniques used in incomplete record situations

8.1 INCOMPLETE RECORDS:

Incomplete record questions test the ability to prepare accounts in the following situations

 A trader does not maintain a ledger and therefore has no continuous double entry record of

transactions.

 Accounting records are destroyed by fire or accident

 Some essential figure is unknown and must be calculated as balancing figure.

The approach to incomplete record questions is to build the information given so as to complete the

necessary double entry. This may involve reconstructing the control accounts for cash and bank, trade

receivables and payables.

Where inventory is the unknown figure it will be necessary to use information on gross profit

percentages so as to construct a working for gross profit in which the unknown figure can be inserted as

a balance.

The construction of a cash book largely from bank statements showing receipts and payments during

the period is often an important feature of incomplete records problem.

Drawings often appear as an incomplete records problem. The trader has been drawing money but does
not know how much.

Where no trading records have been kept, profit can be derived from opening and closing net assets by

use of the business equation.

8.1.1 Opening position:

There should not be any missing item in the opening statement of financial position of a business,

however a question is brought with the two sides of the statement not balancing, then use the

accounting equation to get the missing figure.

Example:

Suppose John’s business has the following assets and liabilities as at 1.1.2010

Shs

Fixtures and fittings 7,000

Provision for depreciation (f&F) 4,000

Motor vehicles at cost 12,000

Provision for depreciation (MV) 6,800

Inventory 4,500

Trade accounts receivables 5,200

Cash at bank & in hand 1,230

Trade accounts payable 3,700

Prepayment 450

Accrued rent 2,000

Required: Prepare a statement of financial position inserting the balancing figure for proprietor’s

capital.

Solution:

Statement of financial position as at 1/1/2010

Shs

Assets

Non current assets

Fixtures and fittings at cost 7,000

Less accumulated depreciation (4,000) 3,000

Motor vehicles at cost 12,000

Less accumulated depreciation (6,800) 5,200

Current assets

Inventory 4,500

Trade accounts receivable 5,200

Prepayment 450

Cash 1,230 11,380

Total assets 19,580

Capital and liabilities:

Proprietors capital (bal) 13,380

Current liabilities

Trade accounts payable 3,700

Accrual 2,000 5,700

Total capital and liabilities 19,580

8.1.2 Credit sales and receivables:

The approach here is to build up the information given so as to complete the necessary double

entry. This may involve reconstructing control accounts for cash and bank , trade accounts

receivable and payable. The formula below can be very helpful;

Shs

Payments from trade accounts receivable xx

Add: closing balance of trade accounts receivable xx

Less: Opening balance of trade accounts receivable (xx)

Credit sales in the period x

Example:

Suppose that John’s business had trade accounts receivable of shs 1,750,000 on 1 st April 2010 and

trade accounts receivable of shs 3,140,000 on 31 st March 2011. If payments received from

receivables during the year to 31 March 2011 were shs 28,490,000 and if there are no bad debts,

what would be the credit sales for the period?

 Solution:
Shs
Cash from receivables 28,490,000
Add: Closing receivables 3,140,000
Less: Opening receivables 1,750,000
Credit sales (29,880,000)

Alternatively you could make the above calculation in a T- account with the credit sales being the

balancing figure. Try it out please.

8.1.3 Purchases and trade accounts payable:

A similar relationship exists between purchases of inventory during a period, the opening and

closing balances for trade payable and amounts payable to suppliers during the period. You can get

the unknown amount of purchases as follows;

Shs

Payments to trade accounts payable during the period xx

Add: Closing balance of trade payable xx

Less: Opening balance of trade accounts payable (xx)

Purchases during the period xx

Try out the following activity.

Activity:

Suppose that John’s business has trade payables of shs 3,728,000 on 1 October 2010 and trade

payables of shs 2,645,000 on 30 September 2011. If payments to trade payables during the year to

30 September 2011 were shs 31,479,000, what would be the purchases for the year?
8.1.4 Establishing cost of sales:

Where inventory, purchases or sales is the unknown figure it would be necessary to use information on

gross profit percentages to construct a working for gross profit in which the unknown figure can be

inserted as a balance.

The following formula can be used to find the figure for cost of purchases.

Since Opening inventory + Purchases – closing inventory = Cost of goods sold, then

Cost of goods sold + closing inventory - Opening Inventory = Purchases.

Example:

Suppose that the inventory for John’s business on 1/7/2010 has a value of shs 8,400,000, and an

inventory count at 30/6/2010 showed inventory to be valued at shs 9,350,000. Sales for the year to

30/6/2010 are shs 80,000,000 and the business makes a markup of 33 ⅓% on cost for all items that it

sells. What were the purchases during the year?

Solution:

The cost of goods sold can de rived from the value of sales as follows;
 Shs

Sales (133⅓%) 80,000,000

Gross profit (mark up) (33⅓%) 20,000,000

Cost of goods sold 60,000,000

Note the cost of goods sold is 75% of the sales value

We can determine the purchases thus as;

Cost of goods sold 60,000,000

Plus closing inventory 9,350,000

Less Opening inventory (8,400,000)

Purchases 60,950,000

We now need to now different terms at this point.

1) Mark up is the profit as a percentage of cost

2) Gross profit is the profit as percentage of sales

From the above example, the mark up on cost is 33⅓% and the gross profit percentage is 25% ie (

33⅓/133⅓ * 100%)

8.1.5 Stolen goods or goods destroyed:

If the quantity of goods stolen or destroyed is unknown, then the cost of such goods is the difference

between the cost of goods sold and Opening inventory at cost + purchases- closing inventory.

Such a loss is not a trading loss and should be accounted for in the two methods below;

a) If the lost goods were not insured, the business must bear loss

DR Income Statement
CR Cost of sales

b) If the lost goods were insured

DR Insurance claim account

CR Cost of sales

With the cost of the loss

8.1.6 Cash book:

The cash book is largely prepared from bank statements showing receipts and payments of a business

during a given period and is often an important feature of incomplete records problems.

This can happen in a shop where its at times difficult to construct a cash book daily. Where there

appears to be a sizeable volume of receipts and payments a two column cash book can be helpful in

identifying any missing value.

8.1.7 Accruals and prepayments:

When there is an accrued expense or a payment, the charge to be made to the income statement for

the item concerned should be found from the opening balance b/f and cash payments for the item

during the period. This figure can be got as a balancing figure in the T account.

Example:

Suppose on 1 April 2006 a business had prepaid rent of shs 700,000 which relates to the next accounting

period. During the year to 31 March 2007 it pays shs 9,300,000 and at 31 March 2007 the prepayment of

rent is shs 1,000,000. What would be the cost of rent in the income and expenditure account for the
year to 31 March 2007 ?

Solution:

This is easily done by constructing a T account

Rent

Prepayment balance b/f 700,000 I & E (balancing figure) 9,000,000

Cash 9,300,000 Prepayment balance c/f 1,000,000

10,000,000 10,000,000

Bal b/f 1,000,000

8.1.8 Drawings:

These often feature as a missing item in an incomplete record problem. The trader has been drawing

money but does not know how much. Where personal items of receipts and payments are made, the

following adjustments should be made.

E.g if a business owner receives shs 600,000 in dividend income and pays it into his bank account, the

accounting entry is

DR cash

CR Drawings

Payments should be charged to drawings on account ie

DR Drawings

CR Cash

8.1.9 The business equation:

Where no trading records have been kept, profit can be derived from opening and closing net assets as

below;

Ie Capital = assets less liabilities.

Capital is changed by money paid in by the trader, drawings by the trader and profits or losses. So if we

establish thrthe traders net assets at the beginning of the period, we can compute profits by Profit (loss)

= movement in net assets – capital introduced + drawings.

From the discussion in this chapter we can be able to deal with incomplete record problems by following

the approach below;

a) Establish the opening statement of financial position and the proprietor’s interest.

b) Open up four accounts ie income and expense, cash book, trade receivables and trade payables.

c) Enter opening balances in these accounts

d) Work through the given information line by line and enter each item into the appropriate account

e) Look for balancing figures

f) Complete the income statement and statement of financial position.

Exam typeReview question:

John is a sole distributor of tiles and he purchases floor tiles at a trade discount of 20% from his supplier

and annually in May she receives an agency commission of 1% of his purchases every May for the year

ended previous 31 March. For several years he has obtained a gross profit of 40% on all sales. In January

there was burglary and John lost inventory costing sh 4,000,000 as well as many accounting records.

After carefullcareful investigations, the following information has been obtained covering the year

ended 31 March 2010.

a) Assets and liabilities at 31 March 2010 were as follows;

Shs
Building at Cost 10,000,000

Accumulated depreciation 6,000,000

Motor vehicles at cost 5,000,000

Accumulated depreciation 2,000,000

Inventory at cost 3,200,000

Trade accounts receivable 6,300,000
Agency commission 300,000
Prepayments (trade expenses) 120,000
Bank balance 4,310,000
Trade accounts payable 4,200,000
Accrued vehicle expenses 230,000
b) John has been notified that he will receive agency commission of sh 440,000 on 1 May 2010

c) Inventory at cost at 31 March 2011was valued at shs 3,000,000 more than a year previously

d) In October 2010 inventory costing shs 1,000,000 was damaged by dampness and had to be scrapped

as worthless.

e)Trade accounts payableat 31 March 2011 related entirely to goods received whose list prices totaled

sh 9,500,000

f) Discounts allowed amounted to shs 1,620,000 and discounts received were shs 1,200,000

g) Trade expenses prepaid at 31 March 2011 totalled shs 80,000

h) Trade accounts receivable at 31 March amounted to shs 6,700,000

i) Vehicle expenses for year ended 31 march 2011 were shs 6,700,000

j) All receipts are passed through the bank account

k) Depreciation is charged annually at the following rates buildings 5% on cost and Motor vehicles 20%
on cost
l) Commissions received are paid directly to the bank
m) Other bank payments were; Vehicle expenses shs 6,720,000, Drawings shs 4,300,000 and trade
expenses shs 7,360,000.
n) John is not insured against loss owing to burglary or damage to inventory due to dampness.

Required:

Prepare John’s Income statement for the year ended 31 March 2011 and the statement of financial

position on that date.

CHAPTER NINE
PREPARATION OF FINANCIAL STATEMENTS OF PARTNERSHIPS:
Chapter Outline:

-Introduction

-Advantages and disadvantages of partnerships

-Partnership agreements

-Preparation of final accounts of partnerships

- Changes in partnerships

9.0 Introduction

So far we have considered businesses owned by one person. In this chapter we will consider how we can

account for business owned by more than one person. It examines how we can account for

partnerships.

Learning objectives:

By the end of this chapter students should be able to;

 Understand and identify the typical content of a partnership agreement.

Understand the nature of capital and current accounts and division of profits

Calculate and record partners shares of profits and losses

Prepare extracts of current and capital account

Prepare extracts of the income statement and statement of financial position of a partnership.
9.1 Definition of a partnership
Partnership may be defined as a relationship between persons carrying on a business with a view of

profit. In a partnership business, two or more persons jointly run a business.

Thus the minimum number of partners is two and the maximum is normally 20. The exception being

banks where there cannot be more than 10 partners and professional bodies like accountants, solicitors,

and stock exchange members where there is no maximum limit.

9.2 Advantages and disadvantages of partnerships

9.2.1 Advantages in comparison to sole trading

a). Business risks are spread among more than one person.

b). Individual partners can develop special skills that can benefit other partners, where as in sole

business one person bears all responsibility.

c). Certain partners may be able to draw upon larger capital resources.

9.2.2 Advantages in comparison to a company

a). The arrangement for set up is less formal than that of a company.

b). It is easier to dissolve a partnership business than to dissolve a company.

9.2.3 Disadvantages of partnerships

a). Disputes may arise between partners

b). A partner may be jointly and severally liable for his partners. This means that if one partner is

being sued in relation to the business of the partnership, the other partners share in
 responsibility.

c). Like sole trading, there is no limited liability in partnership except for limited partners.

9.3 Partnership agreements

A partnership agreement, which need not necessarily be in written form, will govern the relationship

between the partners. The terms under which the partnership operates are set out in this document.

The initial capital put into business by each partner is shown by means of a capital account for each

partner. The net profit of the partnership is appropriated by the partners according to previously agreed

ratio. Each partner also has a current account to which their drawings are charged. Partners may be

charged interest on their drawings and may receive interest on capital.

Important matters to be covered include;

 Name of firm, the type of business and duration.

 Capital to be introduced by partners.

 Distribution of profits between partners.

 Arrangement for admission of new partners.

 Procedures to be carried out when a partner retires or dies.

 Preparation and audit of accounts.

9.3.1 Rules in the absence of an agreement

Where no agreement exists, then the provisions of the partnership act apply.

These provisions are: -

a). Profits and losses are to be shared equally.

 b). There is to be no interest allowed on capital.

c). No interest is to be charged on drawings.

d). Salaries are not allowed.

e). Any loan made to the partnership by a partner is to carry interest at the rate of 5% p.a.

9.3.2 Capital Accounts

The partners contribute capital as specified in their agreement. Partners need not contribute equal

amounts of capital. The balance for the capital account will always be a brought forward credit entry in

partnership accounts, because the capital contributed by proprietors is a liability to the business.

9.3.3Current. Current Accounts are used to deal with the regular transactions between the partners and

the firm. They are used to record profits retained in the business by each partner. A current account is a

sort of capital account which increases in value when partnership makepartnership makes profits.

The main differences between capital and current account in accounting for partnerships are;

- The balance on the capital account remains static from year to year

- The current account is continually fluctuating as partnerships make profits

- When the agreement provides for interest on capital, partners receive interest on their balance

in the in capital accounts not on the balance in their current accounts.

The drawings account serveaccount serves the exact purpose as the drawings account of a sole trader.

Each partners drawings are recorded in a separate account. At the end an accounting period each

partners drawings are cleared to his current account.

DR current account of partner

CR Drawings account of partner

The partnership statement of financial position will therefore consist of ;

- Capital accounts of each partner

- Current accounts of each partner net drawings.

9.3.4 Loans by partners:

An existing or previous partner may make a loan to partnership in which case he becomes a creditor of

the partnership. On theOn the statement of financial position such a loan is not included in partners

funds but shown separately as long term liability.

However interest on such a loan will be credited to the partners current account.

Note that interest on loans from partners is accounted for as an expense in the income statement and

not as an appropriation of profit.

9.3.5 Appropriation of net profits:

Profit and loss sharing ratios are fixed and mentioned in the partnership deed. These ratios are normally

fixed in view of capital contributed by the partners. The sharing out is shown in an appropriation

account which follows the income statement. The accounting entries are;

DR Income and expense account with net profit/d

CR Appropriation account with net profit b/d

DR appropriation account

CR Current accounts of each partner with additional share of profits for each partner.

The following steps are taken in appropriation of profit

a) Establish the net profit

b) Appropriate interest on capital and salaries first.

c) If partners agree to pay interest on their drawings during the year

DR current accounts

CR appropriation of profit

d) The difference between the net profits and appropriations for salaries and interest is the residual

profit. Share it between partners in the profit sharing ratio

e) Each partners share of profits is credited to his current account

f) The balance on each partners drawings account is debited to his current account.

9.3.6 Interest on capitals

Sometimes, the partnership agreement provides the payment of interest to the partner at a specific

percentage of their capital amounts contributed. If capital contributed is different then the payment of

interest will give more benefit to partners who have contributed greater amounts. The payment of

interest is an internal arrangement between the partners.

9.3.7 Interest on drawings

Partners may be entitled to withdraw some money for their personal users. To deter the partners from

taking out cash unnecessarily, a charge may be levied on each withdrawal.

9.3.8 Guaranteed minimum share of profit:

The agreement may provide that one partner has a guaranteed minimum profit share.

Example:

Tony, Joy and Gordon are in business sharing profits 4:3:3 after allowing salaries of shs 30,000 for tony

and John. Tony has a guaranteed minimum profit share of shs 120,000. Profit for the year is Shs 260,000.

Show the appropriation.

Solution

Tony (shs) John(shs) Gordon(shs) total (shs)

Salaries 30,000 30,000 60,000

Residual profit share

4:3:3 80,000 60,000 60,000 200,000

110,000 90,000 60,000 260,000

Adjustment for

Guaranteed share 10,000 (5,000) (5,000)

Profit share 120,000 85,000 55,000 260,000

9.3.9

Salaries to partners

A partner may be responsible to perform some extra duties as compared to the other partners. As a

reward for this he may have a salary, which is paid out of profits.
9.4 Preparation ofThe final accounts of partnerships
The final accounts of a partnership consist of: -

1). Trading account

2). Profit and Loss Account

3). Profit and Loss Appropriation Account

4). Balance SheetStatement of financial position.

There is no difference in the trading account and profit and loss account of a sole trader and a

partnership. However a partnership has an extra section, the profit and loss appropriation account

and it is in this account that the distribution of profits is shown.

Example I

Black and white are in partnership sharing profits and losses in the ratio 3:2 respectively. During the

year ended 31st December 20 10 the net trading profit was shs 15,500,000 and the partners

drawings were;

Black 3,000,000

White 2,500,000

Interest is charged on partner's capital at the rate of 5%. Interest is also charged on drawings at the

rate of 5%.

White is entitled to a salary of shs. 1,500,000p.a

The balance on the partner's account at 1st Jan. 20 11was;

Capital A/c Current A/c

 Black 20,000,000 1,570,000 CR

White 15,000,000 890,000 CR

Required;

Prepare the partnership profit and loss appropriation account and the partners current accounts for

the year ended 31st December 20 x 1.

SSolution;

Black and white

Profit and loss appropriation account for the year ended 31st Dec.-20 x1.

Shs Shs

Net profit 15,500,000

Add: Interest on drawings

Black 150,000

White 125,000 275,000

15,775,000

Less: Interest on capital

Black 300,000

White 250,000
 1,500,000 2,050,000
Salaries: White

13,725,000
Balance of profits shared

8,235,000
Black 3/5

5,490,000 13,725,000
White 2/5

Partner’s Current Accounts

Black White Black White

Drawings 3,000,000 2,500,000 Balance b/d 1,570,000 990,000

Interest drawings 150,000 125,000 Interest on 300,000 250,000

capital

Salary - 1,500,000

Balance c/d 6,955,000 5,505,000 Share of profits 8,235,000 5,490,000

10,105,000 8,130,000 10,105,000 8,130,000

Example II

Mukasa and Masembe are in partnership sharing profits and losses equally. The following is their

trial balance as at 30 June 20 x 2.

Dr Cr

Shs Shs
Buildings at cost 75,000

Provision for depreciation: Buildings 25,000

Fixtures at cost 11,000

Provision for depreciation: Fixtures 3,300

Receivables 16,243

Payables 11,150

Cash at bank 677

Inventory at 30 June 20 1 1 41,979

Sales 123,65

Purchases 85,416

Carriage outwards 1,288

Discounts allowed 155

Loan interest 4,000

Office expenses 2,416

Salaries and wages 18,917

Bad debts 503

Provision for bad debts 400

Loan from King 40,000

Capitals: Mukasa 35,000

Masembe 29,500
 DR CR

Current Accounts: Mukasa 1,306

Masembe 298

Drawings: Mukasa 6,400

Masembe 5,650

269,604 269,604

Required:

Prepare the trading and profit and loss appropriation account for the year
ended 30 June 20 12 and a balance sheet as at that date.

a). Inventory on 30 June 20 1 2, was valued at shs 56,340

b). Expenses to be accrued: -

Office expenses shs 96, wages shs 200.

c). Depreciate fixtures at 10 per cent on reducing balance basis,

building shs 1,000

d). Reduce provision for bad debts to shs 320.

e). Partnership salary; Mukasa shs 800.

f). Interest on drawings,

Mukasa shs 180

Masembe shs 120

g). Interest on capital account balance at 10 percent.

9.5 CHANGES IN PARTNERSHIPS;

Various changes can occur in the constitution of an established partnership. This may involve changes in

the composition of the partnership e.g.

a). A new partner is admitted

b). An old partner dies or retires

The change may also take the form of the same partners changing their profit and loss sharing ratios.

When there is change in a partnership the capital gains made or goodwill build by old partners must be

credited to their capital accounts. This helps give some benefits to the old partners for their earlier

tasks in the business.

Example:

Hooke and line have been in partnership for many years, sharing profits equally. On 1 st October

2008, Fatty is admitted to the partnership and it is decided that Hooke, line and fatty will now share

profits 4:2:2. The net profit for the year to 31 December 2008 is 150,000,000. Show how this will be

split between partners.

Solution:

There are two distinct periods here; 9 months of Hooke and line and 3 months of Hooke, Line and

fatty. Profits average sh 12,500,000 per month. So we apportion as follows

Hooke Line Floater total

Jan- sept 2008

112,500,000 56,250,000 56,250,000 112,500,000

Oct- Dec 2008

37,500,000 15,000,000 15,000,000 7,500,000 37,500,000

 71,250,000 71,250,000 7,500,000 150,000,000

9.5.1Goodwill

When a business changes hands, the price paid will commonly exceed the net value of the tangible

assets owned by the business. The difference is an intangible asset referred to as goodwill.

Goodwill has been defined as the advantage, whenever it may be, which a person gets by continuing

to carry on a business which has been carried on for some time previously.

Goodwill is the excess of the cost of the acquisition over the acquirers interest in the fair value of

the identifiable assets and liabilities acquired as at the date of the exchange transaction.

Factors which give rise to goodwill may include:-

 A large number of customers who will continue with the new owner.

 Good reputation of the business

 Favourable location of the business.

 Possession of popular trade marks.

 Experienced and reliable employees.

Good will should not be left in the statement of financial position.

Valuation of Goodwill

There is no generally acceptable standard formularformula for valuing goodwill. Different parties

therefore use various methods, and these include;

Good will = Value of business – net asset value.

 Example: In case of Hooke, Line and Fatty above assume that the business had a goodwill of Shs

300,000,000 at 1 October 2008. The partners request that goodwill is created and then reversed on

each change.

Solution:

Current Accounts(Accounts (shs000)

Hooke line Fatty Hooke line Fatty

1/10/2008 120,000 120,000 60,000 1/10/2008

Goodwill created 150,000 150,000

Good will

1/10/2008 Current a/c 300,000 1/10/2008 Current accounts 300,000

Example :

Locke, nice and Mussyt are in partnership with an agreement to share profits in the ratio 3:2:1. They

also agree the following terms

- All three should receive interest at 12% on capital

- Mussy should receive a salary of Shs 6,000,000 per annum

- Interest will be charged on drawings at the rate of 5%

- The interest rate on the loan is 5%

The statement of financial position of the partnership as at 31 December 2005 revealed the

followindfollowing

Shs000 Shs000

Capital accounts
 Locke 20,000

Niece 8,000

Mussy 6,000 34,000

Current accounts

Locke 3,500

Niece (700)

Mussy 1,800 4,600

Loan account (locke) 6,000

Capital employed 44,600

Drawings made durin the year to 31 December 2006 were as follow

Locke 6,000

Niece 4,000

Mussy 7,000

Net profit for the year to 31 December 2006 was shs 24,530,000.

Required:

Prepare the appropriation account for the year ended 31 December 2006 and the partner’s capital

and current accounts.

Solution:

The interest payable by each partner on their drawings during the year is

Shs000

Locke 5% x 6,000,000 300

Niece 5% x 4,000,000 200

Mussy 5% x 7,000,000 350

 850

These payments are debited to the current accounts and credited to the appropriation account.

The interest payable to Locke on his loan is 5% x 6,000,000 = shs 300,000

Appropriation Account

Shs 000 Shs000

Net profit less loan interest (24,530-300) 24,230

Add interest on drawings 850

25,080
Less Mussy Salary (6,000)
19,080
Less interest on capital
Locke 12% x 20,000,000 2,400
Niece 12% x 8,000,000 960
Mussy 12% x 6,000,000 720
4,080
15,000
Residual profits
Locke 3/6 7,500
Niece2/6 5,000

Mussy 1/6 2,500

15,000
 Locke, Niece, Mussy

Appropriation account

For the year ended 31 December 2006

Shs Shs shs shs

Salaries: Mussy 6,000 Net profit b/d 24,230

Interest on capital Interest on drawings

Locke 2,400 Locke 300

Niece 900 Niece 200

Mussy 720 4,080 mussy 350 850

Residual profits

Locke 7,500

Niece 5,000

Mussy 2,500 15,000

25,080 25,080

Partners Current accounts

Locke niece mussy Locke Niece Mussy

Bal b/f 700 Bal b/f 3,500 1,800

Interest on drawings 300 200 350 Loan on capital 300

Drawings 6,000 4,000 7,000 Interest on capital 2,400 900

7,200
Balance c/f 7,400 1,060 3,670 Salary 6,000

13,700 5,960 11,020 13,700 5,960 11,020

Partner’s capital accounts

Locke Niece Mussy

Bal b/f 20,000 8,000 6,000

Now the statement of financial position can be prepared.

Shs000 Shs000

Capital accounts

Locke 20,000

Niece 8,000

Mussy 6,000 34,000

Current accounts

Locke 7,400

Niece 1,060

Mussy 3,670 12,130

Loan account (Locke) 6,000

52,130
Net assets:

As at 31 December 2005 44,600

Added during the year (24,230-17,000) 7,230

Add loan interest 300

As at 31 December 52,130

Activity:

If Hooke, line and fatty continued trading for a further year and they are considering admitting

another partner Sonia on 31 December 2009. For the purposes of calculating goodwill, the partners

obtain a valuation of the business as if it were to be sold on 31 December 2009. The valuation is shs

750,000,000. The statement of financial position as at 31 December 2009 shows net assets of shs

350,000. Calculate the good will

Solution:

Good will = Value of business – net assets value.

= 750,000,000 – 375,000,000

= Shs 375,000,000

Review Questions
 1. What is a partnership?

2. Why might a sole trader take on a partnerpartner?

3. What is the difference between partnerspartner’s capital account and a partnerspartner’s current

accountaccount?

4. How is profit shared between partners?

Example

Mukasa and Masembe are in partnership sharing profits and losses equally. The
following is their trial balance as at 30 June 20 x 2.
Dr Cr
Shs Shs

Buildings at cost 75,000

Provision for depreciation: Buildings 25,000
Fixtures at cost 11,000
Provision for depreciation: Fixtures 3,300
Receivables 16,243
Payables 11,150
Cash at bank 677
Inventory at 30 June 20 1 1 41,979
Sales 123,65
0
Purchases 85,416
Carriage outwards 1,288
Discounts allowed 155
Loan interest 4,000
Office expenses 2,416
Salaries and wages 18,917
Bad debts 503
Provision for bad debts 400
Loan from King 40,000
Capitals: Mukasa 35,000
 Masembe 29,500

DR CR
Current Accounts: Mukasa 1,306
Masembe 298
Drawings: Mukasa 6,400
Masembe 5,650
269,604 269,604
Required:

Prepare the trading and profit and loss appropriation account for the year ended 30 June 20 12 and

a statement of financial position as at that date.

a). Inventory on 30 June 20 1 2, was valued at shs 56,340

b). Expenses to be accrued: -

Office expenses shs 96, wages shs 200.

c). Depreciate fixtures at 10 per cent on reducing balance basis, building shs 1,000

d). Reduce provision for bad debts to shs 320.

e). Partnership salary; Mukasa shs 800.

f). Interest on drawings,

Mukasa shs 180

Masembe shs 120

g). Interest on capital account balance at 10 percent.

CHAPTER

ADJUSTMENTS IN ACCOUNTS:
 This chapter highlights the adjustments required in final accounts of different items including

depreciation, provisions, bad debts, accruals and prepayments.

Learning objectives

By the end of this chapter you should be able to;

 Calculate the charge for depreciation using different methods

 Calculate the depreciation on revaluation of an asset

 Record depreciation in the income statement and statement of financial position.

 Understand how matching principle applies to accruals and prepayments

 Identify and calculate adjustsments needed for accruals and prepayments

 Understand the impact on profit and net assets of accruals and prepayments

 Identify the impact of bad debts on the income statement and statement of financial

position

DEPRECIATION OF NON-CURRENT ASSETS

Fixed assets are those assets of monetary and material value bought for use in business over their life

span. When fixed assets are used in business they lose value therefore the monetary costs in a fixed

assets is termed as depreciation.

Depreciation is a monetary loss in a fixed assets due to use, wear and tear, passage of time running out

of date (obsolescence) Erosion for hard, decay for machinery depletion for quarries, etc.

Depreciation is part of the original cost of the fixed assets consumed during its period of use by the firm

therefore it is an expense for services consumed in the same way as expenses for items such as salaries
and wages, rent electricity etc it is charged against profit.

It is also deducted from the value of noncurrent assets in the statement of financial position.

With the exception of land held on free hold or very long leasehold, every noncurrent asset eventually

wears out over time. Machines, fixtures and fittings and even buildings to not last forever.

Since an asset has a cost, a limited useful life and its value eventually declines, it follows that a charge

should be made in the income statement to reflect the use that is made of the asset. This charge is what

we call depreciation.

Accounting for depreciation is governed by IAS 16 Property, Plant and equipment which spells out the

following definitions.

 Depreciation is the allocation of depreciable amount of an asset over its estimated useful life.

Depreciation for the accounting period is charged to the net profit or loss for the period.

 Depreciable assets are assets which;

- Are expected to be used for more than one accounting period

- Have limited useful life

- Are held by an enterprise for production or supply of goods and services etc

 Useful life is the period over which a depreciable asset is expected to be used by the

enterprise.

 Depreciable amount is the historical cost less the estimated residual value.

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

The following factors should be considered when estimating the useful life of a depreciable asset;

- Expected physical wear and tear

- Obsolescence

- Legal or other limits on the use of the assets

This should be reviewed periodically.

Residual valuein most cases is immaterial and if it is likely to be material it should be estimated

based on current situation.

Depreciation methods:

Consistency is important ie the depreciation method selected should be applied consistently from

period to period unless circumstances justify a change. If changed the effect should be quantified

and reason for the change disclosed.

IAS 16 requires disclosure of the following;

- Depreciation method used

- Useful lives or depreciation rates

- Total depreciation allocate for the period

- Gross amount of depreciable assets and the related accumulated depreciation.

METHODS OF CALCULATING DEPRECIATION

Two methods of depreciation are specified for your level;

- Straight line method

 - reducing balance method

We have already seen that when a non current asset is depreciated, the charge for depreciation is

an expense of the accounting period and the reduction in the value of the asset is shown by

reducing the asset in the statement of financial position by the depreciation charge to get the net

book value.

1. Straight line method/fixed instalment method.

This is the most commonly used. It assumes equal amount of depreciation charge each year

over the life span of a fixed asset. It is calculated by-

Depreciation = Cost of asset – residual value

Expected useful life of the asset

Where a fixed asset has no disposal value at the end of its life span the formula changes to

Depreciation = cost of asset

Expected useful life of the asset

Example

A motor vehicle is bought for 10,000,000/= and has an expected lifespan of 4 years after which

disposed at 2,000,000/= Calculate depreciation on the motor vehicle.

Solution

a) Depreciation= Cost - Residual value

lifespan

= 10,000 ,000 - 2,000,000

= 8,000,000

= 2,000,000/= depreciation charge each year for 4 years

b) Depreciation = cost

life span

if the fixed asset is assumed where no disposal value

Depreciation = 10,000,000

= 2,500,000/= depreciation charge each year for 4 years

If non current assets are acquired during the year, then its fair to charge an amount for depreciation

which reflects the limited use the business has from the asset in that period.

Activity:
 A business which has an accounting year which runs form 1 January to 31 December purchases a

new noncurrent asset on 1 April 2010 at a cost of shs 24,000,000. The expected life of the asset is 4

years and it has a nil residual value. What shoud be the depreciation charge for 2010?

Solution:

Annual depreciation charge = 24,000,000/4 = Shs 6,000,000 per year

But since the asset was acquired on 1 April, the business has only benefited from the use of the

asset for 9 months instead of 12 months. So it would be fair to charge depreciation in 2010 only

9/12 * 6,000,000 = shs 4,500,000.

2. Reducing Balance Method/Diminishing

Reducing balance method where a fixed rate of percentage for depreciation is applied on costing. In

the first year and subsequent, years the rate is applied on the reducing balance i.e cost less

depreciation charge in the 4 years.

Example

A motor van is bought at 10,000,000/= and depreciate charge 20% is to be applied.

Shs

Cost 10,000,000

Depreciation (1st yr) 20% x 10,000 2,000,000

Balance c/f 8,000,000

Depreciation (2nd yrs) 20% x 8,000,000 1,600,000

Balance c/f 6,400,000

 Depreciation (3rd yr)20% x 6,400,000 1,280,000

Balance c/f 5,120,000

Depreciation (4th yr) 20% x 5,120,000 1,024,000

Balance c/f 4,096,000

Depreciation (5th yr) 20% x 4,096,000 819,200

Balance c/f 3,276,800

The percentage rate may not be given therefore the rate can be calculated by use of:-

R = 1 - n s

where n = lifespan of the asset

s = residual value

c = cost of the asset

r = rate of depreciation

Example

A machine is bought for 8,000/= and estimated to have a lifespan of 4 years after which be disposed

at 500/=. Show the depreciation charge over the lifespan of asset.

r =1 - n s
 c

r = 1 - 4 x 500

8000

r = 1 - 4 x 0.0625

1 – 0.5

= 0.5 x100 = 50%

Solution

Shs

Cost 8,000

1st yr (Depreciation) 50% x 8,000 4,000

Balance c/f 4,000

2nd yr Depreciation 50% x 4,000 2,000

Balance c/f 2,000

3rd yr Depreciation 50% x 2000 1,000

Balance c/f 1,000

4th yr depreciation 50% x 1,000 500

Balance c/f 500

Fall in market value of a non current asset:

When the market value of a non current asset falls and the fall is expected to be permanent, the
asset should be written down to its new low market value. The charge in the income statement for

the diminution in the value of the asset during the period should be

Shs

Carrying Value at beginning of period xx

Less new reduced value (xx)

Charge for diminution in asset value xx

Change in expected useful life or residual value of an asset:

If the useful life of an asset changes, the depreciation charge will also change and the new charge is

calculated as below;

New depreciation = Net Book Value – residual value

Revised useful life

You should note that depreciation is not a cash expense.

Activity:

1. What are the purposes of providing for depreciation?

2. In what circumstances is the reducing balance method more appropriate than the straight line

method?

Accumulated depreciation:

This is the amount set aside as charge for wearing out of non current assets. You should remember
that the depreciation charge is made posted to the income statement in each accounting period and

the total accumulated depreciation on a non current asset builds upas the asset gets older. The

following entries are made;

DR: income statement (depreciation expense)

CR: Accumulated depreciation account (statement of financial position) with depreciation charge for

the period.

The balance on the statement of financial position depreciation account is the total accumulated

depreciation. The non current asset account is unaffected by depreciation. In the statement of

financial position, the total balance on the accumulated depreciation account is set against the value

of non current assets to derive the carrying value (Net book value) of the non current asset.

Example:

ABC ltd set up a computer software business on business on 1 March 2006. He purchased a

computer system on credit from a manufacturer at a cost of shs 1,600,000. The system has an

expected life of 3 years and a residual value of shs 250,000. Using straight line method of

depreciation. Prepare the non current asset account, accumulated depreciation account and an

extract of income and expenditure and statement of financial position.

Solution

Noncurrent asset: Computer equipment

Shs Shs

1.3.06 Accounts payable 1,600,000 28.2.07 Bal c/d 1,600,000

 1.3.07 Bal b/d 1,600,000 28.2.08 Bal c/d 1,600,000

1.3.08 Bal cb/d 1,600,000 28.2.09 Bal c/d 1,600,000

Accumulated depreciation

28.2.07 Bal c/d 450,000 28.2.07 I &E 450,000

28.2.08 Bal c/d 900,000 1.3.07 bal b/d 450,000

28.2.08 I & E 450,000

28.2.09 Bal c/d 1,350,000 1.3.08 Bal b/d 900,000

28.2.09 I & E 450,000

1.3.09 Bal b/d 1,350,000

Annual depreciation charge = 1,600,000 – 250,000 = shs 450,000

Income statement:

28.2.07 depreciation 450,000

28.2.08 depreciation 450,000

28.2.09 depreciation 450,000

Statement of financial position (Extract)

2007 2008 2009

Computer equipment at cost 1,600,000 1,600,000 1,600,000

Less accumulated depreciation (450,000) (900,000) (1,350,000)

 Carrying Value 1,150,000 700,000 2,500,000

Revaluation of noncurrent assets:

When a non current asset is revalued depreciation is charged on the revalued amount. Revaluation

gain cannot go to the income statement as it has not be realized and it is recognized in the

statement of comprehensive income by transferring to a revaluation reserve. The accounting entries

are;

DR: Non current assets

CR: Revaluation reserve.

After revaluation depreciation will be charged as follows;

Revalued amount

Remaining useful life

DISPOSAL OF A Noncurrent asset

When a non current asset is sold, there is likely to be a profit or loss on disposal. On disposal of a

fixed asset, the following entries are necessary

i) An asset disposal account is opened where the cost price of the asset is posted to thus

Dr. Asset disposal account with the cost price

Cr. Non current asset account

ii) Dr. Accumulated depreciation accounts

Cr. Non current Asset account

 With the cost of asset disposed off.

iii) Dr. Accumulated depreciation account

Cr. Disposal of non current asset account

With the accumulated depreciation on the asset as at the date of sale

iv). Dr. Receivable account/ Cash book

Cr. Disposal of non current asset with the sale price of the asset.

Example

A machine is bought on 01-01-19x5 for shs 1000 and another machine is bought on 01-01-19x6 for

shs 1200. The first machine is sold on 30-06-19x7 for 720. the firm policy is to depreciation

machinery at 10% using the straight line method and the financial year end on 31-12-19xx. Show the

required accounts.

Solution

Machine a/c

19x5 19x5

Jan 01 Cash 1000 Dec 31 Bal c/f 1000

19x6 19x6

Jan 01 Bal b/f 1000 Dec 31 bal c/f 2200

Oct 01 Cash 1200

 2200 2200

19x7 19x7

Jan 01 Bal b/f 2200 J un 30 Machinery 1000

Disposal a/c

____ Dec 31 Bal c/f 1200

2200 2200

19x8

Jan 01 Bal c/f 1200

Machinery Disposal account

19x7 19x7

Jan 30 Machinery a/c 1000 Jan 30Prov. for Dep 200

Jun 30Cash 720

____ Dec 31 P & L a/c 80

1000 1000
Provision for depreciation account

19x5 19x5

Dec 31 Bal c/f 100 Dec 31 P & L a/c 100

19x6 19x6

Dec 31 Bal c/f 320 Jan 01 Bal b/f 100

___ P & L a/c 220

320 320

19x7 19x7

Jun 30 Machinery Jan 01 Bal b/f 320

Disposal a/c 200 Dec 31 P&L 120

Dec 31 Bal c/f 240 ___

440 440

19x8

Jan 01 Bal b/f 240

Cashbook

19x7

Jun 30 Disposal 720

Profit and loss account (Extract)

Shs

Less

19x5

Dec 31 Provision for Depreciation (machinery) 100

19x5

Dec 31 Provision for Deprecation (machinery) 220

19x7

Dec 31 Provision for Depreciation (machinery) 120

Loss on disposal (machinery) 80

Balance sheet (Extract)

Shs Shs

19x5

Machinery (Cost) 1,000

Less Depreciation 100 900

19x6
 Machinery (Cost) 2,200

Less Depreciation 320 1,880

19x7

Machinery (cost) 1,200

Less Depreciation 240 960

IAS 16 covers all aspects of accounting for property, plant and equipment. This represents a bulk of

items which are tangible non current assets.

Recognition of property, plant and equipment depends on two criteria

a) Its probable that future economic benefits associated with the asset will flow to the entity

b) The cost of the asset to the entity csn be measured reliably.

Please note that an item that qualifies as property plant and equipment is initially measured at cost and

the following entry is made;

DR Non current asset- cost

Cr Cash/payable

The cost of an item of property, plant and equipment is comprised of;

 Purchase price

 Initial costs of dismantling and removing the items and restoring site on which it is located

 Directly attributable costs e.g site preparation, initial delivery and handling costs,installation

costs, professional fees.

The Asset register

This is used to record all noncurrent assets and is an internal check on the accuracy of the nominal

ledger. The following data data detail is kept in the asset register.

 Reference number

 Manufacturers serial number

 Description of the asset

 Location of the asset

 Department which owns the asset

 Purchase date (for calculation of depreciation)

 Cost

 Depreciation method and estimated useful life

 Carrying value (Net Book Value

From time to time the asset register should be checked to the accounting records. Any discrepancies

must be investigated and records corrected.

Actvity:

1. In a statement of financial position prepared in accordance with IAS 16, what does carrying value

represent?

ACCRUALS AND PREPAYMENTS:

We shall start by defining what the above terms mean.

Accrued expenses (accruals) are expenses which relate to an accounting period but have not been

paid for. They are shown in the statement of financial position as a liability.
Prepaid expenses (prepayments) are expenses which have already been paid but relate to a future

accounting period. They are shown in the statement of financial position as an asset.

Accruals and prepayments might seem difficult at first but the example below will help us clarify the

principal involved, that expenses must be matched against ttthe period to which they relate.

Example:

Ford motor spares ends its financial year on 28 February each year. His telephone was installed on 1

April 2006 and he receives his telephone account quarterly at the end of each quarter. On the basis

of the following datacalculate the telephone expense to be charged to the income statement for the

year ended 28 February 2007.

Ford motors telephone expense for three months

Shs

30.6.2006 23,500

30.9.2006 27,200

31.12.2006 33,400

31.3.2007 36,000

Solution

The telephone expenses for the year ended 28 february 2008 are

Shs

1 March-31 March 2006 0

1 April-30June 2006 23,500

1 July- 30 Sept 2006 27,200

1 October- 28 December 2006 33,400

1 January- 28 Feb 2007 24,000

108,100

The charge foer 1 January -28 February 2007 is two thirds of the quartely bill received on 31 March

As at 28 February 2007 no telephone has been received because it is not due to another month.

Telephone charge of shs 24,000 is accrued which is two thirds of the bill for the quarter. This will

appear in the statement of financial position as a current liability.

Example: prepayments

Gatsby garage pays fire insurance annually in advanceon 1 june each year. Its financial year ends 28

February. The following recording of insurance payments has been provided. You are required to

calculate the charge to the income statement for the financial year to 28february 2008

Insurance paid

1.6.2006 shs 600,000

1.6.2007 Shs 700,000

Insurance costs for

a) The three months 1 march-31 May 2007 (3/12 x 600,000) 150,000

b) The 9 months 1 june2007 to 28 February 2008 (9/12 x 700,000) 525,000

Insurance cost for the year charged to the income statement 675,000

At February 2008 there is a prepayment covering the period 1 March-31 May 2008. This insurance

premium was paid on 1 June 2007 but inly 9 months of full annual costis chargeable to the
accounting period ended 28 February. The prepayment of 3/12 x 700,000) Shs 175,000as at 28

February 2008 will appear as a current asset in the statement of financial position.

The prepayment of 3/12 x 600,000= 150,000 will appear in the statement of financial position as at

28 February 2007.

The table below shows us how accruals and prepayments affect the profit and net assets:

Effect on income/ Effect on profit Effect on

expenses assets/liabilities

Accruals Increases expenses Reduces profit Increases liabilities

Prepayments Reduces expenses Increases profit Increases assets

Prepayments on Reduces income Reduces profit Increases liabilities

income
 BAD(IRRECOVERABLE) DEBTS
These are specific debts owed to a business which it decides are never going to be paid.
Ther are written off as an expense in the income statement. The following entry is passed.
DR irrecoverable debts
CR receivable control account

Irrecoverable debts are accounted for as follows;

Sales are shown at their invoice value in the income statement
Irrecoverable debts written off are shown as an expense in the income statement
The credit entry removes the receivable from the receivables account.

Irrecoverable debts written off and subsequently paid:

If this happens the following entry is made
DR Cash account
CR irrecoverable debts expense

Allowances for receivables may be specific or simply a percentage allowance based on past
experience of irrecoverable debts. An increase in the allowance for receivables is shown as
an expense in the income statement.

The receivables in the statement of financial position are shown net of any receivables
allowance.
At the end of the accounting period, the balance on the irrecoverable debts accounts is
transferred to the I & E ledger account.
DR I & E account
CR Irrecoverable debts account
However if the irrecoverable debt is subsequently recovered, the accounting entries will be
DR Cash account
CR Irrecoverable debts account (expense)

Example:
At 1 October 2005 a business had a total outstanding debt of shs 8,600,000. During the year
to 30 September 2006 the following transactions took place.
a) Credit sales amounted to shs 44,000,000
b) Payments from various customers amounted to Sh 49,000,000
c) Two debts for shs 180,000 and 420,000 were declared irrecoverable and the consumers
are no longer purchasing goods from the company. These are to be written off.
Required:
Prepare the trade account receivable and the irrecoverable debts account for the year.

Solution:

Trade accounts receivable

Shs 000 Shs000
Bal b/f 8,600 Cash 49,000
Sales 44,000 irrecoverable debt 180
 Irrecoverable debt 420
Bal c/f 3,000
52,600 52,600

Irrecoverable debts
Receivables 180 I & E a/c 600
Receivables 420
600 600

Allowance for receivables:

Only movement on the receivable allowance is debited or credited to irrecoverable debts in
the income statement. In subsequent years adjustments mnay be needed to the amount of
the aloownce and the procedure to follow is as follows;
a) Calculate new allowance required
b) Compare it with existing balance on allowance account
c) Calculate increase or decrease
If a higher allowance is required now;

CR Allowance for receivable

DR Irrecoverable debt with amount of the increase

If a lower allowance is needed now than before

DR allowance for receivables’
CR irrecoverable debts expense with amount of the decrease

PROVISIONS AND CONTIGENCIES: (IAS 37)

A provision should be recognized;
When an entity has inciurred a present obligation
When it is probable that transfer of economic benefits will be required to settle it
When a reliable estimate can be made to the amount involved
IAS 37 views a provision as a liability of uncertain timing or amount. It distinguishes
provisions form other liabilities on the basis that for a provision there is uncertainty about
timing or amount of the future expenditure. A provision is accounted for as follows;
DR Expense account
CR Provision account.

Example:
Abusiness has been told by its lawyers that it is likely to pay shs 10,000,000 damages for a
product that failed. The business duly set up the provision on 31 december 2007. But in the
following year the lawyers found that the damages were morelikely to be shs 50,000,000.
How is the provision treated in the account at 31 december 2007 and 31 december 2008.

Solution:
The business needs to set up a provision as follows;
DR Damages (IS) 10,000,000
CR Provision (SOFP) 10,000,000
 In the income statement under expenses we have provision of shs 10,000,000 and in the
statement of financial position this figure appears under non current liabilities.

At 31 December 2008
The business needs to increase the provision
DR Damages 40,000,000
CR Provision 40,000,000
So statement of financial position will show non current liability (provision for damages at
50,000,00) and in the income statement the expense will be shs 40,000,000.

A provision is made when there is a legal and constructive obligation. Examples include
warranties, guarantees and sale returns.

Contingent liability
An entity should not recognize a contingent asset or liability but it should disclose it.
IAS 47 defines a contingent liability as a possible obligation that arises from past events
and whose existence will be confirmed only by the occurrence or non occurrence of one or
more uncertain future events or a present obligation that arises from past events.

A contigent asset is a possible asset that arises from past events and whose existence will be
confirmed by the occurrence of one or more uncertain future events not wholly within the
enterprises control. A brief description of these must be provided including the estimate of
their financial effect and details of any uncertainities.

Contigent assets must only be disclosed in notes if they are probable.

Review Questions
1. A business purchases two machines on 1 January 2005 at a cost of Sh 15,000,000. Each
had an estimated life of five years and nil residual value. The straight line method is used.
On 31 March 2007 one machine was sold for shs 8,000,000 on credit because of reduction in
activity. Later in the year production was abandoned altogether and the second machine
was sold on credit to a buyer at shs 2,500,000 cash on 1 December 2007.
Required:
Prepare the machinery account, depreciation of machinery account and disposal of
machinery account for the year to 31 December 2007.

2. When Dan commenced trading as a car dealer on 1 January 2001, he purchased business
premises at a cost of shs 50,000,000.
For purposes of calculating depreciation, he decided the following;
a) The land part of the business premises was worth shs 20,000,000 (not to be depreciated)
b) The building part of the premises was worth the remaining shs 30,000,000. This would
be depreciated by straight line method to nil residual value over 30 years.
After 5 years of trading on 1 January 2006, Dan decides that the business premises are now
worth shs 150,000,000 divided as Land 75,000,000 and building 75,000,000. He estimates
that the building still has a further 25 years of useful life remaining.
Required:
Calculate the annual charge for depreciation in each of the 30 years in its life, and the
statement of financial position value of land and building at the end of each year.

CHAPTER TEN

PREPARATION OF FINANCIAL STATEMENTS OF LIMITED COMPANIES:

Chapter Outline:

- Introduction

- Definition of limited companies

- Types of companies

- IAS 1 presentation of financial statements

- Statement of comprehensive income

- Statement of financial position

- IAS 18

10.0 Introduction:

This chapter looks at preparation of financial statements of limited companies and their general

content which is governed by IAS 1, presentation of financial statements. We shall explain items in

the financial statements that we have not yet discussed in the previous chapters. We shall also look

at IAS 18 revenue since this has a great impact on the content and form of company accounts.

Learning Objectives:

By the end of this chapter, you should be able to;

 Prepare extracts of the income statement and statement of financial position.

 Understand the interrelationship between the two statements

  Identify items requiring separate disclosure

10.1 Definition of a limited company

Limited companies developed as a result of the need for owners not taking part in the management

of the business. This is also coupled with the limitations of sole trade and partnership businesses.

Abusinesses. A limited company is a legal person set up by law. A company once set up can sue or

be sued in its own name.

The process of setting up a company is initiated by promoters, who draft the constitution of the

company. The constitution consists of:

 Memorandum of association and

 Articles of association.

10.1 types Types of companies

Limited liability companies: In event that such a company fails to pay its debts, the members are only

liable to the debts up to the amount of capital in form of shares they subscribed.

Private companies: These are companies;

 Whose membership is limited to a minimum of 2 and a maximum of 80,

 Whose shares are not easily transferable,

 That can notcannot raise capital from the public.

Public companies: These are companies;

 Whose minimum membership is 7 with no maximum,

 Whose shares can be transferable and

 Which can invite members of the public to subscribe for shares?

10.2 IAS 1 Presentation of financial statements:

IAS 1 lists the required contents of a company’s income statement and statement of financial position

sheet. It also give guidance on how items should be presented in the financial statements.

Key definitions of capital:

1) AuthorisedAuthorized share capital: This is the share capital that the company has been

allowed to issue out to shareholders. It can also been referred to as registered or nominal

capital.

2) Issued share capital: This refers to the total share capital actually issued to shareholders.

3) Called up share capital: This comprises thatof that proportion of the issued share that the

company directors have asked the shareholders to make payment for.

4) Uncalled up share capital: This is the proportionthe proportion of the issued share capital

which remains to be received in future.

5) Paid up capital: This is the total of the amount of share capital that has been paid for by the

shareholders.
Types of shares

Shareholders of limited companies are entitled to rewards in form of dividends. The amount of

dividends that each shareholder receives depends on the type of shares as follows:

a) Preference shareholders are entitled to a fixed percentage dividend and are supposed to receive it

before any other shareholders receive anything. In the final accounts preference shares are stated as,

say; 50,000 10% preference shares of shs. 1,000 each. This means that the total capital raised was;

Shs. 50,000,000 ( 50,000 shares x shs. 1,000)

and the dividend entitlement is;

Shs. 5,000,000 ( shs. 50,000000 x 10%)

b) Ordinary shareholders: These are also referred to as equity shareholders rank for dividend from the

remainder of the total profits. It is worthy of mention that the remaining profits of the company belong

to the ordinary shareholders. They can be stated as, say, 20,000 Ordinary shares of shs. 1,000 each. The

dividend for ordinary shareholders is normally determined by directors mid way (interim) or at the end

of the year (final).

10.3 Profit or loss for the period:

This is shown in the income statement. IAS 1 stipulates that all items of income and expense recognized

in a period shall be included in profit or loss unless a standard or an interpretation requires otherwise.
10.3.1 Statement of comprehensive income:

This adjusts the income statement for certain gains and losses e.g gain on properyproperty revaluation.

So it presents all gains and losses recognized in the income statement and those recognized through

other reserves.

IAS 1 specifies disclosure of certain items as;

 Some items must appear on the face of the statement of financial position or income

statement.

 Other items can appear in a note to the financial statements

 Recommended formats are given

Also disclosures specified by other standards should be made.

Identification of financial statements:

They must be distinguished from any other information published with them. Each element of financial

statements should be identified clearly. The following should be clearly spelt out; name of entity,

reporting date, reporting currency and the level of precision used in presenting the figures.

10.3.2 Statement of financial Position format:

ABC Co

Statement of financial position as at 31 December 2010

2010 2009
 Shs Shs
Assets:
Noncurrent assets
Plant property & equipment x x
Goodwill x x
Other intangible assets x X x X

Current assets:
Inventories x x
Trade receivables x x
Other current assets x x
Cash & cash equivalents x X x X
Total assets XX XX

Equity & liabilities

Equity
Share capital x x
Retained earnings x X x X

Non current liabilities

Long term borrowings x x
Long term provisions x X x X
Current liabilities
Trade and other payables x x
Short term borrowing x x
Current tax payable x x
Short term provisions x X x X

Total equity & liabilities XX XX

10.3.3

Format: Statement of comprehensive income:

ABC Co

Statement of comprehensive income for the year ended 31 December 2010

 2010 2009

Shs Shs

Revenue x x

Cost of sales (x) (x)

Gross profit x x

Other income x x

Distribution costs (x) (x)

Administrative costs (x) (x)

Other expenses (x) (x)

Finance cost (x) (x)

Profit before tax X X

Tax (x) (x)

Profit for the year X X

Other comprehensive income

Gain on property revaluation x x

Total comprehensive income for the year XX XX

Note that if a question requires you to prepare an income statement, then that will include items

from revenue to profit for the year.

10.4 Notes to financial statements:

1a. Accounting policies: This should be the first note to the accounts and is governed by IAS1. The

following policispolicies should be disclosed; depreciation, inventories, revaluation of long term assets.
2b. General statement of financial position disclosures include;

- Restrictions to title of assets

- securitySecurity given in respect of liabilities

- contigentContingent assets and contigentcontingent liabilities

- Amounts committed for future capital expenditure

-Events after the reporting date

3c. Property plant and equipment:

- land and buildings

- Plant nd equipment

-other categories of assets

- Accumulated depreciation

- Separate disclosure for leasehold and assets on hire purchase

4d. Other non currentnoncurrent assets

- Long term investments

- Ling term receivables

-goodwill

-Patents, trademarks

- developmentDevelopment costs capitalizes

5e. Investments

6f. Receivables

7g. Cash

8h. ShareholdersShareholders’ interests

- share capital with all the detail like number of shares, par value etc

- Statement of changes in equity

9i. Non currentNoncurrent liabilities

10j. Other liabilities and provisions

11k. Payables

10.5 Items in the statement of comprehensive income:

1.Revenuea. Revenue:

The rules of revenue recognition are subject to IAS 18 Revenue.

2b. Cost of sales: This represents a summary of detailed workings as we used in the sole traders

statements.

3c. Expenses: These are collected under headings. Any detail is given in the notes

4d. Managers salary. Remember for a sole trader this is an appropriation not an expense.

5e. Income tax. Taxation affects both the statement of financial position and the income statement. All

companies pay corporation tax on profits. The charge for income tax in a year is shown as a deduction

from net profit and in the statement of financial position tax payable is shown as a current liability.

The matching concepts apply to revenue and expenses. So we have to adjust for accruals and

prepayments.

The net profit is usually transferred to retained earnings in the statement of changes in equity and the

closing balance in the statement of changes in equity is transferred to the statement of financial

position.
10.6 Items in the statement of financial position:
1.The assets are the same as those of a sole trader. The only difference is that the detail is given in notes

and only the totals are shown on the face of the statement of financial position.

2. Equity

3. Liabilities

4. The statement of financial position makes use of the accounting equation concept

Note: You should be aware of the current and non currentnoncurrent distinction as well as their
disclosure requirements laid down in IAS1. We have already discussed these in the previous chapters so
you can refer.

Example 1

The following list of balances as at 31.03.201103 was extracted from the books of Great Africa Ltd.

Item (shs)

Ordinary share capital £1 each fully paid 200,000

Share premium account 20,000

Retained earnings at 31.03.2003 15,000

Cost of goods sold 350,000

Rental and rates 11,400

Postages and telephone 5,600

Salaries and wages 21,000

Directors fees 12,000

Motor expenses 24,100

 Sales 500,000

Debtorstrade receivables 21,700

Stock in tradeinventory at cost 38,000

Freehold property at cost 140,000

Fixture and fittings at cost 120,000

Provision forAccumulated depreciation 72,000

Motor vehicles at cost 80,000

Provision forAccumulated depreciation 16,000

Cash at bank 7,000

Creditors Trade payables 7,800

Additional information:

i) The authorized share capital of the company is 250,000.

ii) The company’s freehold property was valued at £ shs190,000 on 31.03.20032011. The

company’s directors have decided that the valuation should be reflected in the accounts

iii) (a) Rates and rent prepared at 31.03.2003 2011 amounted to £shs 2,300

(b) Accrued expenses included telephone and postages; motor expenses were 900 and 300

respectively.
 iv) In February 20032011, the company sold a motor vehicle, which had been bought for £shs

8000 in January 200009. The only entry in the company’s books of accounts relating to the

sale concerns the receipt of the sale proceeds of £shs1500, which have been credited to

motor expenses.

v) The directors are recommending that a dividend of 15% be paid on the ordinary shares for

the year-ended 31.03.201103.

Required :to pPrepare relevant accounts for its internal and external use.

Solution
 Great Africa Ltd
Trading, profit and loss appropriation accountIncome statement
For the year ended 31.03.201103

(shs) (shs) (Shs)

Sales 500,000
Less: cost of goods sold 350,000
Gross profit 150,000
Less: Operational expenses
Rent and rates – paid 11,400
Less: prepaid 2,300 9,100
Telephone and postage 5,600
Add: accrued 900 6,500
Salaries and wages 21,000
Directors fee 12,000
Motor expenses paid 24,100
Add unpaid 300 24,400
Credited motor sales proceeds 11,500
Depreciation
Fixtures and fittings 6,000
Motor vehicles 14,400
Loss on sale of motor vehicle 1,700 96,600
Net profit 53,400

Net profit b/f 53,400

Retained profit b/f 15,000 68,400
Less ordinary dividend proposed 30,000
Retained profit c/f 38,400
 Great Africa Ltd
Balance sheetStatement of financial position as at 31.03.20032011

Non-current assets Cost Acc.

Dep NBV

Freehold property at valuation 190,000 - 190,000

Fixtures and fittings 120,000 78,000 42,000
Motor vehicles 72,000 25,600 46,400
382,000 103,600 278,400

Current assets
Stock 38,000
Debtors 21,700
Prepaid 2,300
Bank 7,000
69,000

Current liabilities
 Creditors 7,800
Proposed Div 30,000
Accrued expenses
Telephone and postages 900
Motor expenses 300 39,000 30,000

Total net assets 308,400

Financed by:
AuthorisedAuthorized share capital 250,000
Ordinary share of £1 each
Share premium 200,000
Profit on revaluation 20,000
Retained profit 50,000
38,000
308,000

Freehold premises

Balance b/f 140,000

Profit on revaluation 50,000

Balance c/f 190,000

Motor vehicles

Balance b/f 80,000

Disposal acco

unt 8,000

Balance c/f 72,000

DDisposal account

Cost 8,000

Provision for depreciation 4,800

Profit and loss 1,500

Loss on sales 1,700

PProvision for depreciation on motor vehicles

Balance b/f 16,000

Profit and loss account 14,400

30,400

Disposed 4,800

Balance c/f 25,600

10.8 IAS 18 Revenue:
This standard is concerned with recognition of revenues arising from fairly common transactions

- The sale of goods

- The rendering of services

- The use of other assets of the entity yielding interest

Revenue is recognized when an entity has transferred to the buyer the significant risks and rewards

of ownership and when revenue can be measured reliably.

Revenue is recognized as earned at the point of sale at which four criteria have been met

 The product or service has been provided to the buyer

 The buyer has recognized his liability to pay for the goods or services provided

 The buyer has indicated willingness to hand over cash or other assets to settlement of a

liability.

 The monetary value of goods or services has been established

IAs 18 recognizes revenue when future economic benefits will flow to the entity and when the

benefits can be measured reliably. It recognizes revenue from specific types of transactions or

events like sale of goods, rendering of services, use by others of entity assets yielding interest,

royalties and dividends.

The standard excludes various types of revenue arising from leases, insurance contracts, changes in

value of financial instruments or other current assets, natural increases in agricultural assets etc.

Revenue is gross inflow of economic benefits during the period arising in the course of the ordinary
activities of an entity whose inflow results in increases in equity. Revenue does not include sales

taxes, Value added taxes.

The following items should be disclosed when accounting for revenue

- Accounting policies

- Amount of each significant category of revenue recognized in the period

- Amount of revenue arising from exchange of goods or services

Review question:

Abacus a limited company has the following trial balance as at 31 December 2010

DR (shs000) CR (shs000)

Cash at bank 100

Inventory at 1 January 2010 2,400

Administrative expenses 2,206

Distribution costs 650

Noncurrent assets at cost

Buildings 10,000

Plant & equipment 1,400

Motor vehicles 320

Suspense 1,500

Accumulated depreciation

Buildings 4,000

Plant & equipment 480

Motor vehicles 120

Retained earnings 560

Trade receivables 876

Purchases 4,200

Dividend paid 200

Sales revenue 11,752

Sales tax payable 1,390

Trade payables 1,050

Share premium 500

Shs 1 ordinary shares 1,000

22,352 22,352

The following additional information is relevant;

a) Inventory at 31 December 2010 was valued at shs 1,600,000.While doing the inventory count,

error in the previous year’s inventory count were discovered. Inventory b/f at the beginning of the

year should have been Shs 2,200,000 not 2,400,000 as above.

b) Depreciation is to be provided as follows;

- Buildings at 5% straight line charged to administrative expenses

- Plant and equipment at 20% on reducing balance basis charged to cost of sales

- Motor vehicles at 25% on reducing balance basis charged to distribution costs

c) No final dividend is being proposed

d) A customer has gone bankrupt owing shs 76,000. This debt is expected to be recovered and an

adjustment should be made. An allowance for receivables up of 5r% is to be set up.

e) 1 million new ordinary shares were issued at shs 1.5 on 1 December 2010. The proceeds have

been left in the suspense account.

Required

Prepare the income statement for the year to 31 December 2010, a statement of financial position

and statement of changes in equity at that date in accordance with the requirements of IAS 1.
 Ignore taxation.

CHAPTER ELEVEN
PREPARATION OF FINANCIAL STATEMENTS OF NON PROFIT MAKING
ORGANISATIONS
Chapter outline:

- Introduction

- Definition of nonprofit making organizations

- Preparation of accounts for nonprofit making organizations.

11.0Introduction:

This chapter deals with preparation of financial statements for non profit making organization and

will highlight how these differ from financial statements of limited companies

Learning objectives:

By the end of this chapter you should be able to;

 Prepare financial statements of nonprofit making organization from information

given

 Highlight differences between the financial statements of such organizations with

those of profit making organizations.

11.1 Definition of nonprofit making organization

These are organizations whose main purpose is not trading or making profit. They are run to assist its

members or relief its members or community from unfavourable conditions/situations. Such as poverty,

famine etc. such organizations may include clubs, charities, associations etc.
Ordinarily Non-profit/trading organizations don’t prepare a trade, profit and loss account unless they

carry out some trading activity. So a trading account is prepared to ascertain the trading profit or loss of

that activity.

11.2 Accounts prepared by non-trading organization

a) Receipts and payment account – prepared as a summary of the cash book for the period

therefore receipts received in the period and payments for the same period are cash.

b) Income and expenditure account – prepare to ascertain the surplus or deficit for the period of a

non-trading organization. It shows income and expenditure for the organization for the financial

year end.

c) Statement of affairs – prepared to ascertain accumulated fund for the organization either at end

or start of the financial year.

d) Statement of financial position – prepared to ascertain the financial position of the organization

as at that date, shows assets and liabilities for the organization.

N.B Non-trading organisation raise their operational funds by subscriptions, life membership,

donations, entrance fees etc.

Example

The following is a summary of the receipts and payments of Mbarara Rotary Club during the year

ended 31st July 2011.

Receipts and payments account for the year ended 31 July 2011.

Cash and bank b/f 120,000 Secretarial expenses 163,000

Competition tickets 437,000 Rent 1,402,000

Members subscriptions 1,987,000 Speakers expenses 1,275,000

 Donations 177,000 Donations 35,000

Refunds on rent 500,000 Prizes for competition 270,000

Balance c/f 13,000 Stationery 179,000

3,324,000 3,324,000

The following valuations are also available as at 31 July 2011.

2010 2011

Equipment (cost 1,420,000) 975,000 780,000

Subscriptions in arrears 65,000 85,000

Subscriptions in advance 10,000 37,000

Owing to suppliers of competition prizes 58,000 68,000

Stocks of competitions prizes 38,000 46,000

Required to prepare relevant accounts

Solution

a) Statement of affairs as at 01.08.2010

Assets

Equipment 975,000

Stock of prizes 38,000

Subscriptions in arrears 65,000

Cash and bank 210,000 1,288,000

Liabilities
 Subscription in advance 10,000

Suppliers owings 58,000 68,000

Accumulated fund 1,220,000

Subscription account

Balance b/f 65,000 Balance b/f 10,000

Income and expenditure 1,980,000 Cash/bank 1,987,000

Balance c/f 37,000 Balance c/f 85,000

2,082,000 2,082,000

Balance b/f 85,000 Balance b/f 37,000

c) Competition prizes

Balance b/f (Stock) 38,000 Balance b/f 58,000

(creditors)

Cash 270,000 Cost of prizes 272,000

Balance c/f (creditors) 68,000 Balance c/f (Stock) 46,000

376,000 376,000

Balance b/f 46,000 Balance b/f 68,000

d) Sales of tickets

Shs

Sales proceeds from tickets 437,000

 Less: cost of prizes 272,000

165,000

e) Rent account

Shs

Cash 1,402,000

Less: Refund 500,000

902000

f) Depreciation for the year

Shs

Cost at start 975,000

Cost at end 780,000

195,000

g) Accumulated depreciations

Shs

Original cost 1,420,000

Cost at 01.08.2001 975,000

Accumulated depreciation 445,000

Add: Depreciation for the year 195,000

640,000
 Mbarara Rotary Club
Income and expenditure account for the year ended 31st July 2011
Shs Shs

Income
Subscription 1,980,000
Profit on sale of tickets 165,000
Donations 177,000
2,322,000

Expenditure
Rent 902,000
Speakers expenses 1,275,000
Secretarial expenses 163,000
Stationery 179,000
Donations to charities 35,000
Depreciation 195,000 2,749,000
Deficit 427,000

Mbarara rotary club

Statement of financial position as at 31st July 2011.

(shs) (Shs) (Shs)

Assets (non current) Cost Acc dep NBV

Equipment 1,420,000 640,000 780,000

Assets (current)
Stock of prizes 46,000
Subscription in arrears 85,000
131,000
Liabilities (current)
Creditors for prizes 68,000
Subscription in advance 37,000
Bank overdraft 13,000 118,000
Net current assets 13,000
 Total net assets 793,000
Financed by:
Accumulated fund 1,220,000
427,000
793,000

Review Question

The assets and liabilities of Mbarara FC as at 31st December 2009 were as follows:-

(shs)

Pavilion less depreciation 130,980

Bank and cash 10,670

Bar stock 2,910

Bar debtors 2,310

Prepaid rates 680

Contributions owing to sports club by users of sport club facilities 7,780

Bar creditors 4,270

Loans to sports club 10,800

Water outstanding 130

Electricity outstanding 1,300

Miscellaneous 750

Loan interest 330

Contributions prepaid 3,980

The treasurer has analysed the cash book for the year and produced the following receipts and

payments account for the year ended 31-12-2010.

Shs Shs

Balance b/f 10,670 Bar purchases 29,370

Bar sales 40,300 Repayment of loan 1,700

Telephone 340 Rent of ground 790

Contributions 17,800 Rates 3,200

Socials 1,770 Water 380
Miscellaneous 560 Electricity 5,060
Insurance 2,210
repairs 3,260
Socials expenses 670
Maintenance of ground 1,330
Wages of ground man 1,400
Telephone 1,030
Bar sundries 1,440
Loan interests 970
Miscellaneous 1,630
______ Balance c/f 17,000
71,440 71,440
st
The treasurer also provides the following information as at 31 December 2010.
(shs)
Bar stock 3,940
Bar debtors 500
Bar creditors 9,010
 Rent prepaid 160
Water outstanding 230
Electricity outstanding 350
Creditors for bar sundries 650
Contributions outstanding 4,250
Contributions paid in advance 6,570
Rates prepaid 760
Depreciation on the pavilion for the year was 4,980.

Required prepare the relevant accounts

 CHAPTER TWELVE
STATEMENT OF CASH FLOWS
Chapter outline:

-Statement of cash flows

- Presentation of cash flow statements

-Reporting cash flow from operations

12.0 Introduction

This chapter deals with preparation of cash flow statement and highlights the importance of the

distinction between cash and profit. The chapter adopts a systematic approach to preparation of this

statement.

Learning objectives:

By the end of this chapter, you should be able to;

 Differentiate between profit and cash flow

 Describe the benefits and draw backs to users of financial statements of a statement of

cashflow.

 Prepare extracts of the cash flow using different methods

12.1 IAS 7 Statement of Cash flows:

Statements of cash flows are a useful addition to the financial statements of a company because

accounting profit is not the only indicator of performance.

Statement of cashflows concentrates on the sources and uses of cash and is a useful indicator of a
company’s liquidity.

The aim of IAS 7 is to provide information about the entity’s ability to generate cash and cash

equivalents as well as indicating the cash needs of the entity. The statement of cash flows should be

presented as an integral part of an entity’s financial statements. All entities are required by the standard

to produce it.

Its provides information that helps users to appreciate the change in net assets of the entity and the

ability to adapt to changing circumstances by adjusting the amount and timing of cash flows.

Several definitions are encountered in this standard as below;

 Cash :- comprises cash on hand and demand deposits

 Cash equivalents: - are short term highly liquid investments that are readily convertible to

known cash amounts. The cash equivalents are not held for investment or other long term

purposes. To fulfill this an investment’s maturity date should normally be three months form the

acquisition date.

 Operating activities are the principal revenue producing activities of the enterprise other than

investing and financing activities

 Investing activities are the acquisition and disposal of non current assets and other investments

not included in cash equivalents. This includes loans and borrowings from banks

 Financing activities are activities that result in changes in the size and composition of the equity

capital and borrowings of the entity.

12.2 Presentation of a statement of cash flows:

IAS 7 requires cash flows in the period to be classified by operating, investing and financing
activities. The manner of this presentation depends on the nature of the enterprise.

Operating activities: This shows whether and to what extent, companies can generate cash from

their operations. It will mostly comprise of items which determine the net profit or loss of the

enterprise. Examples of cash flows from operating activities are;

 Cash receipts from sale of goods and rendering services

 Cash receipts from royalties

 Cash payments to suppliers

 Cash payments to and on behalf of employees.

Investing activities: This shows the extent of new investment in assets which will generate future

profit cash flows. Examples of cash flows under this heading are;

 Cash payments to acquire property, plant and equipment, intangible assets and other

noncurrent assets

 Cash receipts from sale of the above properties

 Cash payments to acquire shares and debentures

 Cash advances and loans made by other parties

 Cash receipts from repayment of advances and loans made by other parties.

Financing activities: this shows the share of cash which the enterprises capital providers have

claimed during the period. Its an indication of the likely future interest and dividend payments.

Examples include;

 Cash proceeds from issuing shares

 Cash payments to owners to acquire or redeem shares

 Cash proceeds from issuing debentures, loans, bond etc

  Cash repayments of amounts borrowed.

12.3 Reporting cash flows from operations:

The standard offers a choice of method to calculate this cash flow. There are two methods;

a) Direct method which discloses the major classes of gross cash receipts and gross cash payments

b) indirect method where the net profit or loss is adjusted for the effects of transactions of a non

cash nature, any deferrals or accruals of past or future operating cash receipts or payments.

The direct method discloses information that is not else where in the financial statements which

could be of use in estimating future cash flows. However the indirect method is simpler and more

widely used.

12.3.1 Direct Method:

The information needed can be extracted from accounting records and cashflow from operations

calculated from the proforma below;

Shs

Cash receipts from customers xx

Cash paid to suppliers and employees xx

Cash generated from operations (xx)

12.3.2 Indirect Method:

This is easier than the direct method. The net profit or loss for the period is adjusted for the

following.

a) Changes during the period in inventories, operating receivables and payables.

b) Noncash items e.g depreciation, provisions, profit/loss on sale of assets

c) Other items, the cash flows from which should be classified under investing or financing activities.

A proforma of such a calculation is as below;

Shs

Profit before interest & tax xx

Add: depreciation xx

Loss(profit) on sale of noncurrent assets xx

I(increase)/decrease in payables (xx)/xx

(increase)/decrease in receivables (xx)/xx

Increase/(decrease) in payables xx/(xx)

Cash generated from operations xx

Interest (paid)/received (xx)/xx

Income taxes paid (xx)

Net cashflow from operating activities xx

12.3.4 Why are some items added and others subtracted?

 Depreciation is not a cash expense but is deducted in arriving at the profit figure in the

income statement. So it makes sense to add back.

 A loss on disposal needs to be added back and profit deducted

 An increase in inventories means less cash ie cash has been spent on buying inventory

 An increase in receivables means the company ‘s receivables have not been paid as much

and so there is less cash

 If we pay off payables causing the figure to decrease again we have less cash

The direct method should be used where the necessary information is not too costly to obtain but is
not demanded by IAS 7 . SO this method is rarely used

Interest and dividends:

Cash flows from interest and dividends received and paid should be disclosed separately. Each

should be classified in a consistent manner from period to period as either operating, investing or

financing activities.

Dividends paid by an enterprise can be classified as a financing cash flow or as a component of cash

flow from operating activities.

Taxes on income:

Cash flows arising from taxes on income should be separately disclosed and should be classified as

cash flow from operating activities unless they can be identified to fall in other categories.

Components of cash and cash equivalents:

These should be disclosed and reconciliation should be presented showing the amounts in the

statement of cash flows reconciled with the equivalent items reported in the statement of financial

position. Also the accounting policy used in deciding these items should be disclosed.

Other disclosures:’

All enterprises should disclose together with a commentary by management any other information

likely to be of importance for example;

a) Restrictions on use or access to any part of cash equivalents

b) The amount of undrawn borrowing facilities which are available

c) Cash flows which increased operating capacity compared to cash flows which maintained

operating activity.
Example:

RECO co’s income statement for the year ended 31 December 2009 and statements of financial

position at 31 December 2008 and 31 December 2009 were as follows.

Reco co

Income statement for the year ended 31 December 2009

Shs 000 Shs 000

Sales 720

Raw materials 70

Staff costs 94

Depreciation 118

Loss on disposal of non current asset 18 (300)

420

Interest payable (28)

Profit before tax 392

Taxation (124)

Profit for the period 268

Reco co

Statement of financial position as at 31 December 2009

2009 2008

Shs 000 Shs000 Shs 000 Shs 000

Assets
Plant, property and equipment
Cost 1,596 1,560
Depreciation 318 1,278 224 1,336

Current Assets:
Inventory 24 20
Trade receivables 76 58
Bank 48 148 56 134
Total assets 1,426 1,470
Equity & liabilities
Capital and reserves
Share capital 360 340
Share premium 36 24
Retained earnings 716 1,112 514 878
Noncurrent liabilities
Noncurrent loans 200 500
Current liabilities
Trade payables 12 6
Taxation 102 114 86 92
1,426 1,470
During the year, the company paid shs 90,000 for a new piece of machinery

Dividends paid during 2009 totalled shs 66,000

Required :
Prepare the statement of cash flows for Reco co for the year ended 31 December 2009 in

accordance with requirements of IAS 7 using the indirect method.

Solution:
Shs000 shs000
Net cashflow from operating activities:
Profit before tax 392
Depreciation charges 118
Loss on sale of property, plant & Equipment 18
Interest expense 28
Increase in inventories (4)
Increase in receivables (18)
Increase in payables 6
Cash generated from operations 540
Interest paid (28)
Dividends paid (66)
Tax paid(86+124-102) (108)
Net cash outflow from operating activities 338

Cash flow from investing activities:

Payments to acquire property, plant & equipment (90)
Receipts from sales property, plant & equipment 12
Net cash outflow from investing activities (78)

Cash flow from financing activities:

Issues of share capital (360 + 36 – 340 -24) 32
Long term loans repaid (500 -200) (300)
Net cash flow from financing (268)
Decrease in cash and cash equivalents (8)
 Cash and cash equivalents at 1.1.2009 56
Cash and cash equivalents at 31.12.2009 48

12.4 Advantages of cash flow accounting:

a) Survival in business depends on the ability to generate cash and it’s the cash flow that shows that.

b) Cash flow accounting is more comprehensive than profit which is dependent on accounting

conventions and concepts

c) Payables are more interested in the enterpise’s ability to repay them than in its profitability

d) Cash flow accounting provides a better means of comparing the results of different companies

than traditional profit reporting

e) Cash flow reporting satisfies the needs of all users better.

f) Cash flow forecast are easier to prepare

g) The accruals concept is confusing and cash flows are more easily understood

h) Forecasts can be monitored by publication of variance statement

Activity

1. Can you think of some disadvantages of cah flow accounting?

2. What is the objective of IAS 7?

3. What are the benefits of cash flow information according to IAS 7?

4. Define cash and cash equivalents according to IAS 7.

Review question:

1. Below are the financial statements of Shimuk Ltd. You are a financial controller faced with the

task of implementing IAS 7 Statement of cash flows.

Shimuk Ltd

Income statement for the year ended 31 December 2010.

Shs 000

Revenue 2,553

Cost of sales (1,814)

Gross profit 739

Distribution costs (125)

Administrative expenses (264)

350

Interest received 25

Interest paid (75)

Profit before taxation 300

Taxation (140)

Profit for the period 160

 Shimuk Ltd

Statement of financial position as at 31 December 2010

2010 2009

Shs Shs

Assets:

Non current assets

Property, plant & equipment 380 305

Intangible assets 250 200

Investments - 25

Current assets:

Inventories 150 102

Receivables 390 315

Short term investments 50 -

Cash in hand 2 1

Total assets 1,222 948

Equity & Liabilities:

Equity

Share capital (shs1 ordinary shares) 200 150

 Share premium 160 150

Revaluation reserve 100 91

Retained earnings 260 180

Non current liabilities:

Loan 170 50

Current liabilities:

Trade payables 127 119

Bank overdraft 85 98

Taxation 120 110

Total equity & liabilities 1,222 948

The following information is available;

a) The proceeds from the sale of non current asset investments amounted to shs 30,000.

b) Fixtures and fittings, with original cost of shs 85,000 and a net book value of shs 45,000 were sold for

shs 32,000 during the year.

c) The following information relates to property, plant and equipment.

31.12.2010 31.12.2009

Shs000 Shs 000

Cost 720 596

Accumulated depreciation 340 290
Net Book Value 380 305
d) 50,000 sh 1 ordinary shares were issued during the year at a premium of 20 cts per share
e) Dividends totaling shs 80,000 were paid during the year.

Required:
Prepare the statement of cash flows for the year to 31 December 2010 using the format laid down by

IAS7.

REFERENCES:
1. ACCA (2010) Financial Accounting International). BPP learning media ltd.

2. Frank Wood & Alan Singer (2002) Business Accounting 10th edition. Pearson Company. New York.

3. H. Johnsn & William (1998) A practical foundation of accounting. Tata McGraw Hill

4. IASB International Financial Reporting Standards

5. Government of Uganda. Laws of Uganda

6. Sserwanga A (2005) Introduction to financial accounting. 1st ed. Widelink services, Kampala.
Contents
PREFACE:.........................................................................................................................3

CHAPTER ONE.................................................................................................................4

1.0 INTRODUCTION......................................................................................................4

1.1 Financial Accounting........................................................................................4

1.2 Cost accounting...................................................................................................5

1.3 Management accounting..................................................................................6

1.4 Book Keeping and Accounting........................................................................7

1.5 Users/interested parties in accounting information.............................8

1.6 OBJECTIVES OF FINANCIAL STATEMENTS...............................................13

1.7 ACCOUNTING PRINCIPLES/CONCEPTS/CONVENTIONS.......................14

1.8. Accounting Regulatory Framework:..........................................................27

1.9. FORMS OF BUSINESS:........................................................................................31

CHAPTER TWO:.............................................................................................................33
PRINCIPLES OF DOUBLE ENTRY AND ACCOUNTING SYSTEM......................33

2.1 The Accounting equation:.................................................................................34

2.3 DOUBLE-ENTRY ACCOUNTING........................................................................48

2.4 Accounts.................................................................................................................49

CHAPTER THREE..........................................................................................................59

THE PREPARATION OF BOOKS OF ACCOUNTS..................................................59

3.1 Subsidiary books and sources of information...........................................60

3.2 Sources of information......................................................................................61

3.3 JOURNALS...............................................................................................................63

3.4 THE MAIN BOOK OF ACCOUNTS......................................................................75

3.5 Posting transactions from the Journals to the Ledgers..........................87

CHAPTER FOUR............................................................................................................98

ADJUSTMENTS IN ACCOUNTS:................................................................................98
4.0 Depreciation of non-current assets..............................................................99

Fixed assets are those assets of monetary and material value bought for use in
business over their life span. When fixed assets are used in business they lose
value therefore the monetary costs in a fixed assets is termed as depreciation.
..........................................................................................................................................99

Example........................................................................................................................101

Solution.........................................................................................................................101

Example........................................................................................................................103

Example........................................................................................................................104

Solution.........................................................................................................................104

4.1.3 Accumulated depreciation:..............................................................................105

Annual depreciation charge = 1,600,000 – 250,000 = shs 450,000.....................106

Example........................................................................................................................108

Solution.........................................................................................................................108

4.2 ACCRUALS AND PREPAYMENTS:..................................................................112

4.3 BAD(IRRECOVERABLE) DEBTS.....................................................................114

4.4. Provisions and contingencies: (IAS 37)....................................................117

CHAPTER FIVE............................................................................................................120

PREPARATION OF A TRIAL BALANCE...............................................................120

5.1 Definition of a trial balance...........................................................................120

5.2 Preparing a trial balance................................................................................120

5.3 EXTRACTION OF TRIAL BALANCE...............................................................126

5.4 Errors detected by a trial balance...............................................................135

5.5. Errors not detected by the trial balance..................................................135

CHAPTER SIX...............................................................................................................138

BANK RECONCILIATIONS......................................................................................138

6.1 Preparing Bank Reconciliation Statements.............................................138

6.2 Agreement of the cash and bank balances...............................................140

6.3 Steps to follow reconciling account balances:........................................143

6.4 Relevance of Bank reconciliation................................................................144

CHAPTER SEVEN........................................................................................................148

PREPARATION OF FINANCIAL STATEMENTS OF SOLE TRADERS............148

7.1 FINAL ACCOUNTS OF A SOLE TRADER.......................................................148

7.1.1Points to note about the Income Statement.................................................148

We shall study the preparation of final accounts of a sole trader by looking at an

example.........................................................................................................................149

Example:........................................................................................................................149

Trial Balance of Sarah Kagezi on 31/12/2010...........................................................149

Total...............................................................................................................................149

Additional Information................................................................................................150

Treatment of Depreciation in Final Accounts...........................................................150

Total...............................................................................................................................150

Additional Information................................................................................................151

Required: Prepare........................................................................................................151
Treatment of Bad Debts Provisions in Final Accounts............................................151

Total...............................................................................................................................151

Total...............................................................................................................................152

CHAPTER EIGHT.........................................................................................................155

PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE

RECORDS.....................................................................................................................155

8.1 INCOMPLETE RECORDS:.................................................................................155

CHAPTER NINE...........................................................................................................166

PREPARATION OF FINANCIAL STATEMENTS OF PARTNERSHIPS:..........166

9.1 Definition of a partnership............................................................................166

9.2.1 Advantages in comparison to sole trading....................................................167

9.2.2 Advantages in comparison to a company.....................................................167

9.2.3 Disadvantages of partnerships........................................................................167

9.3 Partnership agreements................................................................................167

9.3.1 Rules in the absence of an agreement...........................................................168

9.3.6 Interest on capitals............................................................................................170

9.3.7 Interest on drawings.........................................................................................171

9.3.9...............................................................................................................................171

Salaries to partners.....................................................................................................171

9.4 Preparation of final accounts of partnerships........................................172

Example........................................................................................................................172

9.5 CHANGES IN PARTNERSHIPS;.......................................................................174

Good will.......................................................................................................................176

Example :.......................................................................................................................176

Locke 3,500..................................................................................177

Partners Current accounts..........................................................................................179

DR CR..................................................................................................................182

CHAPTER TEN.............................................................................................................184

PREPARATION OF FINANCIAL STATEMENTS OF LIMITED COMPANIES:

........................................................................................................................................184
10.1 Definition of a limited company................................................................184

10.1 Types of companies.......................................................................................185

10.2 IAS 1 Presentation of financial statements:..........................................185

Types of shares............................................................................................................186

10.3 Profit or loss for the period:.......................................................................186

10.3.2 Statement of financial Position format: 187

10.3.3188

Format: Statement of comprehensive income: 188

ABC Co188

2010 2009..............................................................................................................188

10.4 Notes to financial statements:....................................................................189

10.5 Items in the statement of comprehensive income:......................................190

10.6 Items in the statement of financial position:........................................191

Required :Prepare relevant accounts for its internal and external use. ............193

10.8 IAS 18 Revenue:..............................................................................................197

CHAPTER ELEVEN.....................................................................................................200

PREPARATION OF FINANCIAL STATEMENTS OF NON PROFIT MAKING

ORGANISATIONS......................................................................................................200

11.1 Definition of nonprofit making organization.......................................200

11.2 Accounts prepared by non-trading organization................................201

Example........................................................................................................................201

Required to prepare relevant accounts...................................................................202

Solution.........................................................................................................................202

Assets............................................................................................................................202

Income..........................................................................................................................205

Expenditure..................................................................................................................205

Required prepare the relevant accounts.................................................................208

CHAPTER TWELVE...................................................................................................209

STATEMENT OF CASH FLOWS..............................................................................209

12.1 IAS 7 Statement of Cash flows:...................................................................209

12.2 Presentation of a statement of cash flows:............................................210

12.3 Reporting cash flows from operations:..................................................212

12.4 Advantages of cash flow accounting:.......................................................218

REFERENCES:.............................................................................................................222