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FINANCIAL ACCOUNTING II 2019 VERSION

LEARNING OBJECTIVES

By the end of the module, the learner should be able to

1. Analyze the cash inflows and outflows of the business

2. Incorporate the effects of share issues into the financial statements of a company

3. Prepare termly financial reports for ideal decision making

DETAILED MODULE DESCRIPTION

SUB MODULE1 JOINT VENTURES DURATION: 4 HR

DISTINCTION BETWEEN A JOINT VENTURE BUSINESS AND A PARTNERSHIP

PURPOSE OF JOINT VENTURE BUSINESS

PREPARATION OF JOINT VENTURE ACCOUNTS

SUB MODULE 2 DURATION: 4 HRS

HIRE PURCHASE ACCOUNTS

IMPORTANCE OF HIRE PURCHASE

PREPARATION OF HIRE PURCHASE ACCOUNTS

SUB MODULE 3 CONSIGNMENTS ACCOUNTS DURATION: 4 HRS

PARTIES INVOLVED IN CONSIGNMENT BUSINESS

PURPOSE OF CONSIGNMENT BUSINESS

CONSIGNOR AND CONSIGNEEE ACCOUNTS

SUB MODULE 4 PARTNERSHIP ACCOUNTING 2 DURATION: 8 HRS

REVALUATION ACCOUNTS

REALIZATION ACCOUNTS

DISSOLUTION OF PARTNERSHIP BUSINESS

SUB MODULE 5 MANUFACTURING ACCOUNTS DURATION: 8 HRS

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COSTS OF A MANUFACTURING FIRM

STOCKS OF A MANUFACTURING FIRM

ACCOUNTS OF A MANUFACTURING FIRM

SUB MODULE 6 COMPANY ACCOUNTS DURATION: 6 HRS

TYPES OF COMPANIES

FORMATION OF COMPANIES

RAISING COMPANY CAPITAL

TYPES OF SHARES

ISSUE OF SHARES AND DIVIDENDS

DIVIDENDS AND INTERESTS

REDEMPTION OF DEBENTURES

PREPARATION OF FINAL ACCOUNTS OF AC OMPANY

SUB MODULE 7 BRANCH ACCOUNTS DURATION: 6 HRS

TYPES OF BRANCHES (INLAND, FOREIGN, DEPENDENT AND INDEPENDENT BRANCHES)

PURPOSE OF BRANCH ACCOUNTING

PREPARATION OF BRANCH ACCOUNTS

BENEFITS AND LIMITATIONS OF BRANCHES

SUB MODULE 8 DEPARTMENTAL ACCOUNTS DURATION: 6 HRS

DISTINCTION BETWEEN DEPARTMENTAL ACCOUNTS AND BRANCH ACCOUNTS

IMPORTANCE OF DEPARTMENTAL ACCOUNTS

PREPARATION OF DEPARTMENTAL ACCOUNTS

SUBMODULE 9 SINGLE ENTRY AND INCOMPLETE RECORDS DURATION: 10HRS

CAUSES OF INCOMPLETE RECORDS

CONVERTING SINGLE ENTRY INTO DOUBLE ENTRY RECORDS

PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS

SUB MODULE 10 CASH FLOW STATEMENTS DURATION 7 HRS

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PURPOSE OF CASH FLOW STATEMENTS

CASH INFLOW AND CASH OUT FLOW

CONSTRUCTION OF CASH FLOW STATEMENT (DIRECT AND INDIRECT METHODS)

SUB MODULE 11 RATIO ANALYSIS DURATION 8 HRS

TYPES OF ACCOUNTING RATIOS (LIQUIDITY, PROFITABILITY, EFICIENCY, GEARING AND

MARKET RATIOS)

COMPUTATION OF RATIOS

ANALYSIS OF RATIOS

EXAMINATION AND COURSEWORK:

EXAMINATION: 70%

COURSEWORKS:

TESTS AND COURSEWORKS 15%

NOTES 15%

AND CLASS ATTENDENCE 05%

COURSEWORK:

INSRUCTIONS:

 Individual coursework must be done in your book well-presented and in a good

hand writing
 You should hand in your book in time for marking on the day the Instructor tells
you to do so.
 Group coursework must be typed and printed work.

INDIVIDUAL COURSE WORK: (CLASS 1)

INDIVIDUAL COURSE WORK: (CLASS 2 AND 3)

GROUP COURSE WORK: (10 STUDENTS PER GROUP)

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TOPIC ONE: JOINT VENTURE ACCOUNTS

A joint venture refers to a situation or a business setting where more persons or firms
tackle a particular business venture together instead of engaging in separately. For
example one merchant can provide a ship, another one goods and the other capital and
profits or losses dealt with in an agreed ratio.

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Joint ventures are forms of partnerships but are limited to a particular transaction.
There may be several joint ventures as between the same parties, but each one may be
different for each one.

CHARACTERISTICS OF A JOINT VENTURE.

 It is a temporary partnership that ends with completion of the venture.

 A partnership without the use of a firm’s name.

 Aims at making profits and distributing them to members.

THE MEMORANDUM ACCOUNT OF A JOINT VENTURE

The memorandum account is called so because the account its self is not going to be
incorporated into each person’s double recording but all that will be required is an
entry in each set of books to record their shares of profit and losses.

After the entries have been made, the balance on joint venture accounts can be carried
down. If the balance carried down is credit one, then the person has received more
from a joint venture than he is entitled to keep and he will have to pay this amount to
persons who have received less than his entitlement, this is being shown by a debit
balance.

Therefore the partner with a credit balance must pay off one with a debit balance.

A memorandum joint venture is drawn to

 Find out the shares of net profit or loss of each party to the joint venture.

 To help calculate the amounts payable and receivable to close the venture.

EXAMPLE ONE

Oliya and Apon enter a joint venture to share profits and losses equally resulting from dealings
in second hand cars. Both parties take an active part in the business each recording his
own transactions. They have no joint bank account or separate set of books.

January 1st Oliya buys 3 cars for Shs 900

January 31st Oliya pays for repairs and spraying of vehicles shs 60
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March 1st Apon pays garage rental Shs 20 and advertising Shs 20

April 12th Apon pays for license and insurance renewal of vehicles Shs 36

August 10th Apon buys a vehicle in excellent condition for Shs 100.

August 31st Oliya sells the four vehicles to various clients, the sales being completed to
this date totaling to shs 1600

Required

Open up

1. Oliyas joint venture account

2. Apons joint venture account

3. Memorandum joint venture account

EXAMPLE TWO

Plant, Hoe and Reap entered into a joint venture for dealing in carrots. The transactions
connected with this ventured were,

January 8th plant rented land cost shs 156

January Hoe supplied seeds cost shs 48

January 17th Plant employed labor for planting shs 105

January 19th Hoe charged motor expenses shs 17

January 30th Plant employed labor for fertilizing shs 36

February 20th Plant paid the following expenses

Sundries shs 10, labor shs 18, fertilizers shs 29,

March 17th Reap employed labor for lifting carrots shs 73

March 30th sale expenses to London paid by Reap were shs 39.

March 31st, Reap received cash from sale proceeds gross shs 987.

Required:

Show the joint venture accounts in the books of Plant, Hoe and Reap.
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Also show in full the method of arriving at the profit on the venture which is to be
apportioned, Plant seven twelfth, Hoe three twelfth and Reap two twelfths.

Any outstanding balances between the parties are settled by cheque on 31st April

REVISION EXERCISE

Two traders Damalie and Gallet agreed to undertake a joint venture in low priced goods
sharing profits and losses in the ratio of 1:3 respectively. The venturers kept separate
set of books to record the joint venture transactions which were as follows;

Transactions recorded by Damallie include the following

Cash sales shs 400

Credit sales shs 300

Purchase of goods for sale shs 200

Expenses incurred shs 140

Cost of goods appropriated from own stock shs 200

Transactions recorded by Gallet

Purchases made shs 600

Expenses incurred shs 60

Cash sales shs 800

Unsold stock taken over shs 100

At the finalization stage of the joint venture, the venturers balanced their accounts with
the transfer of cash.

Required:

To show the joint venture accounts in respective coventurers books

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TOPIC 2: MANUFACTURING ACCOUNTS

It is a form of accounts prepared by the organizations which are engaged in the
manufacturing process. That is, they buy material and turn them into finished goods. It
is produced for internal use only. Manufacturing accounts are an extension of the
trading account.

These accounts are prepared for the following purpose.

 To find the cost of goods manufactured.

 To calculate the amount of any profit on manufacturing process.

Main features of manufacturing accounts

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 Prime cost

 Factory cost

 Work in progress

 Factory profit

 Un realized profit on fished goods

Prime cost is the cost of raw material consumed, direct wages and any direct expenses.

Direct expenses are those which can be attributed to the production of a commodity.

Prime cost plus factory overheads are called factory cost.

Factory overheads are indirect expenses which are incurred for example salaries of
supervisors, factory power, rent, rates, insurance and depreciation on plant.

Work in progress.it is cost of those items which remain incomplete at the end of the
accounting period. The work in progress is valued at prime cost or factory cost. There
may be opening and closing work in progress.

If opening work in progress is greater than closing work in progress, then the difference
is added in the factory cost and vice versa.

The goods manufactured during any period are transferred to the trading accounts.
These may be transferred as under.

At actual factory cost

Dr. trading account

Cr. manufacturing account.

At the market value of inflated price.in this case, the goods manufactured are
transferred at a specific price which includes the factory cost. And profit on
manufacturing process. This profit is called manufacturing margin.

Manufacturing margin

Dr. Manufacturing account

Cr. Profit and loss account

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Unrealized profit.

Another feature for manufacturing account is provision for unrealized profits on

finished goods arises because the closing stock of finished goods is valued at cost plus
factory profit.

The amount of unrealized profit to be deducted from profit in the profit and loss
account is the difference between unrealized profit brought forward and carried
forward. The provision for unrealized profit appears in the balance sheet as a deduction
from closing stock of finished goods.

In manufacturing business, the costs are divided into different types. These are
summarized in the chart below;

Direct materials

Direct labor

Direct expenses = prime cost +indirect manufacturing costs = production cost + administration
expenses + selling and distribution expenses + financial charges + total cost.

Direct costs and indirect costs

When you see the word direct followed by a type of cost, you know that it has it has
been possible to trace the costs to an item being manufactured.

The sum of all direct costs is known as the prime costs. If a manufacturing related cost
cannot easily be traced to the item being manufactured, then it is an indirect cost and
will be included under indirect manufacturing costs which are also known as factory
overheads expenses.

Production cost is the sum of prime cost plus manufacturing costs.

For example the wages of a machine operator making a particular item will be direct
labor while the wages of a foreman in charge of many workers on different jobs will be
indirect labor, and will be part of the indirect manufacturing costs. Other examples of
costs being direct costs would be

 Cost of raw material including carriage inwards on raw materials.

 Hire of special machinery for a job.

 Indirect manufacturing costs

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Indirect manufacturing costs are all costs which occur in factory or other place where
production is being done but which cannot easily be traced to items being
manufactured. Examples are wages of cleaners, wages of crane drivers, rent of a
factory, depreciation of plant and machinery, cost of operating forklift trucks’ factory
power and factory lighting etc.

Administration expenses

Administration expenses consist of items as managers’ salaries, legal and account

charges, the depreciation of accounting machinery and secretarial studies.

Selling and distribution expenses

Selling and distribution expenses are items such as sales staff salaries and commission,
carriage outwards, depreciation of delivery vans, advertising and display expenses.

Financial charges

Financial charges are expense items such as bank charges and discount allowed.

NB: sometimes if a business has produced less than the customers have demanded, it
may buy in some finished goods. In this case, the trading account will have both a figure
for purchase of finished goods and a figure for production cost of goods completed.

NB: In manufacturing accounts, we have only two direct expenses that is

Direct labor (factory wages)

Royalties or rent reward for use of someone’s land.

MANUFACTURING STATEMENTS

This involves preparing manufacturing statements either with work in progress inclusive
or without work in progress

Example with work in progress (Partially done work)

Example one

Prepare the manufacturing accounts of Global links without work in progress being
given the information below.

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Stock of raw materials on 1st January 2016 was shs 4,300, factory wages shs 12,900,
factory lighting shs2,800, carriage on raw materials shs 1,420, purchases of raw
materials 22,000, stock of raw materials 31st January 2016.

Example two

Dragon ltd avails you with the following information.

Purchase of raw materials shs 28,600, factory power shs 4,000, and stock of raw
materials shs 3,000, factory wages shs 14,000, and stock of raw materials shs 1940.

Example with work in progress

 Prepare the manufacturing statement of BK ltd with work in progress given the
information below.

Stock of raw materials January 1st 2016 shs 1,940 , purchases of raw materials shs
15,600, work in progress on 1st January 2016 shs 1,040, work in progress 31st January
shs 610, stock of raw materials 31st January 2016 shs 2,140, factory power shs 4,611,
factory wages shs 6,632.

 KLN provides you with the following information for the year 2015 as follows.

Stock of raw materials 1st April 2015 was 1,110, carriage in on raw materials was shs
640, returns out on raw materials shs 1,000, factory power shs 2,610, depreciation on
plant shs 4,000, purchases of raw materials 18,960,factory cleaning shs 1,500, stock of
raw materials was shs 6,411,work in progress shs 1,640, work in progress shs 2,000.

MANUFACTURING, TRADING AND PROFIT AND LOSS ACCOUNT

Given the information below that relates BHJ manufacturers for the year ended 31 December
2015.

Stock of raw materials 1st January 2015 shs 5,650

Stock of finished goods on 1st January shs 6,667,

Stock of partly finished goods on 1st January 2016 shs 2,100

Sale of finished goods was shs 66,540

Purchases of raw materials shs 32,100,

Manufacturing wages shs 6,540,

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Factory power shs. 4,443,

Office rent shs. 2,300,

Rates (½ offices, ½ factory), shs. 3,200

Cleaning expenses shs. 1,450

Returns of finished goods shs. 1,234

Insurance shs. 1,980

Gas shs. 1,000

Depreciation on plant shs. 3,500

Depreciation on furniture shs. 1,340

Depreciation on delivery van shs. 2,100

Bad debts shs. 500

Lighting and heating (¼ office, ¾ factory) shs. 4,432

Stock of finished goods shs 31st December 2016 shs. 4,533

Stock of partly finished goods 31st December 2016 shs. 3221,

Closing stock of raw materials 31st December 2016 shs. 8,887

Prepare the manufacturing, trading and profit and loss account from the following information.

TRANSFER OF MANUFACTURED GOODS TO TRADING ACCOUNT AT A MARKET PRICE.

01/January/2015 31/December
/2015

Stock of Shs 5,000,000 Shs 8,000,000

finished
goods at cost

The production cost for the year was shs 66,000,000.The goods were transferred to the income
statement at a markup of 10%.

Solution
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Opening stock of finished goods = 10/100 *5,000,000

Closing stock of finished goods = 10/100*8,000,000

Production cost for the year = 10/100*60,000,000

Dr Provision for unrealized profits Cr

Balance c/d Balance b/d

800,000 500,000

P & L a/c
300,000

800,000
800,0000

THE INCOME STATEMENT

SHS SHS

SALES 80,000,000

Less Cost of sales:

Opening stock of finished goods 5,500,000

Add production cost of manufactured goods 66,000,000

Less closing stock of finished goods 8,800,000 62,700,000

Gross profit
17,300,000

Add manufactured profit 6,000,000

Less provision for unrealized profit 300,000

Example

The following information relates to the books of JKL LTD for the year ended 31st
December 2015.

Inventory as at 1st January 2015 was SHS

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Raw material 13550

Work in progress 6,500

Finished goods 12,800

Purchases and expenses for year

Raw materials 237,600

Indirect materials 1,850

Direct wages 53,230

Factory power 4,550

Factory lighting 1,975

Office lighting 930

Printing and stationery 1,264

Communication 500

Factory salaries 11,500

Office salaries 9,900

Factory insurance 1,210

Other insurance premium 450

Depreciation:

Factory equipment 5,000

Office equipment 600

Office expenses 1,680

Advertising 850

Sales as at 31st December 2015 378,100

Additional information:

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Finished goods during the period are transferred from factory at a manufacturing price
of cost of production price plus 20%.

Stock at 31st December 2015

Raw materials 24,000

Work in progress 7,987

Finished goods 18,050

Prepayments:

Factory insurance 116

Other insurance premium 45

Accruals:

Direct wages 1,342

Factory lighting 197

Office lighting 43

Factory power 350

Required

Prepare a manufacturing trading and profit and loss account for the year ended 31st
December 2015.

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TOPIC 3: PARTNERSHIP ACCOUNTS

REVALUATION ACCOUNTS IN PARTNERSHIP
A revaluation of assets and liabilities is necessary under the following conditions.

 When a new partner is admitted in the firm

 When a partner retires from a firm

 In case of change in profit and loss sharing ratio.

It is not only goodwill that can be revalued but the assets and liabilities can also be
revalued in order to discover their meangful value to arrive at the current capital
account balances.

REVALUATION OF GOODWILL IN PARTNERSHIP ACCOUNTS

Goodwill refers to an intangible asset arising from the business ability to earn more profits as
compared to other firms in the similar trade.

REASONS FOR RISE OF GOOD WILL IN THE BUSIMNESS

1. The procession of trademarks and patent rights may account for goodwill.

2. The cost of research and development which might have brought about cheaper
manufacturing methods of a product.

3. The location of the business premises may be more valuable if the business does not change.

4. The business may have enjoyed some form of monopoly either nationally or internationally.

5. the value of labor force including management skills other than that of the retiring proprietor
may be carried forward. Skilled management is an asset to the business.

6. A new business may continue to trade under the same name as that of the original firm.

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METHODS OF TREATING GOODWILL IN BOOKS OF ACCOUNTS

1. Revaluation method. In this method, good will is maintained in the books of accounts of a
business

2. Memorandum revaluation method. This is where goodwill is eliminated in the books of

accounts of the business.

Example:

X, Y and Z are partners and have always shared profits and losses in the ratio 4:3:1 respectively.
They are altering their profits and losses sharing ratio to 3:5:2 respectively. Their
balance sheet as at 31st December 2016 was

NET ASSETS 14,000

TOTAL 14,000

CAPITALS

X 6,000

Y 4,800

Z 3,200

TOTAL 14,000

The partners agreed to value goodwill at shs 12,000on the change.

Required:

a) Use revaluation method and memorandum revaluation method to come up with

1. Goodwill account

2. Capital account

3. Balance sheet as at that date

Example 2:

X and Y are in partnership sharing profits and losses equally. They agreed to admit Z by agreement.
Goodwill was valued at shs6,000 and to be introduced in the books of the partnership. Z is required
to provide capital equal to that of Y after he has been credited with share of goodwill. The new

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profit sharing ratio will be 4:3:3 for X, Y and Z respectively. The balance sheet before admission of Z
was as follows.

BALANCE SHEET

Non-current Assets 15,000

Bank 2,000

17,000

Capital

X 8,000

Y 4,000

Current liabilities 5,000

17,000

Required:

Draw up the ledger accounts to reflect the admission of Z and the treatment of goodwill using

 Revaluation method

 Memorandum revaluation method.

Example 3: X and Y are partners sharing profits and losses in the ratio of ¼ and ¾ respectively.
On the 31st December, 2016 their balance sheet was as follows.

THE BALANCE SHEET OF X AND Y

AS AT

31ST DECEMBER, 2016

Non-current Assets

Premises 100,000

Furniture 80,000

Motor van 40,000

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Fixture and fittings 25,000

245,000

Current Assets

Inventory 60,000

Accounts receivable 45,000

Bank 80,000

Cash 35,000 220,000

465,000

Capital and Liabilities

Capitals

X 200,000

Y 180,000 380,000

Current Liabilities

Accounts payable 15,000

Bill payable 10,000 25,000

Noncurrent liabilities

Stanbic bank loan 60,000

465,000

On the 31st December, the partners agreed to admit Z and he was to pay 120,000 and he is entitled
to ¼ of the profits and losses. The revaluation exercise was carried out s follows

Premises were revalued at 120,000

Furniture 90,000

Fixtures and fittings 20,000

Goodwill account 180,000

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Required:

Prepare the necessary ledger accounts for the transactions above including a balance sheet as at
that date.

PARTNERSHIP DISSOLUTION
Dissolution of a partnership refers to the official process of bringing a partnership firm to an
end. OR It is when a partnership is ceased by its members to operate or commence
further business.

REASONS FOR DISSOLUTION/ CLOSURE OF A PARTNERSHIP

 Closure of partnership by law or government.

 Bankruptcy of a partner.

 The death of an active partner,

 Factors such as ill health, old age, may bring about closure of a partnership.

 Disagreements between partners.

 Unprofitable partnerships.

 Elapse of time or the completion of purpose for which the firm was formed.forexample
a temporary firm.

 In case of admission of a new partner.

 Retirement of one partner especially an active one.

 Insanity.

In their accepted sense, dissolution accounts means that the debts of the partnership
are discharged and the assets distributed in accordance with the partnership deed or
the provisions of partnership Act 1890.

THE REALIZATION ACCOUNT/ THE DISSOLUTION ACCOUNT

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This is the account in which the profit or loss on realization is calculated, so that
transfers can be made of the profits or losses to increase or reduce the amounts
repayable to partners or by them, in respect of their capital accounts.

The excess of credits over debits in this account implies a profit on realization while
excess of debits over credits implies a loss on realization

Any costs incurred on realizing assets will be debited to the realization account and a
profit or loss realized is divided between the partners in profit and loss sharing ratio
and will be transferred to their capital accounts

It should be known that realization in this case means sold, therefore liabilities are not
realized but they are just discharged or paid off and if liabilities are recorded in the
realization account, it is an error of principle that has been made.

As a matter of convenience, it is often found that discounts on creditors, being again,

are shown on the credit side of the realization account. They could instead be divided in
the profit and loss sharing ratios and credited to the partners’ capital account.

NOTE: Realization account is also known as a dissolution account

THE RULE IN GARNER VS MURRAY 1904

It sometimes happens that a partner’s capital account finishes up with a debit balance.
Normally a partner will pay in an amount to clear his indebtedness to the firm.
However, some times, he will be unable to pay all or part, of such a balance.

In the case of Garner Vs. Murray, a case in England, the court ruled that subject to any
agreement contrary, such a deficiency was to be shared by the other partners NOT in
the profit or loss sharing ratios BUT in the ratio of their last agreed capitals. By their last
agreed capitals is meant the credit balances of their capital accounts in the normal
balance sheet drawn up at the end of their last accounting period.

The partners who bear the others indebtedness to the firm have a legal right to sue
such a partner for recovery of the sum should his /her fortunes improve.

NB: GARNER VS MURRAY rule does not apply partnerships in Scotland.

Example:

Kato and Kasuku have been partners for years sharing profits and losses in the ratio 2:3
respectively. On 31st December 2016, the partners decided to dissolve the partnership
and the balance sheet as at that date is given below.
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NON-CURRENT ASSETS

SHS

Plant and machinery 300,000

Furniture 200,000

Motor vehicles 400,000

CURRENT ASSETS

Inventory 120,000

Accounts receivable 50,000

Cash at bank 80,000

TOTAL 1,150,000

CAPITAL AND LIABILITIES

Capital

Kato 400.000

Kasuku 600,000

Accounts payable 150,000

TOTAL 1,150,000

Assets were realized as follows.

Plant and machinery shs 320,000

Furniture shs 250,000

Accounts receivables were taken over by Kato at a valuation of shs 45,000. Kasuku took
over one motor vehicle at a valuation of shs 150,000.Other motor vehicles were sold
for shs 300,000.Inventory realized shs 110,000 and realization expenses were shs
30,000,

Required:

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(a) Realization account

(b) Assets accounts and liability accounts

© Capital accounts of partners

d) Bank account

Try out this question:

Identify and explain the advantages of a dissolution account.

QUESTION WITH THE USE OF GARNER VS. MURRAY IN PARTNERSHIP ACCOUNTS

Tom, Roger and James are in partnership sharing profits and losses equally. Their balance sheet
as at 31st December, 2016 was as follows.

Fixed Assets Pounds

Buildings 1,000

Motor vehicle 2,000

Fixture and fittings 1,500

Machinery 1.506

6,006

Current Assets

Stock 9,500

Debtors 7,800 17,300

23,306

Capitals

Tom 4,000

Roger 3,000

James 416 7,416

Creditors 6,250

Bank overdraft 9,640

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23,306

On the 1st January, 2017, the partnership was dissolved and the following happened.

 The assets were sold to Namasuba College of commerce for the following pounds.

Buildings 3,000

Motor vehicle 1,000

Fixture and fittings 2,500

Machinery 700

Stock 9,000

Debtors 3,800

 The creditors were settled for 6,103 pounds

 James was declared bankrupt with no assets.

Required:

1. Realization account

2. Partners’ capital accounts

3. Asset Accounts

4. Liability Accounts

5. Cash account

TOPIC 4: BRANCH ACCOUNTS

Where an organization is increasing in size or is intending to diversify its activities, it
may find it necessary or advantageous to control operations more precisely by
instituting a system of departmental or branch accounting.

As each department or branch is established as a separate cost and or accounting

Centre, the net profit per branch can be found and accumulated to arrive at the profit
of the whole businesses

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Various types of business organizations may operate through branches, for example
banks, building societies, estate agents etc. may do so.

Whatever the business activities may be, the principles remain the same for preparing
accounts in any situation.

Branch accounts may be considered to fall into two main categories of accounting
problems namely; branch accounts with the main trading Centre (head office) and
subsidiary trading centres (the branches), but the with all accounting records being
maintained by the head office.

Separate entity branch accounts where branches maintain their own records which
must be combined with head office records in order to prepare accounts for the whole
business.

Generally the head office provides the finance for acquisition of branch premises,
fixtures and fittings and other non-current assets, and will usually supply all goods for
resale to the branch. In this way, a centralized and a more competitive buying and
pricing can be maintained although some branches may be allowed to make some local
purchases and set prices according to local conditions (competition from other stores).

Cash takings will often be banked on a daily basis to the head office bank account
without making any deductions for expenses, the head office supplying funds for
wages, local advertising, administration and running expenses.

Although not a separate legal entity, the branch usually functions as a fairly
autonomous unit and maintains the accounts related to its sales, inventory, debtors and
creditors etc. The degree of independence and control maintained by the head office
over the branch is a matter of management policy, which may result in many high breed
forms of branch operations.

Whatever the exact organizational form, a branch office operations may be accounted
for separately either because it is more convenient to keep to keep separate records or
because a determination of the branch profit /loss account is desired or both.

The objectives of an accounting system therefore should be to enable management at head

office to;

To identify the level of sales and expenditure for each branch and hence the profit /loss
account by the branch.

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To control inventory held at each branch by knowing how much inventory there should
be at any given moment and by making checks to ascertain whether actual inventory
held at the branch is consistent with the theoretical figure. Inventory is often
transferred to the branch at selling price.

There are two methods of keeping the books

 The head office maintains and keeps all the accounting records.

 Each branch has its own accounting system.

BRANCH ACCOUNTS: THE HEAD QUARTER KEEPS THE BOOKS.

As the head office maintains all accounting records, it is able to record the branch
inventory and operations quiet precisely.

Goods may be sent to the branch and record at

i) Selling price of the branch

ii) Cost price plus certain mark-up percentage

iii) Cost price to the head office

Method (i) or selling price of the branch is the most commonly adopted as it gives the
greatest amount of control over the branch inventory

The accounts that the head office must incorporate into its ledger to deal with the
branch include;

i) The branch stock control account

ii) The branch markup account (or branch adjustment account)

iii) The goods sent to branch account and where necessary

iv) The branch cash and bank accounts

v) The branch debtors account (where the branch sells goods for cash and credit)

vi) The branch expense accounts

The branch stock account is maintained at selling price, being debited with goods sent
to branch and credited with sales, returns to head office, shortages or mark down. The

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balance on the branch stock account should always represent the stock of unsold goods
at selling price.

The branch markup account is effectively the trading account for the branch and is
credited with the mark up that is the potential gross profit on goods held by the branch
where goods are returned to head office or are lost, stolen, destroyed or marked down
the markup account must be debited appropriately, the potential gross profit thus
being reduced.

At the end of the accounting period, the markup on unsold stock or goods (that is
future gross profit) is carried down while the balance (profit or loss) is transferred to
the main profit and loss account.

Students are sometimes asked for a branch profit and loss account. The gross profit of
the branch is derived in the usual way from the branch markup account. Expenses
attributable to the branch may then be deducted to arrive at the net profit earned by
the branch.

The goods sent to the branch account is maintained at the cost price (being credited
with goods sent to branch and debited with goods returned to the head office) and at
the end of the accounting period is closed off to head office purchases (or trading
account) in order to reduce the head office cost of sales figure.

BASIC ACCOUNTING ENTERIES

1. When goods are sent to the branch.

Dr. Branch stock account.

Cr. goods sent to branch account.

Cr. branch markup account

2. When goods are returned by the branch above.

Cr. branch stock account

Dr. Goods sent to branch.

Dr. Markup

3. When sales are made by the branch.

Dr. Consideration (cash, debtors)

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Cr. Branch stock account

4. When cash is received from debtors

Dr. Cash

Cr. Branch debtors

5. Discount allowed, Bad debts

Dr.Branch expenses (could be individual)

Cr.Branch debtors

6. For agreed allowances to customers, off selling price already taken into account when
invoicing that’s to say Mark down.

Dr. Mark up account

Cr Branch stock account

7. When goods are returned by Branch debtors.

Dr. Branch stock account

Cr.Branch debtor’s account

8. When branch debtors return goods direct to Headquarters.

Dr. Goods sent to Branch

Dr.Branch mark up

Cr.Branch debtors

LOSSES

Normal losses are a result of brokerage, waste etc. These affect the mark up.

Abnormal losses are treated as expenses loss. For example theft, stealing and catching
fire.

9. Where there is a normal loss

Dr. Branch markup.

Cr. Branch stock with the full value of the loss at selling price.
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10 Where there is an abnormal loss

Dr.profit and loss account

Dr.Markup (within only markup)

11 Expenses paid in cash.

Dr. Branch expenses

Cr.Cash Account

12. Stock stolen or lost on transit.

Dr. Goods sent to branch accounts

Dr. Branch markup

Cr .Branch stock account.

Dr. Stock lost account on transit

Cr.Purchases Account

NB: if no insurance proceed are got, the stock lost is treated as an expense, or
otherwise the balancing figure is taken to the income statement either as a loss or gain.

Dr. Cash Account

Cr.Stock lost

Cr.Gain a/c

Example One:

ABC Company Ltd has head offices in Kampala and operates a branch in Masaka .The
following information relates to Masaka branch for the year ending 31 st December
2015.

Balance b/d 1st January 2015:

Branch inventory Shs 160,000

Branch accounts receivable Shs 130,000

Closing balances 31st December 2015

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Inventory Shs 240,000

Transactions for the year

Goods sent to the branch shs 900,000

Goods returned by the Shs 30,000

Cash sales Shs 920,000

Cash received from customers shs 860,000

Bad debs written off Shs 12,000

Cash stolen at branch Shs 12,000

Goods stolen at branch Shs 10,000

Discounts allowed shs 8,000

Returns by the branch customers shs 70,000

Branch expenses paid

Salaries shs 60,000

Rent and rates Shs 40,000

General expenses Shs 16,000

NB: Goods are sent to by the head office to the branch at a Cost.

Required:

Prepare the following accounts in the head office books relating to Masaka Branch for
the year ended 31st December 2015.

a) Branch inventory Account

b) Branch accounts receivable

c) Branch profit and loss

d) Branch goods sent

e) Branch cash account

f) Branch expense account

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Example 2.

Dragon Ltd whose headquarters is in Kampala operates a branch at Masaka. All goods
are bought by head office and invoiced to and sold by Masaka Branch at a cost plus
331/3%. Other than the sales, all the transactions are recorded in the books of
Kampala. The following details are given of the transactions at the branch during the
year ended 28th February, 2015

Stock at hand 1st March 2014 invoice price Shs 26,400,000

Debtors on 1st March 2014 Shs 23,676,000

Stock at hand on 28th February, 2015 at invoice price Shs 23,688,000

Goods sent from Kampala during the year at invoice price Shs 148,800,000

Credit sales Shs 126,000,000

Cash sales Shs 14,400,000

Returns to head office at invoice price Shs 6,000,000

Invoice value of stolen goods Shs 5,600,000

Bad debts written off Shs 888,000

Cash from debtors Shs 134,400,000

Normal loss at invoice price due to wastage Shs 600,000

Cash discount allowed to debtors Shs 2,568,000

Required:

Write up the following accounts as they would appear in books of the books of the
head office for the year ended 28th February 2015

a) Branch stock account

b) Goods sent account

c) Branch debtors account

d) Mark up /inventory adjustment account.

e) Branch expense account

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INTER BRANCH TRANSFERS

Audi Ltd vends motor vehicle components from its head office in Kampala and through
its two branches at Masaka and Jinja. All parts are purchased by Kampala and
transferred to the branches at selling price. The company’ prices are based on standard
markup of cost plus 25%. All accounting records are kept at head office.

The following figures relate to the stock balances and transactions at the branches. All
expressed in terms of transfer prices.

MASAKA JINJA

SHS SHS

Opening stock balance 700,000 900,000

Transfer from Kampala 8,900,000 10,900,000

Transfers to Jinja 300,000 ………………

Transfers from Masaka ……………… 300, 0000

Sales 8, 740, 0000 11,460,000

Closing stock 548,000 512,000

The figures for closing stock were determined by means of a stock account at the end of
the year. Audi ltd has a policy of treating stock losses up to Shs 20,000p.a at any branch
as normal. Other losses are treated as abnormal and are investigated.

Required:
a) To prepare for each branch,

b) The branch stock account

c) Goods sent account

d) Markup account

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TOPIC 5: CONSIGNMENT ACCOUNTS

When a seller sells gods directly to customers whether there are in his home country or
overseas, these are ordinary sales. However, a trader may send goods to an agent to
sell them for him. These goods are said to be on Consignment.

MAIN FEATURES OF CONSIGNMENT ACCOUNTS

 The trader sends goods to the agent. The goods do not belong to the agent. His job is to
sell them and the goods are owned by the trader until they are sold.

 The agent will store the goods until they are sold by him. He will have to pay some
expenses but these will be later refunded by the trader.

 The agent will receive a commission from the trader for his work. The agent will collect
money from the customers to whom he sells the goods. He will pay this over to the
trader after deducting his expenses and commission.

 The statement from the agent to the trader showing how gods were sold and expenses
deducted is called the account sales.

 The trader sending the goods is called the consignor and the agent is called the
consignee.
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MAIN ACCOUNTS IN CONSIGNMENT ACCOUNTS

Example one

Wills of London whose financial year ends 31st December 2015, consigned goods to
Adams his agent in Canada. All transactions were started and completed in 2015.

January 16th 2015 Wills consign goods costing 500 pounds.

February 28th Wills paid carriage to Canada 50 pounds.

Adams the consignee sends account sale to the trader on 31st July when all goods have
been sold. It shows the following

Sales amounted to 750 pounds.

Expenses of Adams were,

Import duty 25 pounds

Distribution expenses 30 pounds

Commission had been agreed at 6% at sales.

Adams paid balance of 650 pounds.

Required:

All necessary accounts in the books of the agent and the trader.

Example 2

On 1st January, Samuel consigned 100 cartons of merchandise to Nathanael in the

Channel Islands having made the following expenses.

Cost of merchandise 1,500 pounds

Carriage to port 80 pounds

Insurance 40 pounds

Nathanael who was entitled to a commission of 5% on sales paid freight at the rate of 3
pounds per carton and 90 pounds as port charges. He sold 60 cartons at 25 pounds
each and 30 cartons at 27.50 pounds each having 10 cartons in stock on 31st March.

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Samuels’ accounting year ended on 31st March.Nathanel forwarded an account sale

with a sight draft with balance due.

Required:

Prepare

a) Nathanael’s account sale.

b) Nathanael’s Ledger books to shoe the transactions

c) Ledger accounts recording Nathanael’s transactions in Samuels’ books.

TOPIC 6: DEPARTMENTAL ACCOUNTS

Organizational operations may be organized in departments and each department
headed by a departmental head.

Departmental accounts help organizations to know how well or badly, each part of
business was performing. The reputation of many successful business persons has been
built on the ability to utilize the departmental accounting principle to guide their
actions to increase profitability of a business.

To find out how profitable each department is, we have to prepare departmental
accounts to give us the facts for each department.

In retail stores accounting, although all departments may be in the same building, it is
useful to control operations by finding the net profit of each department as well as for
the total business.

Usually, trading and profit and loss accounts are prepared in columnar form for each
department and the business as a whole. An important aspect of departmental
accounting is allocation and apportionment of profit and loss expenses to various
departments.

Direct expenses are easily allocated as separate records are usually kept for each
department. However, where a number of departments share in the used of facilities
such as canteen service or administration for processing invoices and other documents,

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some method must be found to apportion the expenses (overheads) on the most
equitable basis to departments.

In practice, several bases of apportionment are used depending upon some relationship
of the expense to the benefit derived by the respective departments.

Allocation. This is where direct expenses are easily allocated to the respective
departments as separate records are usually kept for each department.

Apportionment. This is used when expenses are incurred by the business as a whole
and the common methods used are.

TYPICAL OVERHEADS AND THEIR BASES OF APPORTIONMENT

OVERHEAD BASE

Supervisors’ salary: Time spent in respective departments or production

out put

Power, heating and Lighting: Measured units of electricity or floor area.

Insurance: Floor area, average book value of assets insured.

Canteen services: number of employees

Advertising and selling expenses: Sales value

General administration: Number of employees or the sum of purchase

costs and sales value (linked to the volume of proper work involved).

The expenses of the business are often split between the various departments and the
net profit for each department is then calculated. Each expense is divided between the
departments of what is considered to be most logical basis. This will differ considerably
between businesses.

Direct costs are allocated entirely to the department which would not be paid if the
department closed down and indirect cost /expenses are appropriated.
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Purchase made for one department may be subsequently sold in another department.
In such a case, the items should be deducted from the figure for purchase of the
original purchasing department and added to the figure for purchases for the
subsequent selling department.

The normal problems of preparing accounts (provisions, adjustments, debtors,

creditors, accruals and prepayments) will of course apply. Indeed, records may be
complete and unknowns may have to be calculated before accounts can fully be
prepared.

Another problem which often arises concerns the payments of commission to the
department managers, usually calculated as a percentage of the net profit after
charging that commission. In the latter case, the commission is calculated by applying
the ratio to

COMMISSION PERCENTAGE: (100+ COMMISSION %)

The net profit before commission figure.

If the commission is 5% of the net profit before charging the commission, the ratio 5%
is applied to the net profit before commission.Forexample, if the department makes a
net profit of 5,720 dollars before commission and the departmental manager is entitled
to a commission of 10% of net profit after charging his commission, his commission can
be calculated as

10/100*5,720 = 520

This is of course equal to 10% of the profit after commission 5,200.

INTERDEPARTMENTAL STOCK TRANSFERS

Goods may be moved from one department to another. It should be borne in mind that
both the giving and the receiving departments belong to the same accounting entity
and neither department should realize any income on stock held by the receiving
department should be valued either at cost or at selling value.

To avoid measuring and reporting income on interdepartmental stock transfers, goods

transferred from one department to another should be shown separately on both the
debit and credit sides of the departmental trading account. The contra entry is to debit
the trading account of the receiving department and credit the trading account of the
giving department.

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ADVANTAGES OF DEPARTMENTAL ACCOUNTS

 Easy to compare the contribution to total profit made by each department by simply
calculating the percentage of gross profit on sales for each department.

 Quickly reveals loss making departments which may be closed down or may be re
organized more efficiently.

 Provides financial accounting information for comparing results of different

departments for different years especially if accounts and records are prepared in
columnar format.

 Easy to ascertain the profitability of each department.

 Provides a means of controlling departmental sales and profits.

 Serves as a morale booster especially where departmental managers and supervisors

are remunerated on the basis of their results.

 Stimulates healthy competition among departments which leads to efficiency in

managing the business.

DISADVANTAGES OFD DEPARTMENTAL ACCOUNTS

 Leads to extra costs in terms of hiring extra clerical staff to analyses and maintain
additional ledger accounts.

 Information reflected on departmental accounts may lead to false information.

 It may lead to unhealthy competition and friction among departmental managers,

supervisors and staff if they are not more guided.

COMPUTATIONS:

There are two methods while dealing with departmental accounts that is to say

Gross profit basis (usual method)

Contribution basis

NB: the balance sheet does not normally show assets and liabilities split between
different departments.

Example one:

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The following information relates to northern stores with three departments.

Jewelry Hair Clothing

Pounds Pound Pounds

Inventory of goods / materials at 1st January 2015. 20,000 15,000 30,000

Purchases 110,000 30,000 150,000

Inventory of goods/materials at 31st Dec 2015. 30,000 25,000 40,000

Sales and work done 180,000 90,000 270,000

Wages of assistant in each department 28,000 50,000 60,000

The following expenses cannot be traced to any particular department.

POUNDS

Rent 8,200

Administration expenses 48,000

Air conditioning and lighting 6,000

General expenses 2,400

It is decided to apportion the cost of rent together with air conditioning and lighting in
accordance with the floor space occupied by each department. These were taken up in the
ratios of

 One fifth

 Half

 Three tenth.

Administration expenses and general expenses are to be split in the ratio of sales and
work done.

Required:

Use both Gross profit method and contribution method to find the Net profit for the
various departments and for the whole business.

Example two:

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MKH is a proprietor of a shop selling books, periodicals, newspapers and children’s

games and toys. Their business is divided into two

Department A: Books, periodicals and news papers

Department B: games, toys and fancy goods.

The following balances have been extracted from their nominal ledger at 31 st 2015.

DR. CR.

SHS SHS

Sales

Department A 15,000,000

Department B 10,000,000

Stocks 1st April 2014

Department A 250,000

Department B 200,000

Purchases

Department A 11,800,000

Department B 8,200,000

Wages of sales assistants

Department A 1,000,000

Department B 750,000

Newspaper delivery wages 150,000

General office salaries 750,000

Rates 130,000

Fire insurance: Buildings 50,000

Lighting and air conditioning 120,000

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Repairs to premises 25,000

Inter telephone 25,000

Cleaning 30,000

Accountancy and auditing charges 120,000

General office expenses 60,000

Stocks at 31st March 2015 were valued at

Department A: Shs 30,000

B: Shs 150,000

The proportion of the floor occupied by each department was

Department A: one fifth

B: four fifth

Floor area is to be used to apportion rates, fire insurance, lighting, air conditioning,
cleaning, repairs and telephone.

Turnover will be used to apportion general expenses, general office salaries and
accountancy fees.

Required:

Prepare an income statement for the year ended 31st December 2015. (Use gross profit
method).

TRY OUT THIS NUMBER

Below is a list of balances for DK ltd for the year ended 2015.

SHS SHS

Rent and rates 4,200

Delivery expenses 2,400

Commission 3,840

Insurance 900

Purchases: Department A: 52,800

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B: 43,600

C: 34,800 131,200

Discount received 1,968

Salaries and wages 31,500

Advertising 1,944

Sales department A: 80,000

B: 64,000

C: 48,000

Depreciation 2,940

Opening stock Department A: 14,600

B: 11,240

C: 9,120

Administration expenses and general expenses 7,890

Closing stock Department A: 12,400

B: 8,654

C: 9,746

The following information also relates to the expenses.

Except as follows: expenses are to be apportioned equally between departments.

Delivery expenses: proportionate to sales

Commission 2% of sales

Salaries and wages, insurance in proportionate of 6:5:4

Discount received 1.5% of purchases.

Required: An income statement in columnar format to the transaction detail per

department.

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TOPIC 7: COMPANY ACCOUNTS

A company is an association of persons who come together and combine resources to
form a separate entity which is distinct from those who formed it.

A company or corporation is therefore a legal entity separate and set apart from its
members or shareholders. This legal personality is an artificial which is distinguishable
from natural personality.

TYPES OF COMPANIES

Under the companies Act, provision is made for the different types of companies that
can be lawfully formed in Uganda. The different types of can be classified into two
categories

PRIVATE COMPANIES

A private company is where two to fifty people come together to contribute capital to
set up a business with the aim of making profits.

CHARACTERISTICS OF PRIVATE COMPANIES.

They must have a minimum of 2 members.

Shares are not freely transferable like in a public company but must first seek consent
of the directors of the company.

The minimum number of members in a private company is 50 excluding past and

present employees.

It cannot advertise to the public inviting members of the general public to come and
buy its shares and debentures.

Only one director is required in case of a private company. This means that for such
company to commence business there must be a minimum of at least one director.

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A private company can commence business immediately upon incorporation. That is it

can start doing business as soon as it is formed or registered with the registrar of
companies and issued with a certificate of incorporation.

A private company requires a quorum of 2 members at a general meeting for any valid
business of the meeting to be conducted.

PUBLIC COMPANIES

A public limited company is when 7 to infinity people come together and contribute
capital with a view of maximizing profits.

CHARACTERISTICS OF PUBLIC COMPANIES.

A public company must have a minimum of 7 members at its formation but there is no
maximum limit.

A public company requires a minimum of 2directors. There must always be a minimum

of 2 directors for such a company to legally operate.

A public company cannot commence business immediately upon incorporation but

requires a trading license to do so.

A public company must hold a statutory meeting between 1-3 months from the date it
started doing business.

The quorum in the general meeting for such company is 3 members.

A public company can issue a prospectus to the public encouraging them to acquire
shares in their company. Thus, the decisive advantage of public company over private
company is its rights to raise capital.

A company whether private or public may be

Limited by shares

Limited by guarantee

Unlimited

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A company limited by shares. This is where the memorandum of association limits the
liability of its members to the amount.

A company limited by guarantee. This is one where the liability of its members is limited
to such amounts as they may have undertaken to contribute to company assets in the
event of winding up. These companies are not profit motivated and are commonly
charitable organizations. For such companies, it must be stated in the memorandum of
association that the members undertake to pay a specified amount of money on
winding up of the company in the event that the assets of the company available are no
sufficient to meet the debits of the company.

Unlimited companies. These are companies where the liabilities of members have no
limit.

Statutory companies. These are formed by Acts of parliament and do not go through
the process of incorporation as stipulated under the companies Act. Parliament seats
and enacts a law which brings into existence such a company. The said law provides for
the objects of the company, its management, appointment among others. Such
companies are normally intended to provide social amenities for example NWSC,
Uganda Revenue Authority.

Corporation sole. These consist of one human member at a time being the holder of an
office. They are mostly created by the Acts of parliament but may also be created by
constitution or common law. For example the office of the Kabaka created by the
constitution and the Administrator created by Acts of parliament.

FORMATION OF A COMPANY

A company is formed by registering it with the registrar of companies and obtaining a

certificate of incorporation. To register a company, a number of documents must be
presented and these include the following.

Memorandum of association. This is the most important documents because it

determines the powers of the company. It lays down the various activities or nature of
business the company has been formed to engage in. it contains the following

Name of the company. Where it is a limited liability company, the name of the company
must end with the word “Limited “.

Location of registered office of the company. It must state that the registered office of
the company is situated in Uganda.

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The actual address of the company must be communicated to the registrar within 14
days after incorporation.

Objects clause. This entails the objective or activities the company has been set out to
deal in.

Nature of the company. Whether private, public or any other kind.

If the company is limited by shares, the amount of share capital and division must be
stated.

If the company is limited by guarantee, the amount each member undertakes to

contribute to assets of the company in the event of winding up must be stated.

The names, addresses and descriptions of subscribers who must at least be 2 for a
private company and 7 for a public company.

It must bear stamp duty. That is tax called stamp duty must be paid..

It must be signed by each subscriber /member in the presence of at least a witness who
must attest to the signature.

Articles of Association. These contain regulations for managing the internal affairs of
the company. They are applied and interpreted subject to the memorandum of
association in that they cannot confer wider powers on the company than those in the
memo.

Thus, where is a conflict or divergence between the memo and articles, the provisions
of memo must prevail.

However, it has been suggested that where the memo is ambiguous or silent on a
particular issue, it may be permissible to resort to the articles in order to solve
ambiguity in the memo.

For an unlimited company and a company limited by guarantee, it is a requirement to

register this document. But for a company limited by shares it is optional. If such a
company does not register one, the articles contained in Table A of the companies Act
are presumed to apply as the Articles of association of the company.

Prospectus. This is a document setting out the nature and object s of a company and
inviting the public to buy or subscribe for its shares. It sets out the numbers of founders
of the company, share qualifications of the directors, names, description, and number
of shares offered to the public for subscription, company property.
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The purpose of the prospectus is to provide the essential information about the
position of the company when its being launched so that those interested in investing
in the company can decide whether not to invest.

This document is only a requirement for public companies and private companies do
not file it because they are not allowed under the law to invite members of the general
public to come and buy its shares.

Statement of nominal capital. This is the document in which the directors of the
company state the capital of the company with which the company is starting to
operate upon its registration and the amounts into which it is to be divided.

Statutory declaration of compliance. This is a statement declaring that all the necessary
requirements of the law under the companies Act on the formation of a company have
been complied with. This document is signed by a legal practitioners /lawyer engaged in
the formation of a company or by a person named in the articles as a director or
company secretary.

List of names and particulars of directors and secretary. In this document, the names of
all the directors and the secretary must be stated as well as their occupations,
addresses, the document must also contain an undertaking by the directors to take and
pay for their qualification shares in the company in case the director is required to hold
such. However, it is not a must for a private company to file this document on its
formation. It can file it even long after the company has been formed. However, for a
public company to be incorporated, this document must be filed together with other
documents.

Reservation of the name. The promoters forming the company or their advocate must
write to the registrar of companies requesting him to search the register of companies
and reserve its name. The search is aimed at ensuring that there is no other name
already registered that is similar to that of the company. However, for the registrar to
register the said name, the following must be satisfied. The name will be reserved if;

It has not already been registered previously.

It does not show concern with the government.

It is not identical with the one that has already been registered so as to confuse the
public.

It is not illegal or has abusive connotations.

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Certificate of incorporation. This is a document that grants permission to a private

limited company to commence business upon registration.

Trading License. This is a document that grants permission to a public limited company
to commence business upon registration.

CAPITAL OF A COMPANY
The term capital means a particular amount with which a business is started. In case of
a company, the term capital refers to the amount raised by issue of shares.

In relation to legal accounting point of view, the capital of a company is classified on the
basis of the amount stated in the capital clause of association.

The capital is fixed after making careful analysis of the present and future requirements
of the company.

Capital of the company is generally divided into the following categories;

CLASSES OF CAPITAL

Authorized / registered capital. This is the maximum amount of capital which a

company can issue. It’s authorized capital because the company has an authority to
issue this much and registered capital because the maximum amount limit of the
capital to be issued is fixed at the time of registration of the company. It is mentioned in
the capital clause of its memorandum of association and while deciding about the
authorized capital, the present and future needs of the company are carefully worked
out.

However, if at any stage a company wants to issue more capital than the authorized,
then it will have to alter capital clause in its memo.

It’s also known as registered capital /nominal capital.

Issued and un issued capital. Issued capital is that part of authorized capital which is
actually offered to the public for subscription in the form of shares. Therefore the
balance of authorized capital remaining to be issued is called unissued capital.

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For example, if the authorized capital of the company is Shs1,000,000 and the company
issues shares valuing Shs700,000.calculate.

Issued share capital = authorized capital – issued capital

1,000,000-700,000

=Shs300 000

Subscribed Capital. It is that part of issued capital for which applications for
subscriptions have been received from the public. For example advertising 100,000
shares for each 10 shillings and all taken up.

Paid up capital. The paid up capital is the amount of capital which has been paid up by
the shareholders on application each share.

Reserve Capital. This is the capital created in respect of the uncalled capital of the
company. It is the amount which is not callable by the company except in the case of
the company being wound up. It is created by means of a special resolution passed by
the company in its general meeting by ¾ majorities of those voting on it.

Called up capital. This is capital due on shares subscribed and allotted and also
collected from the respective shareholders in installments at different intervals. For
example a company may issue 100,000 shares at 3 shillings each. Sometime the
company is not so in need of money but what it does it makes calls on several basis and
shareholders will pay later.

COMPUTATIONS AND ACCOUNTS OF THE COMPANY

CALLS

A call is a demand served to shareholders to pay money for the shares issued to them.
In most cases, calls are issued in installments. That is

1st call

2nd call

3rd call

4th and final call

TYPES OF CALLS

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Calls in advance. These are calls which are paid for before they fall due. They are shown
I the balance sheet liability side and as a result, attract an interest. This interest is
treated as an operating expense to be debited in the profit and loss account.

Calls in arrears. These are calls which are not yet paid for. They are treated as debtors in
respect of the shareholder that have not paid them.

Money received on calls for shares issued is recorded in the share capital account in
respect to transferring the money due for applications ,allotment and calls account to
the share capital account.

NB: money received for calls is treated as money received for application and
allotment.

ACCOUNTING ENTRIES WHEN CALLS AREMADE.

When a call is made on a share that is the total value of money payable on a call as
decided by the directors.

Dr. Call A/c

Cr. Share capital A/c

When call money is received

Dr. bank A/c

Cr. Call A/c

When calls are in arrears.

Dr. Calls in arrears A/c

Cr. Call A/c

ISSUE OF SHARES AT APREMIUM

This is when shares are issued at a higher price than their nominal value. For example a
share of Shs20 being sold at Shs25, for the Shs5 which is a difference is above the
nominal value is referred to as the premium.

ACCOUNTING ENTRIES TO RECORD SHARES ISSUED AT A PREMIUM

When allotment is made

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Dr. Application and allotment account

Cr. the share capital account with a nominal value payable on application and
allotment .

Dr. application and allotment account

Cr. the share premium account with the premium value.

When allotment money is received.

Dr. Bank A/c

Cr. application and allotment account with amount received for allotment including
premium.

ISSUE OF SHARES AT A DISCOUNT

Shares are issued at a discount when they are issued at a lower price than the nominal
value. For instance a share of Shs20 being sold at Shs15, the discount is being the Shs5
which is the difference between the two.

NB: it is not a common practice of accompanies to issue shares at a discount. The

company law may also restrict the issue of shares at a discount.

ACCOUNTING ENTRIES TO RECORD SHARES AT A DISCOUNT

When allotment is made.

Dr. application and allotment account

Cr. Share capital account with nominal value payable on application and allotment.

Dr. Share capital discount account

Cr. application and allotment account with discount value.

When allotment money is received.

Dr. Bank account

Cr. Application and allotment account with amount received on allotment A/c including
the discount provided.

ISSUE OF SHARE AT PAR

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This is when shares are issued at their nominal value on the market. For example a
share whose nominal value is Shs25 being sold at Shs25.

SUBSCRIPTION OF SHARES

This refers to where a public applies for shares advertised by a public limited company.

OVER SUBSCRIPTION OF SHARES

This is a situation where by shares applied for are more than those issued or subscribed
by the director.

In such a situation the directors may opt to do one of the following;

To reject some of the applications and therefore issue no shares to the applicants.

To make a pro-rata issue that is a fractional issue of the shares by issuing shares to all
applicants on some proportional basis.

To use a combination of the two.

THE PRO-RATA BASIS

This is a fractional issue of shares by issuing shares to all applicants on some

proportional basis. When a company issues a fraction of shares applied for, it must
make a refund for the fraction of shares that were not allotted.

When these applicants are allotted some shares, they become liable for payment of the
required balance on their respective shares allotted other than refund.

The company therefore has to retain the used money for application to make payment
against the allotment money when it becomes due.

ACCOUNTING ENTRIES

On application, the total value of application money received should be received.

On allotment, the applicants who received a fraction of shares applied for should pay
the allotment money less by the excess money from the application.

UNDER SUBSCRIPTION OF SHARES

This is when fewer shares are applied for than are available for issue.

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If the applications are less than the minimum stated, then the application monies must
be returned to the applicants. This does not apply to an established company, if
therefore 1000 shares of 1 pound each are available issue but only 875 shares are
applied for, then 875 will be issued, assuming that this is above the fixed minimum
figure.

The accounting entries will be in respect of 875 shares, no entries being need for the
125 shares not applied for, as this part does not represent a transaction.

FORFEITURE OF SHARES

This is when shares are fully withdrawn from the shareholders by a declaration of
forfeiture as resolved by the directors.

A person whose shares have been forfeited ceases to be a member of a company in

respect of the forfeited shares but remains liable to pay all the companies expenses
which at a time of forfeiture were due but unpaid.

BASIC ACCOUNTING ENTRIES TO RECORD FORFEITED SHARES

On forfeiture of shares

Dr. Share capital Account

Cr. Forfeited share capital Account (with the nominal value of shares.)

When there is an amount of unpaid money on the shares.

Dr. forfeited Shares account

Cr. calls in arrears account.

When there is an amount unpaid on the premium on the forfeited shares, it will create
a balance on the forfeited shares account which will always result into a credit balance
brought down and therefore has to be shown in the balance as a capital reserve
because it is a capital gain.

RE-ISSUE OF FORFEITED SHARES

After the forfeiture, the company may re-issue the shares, unless there is a provision in
the articles of association to prevent. There are certain conditions as to the prices at

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which the shares can be re-issued. These are that the amount received on re-issue plus
the amount received from original shareholder should at least equal to

The called up value where the shares are not fully called up.

The nominal value where the full amount has been called up.

Any premium previously paid is disregarded in determining the minimum re-issue price.

The forfeited shares therefore can be re-issued but the amount received from the
original shareholder and the subsequent purchaser must amount to the nominal value
of the shares. Therefore any surplus from the re-issue should go to the share premium
account.

ENTRIES FOR FORFEITED SHARES RE-ISSUED

On the re-issue

Dr. forfeited shares re-issued account

Cr. share capital with the nominal value of shares re-issued.

When money is received in respect to forfeited shares re-issued.

Dr. Forfeiture A/c

Cr. forfeited shares re-issued a/c

When money is received.

Dr. Bank A/c

Cr. Forfeited shares re-issued A/c with the amount received on forfeiture.

With balancing figure on forfeited shares.

Dr. forfeited shares re-issued account

Cr. share premium account (balancing figure on forfeited shares re-issued).

APPLICATION AND ALLOTMENT

Application in this case refers to the situation where people send in their applications to
subscribe for shares in a company.

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Allotment is an allowance to people to by the company to join it through the sale of its
shares.

METHODS OF APPLICATION AND ALLOTMENT

SEPARATEAPPLICATION ACCOUNT FROM ALLOTMENT ACCOUNT.

This is where a separate application account is drafted and a separate allotment

account is also drafted in the books of account of the business.

APPLICATION ACCOUNT AND ALLOTMENT ACCOUNT COMBINNED

This is where we join the application account and the allotment account and make it
one account in the books of the company.

ACCOUNTING ENTRIES MADE ON APPLICATION AND ALLOTMENT

When application money is received.

Dr. Bank account with application fees

Cr. Application and allotment A/c with application fees.

When refund is made to unsuccessful applicants.

Dr. Application and allotment account

Cr. bank account

When allotment of shares is made. This is the total value payable on application and
allotment as decided by the directors and allotment is done only on successful
applicants.

Dr. Application and allotment account

Cr. Share capital account

When allotment money is received.

Dr. bank account

Cr. application and allotment account.

EXAMPLE ONE

A Ltd issued 50,000 shares of Shs10 each at par on July 1st 2015.
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Required: Show the relevant entries in the ledger accounts.

Solution

Share capital = 50,000*10

= Shs500,000

DR BANK ACCOUNT CR

2015 JULY 1ST SHARE CAPITAL A/C

500,000

DR SHARE CAPITAL ACCOUNT CR

2015 JULY 1ST BANK A/C

A500,000

EXAMPLE TWO

B ltd issued 50,000 shares Shs10 each at Shs13 on January 1 st 2015.

Required:

Show the entries in the relevant ledger accounts.

Share capital = 50,000*10

= Shs500,000

Share premium = (13-10)50,000

= Shs150,000

DR BANK ACCOUNT CR

2015 JAN 1ST SHARE CAPITAL A/C Balance c/d 650,000

500,000
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2015 JAN SHARE PREMIUM A/C

150,000
650,000

650,000

Balance b/d 650,000

DR SHARE CAPITAL ACCOUNT CR

2015 JAN 1ST BANK A/C

500,000

DR SHARE PREMIUM ACCOUNT CR

2015 JAN 1ST BANK A/C

500,000

EXAMPLE 3

C ltd issued 10,000 debentures of shs100 each at 95 on January 1 st 2015.

Required:

Show the necessary ledger accounts in the books of C ltd.

Debenture capital = 10,000*100

= 1,000,000

Discount = (100-95)10,000

= Shs50,000

Bank receives =1,000,000-50,000

= Shs950,000

DR BANK ACCOUNT CR
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2015 JAN 1ST Debentures 950,000

DR DEBENTURE ACCOUNT CR

2015 Jan bal c/d 2015 JAN 1ST BANK A/C

1,000,000 950,000

January 1ST Discount on debenture

50,000
1,000,000

1,000,0000

DR DISCOUNT ON DEBENTURE ACCOUNT CR

2015 JAN 1ST

Debenture 50,000

Example 4.

Executive consultancy group International Limited issued 1,000 shares of Shs100 each
at par payable as follows.

On application Shs40

On allotment Shs60

Application were received for 1,200 shares where upon allotment, applicants for 200
shares

Were rejected and their application money refunded.

Required:

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Journal entries for the above transactions

Draft ledger accounts to show the above transaction.

The balance sheet as at that date.

Example 5.

X trading company offered 100,000 ordinary shares of Shs10 each at a premium of Shs2
payable in installments as below.

On application Shs3

On allotment including premium Shs7

On the first and final call Shs2

Applications were received from 130,000 applicants who were allotted shares as
follows.

The applicants for 80,000 shares were fully accepted.

The applicants for the 40,000 shares only 20,000 were allotted.

The applicants for 10,000 were rejected.

Excess monies for partially accepted applicants are to be used for allotment.

All monies due on allotment and 1st and final calls were received except for Ziwas’ 6,000
shares which he failed to pay for on the first and final call.

Required:

Open up respective ledger accounts

A balance sheet extract as at that date.

TRY OUT THIS NUMBER

AB ltd company offered 100,000 ordinary shares of 1 pound each at par payable as
follows.

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On application 0.35 pound

On allotment 0.35 pound

On first and final call 0.30 pound

Applications were received for 120,000 shares on July 1 st 2015, applications for 10,000
shares were rejected and application money was refunded to unsuccessful applicants.

Allotment was made on the July 10th 2015 and applicants for 20,000 shares were
allotted on half of the number for which they had applied, excess application money
being used to reduce the amount due on allotment. On 15th July, all money due on
allotment was received. The first and final call was made on 1st September 2015 and the
money due on call made was received on 10th September.

Required:Show the necessary entries to record above matters in the company Bank
account and ledger balancing off the end of September 2015.

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TOPIC 8: RATIO ANALYSIS

Interpretation of financial statements is the analysis of financial statements in order to
discover the strength and weaknesses of a company and reveal under trends in its
activities.

REASONS FOR INTERPRETATION OF FINAL ACCOUNTS

To know which company or business gets the best profit.

Financial statements would largely be uninformative to all but the very skilled.

USERS OF RATIOS

The final accounts are analyzed by the following

Ratio category Interested group

Profitability ratio Shareholders, management,

employees, creditors, competitors and
potential investors.

Liquidity ratio Shareholders, suppliers, creditors and

competitors.

Efficiency ratio Shareholders, potential purchasers

and competitors.

Shareholder ratio Shareholders and potential investors

Capital structure ratio Shareholders, lenders, creditors and

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potential investors.

HOW TO USE RATIOS

Ratios need very serious handling. They are extremely useful and if used and
interpreted appropriately and may be misleading otherwise.

PRINCIPLE TECHNIQUES USED IN THE INTERPRETATION OF RAIOS ARE

Accounting ratios

Funds flow statement

These techniques are explained as under

ACCOUNTING RATIOS

These are the means of presenting in form of ratios, or percentages, the information
which enables a comparison to be made between one significant figure and the other.

CATEGORIES OF RATIOS

1. PROFITABILITY RATIOS.

These help in measuring the profitability of the firm.

They include the following;

A. Return On Capital Employed. (ROCE). This is one of the most important profitability
ratios, as it encompasses all other ratios and because an adequate return on capital
employed is why people invest their money in business in the first place.

ROCE= Profit before interest and taxation x 100

capital employed

Capital employed means net capital employed or long term capital.

It is expressed as Capital employed = fixed assets + current assets –current liabilities

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Capital employed may also be arrived at in one of the three ways;

Fixed assets plus current assets, commonly called Gross capital employed.

Fixed assets plus current assets minus current liabilities, commonly known as net
capital employed.

Fixed assets plus current assets minus current liabilities and long term liabilities
commonly called shareholders capital employed or net worth or proprietor capital.

Limited companies

NB: there is no universally agreed definition of return on capital for companies.

The main ones used are

Return on capital employed sourced from ordinary shareholders.

Return on capital employed sourced from all long term suppliers of capital

Return on capital employed sourced from ordinary shareholders

This is also known as return on owners’ equity (ROOE) or more commonly return on
shareholders’ funds.

The return is the net profit for the period. The term shareholders’ funds mean the book
value of all things in the statement of financial position that describes owners capital
reserves.

Owners are the holders of ordinary share capital. This is calculated as;

Ordinary share capital plus all reserves including retained earnings.

Return on capital employed sourced from all long term suppliers of capital. This is also
known as return on capital employed.

The word return in this case means net profit plus any preference share dividends plus
loan notes and long term loan interest.

The word capital means ordinary share capital plus reserves including retained profits
plus preference shares plus loan notes and long term loan.

B. Return on investment. This measures the return on proprietors’ investment in the

company, being their total share capital plus the reserve that they indirectly own.

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Naturally, they are interested in the profits available for distribution. That is the post-tax
profit figure.

ROI = Profits after tax x 100

total share capital +reserves

C. Profit margin = profit before interest and taxation /sales

Asset turnover = sales x 100

capital employed

NB: return on investments = profit margin * asset turnover

2. REVENUE RATIOS.

These ratios measure the cost and profit structure of the company in relation to its
sales revenue.

They include the following;

Gross profit ratio. This ratio indicates the margin of sales price compared to factory or
bought cost.

Gross profit margin = gross profit x 100

sales

Net profit ratio. This indicates the percentage of net profit of sales revenue.

Net profit ratio = net profit X 100

Sales

Cost ratio.

Any item of cost may be expressed as a percentage of sales revenue

Cost of sales ratio= cost of sales X 100

sales

Selling and distribution expense ratio = selling and distribution expenses X 100

Sales

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Administration expenses ratio = Administration expenses X 100

Sales

3. CAPITAL RATIOS.

In the same way as revenue items, balance sheet figures can also be compared to one
another to give capital ratios.

Unlike revenue ratios, they are not usually expressed as percentages, but as ratios for
example 2:1

Capital gearing = fixed interest capital

Equity capital

Equity ratio =total capital employed

equity capital

Equity capital includes ordinary share capital and reserves attributable to ordinary
shareholders.

GEARING. The relationship of equity shares (ordinary shares) to other forms of long
term financing (long term loans plus preference shares) can be extremely important.

Analysts are therefore; keen to ascertain a ratio to express this relationship.

There in one way of calculating gearing. The most widely known method is as follows

Long term loans + preference shares X 100

ordinary share capital +reserves+ preference shares + long term liabilities

The formula is sometimes abbreviated to

Prior charge capital X 100

Total capital

CHANGING GEARING OF A COMPANY

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The management might decide that for various reasons it would change the gearing of
the company. Therefore, the following is done

TO REDUCE GEARING

Issue new ordinary shares

Redeeming loan notes

Retaining profits

TO INCREASE GEARING

Issue loan notes

By buying back ordinary shares in issue

By issuing new preference shares.

Such changes will be influenced by what kinds of investors the company wishes to
attract.

A highly geared company will attract risk taking buyers of ordinary shares, whilst a low
geared company will be more attractive to potential ordinary shareholders who wish to
minimize risk.

4. LIQUIDITY RATIOS.

These ratios measure the ability of the company to fulfill its current liabilities in an
abnormal situation. For example if trade collapsed or if a customer failed to pay a large
debt.

Liquidity is the ability with which one can pay debts as they fall due. Also known as
solvency.

These ratios include the following

Current ratio. This compares current assets which will become liquid within
approximately months with total current liabilities which will be done for payment in
the same period.

It is intended to indicate whether there are sufficient short-term assets to meet the
short-term liabilities.

Current ratio = Current assets

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Current liabilities

When calculated, the ratio may be expressed as either a ratio 1, with current liabilities
being set to 1, with current liabilities being set to 1 or as number of times representing
the relative size of the amount of total current assets compared with total current
liabilities.

With all ratios, once you have performed the calculation, you need to decide what it
tells you. To do so, there is no point in using universal guide, such as the ratio should
always lie between 1:1 and 2:1.

Any such guidance is at best useless and at worst misleading. Instead you need to
consider the result in its context, for example

What is the norm in this industrial sector? For example, retailers are often below 1:1?

Is the company significantly above or below the norm?

If so, can this be justified after an analysis of the nature of these assets and liabilities
and of the reasons for the amounts of each held?

In other words, you need to contextualize every ratio you calculate when you are trying
to understand what the result means, not just this one.

Acid test ratio. This shows that provided creditors and debtors are paid at
approximately the same time, a view might be made as to whether the business has
sufficient liquid resources to meet its current liabilities.

Acid test ratio = Current assets – inventory

Current liabilities

NB: inventory is omitted as it is considered to be relatively illiquid, because depending

on the prevailing and future market forces, it may be impossible it to convert it to cash
in a relatively short time.

5. ASSET RATIOS OR ACTIVITY RATIOS.

These ratios compare revenue figures with capital figures and may be used in addition
to the return on capital percentage to measure management efficiency in using
available assets.

It includes

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Rate of stock turnover. This is calculated by dividing the cost of sales by the average
stock held during the year.

The average stock is taken to be the average of opening plus closing stocks.

Rate of stock turnover = Cost of sales

Average stock

Debtors’ ratio. Debtors’ ratio is divided by sales excluding cash sales to obtain the
average credit period allowed to debtors.

A factor of 365 is used in order to express the results in days rather than a fraction of a
year.

Sales ratio/debtors ratio = Debtor X 365

Sales

Creditors’ ratio. Creditors are divided by purchases excluding cash purchases to give the
average credit period for creditors

Purchases ratio/ Creditors ratio = Creditors X 365

Purchases

Sales/fixed asset ratio. This ratio shows whether the trading value of a company is large
enough to justify its investments in fixed assets.

Sales/ fixed assets = Sales

Fixed assets

6. SHAREHOLDERS RATIO.

The main ratios with which the shareholders are concerned are presented below

A most important point to appreciate is that shareholders’ ratios are concerned with
the market value of the company shares, whereas management ratios deal with
nominal share values. They include the following

Earnings per share (EPS). The total earnings accruing to ordinary shareholders whether
distributed or retained are shown by this ratio.

EPS = Net profit after interest and tax preference

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Number of ordinary shares issued

This gives the shareholders/prospective shareholders a chance to compare ones’ years’

earnings with another in terms easily understood.

Many people consider EPS to be the most important ratio that can be calculated from
financial statements.

Price earnings ratio (PE). This relates the shares’ market price to earnings per share.

The P/E ratio is most important way of expressing the marketability of a company
shares.

P/E ratio = market price per share/Earnings per share

This puts the price into context as a multiple of the earning. The greater the P/E ratio,
the greater the demand for shares.

Dividend yield. These measures the real rate of return by comparing the dividend paid
to the market price of a share.

Dividend Yield = Gross dividend per share

Market price per share

Dividend cover. This gives the shareholder some idea as to the proportion that the
ordinary dividends bear to the amount available for distribution of ordinary
shareholders.

Usually, the dividend is described as being so many times covered by profits made. If
therefore, dividend is said be three times covered, this means that one third of the
available profits is being distributed as dividends.

7. EFFICIENCY RATIOS

Inventory turnover measures how efficient a business is at maintaining an appropriate

level of inventory.

When it is not being as sufficient as it used to be, or being less efficient than its
competitors, this may indicate that control over inventory levels is being undermined.

A reduction in inventory turnover can mean that the business is slowing down.
Inventory may be piling up not being sold.

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This could lead to liquidity crisis, as money may be being taken out of the bank simply
to increase inventory which is not then sold quickly enough.

Sometime inventory turnover can be classified as a liquidity ratio.

LIMITATIONS/CRITICISMS OF ACCOUNTING RATIOS

A set of accounts never shows a complete picture of company activities.

The bases of asset valuation can sometime be misleading. For example FIFO and LIFO

Seasonal factors can upset ratio analysis. For example companies that produce seasonal
goods and services.

Ratios vary enormously between different industries.

It is more difficult to draw correct conclusions from figures and ratios in a particular set
of accounts.

Example one

Below is the information extracted from the books two companies for the year 2015.

STATEMENT OF FINANCIAL POSITION

C D

Pounds Pounds

Non-current assets

+ Current assets

-current liabilities 100,000 160,000

Capital Accounts

Opening balance 80,000

140,000

Add net profit 36,000

36,000
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116,000
176,000

Less drawings (16,000) (16,000)

100,000 160,000

Required:

Calculate the return on capital employed for each firm.

Interpret the results by comparing the ratios of two firms.

Example two

You are given the following information in a form a balance sheet for business E and F.

E F

Non-current assets 40,000 70,000

Current assets

Inventory 30,000 50,000

Accounts receivable 45,000 9,000

Bank 15,000 1,000

90,000 60,000

Current liabilities

Accounts payable (30,000) (30,000)

60,000 30,000

Net assets 100,000 100,000

Capital:

Opening capital 80,000 80,000

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Add net profit 36,000 36,000

Less drawings (16,000) (16,000)

100,000 100,000

Note: sales for E and F amounted to Shs144,000

Gross profit for E and F were identical at Shs48,000

Required:

Determine the following

Current ratio

Acid test ratio

Given the following information for business E and F

C.O.S = 96,000

Opening inventory

E = 34,000

F = 46,000

Closing stock

E = 30,000

F = 50,000

Calculate the inventory turnover.

Interpret the results

Given the information below.

E F

Account receivable 45,000 9,000

Sales 144,000 144,000

Purchases 92,000 100,000

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Required:

Calculate the sales / accounts receivable ratio for both businesses.

Calculate the purchases / accounts payable ratio for both busi

nesses. Interpret the results.

You are given the following information below.

Calculate

The price earnings ratio

Dividend yield

Dividend cover

Net profit after interest and tax and preference dividends = Shs300,000

Number of ordinary shares issued = 500,000

Market price per share = Shs4.20

Gross dividend per share Shs20

Interest Shs10,000

Ordinary dividend paid and proposed = Shs120,000.

You are given the following information from the years 2012 and 2013

2012
2013

SHS
SHS

Sources of capital:

Ordinary share capital authorized and issued (1 pound each share) 500
500

Undistributed profit 350

680

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10% debentures 250

110

Uses of capital 2012

2013

Fixed assets at cost 1,000

1,400

Less depreciation (200)

(250)

800
1,150

Current assets:

Stock 400
550

Debtors 250
350

Cash 80
…………

1,530
2,050

Less current liabilities

Creditors 145
200

Taxation 160
320

Proposed dividend 125

175

Bank overdraft ………………

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11,00
1,290

PROFIT STATEMENT FOR THE YEAR ENDED 31ST DECEMBER

2012
2013

SHS
SHS

Sales 2,000
3,200

Less cost of sales (1,100)

(1,800)

Gross profit 900

1,400

Less trading expenses (450)

(550)

Trading profit 450

850

Less debenture interest (25)

(25)

Net profit before tax 425

825

Less corporation tax (160)

(320)

Net profit after tax 265

505

Less ordinary share dividend (125)

(175)

Undistributed profit for the year 140

330

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You are required to calculate the following

Return on capital employed

Asset turnover

Gross profit percentage

Net profit percentage

Current ratio

Quick ratio

Comment on the current position of the firm with the aid of accounting ratios
previously selected any other information that you consider to be relevant

TOPIC: 9 HIRE PURCHASE

Where goods are acquired other than on immediate cash terms, arrangements have to be
made in respect of the future payments on those goods. The purchaser is allowed a period
of time to settle the outstanding amount and the normal accounting procedure in respect
to debtor and creditor is adopted.

HIRE PURCHASE LAW

A contract for the hire of an asset, which contains a provision giving the hirer an option to
acquire legal title to the asset upon fulfilment of certain conditions stated in the contract.
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The strict legal option is that to the asset does not pass from the seller to buyer hire
purchase installment is paid. In a mean time, however, the buyer will have enjoyed full
use of the asset, just as though he were the legal owner. The accounting procedures are
designed to reflect this economic reality rather than the strict legal position.
SALIENT ISSUES ABOUT HIRE PURCHASE
1. The asset does not belong to the purchaser when it is received from the
supplier instead it belongs to the supplier.
2. The purchaser will pay for the items by instalments over a period of time.
3. The price will usually be higher than the price that it would have been if
paid immediately that is cash price.
4. The asset does not legally belong to the purchaser until the final instalment
is paid and also when the purchaser agrees to the legal option to buy the
asset.
5. If the purchaser opts out of the agreement, he would then have to give the
asset back to the seller. He loses the instalment already paid.
6. If the purchaser is unable to continue paying the instalment, the seller
could normally repossess the asset.

INSTALMENTS
Each payment on hire purchase contract contains
 Payment of part of the amount owing for the cash price of the asset.
 The interest that accrued for the period of time.
The two may be equal or unequal.

ACCOUNTING ENTRIES IN HIRE PURCHASE CONTRACT

1. Though legally not yet owned by the purchaser, accounting treats as though the asset
belongs to the purchaser.
2. The purchaser buys with intention of paying all installments, accounting therefore
treats as if ownership occurred on purchase.
3. The purchase price is split into two sections for accounting purposes.
The cash price
The interest
4. The interest accrues overtime; each period therefore is only with the interest
accrued for that period.

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APPORTIONMENT OF PROFIT ON SALE

1. Consider profit in the period in which it was first sol.
2. Divide it in the number of years in which it is to be paid. Three methods can be
used.
The straight-line method. This is where equal installments are deducted annually.
Sum of years’ digits method. The total interest charge contained in the agreement is
distributed over the life of the agreement arithmetically in proportion to the reducing
balances outstanding. Sum of years’ digits = N(N+r) /2
Where N is the number of installments.
Actuarial method. This is where interest tables are used to allocate the interest charges to
particular periods. This method is the most accurate method of calculating interest. (IAS)
recommends the use of this method.

REPOSSSESSIONS
When customers stop paying instalments, the goods can be taken away from them and the
seller will keep the amounts already paid by them. The repossessed commodity should be
entered in the sellers’ books as they are part of his inventories.
PURCHASER’S RECORDS / BOOKS
Cash price
Dr. fixed asset
Cr. Supplier
Hire purchase interest each period
Dr. hire purchase interest
Cr. Supplier
Hire purchase instalment
Dr. supplier
Cr. Cash book
Close hire purchase interest
Dr. profit and loss
Cr. Hire purchase interest

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Depreciation. This is based on cash price. The interest does not form part of
depreciation calculation.
THE BALANCE SHEET
1. The cash price of the fixed asset appears in the balance sheet.
2. Accumulated depreciation together with the balance on the suppliers account
are shown as deductions from the cash price.
Fixed assets xxx
Less accumulate depreciation xx
Owing to Hire purchase supplier xx xxxx

SELLERS BOOKS OR RECORDS

There are a considerable number of ways of drawing up the final accounts of the business
which sells goods on hire purchase and of calculating the amounts to be shown therein.
The methods chosen should be suitable for the particular firm and needs obviously vary.
There is a vast gulf between the old established firm which sells quality goods to well-
known reputable customers, and the back-street firm which sells cheap, easily breakable
goods, to anyone without enquiring very deeply as to the customer’s credit worthiness.
It can however, be stipulated that the interest earned from hire purchase sales is earned
because money is owed to the firm for a period of time. The interest that should be
credited to the trading account is therefore the amount which has accrued during the
period covered by the account.
On the other hand, the profit made on the goods sold is usually made
1. Treated as being profit of the firm entirely in the period in which it
was first sold to the purchaser. That is when the agreement was entered
into and the goods delivered to him.
2. Apportionment of the profits is brought into the trading account. This
being in the ratio which the cash actually received during the period
bears to the total cash receivable.
It is inappropriate in a book at this level to go into intricate details of the methods used in
practice by firm. With firms that have many hire purchase transactions, the methods of
apportioning interest and profit are often one of the expediency, exact accuracy often
being too costly to achieve.
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Therefore, in an examination, the examiners instructions should always be carried out, he

may be envisaging such a situation. The fact the examinee may disagree with the method
used is irrelevant for the firms’ purpose.
Calculation of profit
Cash price less cost xxx
Add interest earnings xxxx
Total xxxxx

ACCOUNTING ENTRIES
Hire purchase sales
Dr. purchaser
Cr. Sales
Interest on hire purchase
Dr. purchaser
Cr. Interest earned
Interest received in cash
Dr. cash book
Cr. Purchaser
Example:
On the April 2016, Kintu acquired a TV on hire purchase from supreme furniture Ltd. He
paid a deposit of 288,000 and agreed to pay 36 monthly instalments of shs15,000,
payable on the last day of each month. The cash price was shs720,000. He prepares his
accounts annually to 31st December and depreciates the TV at 25% per annum on the
reducing balance.
Show the necessary ledger accounts for the two years to 30 th September 2016, and the
balance sheet extract at each year end. Assume interest is spread evenly over the life of
the agreement.

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TOPIC:10 INCOMPLETE RECORDS/SINGLE ENTRY

Single entry accounting may be defined as a system of book keeping in which the dual
aspect of transactions is ignored and in which personal account only are maintained.

Single entry system in short means any system which is not a complete double entry
system.

In questions based on single entry/incomplete records, some information is provided

and some missing information is to be found.

No set of single rules can be given as short out to the understanding of the principles
involved. A common feature of all incomplete records questions is the concept of
missing figures. These are obtained by applying the basic principles of the diversified
nature but it is the proper observation and understanding which enables the students
to convert incomplete recorded in to complete records and then to prepare the final
A/CS

There are two main kinds of questions based on incomplete records.

These requiring a computation profit based on increase in net assets

Those requiring the production of the final account from a cash book.

COMPUTATIONAL OF PROFIT

From knowledge of the accounting equation you know that unless there has been an
introduction of extra cash of resources in to a business, the only way that capital can be
increased is by making profits.

Identifying profits when opening and closing capital are known.

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If you know the capital at the start of a period and the capital at the end of the period,
profit is the figure found by subtracting capital at the start of the period from that at
the end of the period.

Example

The business had 20,000 pounds as its capital at the beginning of the period. During
20011, there have been no drawings and no extra capital has been brought in by the
owner. At the end of 2011, capital was 30,000

Calculate profit

Profit =Current’s years’ capital - previous years capital

Net profit = 10,000 pounds

If drawings had been made of 7000 pounds calculate profit

If drawings had been 7000 pounds the profit must have been 17,000 pounds

Last years capital + profits-Drawings

This years capital

20,000+x-7000=30,000

We can know see that 17000 profits is the figure needed to complete the formular.

20,000+17,000+-7000=30,000

Identifying profits when you only have a list of the opening and closing assets and
liabilities

In this case you use the accounting equation.

Normal form = C= A+L

Alternate Form = A=C+L

Exercise
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H. Taylor has not kept proper book keeping records, but she has kept notes in diary
form of the transactions of her business. She is able to give you details of her assets and
liabilities as at 31st Dec 2011 and 31st December 2011

Assets

Van 6,000 pounds

Fixture 1800 pounds

Inventory 3000 pounds

Accounts receivable 4100 pounds

Bank 4800 pounds

Cash 200 pounds

Liabilities

Accounts payable 1800 pounds

Loan from J.Ogden 2000 pounds

Drawings during the year 2012 were 5,200 pounds

You need to put all these figures in to format that will enable you to identify the profit

STEPS

Firstly, you need to draw up a statement of affairs as at 31st

Dec 2011. This is really a statement of financial position but is the name normally used
when you are dealing with incomplete records.

From the accounting equation you know that capital is the differences between the
assets and liabilities.

H. Taylor

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Statement of Affairs as

At 31st Dec. 2011

You now draw up the second statement of financial position, this time as at the end of
2012. The formula of opening capital + Profit-Drawings= closing capital is then used to
deduce the figure of profit.

H. Taylor

Statement of Affairs as at 31st

Dec 2012

DRAWING UP THE FINANCIAL STATEMENTS

The following example shows the various stages of drawing up financial statements
from a single entry set of record.

The accountant has found the following details of Transaction for J. Frank’s shop for the
year ended 31st Dec 2011.

The sales are mostly on credit. No record of sales has been kept, but 61,500 pound has
been received from persons to whom goods have been sold, 48,000 pounds by cheque
and 13,500 pounds in cash.

Amount paid by cheque to suppliers during the year was 31,600 pounds.

Expenses paid during the year by cheque

Rent 3,800 pounds, general expenses 310 pounds by cash rent 400 pounds

J .Frank took 250 pounds cash per week for (52 weeks) as drawings.

Other information available.

31st-12-2010 At 21st Dec 2011

Accounts receivable 5,500 6600

Accounts payable for goods 1,600 2,600

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Rent owing _____ 350

Bank Balance 5650 17940

Cash balance 320 420

Facilitator KJ 2016 “out of weaknesses God made strong”

Inventory 6360 6800

The only noncurrent Assets consists of fixtures which were valued at 31st Dec 2010 at
3300 pounds. These are to be depreciated at 10% per annum.

STEP SUMMARIZED

1. Draw up a statement of Affairs on the closing day of the earlier accounting period.

2. Prepare a cash and bank summary showing the totals of each separate item plus
opening and closing balances.

3. Calculate the figures for purchase and sales to be showing in the trading account.

Remember that the figures needed are the same as those which would have been
found if double entry records had been kept.

The figure for (payment to suppliers) must therefore be adjusted to find the figure for
purchases.

The same answer could have been obtained if the information had been shown in the
form of a total accounts payable account, the figure for purchases being the amount
required to make the account totals agree.

Paid during the year xxx

Less payments made, but which Were for goods purchased

In a previous year. (A/Cs payable)

At start) xxx

Add purchases made in the current year for which payment has not yet been made xxx

Goods bought in this year.

Sales: the sales figure will only equal receipts where all the sales are for cash.
Therefore, the receipts figure need adjusting to find sales. This can only be done by
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constructing, a total accounts receivable account, the sales figure being one needed to
make the totals agree.

Expenses

Where there are no accounts or prepayments either at the beginning or end of the
accounting period, the expenses paid will equal expenses used up during the period.
These figures will be charged to the income statement.

On the other hand, where such prepayment or accruals exist, an expense account
should be drawn up for that particular item. When all known items are entered, the
missing figure will be the expenses to be charged for the accounting period.

Draw up the statement of financial position are last step.

Incomplete records with missing figures

In practice, part of the information relating to cash receipts or payments is often

missing. If the missing information is in respect of one type of payment, then it is
normal to assume that the missing figure is the amount required to make both totals
agree in the cash column of cash and bank summary.

This does not happen with bank items owing to the fact that another copy of bank
statement can always be obtained from the bank.

It must be emphasized that the use of balancing figures is acceptable only when all the
other figures have been verified should, for instance, a cash expense be omitted when
cash received form debtors is being calculated, this would result in an understatement
not only of expenses but also, ultimately of sales.

Where there are two missing pieces of information.

Quite often the only cash expense item for which there is some doubt is drawings.
Receipts will normally have been retained for all the others.

If both cash drawings and cash receipts from debtors (or from cash sales) were not
known, it would not be possible to deduce both of these figures separately. The only
course available would be to estimate which over figure was more capable of being
accurately assessed, use this as if it were a known figure then deduce the other figure.
However, this is a most unsatisfactory position as both of the figures are estimates, the
accuracy of each one relying entirely upon the accuracy of the other.

Cash sales and purchases for cash

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Where there are cash sales as well as sales on credit terms, then the cash sales must be
added to sales on credit to give the total sales for the year.

This total figure of sales will be the one shown in the trading account part of income
statement.

Similarly, purchases for cash will need to be added to credit purchases in order to
produce the figure of total purchases for the trading account.

Inventory Stolen, lost or destroyed when inventory is stolen, lost or destroyed, its value
will have to be calculated. This could be needed to justify an insurance claim or to settle
problems concerning taxation etc.

If inventory had been valued immediately before the fire burglary etc., then the value of
the inventory lost would obviously be known.

Also, if a full and detailed system of inventory records were kept, then the value would
also be known. However, as the occurrence of fires or burglary as cannot be foreseen,
and many small businesses do not keep full and proper inventory records, the value of
the inventory lost has to be calculated in some other way.

Bear in mind that you are going to calculate figures as at the time of the fire or theft,
not at the end of the accounting period.

TOPIC 11: CASH FLOW TATEMENTS

The following terms are used in this Standard with the meanings specified:

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Cash comprises cash on hand and demand deposits.

Cash equivalents are short-term, highly liquid investments that are readily convertible
to known amounts of cash and which are subject to an insignificant risk of changes in
value.

Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities are the principal revenue-producing activities of the enterprise and
other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.

Financing activities are activities that result in changes in the size and composition of
the

equity capital and borrowings of the enterprise.

IMPORTANCE OF CASH FLOW STATEMENTS

1. Cash flow statement aims at highlighting the cash generated from operating activities.

2. Cash flow statement helps in planning the repayment of loan Schedule and replacement
of fixed assets, etc.

3. Cash is the Centre of all financial decisions. It is used as the basis for the projection of
future investing and financing plans of the enterprise.

4. Cash flow statement helps to ascertain the liquid position of the firm in a better manner.
Banks and financial institutions mostly prefer cashflow statement to analyze liquidity of
the borrowing firm.

5. Cash flow Statement helps in efficient and effective management of cash. The management
generally looks into cash flow statements to understand the internally generated cash which is
best utilized for payment of dividends.

6. Cash Flow Statement based on AS-3 (revised) presents separately cash generated
and used in Operating, investing and financing activities.

7. It is very useful in the evaluation of cash position of a firm.

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Cash and relevant terms as per AS-3 (revised)

As per AS-3 (revised) issued by the Accounting Standards Board

1.(a) Cash fund:

Cash Fund includes

(i) Cash in hand

(ii) Demand deposits with banks, and

(iii) cash equivalents.

(b)Cash equivalents are short-term, highly liquid investments, readily

convertible into cash and which are subject to insignificant risk of changes in values.

2. Cash Flows are inflows and outflows of cash and cash equivalents.

The statement of cash flow shows three main categories of cash inflows and cash
outflows, namely: operating, investing and

financing activities.

(a) Operating activities are the principal revenue generating activities

of the enterprise.

(b) Investing activities include the acquisition and disposal of long-

term assets and other investments not included in cash equivalents.

(c) Financing activities are activities that result in change in the size and composition of
the owner’s capital (including Preference share capital in the case of a company) and
borrowings of the

enterprise.

METHOD OF PREPARING CASH FLOW STATEMENT

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There are two methods of preparing the Cash Flow Statement. Both methods give the
same results in respect of the final total as well as sub-totals of the three sections –
operating, investing and the financing. They differ only in the manner the information
regarding cash flow from operating activities is presented.

INDIRECT METHOD

SOME FACTS ABOUT CASH FLOW STATEMENT:

(i) Only listed companies are required to prepare and present Cash

flow statement.

(ii) The Accounting period for the Cash Flow Statement is the same

for which Profit and Loss Account and Balance Sheet are prepared.

(iii) Cash flow items are as

(a) Cash flow from operating activities

(b) Cash flow from investing activities

(c) Cash flow from financing activities.

(iv) OPERATING ACTIVITIES

Operating activities include revenue producing activities which are

not investing and financing activities.

(v) There are two methods of calculating cash flow from operating activities namely
Direct method and Indirect method.

(vi) Extra ordinary Items: The Cash flow associated with extra

ordinary items should be classified as arising from operating, investing financing

activities. For example, the amount received from Insurance Company on account of
Loss of Stock or loss from earthquake should be reported as cash flow from operating
activities.

PREPARATION OFCASH FLOW STATEMENT

(i) Operating Activities

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Cash flow from operating activities are primarily derived from the principal revenue
generating activities of the enterprise. A few items of cash flows from operating
activities are:

(i) Cash receipt from the sale of goods and rendering services.

(ii) Cash receipts from royalties, fee, Commissions and other revenue.

(iii) Cash payments to suppliers for goods and services.

(iv) Cash payment to employees

(vi) Cash payment or refund of Income tax.

DETERMINATION OF CASH FLOW FROM OPERATING ACTIVITIES

There are two stages for arriving at the cash flow from operating activities

Stage-1

Calculation of operating profit before working capital changes, It can be calculated in

the following manner.

Net profit before Tax and extra ordinary Items xxx

Add Non-cash and non-operating Items which have already been debited to profit and
Loss Account i.e.

Depreciation xxx

Amortization of intangible assets xxx

Loss on the sale of Fixed assets. xxx

Loss on the sale of Long Term Investments xxx

Provision for tax xxx

Dividend paid xxx xxx xxx

Less: Non-cash and Non-Operating Items which have already been credited to Profit
and Loss Account i.e.

Profit on sale of fixed assets xxx

Profit on sale of Long term investment xxx xxx

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Operating profit before working Capital changes. xxx

Stage-II

After getting operating profit before working capital changes as per

stage I, adjust increase or decrease in the current assets and current

liabilities.

The following general rules may be applied at the time of adjusting current

assets and current liabilities.

A. Current assets

(i) An increase in an item of current assets causes a decrease in cash inflow because

is blocked in current assets.

(ii) A decrease in an item of current assets causes an increase in cash inflow because
cash is released from the sale of current assets.

B. Current liabilities

(i) An increase in an item of current liability causes a decrease in cash

outflow because cash is saved.

(ii) A decrease in an item of current liability causes increase in cash out flow because of
payment of liability.

Thus, Cash from operations = operating profit before working capital

changes + Net decrease in current assets + Net Increase in current

liabilities – Net increase in current assets – Net decrease in current

liabilities.

Step - II

Investing Activities

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Investing Activities refer to transactions that affect the purchase and sale of fixed or
long term assets and investments.

Examples of cash flow arising from Investing activities are

1.Cash payments to acquire fixed Assets

2. Cash receipts from disposal of fixed assets

3. Cash payments to acquire shares, or debenture investment.

4. Cash receipts from the repayment of advances and loans made to third parties.

Thus, Cash inflow from investing activities are

Cash sale of plant and machinery, land and Building, furniture, goodwill etc.

Cash sale of investments made in the shares and debentures of other

companies

Cash receipts from collecting the Principal amount of loans made to

third parties.

Cash outflow from investing activities are:

Purchase of fixed assets i.e. land, Building, furniture, machinery etc.

Purchase of Intangible assets i.e. goodwill, trade mark etc.

Purchase of shares and debentures

Purchase of Government Bonds

Loan made to third parties

Step- III

Financing Activities

The third section of the cash flow statement reports the cash paid and

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received from shareholders Capital. Examples of cash flow arising from financing
activities are

Cash proceeds from issue of shares or other similar instruments.

Cash proceeds from issue of debentures, loans, notes, bonds, and other short-term
borrowings

Cash repayment of amount borrowed

Cash Inflow from financing activities are Issue of Equity and preference share capital for
cash only.

Issue of Debentures, Bonds and long-term note for cash only

Cash outflow from financing activities are:

Payment of dividends to shareholders

Redemption or repayment of loans i.e. debentures and bonds

Redemption of preference share capital

Buy back of equity shares m activities with non-current or long term liabilities and

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