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Bachelor of Commerce

in Accounting

Financial Accounting 2

Module BACC 106

Author: Ephraim Matavire
Master of Business Administration (ZOU)
Bachelor of Accounting Science (UNISA)
ICSA (The Institute of Chartered Secretaries and
Administrators in Zimbabwe)
FIAC

Content Reviewer: Patrick Paradza

Master of Accountancy (Southwest Mission State
University)
Bachelor of Science (Honours) Economics (University
of Rhodesia)
Bachelor of Accountancy (Special) Honours
(University of Zimbabwe)
ICSA (The Institute of Chartered Secretaries and
Administrators in Zimbabwe)

Editor: Calisto Munongi

MSc Mathematics (UZ)
BSc (Hons) Applied Mathematics (NUST)
Published by: Zimbabwe Open University

P.O. Box MP1119

Mount Pleasant

Harare, ZIMBABWE

The Zimbabwe Open University is a distance teaching and open

learning institution.

Year: 2012

Reprinted: November 2013

Cover design: T. Ndhlovu

Layout and design: D. Satumba Nyandowe

ISBN No: 978-1-77938-488-4

Printed by: ZOU Press

Typeset in Times New Roman, 12 point on auto leading

© Zimbabwe Open University. All rights reserved. No part of this

P.O. Box MP1119

Mount Pleasant

Harare, ZIMBABWE

The Zimbabwe Open University is a distance teaching and open

learning institution.

Year: 2012

Reprinted: November 2013

Cover design: T. Ndhlovu

Layout and design: D. Satumba Nyandowe

ISBN No: 978-1-77938-488-4

Printed by: ZOU Press

Typeset in Times New Roman, 12 point on auto leading

© Zimbabwe Open University. All rights reserved. No part of this

publication may be reproduced, stored in a retrieval system, or transmitted,
in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise, without the prior permission of the Zimbabwe Open
University.
The Six Hour Tutorial Session At
The Zimbabwe Open University
A s you embark on your studies with the
Zimbabwe Open University (ZOU) by open
and distance learning, we need to advise you so
This is where the six hour tutorial comes in. For
it to work, you need to know that:
· There is insufficient time for the tutor
that you can make the best use of the learning
to lecture you
materials, your time and the tutors who are based
· Any ideas that you discuss in the
at your regional office.
tutorial, originate from your experience
as you work on the materials. All the
The most important point that you need to note is
issues raised above are a good source
that in distance education and open learning, there
of topics (as they pertain to your
are no lectures like those found in conventional
learning) for discussion during the
universities. Instead, you have learning packages
tutorial
that may comprise written modules, tapes, CDs,
· The answers come from you while the
DVDs and other referral materials for extra reading.
tutor’s task is to confirm, spur further
All these including radio, television, telephone, fax
discussion, clarify, explain, give
and email can be used to deliver learning to you.
additional information, guide the
As such, at the ZOU, we do not expect the tutor
discussion and help you put together
to lecture you when you meet him/her. We believe
full answers for each question that you
that that task is accomplished by the learning
bring
package that you receive at registration. What
· You must prepare for the tutorial by
then is the purpose of the six hour tutorial for each
bringing all the questions and answers
course on offer?
that you have found out on the topics
to the discussion
At the ZOU, as at any other distance and open
· For the tutor to help you effectively, give
learning university, you the student are at the centre
him/her the topics beforehand so that
of learning. After you receive the learning package,
in cases where information has to be
you study the tutorial letter and other guiding
gathered, there is sufficient time to do
documents before using the learning materials.
so. If the questions can get to the tutor
During the study, it is obvious that you will come
at least two weeks before the tutorial,
across concepts/ideas that may not be that easy
that will create enough time for
to understand or that are not so clearly explained.
thorough preparation.
You may also come across issues that you do not
agree with, that actually conflict with the practice
In the tutorial, you are expected and required to
that you are familiar with. In your discussion
take part all the time through contributing in
groups, your friends can bring ideas that are totally
every way possible. You can give your views,
different from yours and arguments may begin. You
even if they are wrong, (many students may hold
may also find that an idea is not clearly explained
the same wrong views and the discussion will
and you remain with more questions than answers.
help correct the errors), they still help you learn
You need someone to help you in such matters.
the correct thing as much as the correct ideas.
The Six Hour Tutorial Session At The Zimbabwe Open University

You also need to be open-minded, frank, inquisitive learning package together with the sources to
and should leave no stone unturned as you analyze which you are referred. Fully-fledged lectures
ideas and seek clarification on any issues. It has can, therefore, be misleading as the tutor may
been found that those who take part in tutorials dwell on matters irrelevant to the ZOU course.
actively, do better in assignments and examinations
because their ideas are streamlined. Taking part Distance education, by its nature, keeps the tutor
properly means that you prepare for the tutorial and student separate. By introducing the six hour
beforehand by putting together relevant questions tutorial, ZOU hopes to help you come in touch
and their possible answers and those areas that with the physical being, who marks your
cause you confusion. assignments, assesses them, guides you on
preparing for writing examinations and
Only in cases where the infor mation being assignments and who runs your general academic
discussed is not found in the learning package can affairs. This helps you to settle down in your
the tutor provide extra learning materials, but this course having been advised on how to go about
should not be the dominant feature of the six hour your learning. Personal human contact is,
tutorial. As stated, it should be rare because the therefore, upheld by the ZOU.
information needed for the course is found in the

The six hour tutorials should be so structured that the

tasks for each session are very clear. Work for each
session, as much as possible, follows the structure given
below.

Session I (Two Hours)

Session I should be held at the beginning of the semester. The
main aim of this session is to guide you, the student, on how
you are going to approach the course. During the session, you
will be given the overview of the course, how to tackle the
assignments, how to organize the logistics of the course and
formation of study groups that you will belong to. It is also during
this session that you will be advised on how to use your learning
materials effectively.
The Six Hour Tutorial Session At The Zimbabwe Open University

Session II (Two Hours)

This session comes in the middle of the semester to respond
to the challenges, queries, experiences, uncertainties, and
ideas that you are facing as you go through the course. In this
session, difficult areas in the module are explained through the
combined effort of the students and the tutor. It should also give
direction and feedback where you have not done well in the
first assignment as well as reinforce those areas where
performance in the first assignment is good.

Session III (Two Hours)

The final session, Session III, comes towards the end of the
semester. In this session, you polish up any areas that you still
need clarification on. Your tutor gives you feedback on the
assignments so that you can use the experience for preparation
for the end of semester examination.

Note that in all the three sessions, you identify the areas
that your tutor should give help. You also take a very
important part in finding answers to the problems posed.
You are the most important part of the solutions to your
learning challenges.

Conclusion for this course, but also to prepare yourself to

contribute in the best way possible so that you
can maximally benefit from it. We also urge
In conclusion, we should be very clear that six you to avoid forcing the tutor to lecture you.
hours is too little for lectures and it is not
necessary, in view of the provision of fully self- BEST WISHES IN YOUR STUDIES.
contained learning materials in the package, to
turn the little time into lectures. We, therefore, ZOU
urge you not only to attend the six hour tutorials
Contents

Module Overview ______________________________________________ 1

Unit One: Overview of Financial Analysis

1.0 _ Introduction ______________________________________________ 3

1.1 _______ Objectives ______________________________________________________ 4
1.2 _______ Users of Financial Statements and Their Objectives in Analysing Them 4
__________ Activity 1.1 ______________________________________________________ 6
1.3 _______ Limitations of Financial Accounting Information ____________________ 6
1.4 _______ Techniques in Financial Analysis __________________________________ 7
__________ Activity 1.2 ______________________________________________________ 8
1.5 _______ Summary _______________________________________________________ 8
__________ References ______________________________________________________ 8

Unit Two: Interpretation and Analysis of Financial Statements

2.0 _______ Introduction ____________________________________________________ 9
2.1 _______ Objectives _____________________________________________________ 10
2.2 _______ The Purpose of Ratio Analysis ___________________________________ 10
2.3 _______ Types of Ratios _________________________________________________ 10
__________ 2.3.1 Profitability ratios _________________________________________ 11
__________ 2.3.2 Solvency ratios ____________________________________________ 12
__________ 2.3.3 Efficiency ratios ___________________________________________ 12
__________ 2.3.4 Shareholders' or Investors' ratios ___________________________ 13
__________ Activity 2.1 _____________________________________________________ 17
__________ Activity 2.2 _____________________________________________________ 18
__________ Activity 2.3 _____________________________________________________ 19
2.8 _______ Summary ______________________________________________________ 21
__________ References _____________________________________________________ 22

Unit Three: Bills of Exchange

3.0 _______ Introduction ___________________________________________________ 23
3.1 _______ Objectives _____________________________________________________ 24
3.2 _______ Advantages of a Bill of Exchange _________________________________ 24
3.3 _______ Parties to a Bill _________________________________________________ 24
3.4 _______ Accounting Entries ______________________________________________ 25
3.5 _______ Dishonour of Bills of Exchange __________________________________ 25
3.6 _______ Bills Payable ___________________________________________________ 27
__________ Activity 3.1 _____________________________________________________ 28
3.7 _______ Summary ______________________________________________________ 29
__________ References _____________________________________________________ 29

Unit Four: Partnership Accounts

4.0 _______ Introduction ___________________________________________________ 31
4.1 _______ Objectives _____________________________________________________ 32
4.2 _______ Reasons for Entering into a Partnership __________________________ 32
4.3 _______ Agreement between Partners _____________________________________ 32
4.4 _______ Accounting for Partnerships _____________________________________ 32
4.5 _______ Preparation of Annual Financial Statements of a Partnership _______ 33
__________ Activity 4.1 _____________________________________________________ 35
__________ Activity 4.2 _____________________________________________________ 40
4.6 _______ Partnership Goodwill ___________________________________________ 41
4.7 _______ Dissolution of a Partnership _____________________________________ 44
4.8 _______ The Garner versus Murray Rule _________________________________ 46
__________ Activity 4.3 _____________________________________________________ 48
4.9 _______ Piecemeal Dissolution __________________________________________ 49
__________ Activity 4.4 _____________________________________________________ 53
4.10 ______ Summary ______________________________________________________ 54
__________ References _____________________________________________________ 54

Unit Five: Company Accounting: Formation, Share Capital and

Debentures
5.0 _______ Introduction ___________________________________________________ 55
5.1 _______ Objectives _____________________________________________________ 56
5.2 _______ A Private Company _____________________________________________ 56
5.3 _______ A Public Company ______________________________________________ 56
5.4 _______ Formation of a Company ________________________________________ 56
5.5 _______ Types of Invested Capital _______________________________________ 57
5.6 _______ Share Capital Issues by a Public Company ________________________ 57
5.7 _______ Share Capital __________________________________________________ 57
5.8 _______ Types of Chares ________________________________________________ 58
5.9 _______ Raising of Capital _______________________________________________ 58
5.10 ______ Accounting Entries on Issue of Shares ____________________________ 59
5.11 ______ Redemption of Shares and Debentures ___________________________ 61
__________ Activity 5.1 _____________________________________________________ 66
__________ Activity 5.2 _____________________________________________________ 67
5.12 ______ Summary ______________________________________________________ 68
__________ References _____________________________________________________ 68

Unit Six: Company Published Financial Statements: An Introduction

6.0 _______ Introduction ___________________________________________________ 69
6.1 _______ Objectives _____________________________________________________ 70
6.2 _______ Definitions _____________________________________________________ 70
6.3 _______ Purpose of Financial Statements _________________________________ 71
6.4 _______ Complete Set of Financial Statements _____________________________ 71
6.5 _______ General Features _______________________________________________ 72
6.6 _______ Structure and Content __________________________________________ 73
6.7 _______ Identification of Financial Statements _____________________________ 73
6.8 _______ The Statement of Financial Position ______________________________ 74
6.9 _______ Statement of Comprehensive Income _____________________________ 75
6.10 ______ Statement of Changes in Equity __________________________________ 77
6.11 ______ Notes to Financial Statements ____________________________________ 77
6.12 ______ Capital ________________________________________________________ 78
__________ Activity 6.1 _____________________________________________________ 84
6.13 ______ Summary ______________________________________________________ 85
__________ References _____________________________________________________ 85

Unit Seven: Statement of Cash Flows

7.0 _______ Introduction ___________________________________________________ 87
7.1 _______ Objectives _____________________________________________________ 88
7.2 _______ Difference between Cash Flow and Profit _________________________ 88
7.3 _______ Usefulness of the Statement of Cash Flows ________________________ 88
7.4 _______ Cash and Cash Equivalents ______________________________________ 88
7.5 _______ Standard Headings _____________________________________________ 89
7.6 _______ Types of Inflows and Outflows __________________________________ 90
7.7 _______ Preparing the Operating Activities Section Using the Direct Method _ 91
6.8 _______ Preparing the Operating Activities Section Using the Indirect Method 91
__________ Activity 7.1 _____________________________________________________ 95
7.9 _______ Summary _____________________________________________________ 100
__________ References ____________________________________________________ 100

Unit Eight: Consignment Accounts

8.0 _______ Introduction __________________________________________________ 101
8.1 _______ Objectives ____________________________________________________ 102
8.2 _______ Terms in Consignment Accounts ________________________________ 102
__________ Activity 8.1 ____________________________________________________ 102
8.3 _______ Accounting Entries _____________________________________________ 102
8.4 _______ Books of the Consignor ________________________________________ 103
8.5 _______ Books of the Consignee ________________________________________ 103
__________ Activity 8.2 ____________________________________________________ 106
__________ Activity 8.3 ____________________________________________________ 107
8.6 _______ Summary _____________________________________________________ 108
__________ References ____________________________________________________ 108

Unit Nine: Royalty Accounts

9.0 _______ Introduction __________________________________________________ 109
9.1 _______ Objectives ____________________________________________________ 110
9.2 _______ Terms under Royalty ___________________________________________ 110
9.3 _______ Accounting Entries _____________________________________________ 110
__________ Activity 9.1 ____________________________________________________ 112
__________ Activity 9.2 ____________________________________________________ 113
9.4 _______ Summary _____________________________________________________ 114
__________ References ____________________________________________________ 114

Unit Ten: Joint Ventures

10.0 ______ Introduction __________________________________________________ 115
10.1 ______ Objectives ____________________________________________________ 116
10.2 ______ Joint Venture Accounting Entries ________________________________ 116
10.3 ______ Memorandum of Joint Venture _________________________________ 117
__________ Activity10.1 ____________________________________________________ 119
10.4 ______ Summary _____________________________________________________ 120
__________ References ____________________________________________________ 120

Unit Eleven: Branch Accounts

11.0 ______ Introduction __________________________________________________ 121
11.1 ______ Objectives ____________________________________________________ 122
11.2 ______ Where the Head Office Maintains All the Accounts _______________ 122
__________ 11.2.1 The memorandum method ________________________________ 122
__________ 11.2.2 Fully integrated method __________________________________ 123
__________ Activity 11.1 ___________________________________________________ 127
11.3 ______ Where the Branch Maintains its Full Accounting Records __________ 127
__________ Activity 11.2 ___________________________________________________ 128
11.4 ______ Preparation of Annual Financial Statements ______________________ 130
__________ Activity 11.3 ___________________________________________________ 133
11.5 ______ Summary _____________________________________________________ 134
__________ References ____________________________________________________ 134

Unit Twelve: Investment Accounts

12.0 ______ Introduction __________________________________________________ 135
12.1 ______ Objectives ____________________________________________________ 136
12.2 ______ Nominal Value and Capital Value _______________________________ 136
12.3 ______ Investment Income ____________________________________________ 136
12.4 ______ Presentation Format ___________________________________________ 138
__________ Activity 12.1 ___________________________________________________ 139
__________ Activity 12.2 ___________________________________________________ 145
12.5 ______ Summary _____________________________________________________ 146
__________ References ____________________________________________________ 146

Unit Thirteen: Consolidated Accounts: Introduction

13.0 ______ Introduction __________________________________________________ 147
13.1 ______ Objectives ____________________________________________________ 148
13.2 ______ Key Definitions ________________________________________________ 148
13.3 ______ Criteria for Control ____________________________________________ 148
13.4 ______ Presentation of Consolidated Accounts __________________________ 149
13.5 ______ Constitution of a Group ________________________________________ 149
13.6 ______ A Wholly Owned Subsidiary ____________________________________ 150
13.7 ______ Basic Consolidation Techniques ________________________________ 150
13.8 ______ Acquisition of an Interest in another Company ___________________ 150
13.9 ______ Consolidation of the Statement of Financial Position of a Wholly Owned
__________ Subsidiary at the Date of Acquisition ____________________________ 151
13.10 _____ Consolidation of a Wholly Owned Subsidiary After the Date of _______
__________ Acquisition ___________________________________________________ 155
__________ Activity 13.1 ___________________________________________________ 163
13.11 _____ Summary _____________________________________________________ 164
__________ References ____________________________________________________ 164

Unit Fourteen: Budgeting and Budgetary Control

14.0 ______ Introduction __________________________________________________ 165
14.1 ______ Objectives ____________________________________________________ 166
14.2 ______ Definition of Terms ___________________________________________ 166
14.3 ______ Types of Budgets ______________________________________________ 167
14.4 ______ The Budget Period ____________________________________________ 176
14.5 ______ Purpose of Budgets in Planning _________________________________ 176
14.6 ______ Purpose of Budgets in Controlling ______________________________ 177
14.7 ______ Advantages of Budgeting and Budgetary Control __________________ 177
14.8 ______ Disadvantages of Budgeting and Budgetary Control _______________ 177
14.9 ______ Budget Organisation and Administration _________________________ 178
14.10 _____ Functions of the Budget Officer _________________________________ 178
14.11 _____ The Budget Committee _________________________________________ 178
14.12 _____ The Budget Manual ____________________________________________ 178
14.13 _____ The Budget Preparation Process ________________________________ 179
14.14 _____ Summary _____________________________________________________ 180
__________ References ____________________________________________________ 180

Unit Fifteen: Flexible Budgets

15.0 ______ Introduction __________________________________________________ 181
15.1 ______ Objectives ____________________________________________________ 182
15.2 ______ Shortcomings of a Fixed Budget _________________________________ 182
15.3 ______ The Flexible Budget ___________________________________________ 182
15.4 ______ Steps to Prepare a Flexible Budget ______________________________ 182
15.5 ______ Flexible Budgets for Performance Evaluation _____________________ 184
__________ Activity 15.1 ___________________________________________________ 185
15.6 ______ Flexible Budgets for Planning Purposes _________________________ 185
__________ Activity 15.2 ___________________________________________________ 186
15.7 ______ Summary _____________________________________________________ 187
__________ References ____________________________________________________ 187

Unit Sixteen: Alternative Budgeting Systems

16.0 ______ Introduction __________________________________________________ 189
16.1 ______ Objectives ____________________________________________________ 190
16.2 ______ Zero Base Budgeting (ZBB) ____________________________________ 190
16.3 ______ Advantages of ZBB ____________________________________________ 190
16.4 ______ Disadvantages of ZBB _________________________________________ 191
16.5 ______ The Traditional or Incremental Budgeting _______________________ 191
16.6 ______ Advantages of Incremental Budgeting ____________________________ 191
16.7 ______ Disadvantages of Incremental Budgeting _________________________ 192
16.8 ______ Rolling Budgets ________________________________________________ 192
16.9 ______ Advantages of Rolling Budgets __________________________________ 192
16.10 _____ Disadvantages of Rolling Budgets ________________________________ 192
__________ Activity 16.1 ___________________________________________________ 193
16.11 _____ Summary _____________________________________________________ 194
__________ References ____________________________________________________ 194
__________ Activity 4.3 ____________________________________________________ 195
__________ Activity 8.1 ____________________________________________________ 196
BLANK PAGE
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Module Overview

T
his module was prepared to cover the Financial Accounting II Syllabus
of the Zimbabwe Open University. The content is prepared in a
clear, systematic way and the language used is simple, to ensure better
understanding of concepts. All materials have been arranged to ensure gradual
progression in the development of skills. The following topics are covered
per unit:
In Unit 1 we discuss overview of financial analysis, Unit 2 focuses on the
interpretation and analysis of financial statements, then, Unit 3 looks at bills of
exchange while in Unit 4 we discuss introduction to partnership accounts.
Units 5 and 6 focus on company accounts and company published financial
statements: an introduction respectively. In Units 7, 8 and 9 we look at
statement of cash flows, consignment accounts and royalty accounts. In Units
10, 11 12 and 13 we focus on joint venture accounts, branch accounts,
investment accounts and consolidated accounts - introduction respectively.
The last section of the module focuses on; budgeting and budgetary control in
Unit 14, flexible budgeting in Unit 15, alternative budgeting systems in Unit
16 then, we conclude with answers to selected activity questions in Unit 17.
Financial Accounting 2 BACC 106

The concept or concepts and standards from which accounting practices or

procedures are derived are highlighted whenever possible. Self -evaluation
exercise in the form of activities are included in the Units, to test your
understanding of the subject matter as well as prepare you for the examinations.
Realistic figures or values are not used in the examples and exercises. Instead,
small figures are used so that the learning process is not hampered by
cumbersome calculations, and you, the student, can focus on understanding
the principles and procedures.

As a final word of advice, accounting is a "practical" subject. You are, therefore,

advised to devote a considerable amount of your time to working out problems
and exercises, so that you attain the level of speed and accuracy that will
ensure success in the examinations.

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2 Zimbabwe Open University
1
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Unit One
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Overview of Financial Analysis

1.0 Introduction

I
z
n this unit we discuss that the annual financial statements of a company
comprise of:
The statement of comprehensive income (income statement)which
shows the operating results of the organisation, that is, whether the
business made a profit or loss during the year under review
z The statement of financial position, which shows the financial position
of the business, that is, the assets, liabilities and equity
z The statement of cash flows which shows cash inflows and outflows
z The statement of changes in equity, which shows movements in the
equity accounts
In most cases, Directors and Auditors reports are also attached. The directors'
reports contain information which expands on the information further explaining
what is on the annual financial statements, including forecasts for the ensuing
years. When analysing information on the annual financial statements it is
necessary to critically examine this report in order to make a meaningful analysis
of the figures.
Financial Accounting 2 BACC 106

The auditors' report contains an opinion on whether the statements reveal a

true and fair view of the operations and state of affairs of the company. The
opinion may be qualified, meaning that the auditors were not happy with some
aspects of the statements. Alternatively, as is usually the case it is an unqualified
opinion, meaning that the auditors did not find any material misstatements,
and therefore are of the opinion that the statements reveal a true and fair view.

Financial statements are analysed by various users, both internal and external
to the business, each group having different objectives. The majority look for
credit worthiness and/or sustainable profitability. Current results are usually
compared with prior years' results, and/or industry averages. This unit deals
with the techniques used in the analysis and interpretation of financial
statements.

1.1 Objectives
By the end of this unit, you should be able to:
z identify users of financial statements and their objectives in analysing
them
z describe limitations of financial statement analysis
z evaluate techniques used in financial statement analysis

1.2 Users of Financial Statements and Their

Objectives in Analysing Them
Different users have different objectives when analysing financial statements.
The needs of a user determine the type of analysis a user makes. Outlined
below are some of the users, their objectives and the types of analyses they
make.

Shareholders

Shareholders contribute share capital, and being owners of the company are
primarily concerned about the security of their investment. They want to know
if the company is profitable enough to pay them dividends, and whether the
company's earnings are sustainable. They are therefore interested in the liquidity,
solvency and profitability of the company. Different classes of shareholders
will have different interests. The ordinary shareholders will also be interested
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4 Zimbabwe Open University
Unit 1 Overview of Financial Analysis

in prospects of growth in value of the company which will result in an increase

in the value of their investment.

Management

This group includes all staff and officials who are responsible for ensuring that
the company achieves its objectives. They are involved in the day to day
running of the business, and analyse and evaluate the financial statements as a
guide in planning and controlling financial activities of the company. A wide
range of analysis covering solvency, liquidity and profitability are therefore
conducted. Managers may also have a personal interest in the profits, especially
where bonuses are linked to profits made.

Employees

Employees are concerned about how profitable the company is and the
relationship of profits earned to their wages and salaries. Trade unions can
use this information when negotiating for their members' wage increases, with
the employers. In some cases, employees may hold shares in the company, in
terms of a share ownership scheme, and could have other interests as
shareholders.

Creditors

Short term creditors are primarily concerned about the liquidity of the company,
i.e. its ability to meet its short term obligations as they fall due.

Long term creditors like debenture holders will be interested in the solvency
and financial stability of the company, and whether the company is able to
regularly meet its long term capital redemption and interest obligations.

The government

The government is concerned with the profits made by the company as a

basis for income tax. They also require information from financial statements
for statistical purposes. In some cases the government also holds shares or
debentures in companies and in this respect, their interests are the same as
those of shareholders or debenture holders.

Activity 1.1
1. List any three users of financial statements.
? 2. For each of the users you have listed above, describe what form of
analysis is carried out and the purpose of such analysis.

1.3 Limitations of Financial Accounting Information

When analysing and interpreting financial information, cognisance should be
taken of the inherent limitations in financial information. Some of these limitations
are discussed below:

Only monetary transactions are recorded

Only those transactions that can be measured in monetary terms are recorded.
However, other very important non-financial information, like the competence
and integrity of management and staff, or views of the public about the company,
which could have an impact on the value and future prospects of the company
are not recorded because they cannot be reduced to monetary terms.

Historical nature

Only past accounting information is recorded when management is concerned

about the present and future information for the purposes of decision-making,
planning and control. Furthermore the cost basis is used, and this results in
distortion of actual values of noncurrent assets, as the effects of inflation/
deflation are not taken into account.

Personal bias of the accountant

Accounting information is recorded using generally accepted accounting

practice. However, there is a variety of methods and procedures allowed
under generally accepted practice. The accountant therefore uses his judgement
in selecting the most appropriate method or procedures. An element of bias
comes in and reliance has to be placed on the integrity and competence of the
accountant. The fact that different companies may adopt different methods
also makes inter-company comparisons difficult.

1.4 Techniques in Financial Analysis

Various techniques are used in the analysis of financial statements. Each analyst
will use techniques that suit the objectives of his analysis. The following are
some of the more common techniques:
Common size or vertical analysis
Ratio analysis
Trend or horizontal analysis
These techniques are briefly explained below.

Common size or vertical analysis

Using this method, each item is expressed as a percentage of some total of

which it is a part, for example, each item appearing on the statement of
comprehensive income is expressed as a percentage of the turnover on net
sales, and each item on the statement of financial position is expressed as a
percentage of total assets. This analysis is useful for comparing statements for
successive periods as well as those of different companies in the same industry.

Ratio analysis

A ratio simply means that one number is expressed in terms of another number.
It, therefore, measures the relationship between two or more numbers. This
method is used to show significant relationships between items on the statement
of financial position, the statement of comprehensive income, or any other
financial statement. Ratios facilitate comprehension of financial statements, as
the magnitude of relationships and changes in financial information are
highlighted in a manner that is simple to understand. This is the most widely
used technique, and we will look at it in more detail in the next unit.

Trend analysis

Using this method, changes in one account over two or more years are calculated
and tabulated so that the trends can be easily discerned. To calculate the
percentage change between two periods, you calculate the amount of the
increase/ (decrease) for the period by subtracting the amount for the earlier
year from the later year. If the difference is negative, the change is a decrease
and if the difference is positive, it is an increase Divide the change by the
earlier year's balance. The result is the percentage change. The changes can
also be shown both in dollar terms as well as percentages.

Activity 1.2
1. What are the limitations of financial statements?
? 2. Describe three techniques used in financial statement analysis.
3. Why is ratio analysis important in the analysis of financial statements?

1.5. Summary
In this unit we discussed that the various users of financial statements analyse
them in order to draw out more meaning from them and make informed
decisions. A number of techniques are used, depending on the objectives of
the user. Care should be exercised when carrying out the analyses, because
of the inherent limitations of the accounting information presented. Other
information accompanying the financial statements, for example, the directors'
reports should also be critically analysed to obtain a full picture of the status
and prospects of the business. The same goes when comparing financial
information of different businesses, as the accounting methods used may be
different, thereby necessitating adjustments to the statements before any
meaningful comparison can be made.

References
Faul, M.A. (1998) Accounting - An Introduction 5th Edition.
Butterworths.
Koen, M. and Oberholster, J.G.I. (1999) Analysis and Interpretation of
Financial Statements, 2nd Edition. JUTA.
Wood, F. (2008) Business Accounting 2, 11th Edition. Prentice Hall.

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8 Zimbabwe Open University
2
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Unit Two
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Interpretation and Analysis of

Financial Statements

2.0 Introduction

H aving looked at the various users of financial statements, and the

techniques used in financial analysis in the previous Unit, we now turn
our attention to one of the most commonly used techniques, that is, ratio
analysis.
Financial Accounting 2 BACC 106

2.1 Objectives
By the end of this unit, you should be able to:
z identify two basic types of comparative analysis
z calculate the following types of ratios:
a) Profitability ratios
b) Solvency ratios
c) Efficiency ratios
d) Shareholders or investors ratios.
e) Capital structure ratios

2.2 The Purpose of Ratio Analysis

Ratios are used to describe significant relationships between figures shown
on the statement of financial position and the statement of comprehensive
income or other financial statements. Ratios can be expressed in the form a
percentage, proportion, or rate.

It should be noted that a ratio on its own does not usually convey useful
information to management. It has to be compared with something before it
can be of use to the decision makers. The most common types of comparison
are trends analysis.

Trend analysis is where the current period ratio is compared with that achieved
in previous periods. The aim is to determine if there has been an improvement
or deterioration and then take appropriate action.

The ratios can also be compared with industry averages, that is, those achieved
by other firms in the same industry to determine how the company has fared
in comparison to the industry.

2.3 Types of Ratios

The ratios have been divided into the following categories, under which they
will be discussed:
Profitability ratios
Solvency ratios
Efficiency ratios and
Shareholders or investors ratios.
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10 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

2.3.1 Profitability ratios

These are used to measure the performance of the company in terms of
profitability, and determine if it is worthwhile investing in the company. They
are compared with the previous year to determine if there was an improvement
or not. They can also be used to compare performance with competitors or
industry averages.

Gross profit margin

Gross profit: Sales

This measures the gross profit in every dollar of sales.

Mark up

Gross profit: Cost of sales.

This shows the percentage added to the cost of goods to arrive at the selling
price.

Net profit: Sales

This shows the amount of profit in every dollar of sales. It indicates by how
much prices can be reduced before a loss is made.

Return on capital employed

This ratio is very important to investors as it indicates the return they get for
the money invested in the company. Capital employed can be defined in different
ways:

a) Return on ordinary shareholder equity is calculated as follows:

Profit after tax and preference dividend: average ordinary shareholders' equity

The higher the ratio, the more profitable the investment.

b) The return on capital employed by all long term suppliers of capital,

also known as Return of capital employed (ROCE)

Return: capital employed

where return is = net profit + preference share dividend + interest on

debentures and long term loans.
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Zimbabwe Open University 11
Financial Accounting 2 BACC 106

Capital employed = ordinary share capital + reserves + preference share

capital + debentures and other long term loans.

2.3.2 Solvency ratios

Solvency is the ability of a company to pay its debts when they fall due. The
ratio is used by lenders to determine the creditworthiness of the entity. There
are two ratios, the current ratio and the acid test or quick asset ratio.

Current ratio

Current assets: current liabilities

The ratio is used to determine if there are sufficient current assets to pay off
current liabilities. It is usually expressed as a ratio to one, for example, 2:1

Acid test ratio (or Quick asset ratio)

Current assets - inventory: current liabilities

The ratio measures the ability of the company to pay off current liabilities
without having to sell stocks.

2.3.3 Efficiency ratios

These ratios analyse how efficiently assets were used as this directly affects
profitability.

Asset turnover

Sales: total assets - current liabilities.

It measures how effectively assets are being employed and so a higher turnover
means a more efficient use of assets. It is expressed as the number of times
assets have been turned over.

Inventory turnover

Cost of goods sold: average inventory

Average inventory = (Opening stock +closing stock) / 2

This is expressed as the number of times the inventory was turned over. The
higher the number of times the more efficient the turnover.
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12 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

The average collection period

This is calculated in two steps

Sales per day = credit sales / 365

Average collection period = Total debtors / sales per day.

The aim is to have a short collection period without affecting the sales volume.
A longer collection period means that cash, which could be used to pay other
operational expenses, is tied up in debtors for a longer period.

The average payment period

Use the formula for average collection period.

2.3.4 Shareholders' or Investors' ratios

Earnings per share

The ratio shows how much of the company's earnings can be attributed to
each ordinary share. The formula provided by International Accounting
Standard number 33 (IAS 33) is:

Net profit/loss attributed to ordinary shareholders / the weighted average

number of shares outstanding during the period.

Dividend yield

Gross dividend per share / Market price per share

This measures the real rate of return

Dividend cover

Dividend per share / Earnings per share

This shows how many times earnings cover dividends.

Price Earnings (P /E) ratio

This is the ratio between the market price per share and the earnings per
share.

Market price per share / Earnings per share

Capital structure

These ratios are concerned with the long term financing of the company

Debt ratio

Total debt / Total assets

This shows the extent to which the entity is financed by borrowed funds.

Interest cover

Profits before interest and tax / interest charge

The ratio indicates the number of times that profits earned cover the interest
obligation.

Here is an example to illustrate the points we have discussed above.

Example 2.1
Revival Ltd
Statement of Comprehensive Income for the Year Ended 31 December
2011
2011 2010
$ % $ %
Sales 20 000 100 16 000 100

Opening stock 6 000 5 600

Purchases 16 000 11 920
22 000 17 520
Less closing stock 7 000 6 000
Cost of goods sold 15 000 75 11 520 72
Gross profit 5 000 25 4 480 28
Expenses
Selling and distribution 550 2.7 450 2.9
Van depreciation 1 000 5.0 840 5.2
Administrative 1 850 9.3 1 720 10.7
Financial 600 3.0 400 2.5
4 000 20.0 3 410 21.3
Net profit before tax 1 000 5.0 1 070 6.7
Provision for tax 400 580
Net profit after tax 600 490

Extract from statement of changes in

equity
Preference dividend 110 110
Ordinary dividend 198 198
Retained earnings c/f 292 182
600 490
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14 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

Statement of Financial Position as at 31 December 2011

2011 2010
$ % $ % Change
during 2011
Assets
Non- current assets
Motor vehicles at cost 6 040 30.2 4 440 32.3 1 160
Less depreciation 3 040 15.2 2 040 14.8 1 000
3 000 15.0 2 400 17.5
Premises 7 000 35.0 7 000 50.9
10 000 50.0 9 400 68.4 600
Current assets
Bank 2 200 11.0 - 2 200
Debtors 4 400 22.0 2 600 18.9 1 800
Stock 7 000 35.0 6 000 43.6 1 000
13 600 68.0 8 600 62.5 5 000
Less current liabilities -
Bank overdraft 1 850 13.5 (1 850)
Creditors 3 040 15.2 2 000 14.5 1 040
Tax 560 2.8 400 2.9 160
3 600 18.0 4 250 30.9 (650)

Net working capital 10 000 50.0 4 350 31.6 5 650

Total assets less current 20 000 100.0 13 750 100

liabilities

Less 5% debentures 6 000 30.0 6 000

Net assets 14 000 13 750 250

Equity
5%cumulative preference shares 4 000 20.0 4 000 20.0

Ordinary shareholders’ equity

Ordinary shares 6 000 30.00 6 000 43.6
Retained income 1 442 7.21 1 050 8.4 292
Share premium 518 2.59 5 14 4.1 (42)
General reserve 2 040 10.20 2 040 14.8
10 000 50.00 9 750 70.9

14 000 100.00 13 750 100 250

The following are some of the ratios that can be calculated from the
financial statements:
Ratio 2011 2010 Comments
Current ratio Liquidity increased in
Current assets 136000 8600 2011, meaning that the
Current liabilities 3600 = 3.8 8250 = 2 entity is in a better off
position to pay off its
liabilities as they fall due.
Quick asset ratio This ratio shows an
Debtors and cash 6600 2600 improvement in that in
Current liabilities 3600 = 1.8 4250 = 0.6 2011, the entity is able to
pay off all its liabilities
without having to sell
stock.
Average turnover There is an improvement
period 6000 + 7000 x 12 5600 + 6000 x 12 in the turnover rate, as the
Average stock 2 x 15000 2 x 11520 average stock is being
Cost of sales turned over in 5.2 months
= 5.2 mths = 6 mths in 2011, instead of 6
months in 2010.
Average The entity is taking longer
collection period 2600 + 4400 x 12 2600 x 12 to collect in 2011, as
Average debtors 2 x 20000 16000 compared to 2010.
Sales Perhaps this is a strategy
= 2.1 mths = 2mths to increase sales.
Average payment This reflects a worse
period Average 2000 + 3000 x 12 2000 x 12 position in 2011, as the
creditors x 12 2 x 16000 11920 entity is taking a shorter
Purchases = 1.9mths = 2 mths credit period.

Common size analysis

Each item on the statement of comprehensive income is expressed as a

percentage of sales. Items on the statement of financial position are expressed
as a percentage of total assets -current liabilities.

Trend analysis

You can discern the trend by comparing the percentages of the two periods
shown here

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16 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

Activity 2.1
The following is a summarised statement of comprehensive income of
? Apex Ltd.
2011 2010
$000 $000
Sales 5 500 5 000

Opening stock 1 200 800

Purchases 4 455 4 100
5 655 4 900
Less closing stock (1 200) (900)
Cost of sales 4 455 4 000
Gross profit 1 045 1 000
Less expenses
Administrative salaries and wages 310 245
Travellers salaries and commission 260 240
Rent and rates 140 105
Heat and light 48 45
Carriage outwards 90 85
Sundry office expenses 32 30
880 750
Profit 165 250

Required
As the accountant, draft a report to the management, showing any
comparative figures or percentages you consider significant pointing
out anything to which you think particular attention should be drawn.

Activity 2.2
The following companies are carrying on the same type of business.
? State which company has performed better from the records given
below:
A B C
Current ratio 0 80:1 1.32:1 1.03:1
Quick ratio 0.75:1 0.68:1 0.22:1
Total asset turnover 1,5 times 2.5 times 3.5 times
Return on assets employed 12% 17% 10%
Net profit to sales 8% 7% 3%
Gross margin to sales 20% 15% 12%
Dividends to profit earned 40% 25% 50%

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18 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

Activity 2.3
The following abridged statements of financial position and statements
? of comprehensive income have been presented to you:
Abridged Statements of Financial Position
30 June 2010 30June 2009
Assets
Non-current assets 20 000 21 000
Investments 20 000 20 000
Current assets
Stock 40 000 30 000
Debtors 65 000 60 000
Cash 5 000 19 000
150 000 150 000
Equity and liabilities
Share capital: ordinary shares of $1 each 100 000 80 000
General reserve 12 000 12 000
Retained income 20 000 14 000
132 000 106 000
Liabilities
6% Debentures - (20 000)
Creditors (18 000) (24 000)
150 000 150 000

Abridged Statements of Comprehensive Income

30 June 2010 30 June 2009
Credit sales 192 000 120 000
Cash sales 48 000 90 000
240 000 210 000
Opening stock 30 000 20 000
Purchases 190 000 170 000
220 000 190 000
Less closing stock 40 000 30 000
180 000 160 000
Gross profit carried down 60 000 50 000
240 000 210 000

Gross profit brought down 60 000 50 000

Income from investment 1 200 1 000
61 200 51 000
Less
Interest on debentures - (1 200)
Administration expenses (25 200) (20 800)
Profit for the year 36 000 29 000
Less tax 8 000 6 000
Profit after tax 28 000 23 000
Statement of changes in equity (extracts)
Profit after tax 28 000 23 000
Less dividends 22 000 24 000
Retained income for the year 6 000 (1 000)
Add retained income beginning of the year 14 000 15 000
Retained income at the end of the year 20 000 14 000
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Zimbabwe Open University 19
Financial Accounting 2 BACC 106

Additional information
? 1. The company's shares are listed on the stock exchange and the current
market value is 200 cents per share.
2. On 30 June 2009, the market value of the company's shares was 150
cents per share.
3. Debentures were redeemed from the proceeds of the issue of 20 000
ordinary shares of $1 each.
Required:
(a) Calculate the following ratios for the years 2009 and 2010:
1. Gross profit percentage
2. Net profit to turnover
3. Current ratio
4. Quick asset ratio
5. Inventor turnover
6. Earnings per share
7. Dividend per share
8. Price/earnings ratio.
(b) Comment on the results of (a) above
(c) To what can the decrease in dividend per share be attributed?
(d) What is the reason for the decrease in earnings per share?
(e) What is the reason for the increase in the price/earnings ratio?

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20 Zimbabwe Open University
Unit 2 Interpretation and Analysis of Financial Statements

2.8 Summary
Now that we have gone through this unit, you should be able to make a
meaningful analysis of the financial statement of companies. In this unit we
highlighted the importance of ratio analysis in the interpretation of financial
statements. The analysis and interpretation of financial statements forms the
basis of important decisions by both the management of the entity and investors
and potential lenders. The ratios derived from the analysis can also be used to
compare the performance of the company with that of the industry or other
companies in the industry. However, when inter-company comparisons are
made, care should be taken to ensure that differences in accounting policies
are accounted for, and any adjustments are made to the financial statements
so that you compare like with like.

References
Faul, M.A. (1998) Accounting - An Introduction 5th Edition. Butterworths
Koen, M. and Oberholster, J.G.I. (1999) Analysis and Interpretation of
Financial Statements. 2nd Edition. JUTA.
Wood, F. (2008) Business Accounting 2. 11th Edition. Prentice Hall.

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22 Zimbabwe Open University
3
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Unit Three
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Bills of Exchange

3.0 Introduction

A bill of exchange is an unconditional order in writing addressed by one

person to another signed by the person giving it, requiring the person to
whom it is addressed to pay on demand or at a fixed or determinable future
time a sum certain in money to or to the order of a specified person or to
bearer. In this unit, we look at the accounting treatment of bills receivable and
bills payable.
Financial Accounting 2 BACC 106

3.1 Objectives
By the end of this unit, you should be able to:
z define a bill of exchange
z state the parties to a bill of exchange
z record transactions involving bills of exchange in books of accounts

3.2 Advantages of a Bill of Exchange

There are a number of advantages to bill of exchange some of which include:
It enables an exporter to receive cash soon after goods are dispatched
It enables a buyer to defer payment until goods are received or even
later
A bill can be negotiated to settle other debts
It fixes the date of payment, facilitating planning and prosecution in
case of non payment

3.3 Parties to a Bill

The drawer -the person who writes up the bill.

The drawee - the person on whom the bill is drawn - after acceptance he
becomes the acceptor.

The payee - the person to whom the money is payable.

The drawer writes up the bill and presents it to the drawee for acceptance.
The drawee accepts by endorsing across the face of the bill. Once a bill has
been accepted, the holder of the bill can:
Hold it until maturity date
Negotiate it, that is, transfer it to another person
Discount it - He will get less than the face value of the bill, the difference
being discounting charges

3.4 Accounting Entries

When the bill is accepted, the following entries are made:

Debit Bills receivable account and Credit the drawee.

The subsidiary book in which all bills receivable are recorded is the Bills
Receivable book. All bills receivable are first recorded in this book and then
posted to the ledger.

When payment is made at maturity

Debit Bank and Credit Bills receivable

When a bill is discounted

Debit bank with the amount received, Debit Discounting charges with
discounting charges and Credit Bills receivable with the face value of the bill.

If the bill is negotiated the entries are:

Debit the creditor and Credit Bills receivable with the face value of the bill.

3.5 Dishonour of Bills of Exchange

It sometimes happens that on maturity of the bill, the drawee fails to pay the
amount due when the bill is presented to him. When this happens we say that
the bill has been dishonoured. It will be necessary to restore the indebtedness
by crediting the bills receivable account and debiting the debtor (who has
dishonoured the bill).
Example 3.1

On 1 March 2009, D Ltd had the following debtors: P. Dube $50; L Moyo
$100; and P Lang $150. On the same date, each of the debtors accepted
bills, promising to settle their debts on 30 March 2009.
Required

Enter these transactions in the books of account:

(a) Assuming that all the bills were honoured on maturity.
(b) On 10 March, the bill for L Moyo was discounted, and $10 discounting
charges were levied.
(c) P Lang dishonoured his bill on presentation on 30 March.
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Zimbabwe Open University 25
Financial Accounting 2 BACC 106

Solution

(a) Bills Receivable Book

2009
Mar 1 P Dube 50
L Moyo 100
P Lang 150
Bills Receivable 300
Bills Receivable Account
2009 2009
Mar 1 Sundry debtors 300 Mar Bank 300
30

P Dube
2009
Mar 1 Balance b/d 50 Mar 1 Bills receivable 50

P Lang
2009
Mar 1 Balance b/d 150 Mar 1 Bills receivable 150

Bank
2009
Mar 30 Bills receivable 300

L Moyo
2009
Mar 1 Balance b/d 100 Mar 1 Bills receivable 100

(b) Here we will just show the entries for the discounted bill
Bills Receivable Account
2009 2009
Mar 1 Sundry debtors 300 Mar 10 Bank 90
Discounting 10
charges
Balance c/d 200
300 300
Balance b/d 200

Bank
2009 2009
Mar 10 Bills receivable 90

Discounting Charges
2009 2009
Mar 10 Bills receivable 10

First journalise the dishonour and restore the indebtedness

2009
Mar 30 P Lang 150
Bills receivable 150
Being bill dishonoured on presentation to P Lang

Then post to the ledger

P Lang
2009
Mar 1 Balance b/d 150 Mar 1 Bills receivable 150
30 Bills receivable 150
Bills Receivable Account
2009 2009
Mar 1 Sundry debtors 300 Mar 30 P Lang 150

3.6 Bills Payable

When we accept bills drawn on us by creditors, these are bills payable. The
subsidiary book in which they are recorded is the Bills payable book. The
accounting entries are:

On acceptance of the bill, debit the creditor and credit the bills payable account.

On settlement of the bill, when presented for payment, Debit the Bills payable
account and Credit the bank.

Activity 3.1
J Bloggs, a sole trader, has the following transactions:
? September 1
He owes Masasa Hardware $320 in respect of goods supplied.
Masasa Hardware draws a bill of exchange on Bloggs, payable one
month after date for this amount. The bill is accepted by Bloggs.
September 3
Bob owes J Bloggs $270 in respect of goods supplied and J Bloggs
draws a bill of exchange on him for that amount. This is accepted by
Bob. The bill is payable one month after date.
September 7
Tamuka owes J Bloggs $190 in respect of goods supplied and J Bloggs
draws a bill of exchange on him for that amount. This is accepted by
Tamuka and is payable two months after date.
September 11
J Bloggs owes Chapungu $150 in respect of goods supplied. Chapungu
draws a bill of exchange on Bloggs for that amount. The bill is payable
one month after date and is accepted by J Bloggs.
All bills are paid on due date except that for $190, which was
dishonoured.
Required
Enter these transactions in the books of J Bloggs.

3.7 Summary
In this unit we covered the definition and use of bills of exchange. We also
dealt with the accounting entries in respect of the various situations, on
acceptance of the bills and after acceptance, up to the time it is honoured or
dishonoured. You should now be able to deal with any transactions involving
bills of exchange.

References
Faul, M.A. (1998) Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (2008) Business Accounting 1. 11th Edition. Prentice Hall.

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30 Zimbabwe Open University
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Unit Four
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Partnership Accounts

4.0 Introduction

A partnership is defined as the relationship which subsists between persons

carrying on a business with a view to profit. This unit covers the
accounting entries for partnerships, from the formation to dissolution.
Financial Accounting 2 BACC 106

4.1 Objectives
By the end of this unit, you should be able to:
z state the requirements for setting up a partnership
z prepare annual financial statements of partnerships
z prepare accounts relating to dissolution of partnerships
z account for goodwill on admission of a partner

4.2 Reasons for Entering into a Partnership

Below are some of the reasons for entering into a partnership:
To obtain more capital
To pool together knowledge and experience and give a more
comprehensive service to clients
To share responsibilities

4.3 Agreement between Partners

An oral agreement is enough. However, it is in the partners' interest if the
agreement is reduced to writing in a partnership deed. Some of the items
included in the deed are:
a) Capital contributions by each partner
b) Provisions for interest on capital and drawings if any
c) The profit sharing ratio
d) Duration of the partnership
e) Maximum amount of drawings per partner per year
f) Resolution of disputes and specifications regarding retirement or
admission of new partners, death of partners, and dissolution of the
partnership
g) Rights, powers and duties and responsibilities of each partner.

4.4 Accounting for Partnerships

Capital accounts

A capital account is opened for each partner. This account will show his capital
contribution.

Current accounts

Each partner will also have a current account. This account is used to record
current transactions which affect the partners' equity, for example, share of
profits, interest on capital, and interest on drawings.

Drawings

Each partner's drawings are recorded in the partner's drawings account, and
this account is cleared at the end of the year by transfer to the respective
partner's current account.

4.5 Preparation of Annual Financial Statements of a

Partnership
The annual financial statements of a partnership are similar to those of a sole
trader. However, the following differences should be noted:

(1) The statement of comprehensive income

The appropriation section is added to this statement, to show the allocation of

profits between partners. Examples of entries made in the appropriation
account are:
Writing off of goodwill
Interest on capital
Partners' salaries
Interest on drawings
A brief explanation of each of these items is given below:

Writing off goodwill

Goodwill is the value attached to the good name and reputation of the
partnership. It is usually brought into the books on admission of a new partner
or on retirement of one of the partners. It is an intangible asset, and for this
reason, the partners may feel that it should not be retained in the books, and
agree that it should be written off over a period of time. Writing off is effected
by debiting the appropriation account and crediting the goodwill account.

Interest on capital

Interest on capital is usually allowed in order to adjust the rights of the partners
among themselves, for example, where they share profits equally, but have
unequal capitals. This is a distribution to the owners and is debited to the
appropriation account and credited to the respective partners' current
accounts.

Interest on drawings

Interest is usually charged on drawings by the partners. This is done in order

to discourage partners form withdrawing huge amounts, to the detriment of
the business. Such interest is income to the partners, coming from the owners
of the business and is, therefore, credited to the appropriation account and
debited to the respective partners' current accounts.

Example 4.1

John and James are in partnership with capitals of $5 000 and $3 000, sharing
profits 5:3 respectively. The partnership agreement provides that:

James gets a salary of $1 000

Interest on capital to be provided for at 10% per annum

Interest to be charged on drawings at the rate of 10% per annum

The following information is given for the period ending 30 June 2010 drawings
- John $1 000, James $1 500, all drawn on 1 July 2009 and ($500) goodwill
to be written off. Profit for the year amounted to $6 000.

Required

The Appropriation account for the year ended 30 June 2010.

Solution

Partnership of John and James

Statement of Comprehensive Income for the Year Ended 30 June 2010

Profit b/d 6 000
Interest on drawings
John 100
James 150
250
6 250
Appropriations
Interest on capital
John 500
James 300
800
Salary - James 1 000
Goodwill 500
2 300

3 950
Share of profits John 2 469
James 1 481
(3 950)

Activity 4.1
Tom and Dick are in partnership sharing profits in the ratio 3:2. Their
? capital accounts are Tom $8 000, and Dick $5 000. The partnership
agreement provides for the following:
Interest on capital to be provided at 5% per annum
Dick to receive a salary of $500
5% interest to be charged on drawings
In addition, it was decided that $200 should be written off the goodwill
account.
The balances on current accounts are: Tom $500 Dr, Dick $600 Cr.
Drawings are Tom $2 000 Dick $1 800. Profit for the year was $6
000.
Required
The Appropriation account and the partners current accounts.
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Zimbabwe Open University 35
Financial Accounting 2 BACC 106

(2) The statement of financial position of a partnership

This is also similar to that of a sole trader. However, there will be more than
one capital account, that is, a capital account for each partner. The current
accounts of each of the partners are also shown under the capital accounts.

Example 4.2

Example of a partnership statement of financial position

A and B partnership

Statement of Financial Position for the Year Ended 31 December 2010

Noncurrent Assets
Land and buildings 6 000
Plant and Machinery 4 000
Furniture and Fittings 2 000
Motor vehicles 2 750
14 750
Current assets
Stock 2 000
Debtors 2 000
Bank 1 600
Cash 250
5 850
20 600
Capital accounts
A 7 000
B 5 000
12 000
Current account A (200)
Current account B 1 000
12 800
Non-current liabilities
Mortgage 4 000

Current liabilities
Creditors 3 000
Accrued wages 800
3 800
20 600
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36 Zimbabwe Open University
Unit 4 Partnership Accounts

Example 4.3

The following trial balance was taken from the books of Gordon and Bowden,
car hire proprietors, as at 31 December 2011.

$ $
Capital accounts
Gordon 1 600
Bowden 200
Drawings
Gordon 800
Bowden 240
Hire cars at cost 2 720
Cash at bank 524
Sundry debtors for hire 260
Creditors for repairs 296
Petrol. Oil and grease 365
Sales of petrol 300
Spares and repairs to cars 426
Rent and rates 260
Office salaries 420
Advertising and stationery 126
Car licenses and insurance 220
Receipts from hire of cars 3 400
Creditor for cars purchased on credit 640
Interest (includes $25 paid in advance) 75
6 436 6 436

Prepare a statement of comprehensive income for the year ended 31

December 2011 and a statement of financial position as at that date, making
the necessary adjustments for the following:
Depreciate cars at 25% per annum
Stocks of spares 115
Stock of petrol 50
Doubtful debts 25
Interest on partner's capital at 5%
Commission due to staff at 5% of hire receipts
Licences and insurance unexpired $120
Partner's salary due to Gordon for management $500
Profits to be shared equally between partners

Solution

Workings

Depreciation

25% of $27290 = $565

Amounts to be charged in respect of other adjustments

Petrol, oil Spares Licences Office
and grease and and salaries
repairs insurance
Per trial balance 365 426 220 420
Less closing stocks (50) (115)
Less prepayments (120)
Add commission 5% x 3400 170
To statement of 315 311 100 590
comprehensive income

Statement of Comprehensive Income for the Year Ended 31 December

2011
$ $
Car hire receipts 3 400
P etrol sales 30 0
3 700
Ve hic le c osts
P etrol , oil an d g rease 3 15
S pares an d re pairs 3 11
L ic ence s and in suranc e 1 00
De preciation 5 65
(1 2 91)
Ad ministration
Ren t a nd rates 2 60
S alaries and co mmission 5 90
Ad ve rtisin g a nd stationery 1 26
(976)
F in ance
Inte rest 50
Do ub tful de bts 25
(75)
P ro fit 1 358

Ap propriation s
Go rdo n
Inte rest on cap ita l 80
S alary 5 00
S hare o f profits 3 84
96 4
Bo wd en
Inte rest on cap ita l 10
S hare o f profits 3 84
39 4
1 358
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38 Zimbabwe Open University
Unit 4 Partnership Accounts

Statement of Financial Position as at 31 December 2011

$ $ $
Assets
Non-current assets
Hire cars at cost 2 720
Less depreciation (565)
2 155
Current assets
Petrol oil and grease stocks 50
Spares 115
Trade debtors less provision for doubtful debts 235
Prepaid licences 120
Bank 524
Prepaid interest 25
1 069
3 224

Equity and liabilities

Capital
Gordon 1 600
Bowden 200
1 800
Current accounts
Gordon
Appropriation of profits 964
Less drawings 800
164
Bowden
Appropriation of profits 296
Less drawings 1 240
154
318
2 118
Current liabilities
Trade creditors 296
Accrued commission 170
Other creditors (640) 1 106
3 224

Activity 4.2
Jack and Jill are in partnership sharing profits in the ratio 3:2. The
? following is their trial balance at 31 December 2010:
Dr. Cr.
Gross profit 8 660
Salaries 785
Heating and lighting 490
Rates 450
Bad debts 500
Provision for bad debts 640
Discounts 240 200
Carriage outwards 610
Vehicle expenses 725
Building repairs 250
Loan interest (7% per annum) 70
Advertising 600
Bank 1 290
Debtors and creditors 5 120 2 250
Stock 6 995
Moto vehicles 4 000
Land and buildings 9 500
Goodwill 2 100
Current account:
Jack 175
Jill 105
Drawings
Jack 1 500
Jill 1 395
Bank loan 2 000
Capital accounts
Jack 12 800
Jill 10 000
36 725 36 725

Required
Draw up the statement of comprehensive income for the year and the
statement of financial position as at 31 December 2010, taking into
account the following information:

Motor vehicles to be depreciated at 10%

Advertising amounting to $200 was paid in advance
Wages amounting to $150 are in arrears
Interest on capital to be allowed at 5%
Jack to receive a salary of $300
$400 to be written off goodwill

4.6 Partnership Goodwill

Goodwill is an intangible asset, associated with the good name and reputation
of the entity and the assumption that the entity will continue to make good
profits.

In a partnership goodwill normally arises on admission of a new partner. The

important thing to remember is that goodwill belongs to the old partners, as
they were responsible for building it up. They are therefore rewarded, by
crediting their capital accounts and debiting the goodwill account if it is decided
to open one in the books of account. However there are different ways of
dealing with goodwill, depending on what the partners agree on.

Ways of dealing with goodwill

A goodwill account is raised and the amount is credited to the old

partners in their profit sharing ratio.

The accounting entries are:

Dr goodwill account
Cr the old partners' capital accounts in their profit sharing ratio with the
amount of goodwill
Goodwill is recognised, but a goodwill account is not kept in the books

In this case, two sets of entries are necessary, one raising the goodwill and
crediting the old partners in their profit sharing ratio, and the other removing
the goodwill from the books, by crediting goodwill, and debiting the partners'
(including the new partner) capital accounts in their profit sharing ratio. The
accounting entries are:
To raise the goodwill account
Dr goodwill account and Cr old partners' capital accounts in profit
sharing ratio with the amount of goodwill
To remove the goodwill account from the books
Dr partners' capital accounts (including the new partner) in profit sharing
ratio and Cr goodwill account
A premium is paid by the new partner and retained in the business

In this case the new partner pays in an amount equivalent to his share of the
profits, that is, if he is to get a fifth of the profits, he pays in an amount equal to
a fifth of the goodwill determined. There are two ways of dealing with the
premium, depending on what the partners agree on.
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Zimbabwe Open University 41
Financial Accounting 2 BACC 106

Premium retained in the business

The accounting entries are:

Dr cash and Cr old partners in profit sharing ratio, with the premium paid.

Premium is withdrawn by the old partners

The accounting entries are:

Dr cash and Cr old partners in profit sharing ratio, with the premium paid.

Dr old partners in profit sharing ratio and Cr Bank or Cash, with amounts
paid to old partners.

Example 4.4

A and B are in partnership. Their capital account balances are: A $20 000
and B $30 000. They share profits in the ratio of 2:3 respectively.

On 1 January 2010, they agree to admit C into the partnership. C is to bring

in $10 000 as his capital contribution for a 1/6 (one sixth) share in the profits.
The new profit sharing ratio for the new partnership of A, B and C will be 2:
3: 1. On that day goodwill is valued at $1 500.

Required:

Show the goodwill account and the partners' capital accounts in each of the
following cases.
1. A goodwill account is raised and remains in the books.
2. Goodwill is recognised, but a goodwill account is not kept in the books.
3. C pays a premium for his share of profits and the amount is kept in the
books.
Solutions

A goodwill account is raised and remains in the books.

The goodwill belongs to the old partners who worked to build the reputation
of the partnership, and is therefore, credited to their capital accounts in profit
sharing ratio, that is, A = 2/5 of $1 500 = $600; and B = 3/5 of $ 1 500=
$900.

Capital Account – A
Jan 1 Balance c/d 20 600 00 Jan 1 Balance b/d 20 000 00
Goodwill 600 00
20 500 00 20 600 00
Balance b/d 20 600 00

Capital Account – B
Jan 1 Balance c/d 30 900 00 Jan 1 Balance b/d 30 000 00
Goodwill 900 00
30 900 00 30 900 00
Balance b/d 30 900 00

Goodwill Account
Jan 1 Capital A & B 1 500 00

Goodwill is recognised , but a goodwill account is not kept in the books

The first step is to credit the old partners with the full amount of goodwill in profit sharing ratio. The
next step is to debit all the partners’ (including the new partner) accounts with the full amount of
goodwill in the new profit sharing ratio.
Capital Account – A
Jan 1 Goodwill 500 00 Jan 1 Balance b/d 20 000 00
Balance c/d 20 100 00 goodwill 600 00
20 500 00 20 600 00
Balance b/d 20 100 00

Capital Account – B
Jan 1 goodwill 750 00 Jan 1 Balance b/d 30 000 00
Balance c/d 30 150 00 Goodwill 900 00
30 900 30 900 00
Balance 30 150 00

Capital Account – C
Jan 1 Goodwill 250 00 Jan 1 Bank 10 000 00
Balance c/d 9 750 00
10 000 00 10 000 00
Balance b/d 9 750 00

C pays a premium and the amount is kept in the books

C pays in one sixth of the goodwill, that is, $250, and this amount is shared by A and B in profit sharing
ratio. The accounting entries are shown below.
Capital Account – A
Jan 1 Balance c/d 20 100 00 Jan 1 balance b/d 20 000 00
Bank 100 00
20 100 00 20 100 00
Balance b/d 20 100 00

Capital Account – B
Jan 1 Balance c/d 30 150 00 Jan 1 Balance b/d 30 000 00
Bank 150 00
30 150 00 30 150 00
Balance b/d 30 150 00

Capital Account – C
Jan 1 Bank 10 000 00

4.7 Dissolution of a Partnership

A partnership can be dissolved because of any of the following reasons:
By general agreement of partners, giving notice to each other on the
intention to dissolve the partnership
If for a fixed term, at the expiry of that term
On the death of a partner
On the occurrence of any event that makes it unlawful to carry on the
business of the partnership
Bankruptcy of a partner
By court on application of a partner.
Accounting entries on dissolution of a partnership

Open a Realisation account and debit it with all assets except cash or a debit
balance on a partner's current account. The corresponding credits go to the
respective asset accounts, thereby closing them.

Debit cash and credit Realisation account with proceeds of the sale of assets.
If an asset is taken over by a partner, debit the partner's capital account and
credit the Realisation account.

Credit cash and debit Realisation account with costs of the dissolution.

Pay off liabilities /creditors - Debit creditors and credit cash.

Liabilities are discharged in the following order:

Third parties first
Followed by employees
Then partners' loans
And last, partners capital and current accounts
Balance the realisation account to get the profit or loss on realisation
Share the profit or loss by transferring to the partners' capital accounts
Balance the partners' capital accounts and pay off the balances, that is,
debit the capital accounts and Credit cash
Example 4.5

Alacia and Tafadzwa are in partnership sharing profits 5:3 respectively. They
agree to dissolve the partnership, and their statement of financial position at
the date of dissolution was as follows:

Assets $

Non-current assets
Premises 1 200

Current assets
Stock 1 400
Debtors 1 100
Cash 600
4 300
Equity and liabilities
Capital
Alacia 1 500
Tafadzwa 1 300 2 800

Current liabilities
Creditors 1 500
4 300
Assets other than cash realised $4 500

Required

Draw up the realisation account and the capital accounts of the two partners

Solution
Realisation Account
Assets 3 700 Cash 4 500
Profit to Capital accounts
Alacia (5/8) 500
Tafadzwa (3/8) 300
4 500 4 500

Capital Account – Tafadzwa

Cash 1 600 Balance b/d 1 300
Realisation 300
1 600 1 600

Capital Account – Alacia

Cash 2 000 Balance b/d 1 500
Realisation 500
2 000 2 000

Note that the other accounts which appear on the statement of financial
position are closed by completion of double entry as follows:
Premises Account
Balance b/d 1 200 Realisation 1 200

Stock Account
Balance b/d 1 400 Realisation 1 400

Debtors Account
Balance b/d 1 100 Realisation 1 100

Creditors Account
Cash 1 500 Balance b/d 1 500

Cash Account
Balance b/d 600 Creditors 1 500
Realisation 4 500 Capital – Alacia 2 000
Capital – Tafadzwa 1 600
5 100 5 100

4.8 The Garner versus Murray Rule

This rule was applied where one of the partners was insolvent and could not
pay his share of the loss on dissolution. The rule is that the solvent partners
share the loss in the proportion of the last balances of their capital accounts,
that is, before dissolution.

Example 4.6

A, B and C are in partnership sharing profits and losses [Link] respectively.

The state of affairs at the date of dissolution is as follows:
Dr. Cr
Sundry creditors 3 875
A Loan account 250
Capital A 1 520
Capital B 1 120
Cash 986
Debtors 3 056
Stock 1 844
Furniture and fittings 720
Capital C 159
6 765 6 765

The assets realised $4 844 and realisation expenses were $52. C was unable
to bring in anything. Using the Garner versus Murray Rule, show the realisation
account, the partners capital accounts, and the cash book.
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46 Zimbabwe Open University
Unit 4 Partnership Accounts

Cash Book (Bank Account)

Balance b/d 986 Realisation expenses 52
Realisation 4 844 Sundry creditors 3 875
Deficiency Cash paid in by A 414 A Loan 250
Deficiency Cash paid in by B 276 Capital A 1 349
Capital B 994
6 520 6 520

Realisation Account
Sundry assets 5 620 Bank 4 844
Bank (expenses) 52 Deficiency:
Capital A 414
Capital B 276
Capital C 138
5 672 5 672

Capital Account A
Capital C 171 Balance 1 520
Bank 1 349
1 520 1 520

Capital Account B
Capital C 126 Balance 1 120
Bank 994
1 120 1 120

Deficiency Account
Realisation account loss 828 Bank A 414
Bank B 276
Capital C 138
828 828

Capital Account C
Balance b/d 159 Capital A 171
Realisation – deficiency 138 Capital B 126
297 297

Note the deficit on C's capital account is shared between A and B in proportion
to their original capital balances, that is, $1 520 and $1 120 respectively.

A = 1 520/2 640 x 297 = $171

B = 1 120/2 640 x 297 = $126

Activity 4.3
John, Peter and Tom were partners sharing profits and losses in the
? ratio [Link]. The statement of financial position of the partnership as at
31 December 2006 was as follows:
Assets
Noncurrent assets Cost Acc depn NBV
Premises 180 000 10 000 170 000
Motor vehicles 27 500 5 500 22 000
207 500 15 500 192 000
Current assets
Stock 68 250
Debtors 172 500
Less provision for 1 265 171 235
doubtful debts
Bank 26 065
265 550
Less current liabilities
Creditors (60 000)
205 550

397 550
Noncurrent liabilities
Loan from Tom (7 550)
Net assets 390 000
Equity
Capital John 100 000
Peter 40 000
Tom 160 000 300 000
Current John 30 000
Peter (10 000)
Tom 70 000 90 000
390 000
The assets and liabilities were disposed of as follows:
The premises were sold at $200 000 and legal charges from the sale
amounted to $10 000.
Tom took over the stock and motor vehicle at book value. Except for
$2 500, all debts were collected. The trade creditors were discharged
for $56 000. Realisation expenses of $10 000 were paid.
Required
Prepare the realisation, bank, capital and current accounts for the
dissolution of the partnership.
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48 Zimbabwe Open University
Unit 4 Partnership Accounts

4.9 Piecemeal Dissolution

Sometimes it takes a long time for all the assets of the partnership to be
realised. The partners usually agree that cash be distributed to them as and
when it is available, from the sale of the assets. In order to determine the
amount of cash to be distributed to each of the partners, each realisation is
taken as the final realisation and the possible maximum loss is then calculated
and shared among the partners in profit sharing ratio. The following steps
should be taken to determine the amount of cash to be distributed to each of
the partners:
1. Find out the maximum possible loss, that is, the net book value of the
assets to be realised - cash to be distributed OR total capital balances
- cash to be distributed.
2. The maximum possible loss is shared by the partners in profit sharing
ratio.
3. Apply Garner versus Murray rule if there is any capital deficiency.
4. Distribute any available cash to the partners according to their remaining
capital balances.
5. Repeat the process until all assets have been realised.
Example 4.7

A, C, and L were partners sharing profits and losses in the ratio [Link]. The
statement of financial position of the partnership on 31 December 2006 was
as follows:
Non-current assets Cost Acc dpn NBV
Goodwill 100 000 100 000
Land 150 000 150 000
Plant and machinery 133 000 55 800 77 200
Motor vehicles 32 000 24 000 8 000
41 5000 79 800 335200

Current assets
Stock 64 000
Debtors 65 000
Less provision for doubtful debts 6 000 59 000
Cash 160
123 160

Less current liabilities

Creditors 57 000
Bank overdraft 128 360 (185 360) 66200
290 000
Noncurrent liabilities
Bank loan (20 000)
Net assets 270 000
Capital A 120 000
C 80 000
L 30 000 230 000
Current accounts
A 20 000
L 20 000 40 000

270 000
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Zimbabwe Open University 49
Financial Accounting 2 BACC 106

On 31 December 2006, the partners agreed to dissolve the partnership.

Distribution of cash was to be made as soon as cash was available. The
following transpired in 2007:

January

Provision was made for dissolution expenses of $24 000.

Land was sold for $200 000.

The cash available was used to settle in full the bank overdraft, the bank loan
and all creditors after receiving discounts of $7 600.

March

Plant and machinery which had originally cost $40 000 was sold for $32 000.

$15 000 was received from debtors.

April

Plant and machinery were sold for $51 000 after paying carriage of $2 000.

Fixtures and fittings were sold for $12 000.

May

All outstanding debtors, with the exception of a customer who owed $4 000
settled their accounts.

Motor vehicles were sold for $25 000.

The remaining stock was sold for $22 000.

Dissolution expenses amounted to $2 100.

Required

Prepare a statement of the distribution of cash, to show the distribution of

cash at each stage.

Solution

Distribution Statement
Total A C L
Capital accounts 230 000 120 000 80 000 30 000
Current accounts 40 000 20 000 20 000
270 000 140 000 100 000 30 000
1st distribution
Cash available (Note 2) (47 000)
Maximum possible loss ([Link]) 223 000 (89 200) (89 200) (44 600)
50 800 10 800 (14 600)
L’s capital deficiency shared by (8 760) (5 840) 14 600
A and C in last agreed capital
ratio (120 000:80 000)
Cash distributed 42 040 4 960 0

2nd distribution
Capital balances 223 000 97 960 95 040 30 000
Cash available (51 000 + 12 000) 63 000
Maximum possible loss 160 000 (64 000) (64 000) (32 000)
33 960 31 040 (2 000)
L’s capital deficiency shared by (1 200) (800) 2 000
A and C in last agreed capital
ratio (120 000:80 000)
Cash distributed 32 760 30 240 0

3rd distribution
Capital balances 160 000 65 200 64 800 30 000
Cash available 93 300
Maximum possible loss ([Link]) 66 700 26 680 26 680 13 340
Cash distributed 38 520 38120 16 660

Notes

Note 1

Cash available for distribution

January
Opening balance 160
Receipt from land 200 000
200 160
Less payments
Assumed dissolution expenses (i.e. not actually paid out) (2 400)
Bank overdraft (128 360)
Bank loan (20 000)
Creditors (balancing figure- (the discount is 57 000 - 49 400) (49 400)
There was no distribution to partners.

Note 2
March receipts
Stock 32 000
Debtors 15 000
47 000
Cash available for the 3rd distribution
Surplus in distribution expenses (2 400 - 2 100) 300
Collection of remaining debtors' balances (65 000 - 15 000 - 4 000) 46 000
Proceeds of motor vehicle 25 000
Proceeds of remaining stock 22 000
93 300
Calculation of Capital Balances After Each Distribution

A C L
Opening balances 140 000 100 000 30 000
Cash paid out on 1st distribution 42 040 4 960 0
Capital balances after 1st distribution 97 960 95 040 30 000
Cash paid on 2nd distribution 32 760 30 240 0
Capital balances after the 2nd distribution 65 200 64 800 30 000

Activity 4.4
A, B, and C share profits in the proportion of [Link]. Their statement of
? financial position is as follows:
Assets less liabilities 8 000
Capital accounts
A 3 000
B 3 000
C 2 000
8 000
The partnership is dissolved and the assets are realised as follows:
First realisation 1 000
Second realisation 1 500
Third and last realisation 2 500
5 000
Required
Prepare a distribution statement, showing the distribution of cash to
each of the partners at each realisation.

4.10 Summary
In this unit we introduced you to partnership accounts. It dealt with the formation
of partnerships, the compilation of annual financial statements, the accounting
treatment of goodwill on admission of a new partner, as well as dissolution of
partnerships. You should now be in a position to deal with all these issues with
confidence. You are encouraged to do the activities given in the unit on your
own in order to test your grasp of the concepts explained in the unit.

References
Faul, M.A. (1998) Accounting - An Introduction. 5th Edition.
Butterworths.
Wood, F. (2008) Business Accounting 1. 11th Edition. Prentice Hall.

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54 Zimbabwe Open University
5
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Unit Five
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Company Accounting:
Formation, Share Capital and
Debentures

5.0 Introduction

A company is a legal person or entity, formed by a group of people in

accordance with the law, for the purpose of a defined object. In
Zimbabwe, the Companies Act (Chapter 24:3) is the legislation governing
companies. An important feature of the limited company is the fact that liability
of the owners (shareholders) is limited to the amount they agreed to contribute
in respect of their shares. Once their shares are fully paid up, there is no
recourse to their private property in case of liquidation of the company. Limited
liability companies can either be private or public companies. In this unit we
cover the legal formalities necessary for the formation of company, the raising
of capital, issue of debentures, as well as the redemption of share capital and
debentures.
Financial Accounting 2 BACC 106

5.1 Objectives
By the end of this unit, you should be able to:
z distinguish between a private and public company
z describe the main documents required for the registration of companies
z explain different types of shares in terms of voting rights, the right to
dividends and repayment of capital
z make all accounting entries in connection with the raising and redemption
on share capital and debentures

5.2 A Private Company

The following are the characteristics of a private company: It
restricts the right to transfer shares
limits the number of members to fifty and
prohibits invitation to the public to subscribe to its shares and debentures

5.3 A Public Company

A Public Company is free to offer its shares to the public and has no restriction
regarding the number of members.

5.4 Formation of a Company

All companies have to be registered by the Registrar of Companies. Among
other registration formalities, two important documents have to be filed with
the Registrar of companies. These are:
1. The Memorandum of Association, which provides the basis for the
company and determines its nature and scope.
2. Articles of Association, which govern the internal rules and regulations
of the company.

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56 Zimbabwe Open University
Unit 5 Company Accounting: Formation, Share Capital and Debentures

5.5 Types of Invested Capital

There are three types of invested capital for a company:

Debentures - loans for a specific period, bearing a fixed rate of interest.

Preference shares - Shares carrying a fixed rate of dividend, but without

voting rights. They enjoy preference over ordinary shares in payment of
dividends and repayment of capital.

Ordinary shares - These shares have full voting rights and are entitled to
residual earnings (after payment of preference dividends), from which directors
may declare dividends.

5.6 Share Capital Issues by a Public Company

When a public company wants to issue shares, it issues a prospectus inviting
members of the public to subscribe to its shares. Members of the public then
fill in application forms and pay the amounts specified. The shares are then
allotted and successful applicants (who become shareholders) are advised.
Amounts paid in by unsuccessful applicants are then refunded.

5.7 Share Capital

It is important to distinguish between different types of share capital:

Authorised capital - This is the maximum amount of share capital the company
is allowed to issue in terms of its memorandum of association.

Issued capital - This is the amount of capital that has been issued for
subscription and is the product of the number of shares issued and the nominal
amount of each share.

Called up capital - this is that part of the issued capital that has been called
up, that is, members have been asked to pay this portion of the nominal value
of the shares.

Paid up capital - This is that part of the called up capital that has actually
been paid.

5.8 Types of Chares

There are many types of shares. The shares are usually distinguished by their
voting rights and their rights to dividends, as well as preference in the payment
of dividends and of the capital amount. The more common types of shares
are given below.

Ordinary shares - these have full voting rights and participate in profits after
preference shares.

Preference shares - These enjoy preference over ordinary shares in the

payment of dividends as well as repayment of capital. They have a fixed rate
of dividend, and normally do not have any voting rights.

There are also different variants of preference shares, and the more common
variants are discussed below.

Cumulative preference shares - The fixed dividend accumulates until it is

paid. Arrears in one year are carried forward to the next year.

Redeemable preference shares - These are redeemed after a specified period.

Redemption should be provided for by profits set aside in a reserve fund or
by a fresh issue of shares.

5.9 Raising of Capital

Issue of shares

Shares may be issued at par value or face value, at a premium or at a discount.

When shares are issued at a premium, a "share premium account" must be

opened for the premium. Section 74 (2) of the Companies act stipulates that
this account may only be applied for the following purposes:
Paying up unissued shares to be issued to members
Writing off preliminary expenses
Writing off discounts allowed on issue of shares or debentures
Providing for a premium on redemption of redeemable preference shares
or debentures

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58 Zimbabwe Open University
Unit 5 Company Accounting: Formation, Share Capital and Debentures

There are two ways in which the amounts due on shares can be called up:
1. The full amount is paid on application
2. Amounts are called up in instalments, that is, a portion on application, a
portion on allotment, and a portion on first call and so on.

5.10 Accounting Entries on Issue of Shares

Full amount payable on application

Debit Bank and Credit Ordinary or Preference Share Applicants with amounts
received on application.

Debit Ordinary or Preference Share Applicants and Credit the relevant Share
Capital account with the amounts allotted.

Debit Ordinary or Preference Share Applicants and Credit Band with refunds
to unsuccessful applicants.

Example 5.1

Five hundred thousand (500 000) Ordinary shares of $1 each were issued.
Application moneys for 600 000 shares was received. Five hundred thousand
(500 000) share were allotted, and application money for the unsuccessful
applicants was refunded.
Bank Account
Ordinary share applicants (A) 600 000 Ordinary share applicants (C) 100 000
Balance c/d 500 000
600 000 600 000
Balance b/d 500 000

Ordinary Share Applicants

Ordinary Share Capital (B) 500 000 Bank (A) 600 000
Bank (C) 100 000
600 000 600 000

Ordinary Share Capital

Ordinary share applicants (B) 500 000

The accounting entries are for the following:

A - receipt of application money
B - allotment of shares
C - refunds to unsuccessful applicants
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Amounts are payable in instalments

The accounting entries are as follows:

Debit Bank and Credit Application and Allotment with the amount
received on application.
Debit Application and Allotment and Credit Share Capital with the
amounts allotted.
On allotment, the entries are the same as those on application.

On first call, the entries are as follows:

Debit Bank and Credit First Call with the amount received on first call
Debit First Call and Credit Share Capital, to transfer the amounts
received on first call to the share capital account.
Example 5.2

A company issues 100 000 ordinary shares of $1 each payable as follows:

50c on application
25c on allotment and
25c on 1st call
Applications for exactly 100 000 shares were received with the application
money. All the allotment and 1st call moneys were received on due dates.
BANK
Application & allotment (A) 50 000 Balance c/d 100 000
Application & allotment (C) 25 000
1st call (F) 25 000
100 000 100 000
Balance b/d 100 000

APPLICATION & ALLOTMENT

Ordinary share capital (B) 50 000 Bank (A) 50 000
Ordinary share capital (D) 25 000 Bank (C) 25 000
75 000 75 000

FIRST CALL
Ordinary share capital (F) 25 000 Bank (E) 25 000

ORDINARY SHARE CAPITAL

Balance c/d 100 000 Application &allotment (B) 50 000
Application & allotment (D) 25 000
1st call (F) 25 000
100 000 100 000
Balance b/d 100 000
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The entries are in respect of:

A, C, and E. -receipt of application. Allotment and 1ST call moneys

respectively.

B, D and F - transfer of amounts from application and allotment to the share

capital account.

Issue of shares at a premium

Accounting entries

Remember that the share premium should be transferred to the share premium
account, and also remember the restrictions in respect of use of this account.

The account entries are: (The par value and premium is payable on application).
Debit Bank and Credit the respective shareholders with the amounts
received on application
Debit respective shareholders with amounts due for shares allotted
Credit the respective Share Capital with the nominal amount of the
shares allotted
Credit the Share Premium with the premium received

5.11 Redemption of Shares and Debentures

To safeguard the interests of creditors, the Companies Act does not allow the
reduction of capital, unless authorised by the courts. Consequently redemption
should, as you will recall be provided from:

A fresh issue of shares for the purpose of redemption, or

From profits available for distribution. If redeemed from profits, an amount

equal to the par value of the shares should be transferred to the Capital
Redemption Reserve. The Capital Redemption Reserve is a non-distributable
reserve.

The accounting entries are:

Redemption out of profits

Debit Preference Share Capital and Credit Preference Share Purchase with
the value of shares to be redeemed.
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Debit Preference Share Purchase and Credit Bank with the amount paid out.

Debit Retained profits and Credit Capital redemption reserve with the value
of the redeemed shares.

Example 5.3

One hundred thousand (100 000) 7% redeemable preference shares of Z$1

each are redeemed out of profits.
7% Preference Shares
Preference share purchase (A) 100 000 Balance b/d 100 000

Bank
Preference share purchase (C) 100 000

Preference Share Purchase

Bank (C) 100 000 7% preference share cap (A) 100 000

Capital Redemption Reserve

Statement of comp. Inc (B) 100 000

Statement of Changes in Equity

Capital redemption reserve (B) 100 000

Entries

A - transfer of shares to be redeemed to preference share purchase

B - creation of the capital redemption reserve from profits

C - payout to the preference shareholders

Redeemed out of a fresh issue

The usual entries in respect of the fresh issue are made. Thereafter the following
entries are made:

Debit Preference Share Capital and Credit Share Purchase with the value of
the shares redeemed, Debit Preference Share Purchase and Credit the Bank
with the payment to the shareholders.
Example 5.4

100 000 ordinary shares are issued to provide funds for the redemption of
100 000 7% redeemable preference share of $1 each. The shares are
redeemed at par.
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Unit 5 Company Accounting: Formation, Share Capital and Debentures

7% Redeemable Preference Share Capital

Preference share purchase(C) 100 000 Balance b/d 100 000
Bank
Ordinary shares Applicants (A) 100 000 Preference share purchase (D) 100 000

Ordinary Share Capital

Ordinary share applicants (B) 100 000

Ordinary Share Applicants

Ordinary share capital (B) 100 000 Bank (A) 100 000

Preference Share Purchase

Bank (D) 100 000 7% preference share capital (C) 100 000

Entries

A - receipt of money from ordinary share applicants

B - transfer to ordinary share capital

C - transfer of shares to be redeemed from 7% preference share capital to

the preference share purchase account

D - payout to 7% preference shareholders

If shares are redeemed partly out of a fresh issue and partly out of profits, the
amount to be transferred to the capital reserve is that portion provided from
profits and the accounting entries are: Debit Retained profits or other
distributable reserve and Credit Redemption Reserve

Premiums on redemption

These should be transferred from retained profits or the share premium

account. The accounting entries are:

Debit Retained Earnings or Share Premium and Credit Share Purchase.

Debenture redemption

The funds for redemption may be from:

An issue of share or debentures or

Resources of the company

Redemption from a fresh issue

This resembles the redemption of preference shares from a fresh issue of

shares and the accounting entries are similar

Make entries for the fresh issue and then make entries for the closure of the
redeemable debentures account, followed by entries for payment to the
debenture holders.

Redemption from resources of the company

There are 3 ways of doing this:

1. Annual transfers out of profits, in which case, the amounts taken out of
profits should be transferred to a Debenture Redemption Reserve
account.
2. By purchase in the open market when prices are favourable, in which
case an amount equal to the sum paid should be transferred to the
Redemption Reserve account.
3. From a sinking fund created for this purpose, in which case the
accounting entries are as follows:
For each annual instalments
Debit the Sinking Fund Investment account and
Credit the Bank with the amount of the instalment
Debit Retained profits and Credit Debenture Redemption Reserve with
the same amount
Debit the Debenture Sinking Fund and Credit Debenture Redemption
Reserve with annual interest.
When the investment matures, it is liquidated to provide the funds for the
redemption, and the following entries are made: Debit Bank and Credit
Debenture Sinking Fund Investment.

Thereafter, the payments to the debenture holders are made, that is, Debit
Debentures and Credit Bank.

Example 5.5

Debentures of $10 000 were issued on 1 January 2001, redeemable on

identical terms (that is, $10 000) in 5 years , on 31 December 2005. The
company therefore decided to set aside an equal annual amount, which at an
interest rate of 5% will provide $10 000 on 31 December 2005.

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Unit 5 Company Accounting: Formation, Share Capital and Debentures

Required

Draw up the necessary accounts.

Solution

To get the amount that must be invested annually use the table headed "Annual
sinking fund instalments to provide $1". Using the tables you find that the
amount that is required to provide $1 at the end of five years, at an interest
rate of 5% is 0.180975. To get the amount required to give $10 000 at the
end of 5 years, you simply multiply 10 000 x 0.180975 = $1 809.75.
Statement of Comprehensive Income
2001 DRR (B) 1809.75
2002 DRR (E) 1809.75
2003 DRR (H) 1809.75
2004 DRR (K) 1809.75
2005 DRR (N) 1809.75

Debenture Redemption Reserve

2001 Balance c/d 1 809.75 2001 SCI (B) 1 809.75
2002 Balance c/d 3 709.99 2002 Balance b/d 1 809.75
Dec 31 Bank int. (5%) (D) 90.49
SCI (E) 1 809.75
3 709.99 3 707.99
2003 Balance c/d 5 705.23 2003 Balance b/d 3 709.99
Dec 31 Bank int. (5%) (G) 185.49
SCI (H) 1 809.75
5 705.23 5 705.23
2004 Balance c/d 7 800.24 2004 Balance b/d 5 705.23
Dec 31 Bank int. (5%) (J) 285.26
SCI (K) 1 809.75
7 800.24 7 800.24
2005 Balance c/d 10 000.00 2005 Balance b/d 7 800.24
Dec 31 Bank int (5%) (M) 390.01
SCI (N) 1 809.75
10 000.00 10 000.00
2006 Balance b/d 10 000.00
Debenture Sinking Fund Investment
2001 Bank (C) 1 809.75 2005 Bank (P) 10 000
2002 Bank and interest (a) (F) 1 900.24
2003 Bank and interest (b) (I) 1 995.24
2004 Bank and interest (c) (L) 2 095.01
2005 Bank and interest (d) (O) 2 199.76

Bank (Extracts)
2001 Debentures (issued) (A) 10 000 2001 Deb. sinking f. inv (C) 1 809.75

2002 DRR (interest) (D) 90.49 2002 Deb. sinking f. inv (F) 1 900.24

2003 DRR (interest) (G) 185.55 2003 Deb. sinking f. inv (I) 1 995.24

2004 DRR (interest) (J) 285.27 2004 Deb. sinking f. inv (L) 2 095.01

2005 DRR (interest) (M) 390.16 2005 Deb. sinking f. inv (O) 2 199.76
Deb sink fund (P) 10 000 Debentures (Q) 10 000
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Debentures
2005 Bank (Q) 10 000 2001 Bank (A) 10 000
Notes (a) (b) (c) (d)
Yearly instalment 1 809.75 1 809.75 1 809.75 1 809.75 1 809.75
Interest on sinking fund balance - 90.49 185.49 285.26 390.01
1 809.75 1 900.24 1 995.24 2 095.01 2 199.76
The accounting entries are as follows:

A - money received on issue of debentures

B, L, E, H, K, N - transfers to the debenture redemption reserve account

D, G, J, M - interest on investment

C, F, I, L, O - investments into the sinking find

P - liquidation of the investment and receipt of cash

Q - payments to the debenture holders

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Unit 5 Company Accounting: Formation, Share Capital and Debentures

Activity 5.1
Questions 1and 2 are based on the following Statement of Financial Position:
? Bust Ltd

Statement of Financial Position as at 31 December 2010

Net assets (excluding bank) 40 000

Bank 20 000
60 000

8% Preference share capital 15 000

Ordinary share capital 40 000
Share premium 5 000
60 000
1. Bust Ltd redeems the 8% Preference shares at par. Funds to be provided
by a fresh issue of ordinary shares of $1each.

Required
Show the relevant accounting entries and the statement of financial
position after the redemption.

2. Bust Ltd redeems the 8% Preference shares at par with no issue of

shares.

Required:
Show the relevant accounting entries and the statement of financial
position after the redemption.

Activity 5.2
Dusk Ltd had 5% debentures with a book value of $20 000,
? redeemable in 5 years time. It was decided that a sinking fund be
created to provide funds for the redemption. Accordingly, an investment
with an annual interest rate of 10% is made, with equal instalments
being made at the end of each year. At the end of the 5 years, the funds
from the investment are used to redeem the debentures.

Required
Show all the accounts relating to the redemption.

5.12 Summary
In this unit we dealt with the formation of companies, the raising of capital,
including share capital and debentures, as well as the redemption of share
capital and debentures. The relevant accounting entries were explained with
the aid of examples. Activities were also included to test your understanding
of the material discussed.

References
Cox, D. (1985). Success in Bookkeeping and Accounts. 1st Edition.
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (2008) Business Accounting 2. 11th Edition. Prentice Hall.

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68 Zimbabwe Open University
6
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Unit Six
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Company Published Financial

Statements: An Introduction

6.0 Introduction

I n this unit we look at the basic requirements of International Accounting

Standard 1 (IAS 1)-Presentation of financial statements, and deal with the
requirements for the statement of comprehensive income, the statement of
financial position, the statement of changes in equity as well as notes to financial
statements. The statement of cash flows is dealt with in a separate unit.
International Accounting Standard 1 (IAS 1) prescribes overall requirements
for the presentation of general purpose financial statements, guidelines for
their structure and minimum requirements for their content, in order to ensure
comparability of the financial statements with those of prior periods or other
entities. The standard should be applied in conjunction with other relevant
IFRSs, which set out recognition, measurement and disclosure requirements
for specific transactions and events.
Financial Accounting 2 BACC 106

6.1 Objectives
By the end of this unit, you should be able to:
describe the structure and content of financial statements
explain the nature of items within the financial statements
prepare the following financial statement according to the requirements
of IAS 1:
1. The statement of comprehensive income
2. The statement of financial position
3. The statement of changes in equity and
4. Notes to the financial statements
Summarised below are the main provisions of the IAS. It is important that
you read and understand these provisions before attempting any exercises on
this topic.

6.2 Definitions
Here are some important definitions included in IAS 1:

General purpose financial statements (referred to as financial statements)

- are those intended to meet the needs of users who are not in a position to
require an entity to prepare reports tailored to their particular needs

International financial reporting standards (IFRS) - are standards and

interpretations adopted by the international accounting standards board
(IASB), and comprise:
International financial reporting standards
International accounting standards
Interpretations developed by the international financial reporting
interpretations committee (IFRIC) or the former standing interpretations
committee
Material - omissions or misstatements of items are material if they could,
individually or collectively, influence economic decisions users make on the
basis of the financial statements. Materiality depends on the size and nature of
the omission or misstatement judged in the context of surrounding
circumstances. The size or mature of the item, or a combination for both,
could be the determining factor.

Notes - contain information in addition to that presented in the statement of

financial position, statement of comprehensive income, statement of changes
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Unit 6 Company Published Financial Statements: An Introduction

in equity and statement of cash flows. Notes provide narrative descriptions or

disaggregations of items presented in those statements and information about
items that do not qualify for recognition in those statements.

Owners - are holders of instruments classified as equity.

Profit or loss - is the total income less expenses.

6.3 Purpose of Financial Statements

The purpose of financial statement is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a
wide range of users in making economic decisions. They also reflect
management's stewardship of resources entrusted to them. They provide
information about the entity's:
Assets
Liabilities
Equity
Income and expenses including gains and losses
Contributions by and distributions to owners in their capacity as owners
Cash flows
With this information, users can predict future cash flows and their timing and
certainty.

6.4 Complete Set of Financial Statements

A complete set of financial statements comprises:
a) A statement of financial position as at the end of the period
b) A statement of comprehensive income for the period
c) A statement of changes in equity for the period
d) A statement of cash flows for the period
e) Notes, comprising a summary of significant accounting policies and
other explanatory information and
f) A statement of financial position as at the beginning of the earliest
comparative period when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial statements.
The above are to be presented with equal prominence.
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6.5 General Features

Fair presentation

This requires faithful representation of the effects of transaction and other

events by application of IFRSs, with additional disclosures when necessary.
The entity shall make explicit and unreserved statement of such compliance in
the notes.

Going concern

Management shall assess the entity's ability to continue as a going concern,

and prepare financial statements on a going concern basis, unless management
either intend to liquidate the entity or cease operations, or for any other reason.
If the financial statements are not prepared on a going concern basis, this fact,
the reason for such action and the basis on which financial statements were
prepared shall be disclosed.

Accrual basis of accounting

Financial statements are, except for the cash flow information are prepared
using the accrual basis.

Materiality and aggregation

An entity shall present separately each material class of similar items and
present separately items of dissimilar nature or function unless they are
immaterial.

Offsetting

An entity shall not offset assets and liabilities or income and expenses, unless
required or permitted by an IFRS.

Frequency of reporting

A complete set of financial statements (including comparative information)

must be presented at least annually, and if presented for a shorter or longer
period than one year, the entity shall disclosure:
The reason for using a longer/shorter period
The fact that amounts presented in the financial statements are not entirely
comparable.

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Unit 6 Company Published Financial Statements: An Introduction

Comparative information

Comparative information in respect of the previous period for all amounts

reported in the current period's financial statements is required.

Consistency of presentation

This requires the entity to retain the presentation and classification of items in
the financial statements form one period to another, except when a change is
necessitated by a significant change in the entity's operations or an IFRS
requires a change in presentation.

6.6 Structure and Content

The standard (and other standards) requires particular disclosures to be made
in the statement of financial position, the statement of comprehensive income
and the statement of changes in equity either on the statements or in the notes.
Requirements of the statement of cash flow are set out in IAS 7 (Statement of
cash flows).

6.7 Identification of Financial Statements

Financial statements shall be clearly identified and distinguished from other
information in the same document. In addition, an entity shall display the
following information prominently, and repeat it when necessary for the
information presented to be understandable.
The name of the entity and any change in that information from the end
of the preceding year
Whether statements are for an individual entity or a group of entities
The date of the end to the reporting period or the period covered by
the financial statements
The presentation currency
The level of rounding used in presenting amounts in the financial
statements

6.8 The Statement of Financial Position

Minimum information to be presented

The standard requires that the statement of financial position shall include line
items that present the following amounts:
Property, plant and equipment
Investment property
Intangible assets
Financial assets
Investments accounted for using the equity method
Biological assets
Inventories
Trade receivables
Trade payables
Provisions
Financial liabilities
Liabilities and assets for current tax
Deferred tax liabilities/assets
Issued capital and reserves attributable to owners of the parent
Additional line items, headings and subtotals shall be presented if that enhances
the understanding of the entity's financial position.

Aggregation of similar items may be made on the basis of an assessment of:

The nature and liquidity of assets
The function of assets within the entity and
Amounts, nature and timing of liabilities
Current and noncurrent distinction

Current assets

An asset shall be classified as current when the entity:

Expects to realise/sell/consume it in its normal operating cycle
Holds the asset primarily for the purpose of trading
Expects to realise it within 12 months after the reporting period
The asset is cash or a cash equivalent
An entity shall classify all other assets as non-current.

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Unit 6 Company Published Financial Statements: An Introduction

Current liabilities

An entity shall classify a liability as current when:

It expects to settle it in its normal operating cycle
It holds it primarily for trading
The liability is due to be settled within 12 months after the reporting
period
An entity shall classify all other liabilities as noncurrent.

Disclosure in respect of share capital

The following shall be disclosed in the statement of financial position or

statement of changes in equity or in the notes in respect of each class of share
capital
Number of shares authorised
Number of shares issued and fully paid and issued but not fully paid
Par value per share or that the shares have no par value
A reconciliation of the number of shares outstanding at the beginning
and at the end of each period
The rights, preferences and restrictions attaching to that class including
restrictions on the distribution of dividends and the repayment of capital
Shares in the entity held by the entity or by its subsidiaries or associates
Shares realised for issue under options or contract for the sale of shares,
including terms and amounts
A description of the nature and purpose of each reserve within equity

6.9 Statement of Comprehensive Income

Minimum information

The statement of comprehensive income shall include line items that present
the following amounts for the period:
Revenue
Finance costs
Share of the profit or loss of associates and joint ventures accounted
for using the equity method
Tax expense
A single amount comprising the total of
(i) the post-tax profit or loss of discontinued operations
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(ii) the post-tax gain or loss recognised on the measurement of fair

value less costs to sell or on the disposal of assets or disposal groups
consisting the discontinued operations
A profit or loss
Each component of other comprehensive income classified by nature
Share of other comprehensive income of associates and joint ventures
accounted for using the equity method
Total comprehensive income
Additional line items, headings and subtotals can be made, if they enhance
understanding of the entity's financial performance.

Disclosures

The nature and amount of material items of income and expense must be
disclosed separately in the statement of comprehensive income or notes.
Examples are:
Writing down of inventories to net realisable value or of PP&E to
recoverable amount , as well as reversals of such write-downs
Disposals of items of PP&E
Disposal of inventories
Litigation settlements
Discontinued operations
Classification
The classification of expenses in the statement of comprehensive income
can be based on either the nature of the expense (for example,
depreciation, transport costs, advertising - without reallocating to
functions) or to their function (function of expenditure or cost of sales
method) within the entity (for example, distribution costs, administrative
costs) whichever provides information that is reliable and more relevant.
The respective formats are as follows:
Classification by nature of expense
Revenue X
Other income X
Changes in inventories of finished goods and work in progress X
Raw materials and consumables used X
Employee benefits X
Depreciation and amortisation expense X
Other expenses X
Total expenses (X)
Profit before tax X
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Unit 6 Company Published Financial Statements: An Introduction

Classification by function of expense

Sales X
Cost of sales (X)
Gross profit X
Other income X
X
Distributive costs (X)
Administrative expenses (X)
Other expenses (X)
Profit before tax X

6.10 Statement of Changes in Equity

This statement shall show:
(a) Total comprehensive income for the period, showing separately the
total amounts attributable to the owners of the parent and to non
controlling interest.
(b) For each component of equity, the effects of retrospective application
or retrospective reinstatement recognized in accordance with IAS8.
(c) For each component of equity, a reconciliation between the carrying
amount at the beginning and at the end of the period, separately disclosing
changes resulting from (i) profit or loss
(ii) each item of comprehensive income
(iii) transactions with owners in their capacity as owners, showing
separately, contributions by and distributions to owners and changes in
ownership interests in subsidiaries that do not result in a loss of control
The entity shall disclose either in the statement of changes in equity or in the
notes, the amount of dividends recognised as distributions to owners during;
the period, and the related amount per share.

6.11 Notes to Financial Statements

Note are necessary to assist users to understand the financial statements and
compare them with those to other entities. Notes are normally presented in
the following order:
a) Statement of compliance with IFRSs
b) Summary of significant accounting policies applied, disclosing:
(i) The measurement basis (or bases) used in preparing the financial
statements (for example, historical cost, current cost, net realisable value
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and so on)
(ii) The accounting policies used that are relevant to an understanding
of the financial statements.
c) Supporting information for line items in the order in which each line
item is presented on the respective financial statement.
d) Other disclosures including:
(i) Contingent liabilities
(ii) Non-financial disclosures, for example, the entity's financial risk
management objectives and policies.
Sources of estimation uncertainty

An entity shall disclose information about the assumptions it makes about the
future, and other major sources of estimation uncertainty at the end of the
reporting period, that have a significant risk of resulting in a material adjustment
to the carrying amount of assets and liabilities within the next financial year,
and the notes shall include details of their nature and their carrying amounts at
the end of the reporting period.

6.12 Capital
The standard requires disclosure of information that enables users to evaluate
the entity's objectives, objectives, policies and processes for managing capital
and this should include:
A description of what it manages as capital
Any externally imposed capital requirements, their nature and how they
are incorporated into the management of capital whether it has complied
with such requirements, and if not, consequences thereof
Quantitative data about what it manages as capital
Having outlined the requirements of IAS 1, let us now turn to the practical
side of things, by doing an example that includes most of what we have learnt
so far. This will entail preparing the four annual financial statements, that is, the
statement of comprehensive income, the statement of financial position, and
the statement of changes in equity. The following steps are usually followed in
the preparation of general purpose; financial statements:
Identify and deal with year-end adjustments
Analyse expenses by function into cost of sales, distribution costs,
administration expenses, other income and expenses and finance costs
Prepare the financial statements
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Unit 6 Company Published Financial Statements: An Introduction

Example 6.1

Form the following trial balance of Alpha Ltd, prepare the statement of
comprehensive income, the statement of changes in equity and the statement
of financial position for the year ended 31 December, 2010.

Trial Balance of Alpha Ltd as at 31 December 2010

$ 000 $ 000
Issued share capital 17 250
Retained earnings 57 500
Long term loan 63 250
Bank overdraft 8 625
Provision for tax 5 750
Trade payables 29 900
Accumulated depreciation
-equipment 3 450
-vehicles 9 200
Freehold land 57 500
Freehold buildings 57 500
Equipment 14 950
Motor vehicles 20 700
Inventory at 1 January 2010 43 125
Trade receivables 28 750
Cash in hand 4 600
Purchases 258 750
Bank interest 1 150
Directors remuneration 1 150
Dividends 1 725
Audit fees 1 150
Interest on debentures 6 325
Insurance 3 450
Salaries and wages 18 055
Motor expenses 9 200
Taxation 5 750
Hire charges 300
Light and power 920
Miscellaneous expenses 275
Stationery 1 840
Repairs 2 760
Sales 345 000
539 925 539 925

The following information has not been taken into account in the amounts
shown on the trial balance:
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Financial Accounting 2 BACC 106

1) Inventory at cost at 31 December 2010 was $25 875 000.

2) Depreciation is to be provided as follows:
2% on freehold buildings using the straight line method
10%on equipment using the reducing balance method
25%on motor vehicles using the reducing balance method
3) $2 300 000 was prepaid for repairs and $5 175 000 has accrued for
wages.
4) Freehold buildings were revalued at $77 500 000.
5) The following is a breakdown of salaries and wages:
Factory staff $12 075 000
Warehouse staff $8 280 000
Accounts department $575 000
Sales staff $2 300 000
$23 230 000

6) All motor vehicles are used in the sales department. Depreciation and
other operating expenses are charged as follows: 50% to cost of sales,
25% to distribution costs, and 25% to administration expenses.
7) Directors remuneration is allocated 50% to cost of sales and 50% to
administrative expenses.
Solution

Workings

Adjustments

Salaries and wages = $18 055 000 + accrued $5 175 000 = $23 230 000

Depreciation

Buildings = 2% of $5 750 000 = $1 150 000

Equipment = 10% of (14 950 000 - 3 450 000) = $1 150 000

Vehicles = 25% of (20 700 000 - 09 200 000) = $2 875 000

$5 175 000

Repairs

$2 760 000 - prepayment $2 300 000 = $460 000

Materials used = opening inventory + purchases - closing inventory = $43

125 000 + $258 750 000 - 25 875 000 = $276 000 000
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80 Zimbabwe Open University
Unit 6 Company Published Financial Statements: An Introduction

Total Cost of Distribution Administration

sales costs expenses
$ 000 $ 000 $ 000 $ 000
Salaries and wages
Factory staff 12 075 12 075
Warehouse staff 8 280 8 280
Accounts dept. 575 575
Sales staff 2 300 2 300
23 230 12 075 10 580 575
Depreciation
Freehold building 1 150 575 287.5 287.5
Equipment 1 150 575 287.5 287.5
Motor vehicle 2 875 2 875
5 175 1 150 3 450 575

Operating expenses
Motor expenses 9 200 9 200
Insurance 3 450 1 725 862.5 862.5
Stationery 1 840 920 460 460
Light and power 920 460 230 230
Repairs and 460 230 115 115
maintenance
Hire charges 300 150 75 75
Miscellaneous 275 137.5 68.75 68.75
expenses
16 445 3 622.5 11 011.25 1 811.25

Directors
remuneration
and audit fees
Audit fees 1 150 1 150
Directors remuneration 1 150 575 575
2 300 575 1 725

Totals 47 150 17 25 041.25 4 686.25

422.5
Add materials 276 000 276
000
323 150 293 25 041.25 4 686.25
422.5

Analysis according to function

Statement of Comprehensive Income for the Year Ended 31 December

2010
$ 000
Revenue 345 000.00
Cost of sales (293 422.50)
Gross profit 51 577.50
Distribution costs (25 041.25)
Administrative expenses (4 686.25)
Operating profit 21 850.00
Finance costs (7 475.00)
Profit on ordinary activities before tax 14 375.00
Tax (5 750.00)
Profit for the year 8 625.00
Other comprehensive income: gains on property revaluation 20 000.00
Comprehensive income 28 625.00
Analysis according to nature of expense

Statement of comprehensive income for the year ended 31 December

2010
$ 000 $ 000
Revenue 345 000
Decrease in inventory (17 250)
Raw materials (258 750)
(276 000)
Employee benefits expenses
-salaries (23 230)
-directors (1 150)
(24 380)
Other expenses
Motor expenses (9 200)
Insurance (3 450)
Stationery (1 840)
Audit fees (1 150)
Light and power (920)
Repairs (460)
Hire charges (300)
Miscellaneous expenses (275)
(17 595)
Depreciation (5 175)
Operating profit 21 850

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82 Zimbabwe Open University
Unit 6 Company Published Financial Statements: An Introduction

Statement of Financial Position

$ 000 $ 000 $ 000
Assets
Noncurrent assets
Property plant and equipment 152 825

Current assets
Inventory 25 875
Receivables 28 750
Cash at bank and in hand 4 600
Prepayments 2 300
61 525
214 350

Equity and liabilities

Equity
Share capital 17 250
Revaluation reserve 20 000
Retained earnings 64 400
101 650
Non current liabilities
Debentures 63 250

Current liabilities
Payables 29 900
Accruals 10 925
Bank overdraft 8 625
49 450
214 350

Statement of Changes in Equity for the Year Ended 31 December 2010

Share Retained Revaluation Total

Capital Earnings Surplus
Balances as at 1 January 2010 17 250 57 500 74 750
Changes for 2010
Dividends (1 725) (1 725)
Total comprehensive income for the year 8 625 20 000 28 625
Balances as at 31 December 2010 17 250 64 400 20 000 101 650

Now that we have gone through a comprehensive example, it is time to test

your understanding of the subject, by attempting the following question:

Activity 6.1
$ 000 $ 000
? Sales
Returns outwards
12 050
313
Provision for depreciation
-plant 738
-vehicles 375
Rent receivable 100
Trade receivables 738
Debentures 250
Issued share capital – ordinary shares of $1 each 3 125
Issued share capital–preference shares of $1each treated as equity 625
Share premium 350
Retained earnings 875
Inventory 825
Purchases 6 263
Returns inwards 350
Carriage inwards 13
Carriage outwards 125
Salesmen’s salaries 800
Administrative wages and sallies 738
Land 100
Plant (includes $362 000 acquired in 2010) 1 562
Motor vehicles 1 125
Goodwill 1 062
Distribution costs 290
Administrative expenses 286
Director’s remuneration 375
Trade receivables 3 875
Cash at bank and in hand 1 750
19 539 19 539
You are given the following additional information:
Provide for:
1. An audit fee of $38 000
2. Depreciate plant at 20% using the straight line method
3. Depreciate vehicles at 25% using the reducing balance method
4. Income tax for the year $562 000
5. Debenture interest $25 000
Closing inventory was valued at $1 250
Administration expenses were prepaid by $12 000
Land was revalue by $50 000

Required
Prepare a statement of comprehensive income for the year ended 31
December 2010 in format 1 style, and a statement of financial position
as at that date, as well as the statement of changes in equity for the
year then ended.
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84 Zimbabwe Open University
Unit 6 Company Published Financial Statements: An Introduction

6.13 Summary
In this unit you were introduced to the preparation of annual financial statements
in compliance with the requirements of international accounting standard 1
(IAS1). The unit covered the preparation of the statement of financial position,
the statement of comprehensive income, the statement of changes in equity,
and notes to the financial statements.

References
Elliott, B. Elliott, J. (2011). Financial Accounting and Reporting.14th
Edition. Prentice Hall .
Wood , F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

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86 Zimbabwe Open University
7
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Unit Seven
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Statement of Cash Flows

7.0 Introduction

T he statement of cash flows provides very important information about

the actual cash that came into the entity and how it was paid out, in a
summarised manner.. As you know, cash is the lifeblood of any business.
Without sufficient cash, a business can go bankrupt. In this unit, we look at
the preparation of the statement of cash flows using both the direct and the
indirect methods, in accordance to the provisions of International Accounting
Standard 7 (IAS7).
Financial Accounting 2 BACC 106

7.1 Objectives
By the end of this, unit you should be able to:
z state the uses of the statement of cash flows
z explain the difference between profit and cash flow
z draw up a statement of cash flows, using both the direct and indirect
methods

7.2 Difference between Cash Flow and Profit

The statement of comprehensive income is compiled on an accrual basis. It
also includes many non-cash items, like depreciation. Other items are a result
of estimates. In this respect, it reflects the best estimate of the profit made by
the entity using the accrual method. It does not however show the actual cash
generated or received by the entity and how it was utilised. This vital information
regarding the generation and utilisation of cash is given in a summarised form
in the statement of cash flows.

7.3 Usefulness of the Statement of Cash Flows

Many parties inside and outside the entity use the information on the statement
of cash flows and this includes, managers, investors, employees and
shareholders. The following shows some of the ways in which this information
is used:
a) Users can determine the entity's ability to generate future cash inflows,
by examining relationships between the cash flow items.
b) Users can also determine the entity's ability to meet its obligations and
pay dividends.
c) By examining the reasons for the differences between profit and cash
generated by operations, users can determine the reliability of figures
on the statement of comprehensive income.
d) Users can better understand the changes in assets and liabilities during
the period by examining cash flows.

7.4 Cash and Cash Equivalents

Cash comprises cash on hand and cash at bank, as well as demand deposits.
Cash equivalents are short term investments, which are highly liquid and can
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88 Zimbabwe Open University
Unit 7 Statement of Cash Flows

be converted into cash at short notice. Usually these are surplus idle funds
which are invested by the entity so that they can earn some return. They are
included with cash because they can be converted into cash at short notice.

IAS 7 - Statement of cash flows requires the inclusion of the statement as part
of the annual financial statements and prescribes formats for its preparation.

7.5 Standard Headings

The standard requires cash flows to be shown under the following headings
and in that order:

1. Operating activities

These are the principal revenue earning activities of the entity and other activities
that are not investing or financing activities. The direct method (showing the
relevant constituent cash flows) or the indirect method (calculated by adjusting
the reported operating profit) can be used for this section. A reconciliation
between operating profit and net cash flows should be made and should be
disclosed separately: changes in inventory, accounts payable, accounts
receivable, non-cash items, as well as cash flows from taxes, interest and
dividends.

2. Investing activities

These are activities involving the acquisition and disposal of noncurrent assets
and investments not included under cash and cash equivalents.

3. Financing activities

These activities result in a change in the size and composition of contributed

equity and long term borrowings. These include the issue and redemption of
shares and debentures.

A sub-total for each heading should be included. At the end of the statement,
the net change in cash flows should be shown. This is added to the opening
cash and cash equivalents balance to arrive at the cash and cash equivalents
balance at the end of the period.

7.6 Types of Inflows and Outflows

Generally the types of inflows and outflows under each of these headings are
as follows:
Operating activities

Inflows
Sale of goods
Interest and dividends received
Outflows
Payments to suppliers
Payments to employees
Payment of taxes
Payment of interest
Payment of other expenses
Investment activities - changes in investments and non-current

Inflows
Sale of property, plant and equipment
Sale of investments in other entities
Collection of loans to other entities
Outflows
Purchase of Property Plant and Equipment (PPE)
Investments in other entities
Making loans to other entities
Financing activities - changes in shareholders' equity and long term
liabilities

Inflows
Issue of shares and debentures
Outflows
Redemption of shares and debentures
As a general rule
Operating activities involve the statement of comprehensive income items
Investment activities involve changes in investments and long term assets
Financing activities involve changes in share capital and debentures and
long term liabilities
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90 Zimbabwe Open University
Unit 7 Statement of Cash Flows

7.7 Preparing the Operating Activities Section Using

the Direct Method
This method identifies the actual cash receipts from customers and the actual
payments to suppliers and employees. The figures for the component parts of
this section are calculated as follows:

Cash receipts from customers

Sales + decrease in debtors (or - increase in debtors)

Opening debtors + sales - closing debtors

Cash payments to suppliers

Cost of goods sold + increase in stock (or - decrease in stock) + decrease in

creditors (or - increase in creditors.

Opening creditors = purchases -closing creditors.

Cash payments for operating expenses

Operating expenses + increase in prepaid expenses (or - decrease in prepaid

expenses) + decrease in accrued expenses (- increase in accrued expenses)

6.8 Preparing the Operating Activities Section Using

the Indirect Method
With this method, you start with the profit before interest, tax and investment
income and adjust it for non-cash items (like depreciation and profits or losses
on sale of assets), and also take into account movements in working capital
items, that is, current assets and current liabilities. Increases in current assets
or decreases in current liabilities are outflows of cash, while decreases in
current assets and increases in current liabilities are cash inflows.

Example 7.1

The following are annual financial statements of ABC Ltd:

Statement of Financial Position as at 31 December 2010

2010 2009
$ $
Land at cost 45 000 70 000
Buildings at cost 200 000 200 000
Less accumulated depreciation (21 000) (11 000)
179 000 189 000
Equipment 193 000 68 000
Less accumulated depreciation (28 000) (10 000)
165 000 58 000
309 000 17 000
Current assets
Stock 54 000 0
Pre-paid expenses 4 000 6 000
Debtors 68 000 26 000
Cash 54 000 37 000
569 000 386 000
Ordinary share capital 220 000 60 000
Retained earnings 206 000 136 000
426 000 196 000
Debentures 110 000 150 000
Creditors 33 000 40 000
569 000 386 000

Statement of Comprehensive Income

Sales 890 000
Cost of sales 465 000
Gross profit 425 000
Operating expenses 221 000
Interest 12 000
Loss on sale of equipment 2 000 235 000
Profit 190 000
Tax 65 000
Profit after tax 125 000

The following additional information is provided:

Operating expenses on the statement of comprehensive income include

depreciation expense of $33 000 and amortisation of prepaid expenses of $2
000. ABC Ltd sold the land at its book value and $55 000 in cash dividends
were paid. Interest expense of $12 000 was paid in cash and additional
equipment was purchased for $166 000. Equipment that cost $41 000, having
a book value of $36 000, was sold for $34 000. The debentures were
redeemed at their book value for cash and ordinary share capital ($1) was
issued.

Required

Prepare the statement of cash flows using

a) The direct method
b) The indirect method
Solution
a) Direct method
Cash flow from operations
Cash received from customers 848 000
Payments to suppliers for goods for resale 526 000
Payments to suppliers of other goods and services 186 000
712 000
Interest paid 12 000
Tax paid 65 000
789 000
Cash flows from operations 59 000
Workings

Received from customers:

Opening debtors + sales - closing debtors = 26 000 + 890 000 - 68 000 =

848 000

Payments to suppliers of goods for resale:

Opening creditors +purchases - closing creditors

= 40 000 + (465 000 +54 000) - 33 000 = 526 000

Payments to suppliers of other goods and services:

Operating expenses -depreciation - decrease in prepaid expenses

221 000 - 33 000 - 2000 = 186 000

Equipment purchased = Closing balance (2010) - (Opening balance (2009)

- Disposal

193 000 - (68 000 - 41 000) = 166 000

b) Indirect method
Profit 190 000
Add Depreciation 33 000
Loss on sale of equipment 2 000 35 000
225 000
Add decrease in pre-paid expenses 2 000
Less increase in stock (54 000)
Less increase in debtors (42 000)
Less decrease in creditors (7 000) (101 000)
Cash generated by operating activities 124 000
Tax paid 65 000
59 000
Investment activities
Sale of land 25 000
Sale of equipment 34 000
Purchase of equipment (166 000) (107 000)
Financing activities
Issue of shares 160 000
Redemption of debentures (40 000)
Dividends to shareholders (55 000) 65 000
Net increase in cash 17 000
Opening cash balance 37 000
Closing cash balance 54 000
Note the investment activities and financing activities sections are the same in
both methods,

Activity 7.1
The following information was obtained from the accounting records
? of Zororo Ltd on 31 December 2010.
Zororo Ltd Accounting Records on 31 December 2010
2010 2009
Share capital 158 000 150 000
Retained earnings 98 600 40 600
Furniture at cost price 202 000 130 000
Accumulated depreciation : Furniture 44 000 40 000
Land and buildings at cost price 42 000 26 000
Inventory 24 000 80 000
Debtors 62 000 60 000
Creditors (trade) 44 000 86 000
Bank (favourable) 27 000 23 000
Shareholders for dividends 8 000 1 000
Income received in advance 4 000 3 000
Taxation outstanding 2 400 2 000
Prepaid expenses 2 000 3 600

The following information was obtained from the statement of

comprehensive income for the year ended 31 December 2010.
Profit on sale of furniture 4 000
Lease of motor vehicle 6 000
Provision for tax 48 000
Dividends declared 15 000
Turnover 500 000

Additional information
1. Furniture with a cost price of $24 000 (carrying amount ($8 000) was
sold during 2010. This was replaced with new furniture worth $35
000. All other furniture was purchased with the purpose of extending
the business activities.
2. Gross profit percentage on invoiced price is 40%

Required
Prepare a cash flow statement for the year ended 31 December 2010,
using the indirect method.

Example 7.2 - the direct method

The following are financial statements of DCL Ltd for the year ended 31
December 2011.
Statement of Financial Position as at 31 December 2011
$ $
2011 2010
Non- current assets
Land 37 200 37 200
Building 264 000 264 000
Less accumulated depreciation (129 600) (115 200)
Equipment 44 400 44 400
Less accumulated depreciation (25 200 (16 800)
Investments 0 10 800
190 800 214 680
Current assets
Stationery 360 240
Stock 170 400 163 200
Accounts receivable 56 700 37 440
Cash 29 820 22 020
Prepaid insurance 180 420
448 260 438 000

Equity and liabilities

Equity
Ordinary share capital 172 200 166 800
Share premium 28 320 27 780
General reserve 30 000 24 000
Retained income 47 940 35 640
278 460 254 220
Non- current liabilities
Mortgage 129 600 136 800
Current liabilities
Interest payable 1 320 1 560
Income tax payable 1 140 840
Salaries payable 2 520 2 940
Accounts payable 35 220 51 360
40 200 56 700
448 260 438 000

Statement of Comprehensive Income for the Year Ended 31 December

2011
$ $
Sales 558 000
Opening stock 163 200
Purchases 379 200
542 400
Less closing stock 170 400
Cost of goods sold 372 000
Gross profit 186 000
Operating expenses
Salaries 88 200
Payroll taxes 9 780
Advertising 4 260
Depreciation- buildings 14 400
Depreciation – equipment 8 400
Stationery 1 920
Insurance 1 260
Miscellaneous 840
Total operating expenses 129 060
Income from operations 56 940
Other income
Interest 840
57 780
Other expenses
Interest 12 000
Income before tax 45 780
Tax 11 880
Profit after tax 33 900

Statement of Changes in Equity for the Year Ended 31 December 2011

(extracts)
Profit after tax 33 900
Dividend declared 15 600
Reserve for plant expansion 6 000
21 600
Retained earnings for the year 47 940
Retained earnings b/f 35 640
77 940

Statement of Cash Flows for the Year Ended31 December 2011

$ $ $
Cash from operating activities
Cash receipts from customers 538 740
Interest 840
Total cash receipts 539 580
Cash payments for
Operating expenses
Employees 88 620
Payroll taxes 9 780
Advertising 4 260
Stationery 2 040
Insurance 1 020
Miscellaneous 840
Total 106 530
Interest 12 240
Income tax 11 580
(525 720)
Cash from operations 13 860

Cash from investing activities

Investments 10 800

Cash from financing activities

Repayment of mortgage (7 200)
Share issue 5 400
Share premium 540
Payment of dividend (15 600)
16 860
Net increase in cash 7 800
Cash at the beginning of the period 22 020
Cash at the end of the period 29 820

Workings
Cash from customers

Opening accounts receivable + net sales - closing accounts receivable

= 558 000 + 3 744 - 56 700 = 538 740

Payments to suppliers

Opening accounts payable + purchases - closing accounts payable

51 360 + 379 200 - 35 220 = 395 340

Cash payments to employees

Payable at the beginning + salary expense - payable at the end
2 940 + 88 200 - 2 520 = 88 620
Stationery supplies
Stock at the end = stationery expense - stock at the beginning
360 + 1 920 - 240 = 2 040
Insurance
Prepaid at the end + insurance expense - prepaid at the beginning
180 +1 260 - 420 = 1 020
Interest
Payable at the beginning + interest expense - payable at the end
560 + 12 000 - 320 = 12 240
Income tax
Payable at the beginning + tax expense -payable at the end
840 + 11 880 - 1 140 = 11 580
You can also determine these amounts by using T accounts as shown on the
few accounts selected below.
Interest Account
Cash (balancing figure) 12 240 Balance b/d (given) 1 560
Balance c/d (given) 1 320 Stat of comp. Income (given) 12 000
13 560 13 560
Balance b/d 1 320

Insurance Account
Balance b/d(given) 420 Stat of comp. Income (given) 1 260
Cash (balancing figure) 1 020 Balance c/d (given) 180
1 440 1 440
Balance b/d 180

Stationery Supplies Account

Balance b/d (given) 240 Stat of comp income (given) 1 920
Cash (balancing figure) 2 040 Balance c/d (given) 360
2 280 2 280
Balance b/d 360
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Zimbabwe Open University 99
Financial Accounting 2 BACC 106

7.9 Summary
The Unit dealt with the compilation of the statement of cash flows, in compliance
with the requirements of IAS7. The differences between profit and cash flow
were explained, cash and cash equivalents were also defined and the uses of
the statement were described. Both the direct and indirect methods were
explained. It is important to know both methods, because some questions
will require you to use one particular method.

References
Elliott, B. and Elliott, J. (2011). Financial Accounting and Reporting. 14th
Edition. Prentice Hall.
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

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100 Zimbabwe Open University
8
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Unit Eight
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Consignment Accounts

8.0 Introduction

I n a consignment, one party, the consignor sends goods to another party,

the consignee or agent, who sells the goods on behalf of the consignor.
The goods remain the property of the consignor until sold by the consignee. A
pro-forma invoice is sent together with the goods. The purpose of this
document is to give details of the goods delivered, and not to charge the
consignee. The consignee sends an account sales to the consignor. This
document shows the gross and net proceeds of the consignment, sold by the
consignee on behalf of the consignor. The consignee is paid commission, which
is a percentage of the gross sales amount, for his services. In order to prevent
losses due to bad debts, the consignor pays the consignee an extra commission
called del credere commission. In return, the consignee guarantees to pay
over to the consignor the full proceeds after goods are sold, that is, nay bad
debts are borne by the consignee. This unit deals with the accounting records
kept by both the consignor and the consignee.
Financial Accounting 2 BACC 106

8.1 Objectives
By the end of this unit, you should be able to:
z explain the difference between a consignment and a sale
z describe the consignment accounting system
z draw up accounts for consignment inwards and consignment outwards

8.2 Terms in Consignment Accounts

Consignor - the person who sends goods to an agent (consignee) for sale.

Consignee - the agent who sells goods on behalf of the principal (consignor)
and receives commission for his services.

Commission - payment made by a consignor to a consignee for selling goods

on his behalf. This is usually a percentage of the gross proceeds of the sale.

Activity 8.1
1. Explain the differences between a sale and a consignment.
? 2. What is the difference between a consignment inwards and a purchase
of goods?
3. What does the term 'del credere commission' mean?

8.3 Accounting Entries

After the consignee sells the goods, he sends an account of his transactions
on the consignment in the form of an account sales. This document shows the
gross proceeds from sale of the goods, less expenses incurred and the
commission deducted by the consignee, and the balance of cash which is sent
to the consignor.

Each of the two parties will keep an account of the transactions on the
consignment. From the consignor's view, the consignment is a consignment
outward, and from the consignee's view, it is a consignment inward.

8.4 Books of the Consignor

Let us now look at the accounting entries in the books of the consignor.

When goods are sent to the consignee, the following entries are made:
Dr Consignment Out ward account, and
Cr Goods on Consignment account with the value of goods
When consignor incurs expenses on the consignment:
Dr Consignment Outwards account, and
Cr Bank or Cash. With expenses incurred.
On receipt of the account sales the following entries are made:
For the proceeds of the sale,
Dr the consignee's personal account and
Cr the Consignment outwards account
For the consignee's expenses including commission
Dr consignment outwards account
Cr the consignee's personal account
The balance on the consignee's account is closed by the payment made
by him and the accounting entries for this payment are:
Dr Cash or Bank and
Cr the consignee's personal account
The profit or loss on the consignment outward account is then
transferred to the statement of comprehensive income, and the entries
are:

Dr consignment outwards account and Cr statement of comprehensive income

if there is a profit, or Dr statement of comprehensive income and Cr
consignment outward account if there is a loss.

8.5 Books of the Consignee

Consignment Inward

Form the consignee's point of view, there are two methods of recording the
transactions.

Method 1

On receipt of the goods, no entry is made.

When the consignee incurs expenses in connection with the

consignment, the following entries are made: Dr the consignor and Cr Bank
or Cash.

On sale of the goods, Dr Cash or Bank and Cr the consignor.

For commission due, Dr the consignor and Cr commission account.

To close the consignor's account, Dr the consignor's account and Cr Cash or

Bank with the amount remitted in final settlement of the account.

Method 2

Using this method the accounting entries are as follows:

On receipt of the goods, Dr consignment inward account and Cr the consignor

On payment of expenses relating to the consignment, Dr consignment

inwards account and Cr Cash or Bank.

With the sale proceeds, Dr Cash or Bank and Cr consignment inwards

Commission, Dr consignment inwards and Cr commission.

Balance the consignment inward account and transfer the balance to the
consignor's personal account.

The consignor's personal account is closed by the remittance made, Dr

consignor's account and Cr Bank or Cash.

If there is any stock left at the time of making the payment to the consignor,
the balance is carried down on the consignment inwards account.

Example 8.1

On 1 January, 2010, J Dube Ltd sent goods worth $7 000 to their agent, L
Moyo, based in Gwanda, and incurred the following expenses: Railage $40;
Insurance $50. The agent received the goods , sold them and on 1 March
sent an account sales to the principal, showing that the gross proceeds were
$8 500, and his expenses were as follows: Storage $100; Travelling $150;
and insurance $50. The agent also deducted his commission, calculated at
5% of the gross proceeds.
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104 Zimbabwe Open University
Unit 8 Consignment Accounts

Required
Record the transactions in the books of the consignor
Record the transactions in the books of the consignee
In the books of J Dube Ltd
Date Details Folio Amount Date Details Folio Amount
Consignment with L Moyo Account
Jan 1 Goods on 7 000 00 Mar 1 L Moyo 8 500 00
consignment
Bank - Railage 40 00
Bank - Insurance 50 00
Mar 1 L Moyo- Storage 100 00
- Travelling 150 00
- Insurance 50 00
‐ Commission 425 00
Profit 685 00
8 500 00 8 500 00

L Moyo Account
Mar 1 Consignment 8 500 00 Jan 1 Storage 100 00
Travelling 150 00
Insurance 50 00
Commission 425 00
Bank 7 775 00
8500 00 8 500 00

In the books of the consignee the transactions will be recorded as follows:

Method 1
J Dube Ltd Account
Mar 1 Bank - Storage 100 00 Mar 1 Bank 8 500 00
Bank - Travelling 150 00
Bank - Insurance 50 00
Commission 425 00
Bank 7 775 00
8 500 00 8 500 00

Method 2
Consignment Inward Account
Jan 1 J Dube Ltd 7 000 00 Mar 1 Bank 8 500 00
Bank - Storage 100 00
Bank - Travelling 150 00
Bank - Insurance 50 00
Commission 425 00
J Dube Ltd 775 00
8 500 00 8 500 00

J Dube Ltd Account

Mar 1 Bank 7 775 00 Jan 1 Cons. In. 7 000 00
Cons. In. 775 00
7 775 00 7 775 00

Example 8.2 - where there is stock on hand

On 1 January 2010, B Mann sent goods valued at $825 to his agent, R Lake.
He also paid $65 freight and $40 insurance.

On 15 January 2010, B Mann received an account sales form R Lake, showing

that part of the goods had realised gross $835, and expenses and commission
amounted to $87. Stock unsold was valued at $275.

On January 2010, R Lake remitted what was due at this point.

Required
Record the transaction in the books of B Mann.
Solution
Consignment to R Lake Account
Jan 1 Goods on consignment 825 Jan 15 R Lake – gross proceeds 835
Bank - freight 65 Stock c/d 275
Bank -insurance 40
Jan 15 R Lake - expenses 87
Statement of C. Income 93
1 110 1 110
Stock b/d 275
R LAKE ACCOUNT
Jan 15 Consignment 835 Jan 15 Consignment – exp and 87
commission
Jan 20 Bank 748
835 835

BANK ACCOUNT
Jan 20 R Lake 748

Activity 8.2
On 1 October, J Moosa Ltd of London consigned goods to the cost
? of $1 500 to their agent, J Solomon in Hong Kong, on which they paid
freight and insurance $55. They draw a 90 day bill on him for $1 300.
They discount the bill incurring $15 discounting charges.
On 30 October, J Solomon sends an account sales showing that the
gross proceed of the consignment were $1 729, less his expenses
amounting to $71. He remitted the amount due to J Moosa on the
same date.
Required
1. Record the above transactions in the books of J Moosa.
2. Record the transactions in the books of J Solomon.
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106 Zimbabwe Open University
Unit 8 Consignment Accounts

Activity 8.3
On 1 October, Richard Bell sent goods to their agent, P Gold with a
? pro forma invoice showing the cost of the goods was $500, and freight
$60, and insurance $18 had been paid on this consignment.

On 28 October, P Gold sent an account sales showing that a portion

of the goods had realised $460 deducting expenses $10 and his
commission of $25. He remitted the amount due at this point. The
remaining stock was valued at $280.

On 2 November, P Gold sent another account sales which showed

that the balance of the consignment had realised $320, deducting
expenses $8 and commission $10. He remitted the balance.

Required
Record the transactions in the books of Richard Bell

8.6 Summary
In this unit we dealt with consignments inwards and outwards and examined
the accounting records kept by both the consignor and the consignee.

References
Faul, M.A. (1998). Accounting - An Introduction . 5th Edition. Butterworths.
Garbutt, D. (1974). Carter's Advanced Accounts.7th Edition. Pitman.
Wood, F. (2008). Business Accounting 1. 11th Edition. Prentice Hall.

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108 Zimbabwe Open University
9
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Unit Nine
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Royalty Accounts

9.0 Introduction

T he term royalty originated from the royal right over minerals granted to
miners in return for a payment (royalty) which varied in proportion to
the production. The term is also used for amounts paid for the use of other
assets like patents and copyrights. In this unit we will deal with the accounting
records for royalties.
Financial Accounting 2 BACC 106

9.1 Objectives
By the end of this unit, you should be able to:
z define terms of royalty accounts
z calculate royalties payable
z draw up the relevant ledger accounts

9.2 Terms under Royalty

Minimum rent

This is the guaranteed minimum amount the landlord or owner of the copyright
must receive. This amount is paid even if there is no production.

Short workings

This is the amount by which minimum rent exceeds the actual royalties payable
(based on actual production, that is, production x rate per unit).

The right to recoup short workings

The agreements usually provide for the right to recoup short workings in
subsequent years, within a specific period of time, e.g. six years. This means
that in subsequent years, any excess of royalties over minimum rent is applied
to short workings before payment is made to the landlord. After the specified
period, the remaining short workings are written off to comprehensive income.

9.3 Accounting Entries

Royalty for the year
Debit Royalty account and credit Landlord with the actual royalty.
Debit Landlord and Credit Bank with the payment to the landlord.
Accounting entries when there are short workings:
Debit Royalty and Credit Landlord with the actual royalty.
Debit Short workings and Credit Landlord with the amount of short
workings incurred.
Debit Landlord and Credit Bank with payment of amount due to the
landlord.

Entries for the recovery of short workings

Debit Landlord and Credit Short workings with short workings recovered.
Example 9.1

A Landlord gives JP Ltd the right to work on his land at a royalty of $2 per
ton mined. In the first 3 years, production was 2 000, 5 000, and 7 000 tons
respectively. Show the accounts of JP Ltd.

Solution
Royalty Account
Year
1 A Landlord 4 000
2 A Landlord 10 000
3 A Landlord 14 000

Landlord Account
Year
1 Royalty 4 000
2 Royalty 10 000
3 Royalty 14 000

Using the above example, if the landlord had a right to $11 000 minimum rent
the accounts would be:
Royalty Account
Year
1 Minimum rent 4 000
2 Minimum rent 10 000
3 A Landlord 14 000

Minimum Rent Account

Year
1 royalty 4 000
Short workings 7 000
2 Royalty 10 000
Short workings 1 000

Short Workings Account

Year
1 Minimum rent 7 000
2 Minimum rent 1 000

A Landlord Account
Year
1 Minimum rent 11 000
2 Minimum rent 11 000
3 Royalty 14 000
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If the short workings are recoverable for 2 years after the year in which they
arise, the entries would be as follows:

Royalty Account
Year
1 Minimum rent 4 000
2 Minimum rent 10 000
3 A Landlord 14 000

Short Workings Account

Year Year
1 Minimum rent 7 000 3 A Landlord 3 000
2 Minimum rent 1 000 P and L 4 000
Balance c/d 1 000
8 000 8 000
Balance b/d 1 000

Minimum Rent Account

Year Year
1 A Landlord 11 000 1 Royalty 4 000
1 A Landlord 11 000 Short workings 7 000
2 Royalty 10 000
Short workings I 000

A Landlord Account
Year Year
1 Bank 11 000 Minimum rent 11 000
2 Bank 11 000 Minimum rent 11 000
3 Bank 11 000 Royalty 14 000
Short workings 3 000

Activity 9.1
A company is leasing a mine at a minimum rent of $1 500, merging into
? a royalty of $0.025 per ton. The short workings were recoverable
during the first five years of the lease only. The output for the first 6
years were as follows: 36 000; 52 000; 58 000; 72 000; 76 000; and
96 000 respectively.

Required
Draw up the royalty accounts to record these transactions.
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112 Zimbabwe Open University
Unit 9 Royalty Accounts

Activity 9.2
On 1 January 2008, Swiss Ltd, patentees of a new type of alarm
? clock granted a licence to Timekeepers Ltd to manufacture and les the
clocks. In terms of the licence, Timekeepers Ltd were to pay a royalty
of $0.25 per clock sold, subject to a minimum payment of $2 000 per
annum, to be paid annually on 31 December. Should the royalties,
calculated on the number of clocks sold be less than $2 000 in any
year, the deficiency could be set off against royalties in excess of $2
000 in either of the next two succeeding years
The number of clocks sold was as follows:
Year to 31 December 2008 6 000
Year to December 2009 7 200
Year to December 2010 9 600
Payment to Swiss Ltd were made punctually no due dates. The financial
statements of Timekeepers Ltd are made up to 31 December in each
year.

Required
Show the entries for the above transactions in the books of Timekeepers
Ltd.

9.4 Summary
This unit dealt with royalties and covered accounting entries to be made for
royalty transactions. The calculation of royalties is a fairly simple process as it
involves multiplying the production achieved with the rate. However you should
be careful when dealing with short workings. You should determine if they are
recoverable, and during what period, and then make appropriate entries.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (1993). Business Accounting 1. 11th Edition. Prentice Hall.

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10
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Unit Ten
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Joint Ventures

10.0 Introduction

A joint venture is a temporary partnership, between two or more persons,

where each party contributes towards the capital. Profits are shared in
agreed proportions.
Since the joint venture is for a particular business venture, it is automatically
dissolved at the conclusion of the venture. There is therefore no need to open
a separate set of books for the venture. Each party will open special accounts
in relation to the venture in his books.
The main advantage of a joint venture is that persons can work and share
resources in order to make a profit. For example one person may be able to
buy goods at a very low price, but may not have the capital, the other may
have capital but no business acumen, while a third one may be a good sales
person, able to sell the goods at a very high price. These three can all gain by
pooling their resources and abilities in a joint venture. However, there is also
the disadvantage that one might lose money, damage one's reputation and
lose customers by associating with unprofessional and unscrupulous partners.
Financial Accounting 2 BACC 106

Three types of joint ventures mentioned in IAS 31 are:

z Jointly controlled operations which involve the use of assets and other
resources of the venturers rather than the establishment of a separate
entity. Each venture uses its own assets, incurs its own expenses and
liabilities and raises its own finance.
z Jointly controlled assets involve joint control and often joint ownership
of assets dedicated to the venture. Each venture may take a share of
the output from the assets and each bears a share of the expenses
incurred.
z Jointly controlled entities. A jointly controlled entity is a corporation
partnership or other entity in which two or more venturers have an
interest, under a contractual arrangement that establishes joint control
over the entity.
In this unit we will look at accounting records kept by the venturers to record
transactions in relation to a simple joint venture.

10.1 Objectives
By the end of this unit, you should be able to:
z describe the joint venture accounting system
z draw up accounts for the joint venture, including the Memorandum
Joint Venture account

10.2 Joint Venture Accounting Entries

Each partner will open a joint venture account to record joint venture
transactions

When he purchases goods for the joint venture or pays joint venture expenses

Debit joint venture account and Credit the Bank

On sale of goods

Debit cash and Credit joint venture

For his share of profits

Debit joint venture and Credit profit on joint venture

10.3 Memorandum of Joint Venture

The co-venturers exchange information regarding each person's transactions,
and this information is combined in a memorandum of joint venture to determine
the profit or loss on the venture. This memorandum statement is simply done
on a loose sheet of paper and does not form part of the double entry system.
The profit is then shared in agreed proportions. Each of the partners then post
their share of profits to the joint venture accounts in their ledgers, and the
venturers settle the balances on their accounts.

Example 10.1

B Harris and W Croft agreed on 1 June 2009, to enter into a joint venture for
the purpose of buying 500 tons of wrought iron for $1 200. Harris paid the
amount by cheque. The following is a summary of the transactions with regard
to the venture.

$
June 2 Harris received a cheque from Croft for his half share 600
3 Business expenses paid by Harris 5
4 Harris sold 200 tons for cash 510
7 Harris sold 100 tons for cash 260
10 Croft sold the balance for cash 491
Expenses paid by Croft 6
Required

Draw up the joint venture account in the books of Harris, and the
Memorandum of joint venture statement.

Solution

Books of Harris
Joint Venture Account With Croft
2009 2009
June 1 Bank: Purchases 1 200 June 2 Bank: Croft 600
3 Bank: expenses 5 4 Bank: sales 510
10 Share of profits 25 7 Bank sales 260
Bank: paid to Croft 140
1 370 1 370

Memorandum Of Joint Venture Statement

Purchase: Harris 1 200 Sales Harris 770
Expenses: Croft 6 Sales: Croft 491
Expenses: Harris 5
Share of profits: 25
Croft
25
Harris
1 261 1 261

Bank Account
Jun 30 Croft 140

Books of Croft
Joint Venture with Harris
Jun 2 Bank - purchases 600 Jun 10 Bank - Sales 491
Jun10 Bank -expenses 6 Bank - Harris 140
Jun 30 Share of profits 25
631 631

Bank Account
Jun 30 Harris 140

The memorandum of joint venture remains the same.

Activity10.1
On 1 June 2009, A Builder and B Landowner entered into a joint
? venture for the purpose of the erection and sale of a house. B Landowner
contributes a stand valued at $4 500, and pays A Builder $1 500 cash
for the purposes of the venture.
A Builder is to erect the house and is to receive the following
commissions:
10% on wages paid
15% on materials supplied
Thereafter profits and losses are to be shared equally.
A Builder made the following payments: Wages $3 500; Materials $4
600; in the erection of the house.
Pending the sale of the house for $15 000, rent amounting to $1 200
was received, while current expenses amounted to $600. All these
amounts were received and paid by A Builder.

Required
A memorandum of joint venture statement
The joint venture account in the books of A Builder
The joint venture account in the books of B Landowner

10.4 Summary
In this unit we looked at the accounting records kept by joint venturers to
enable them to determine profits made on the joint venture and settle their
mutual indebtedness.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood , F. (2008). Business Accounting 1. 11th Edition. Prentice Hall.

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11
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Unit Eleven
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Branch Accounts

11.0 Introduction

B ranch accounting has three main categories, that is, one which keeps all
the financial accounts at the head office; one where each branch maintains
its own full accounting system and foreign branches (not discussed in this
module.)
Companies usually expand and diversify their businesses by opening branches
in areas that are geographically far from the parent company, either in another
town or country. When this happens, the head office wants to exercise some
control over the branch, especially on stock and cash, so as to ensure that the
entity does not suffer any losses. A suitable branch accounting system therefore
has to be put in place to ensure that there is sufficient control over the branch's
activities.
In this unit, we only discuss the first two categories given above.
Financial Accounting 2 BACC 106

11.1 Objectives
By the end of this unit, you should be able to:
z explain how accounting transactions are recorded where head office
maintains all the accounts
z explain how accounting transactions are recorded where the branch
maintains its full accounting record
z prepare final accounts where branch accounts are involved

11.2 Where the Head Office Maintains All the

Accounts
When the head office maintains all accounts, the branch would be expected
to sent periodic returns or reports of the financial and other activities to the
head office, to facilitate the making of accounting entries in the head office
books. Control over the branch is exercised in different ways. In some cases,
the head office is responsible for all the purchasing of goods, which are then
invoiced to the branch at selling price.

How goods are invoiced to the branch

Goods supplied to branches may be charged out to them at:

The branch selling price
The cost to the head office, or
The cost to the head office plus mark up
The first method is commonly used because it gives the greatest amount of
control over the branch stock operations.

Goods sent to branch at branch selling price

There are two methods that can be used to account for goods sent to branch
at selling price:
1. The memorandum method
2. The fully integrated methods

11.2.1 The memorandum method

The accounts necessary are:

Branch stock control account (with memorandum columns)

It is essentially a trading account. It deals with:

Opening stock
Goods sent to branch by head office
Sales returns to branch
All the above will be shown at cost price.

The memorandum column shows the above figures at selling prices.

The branch stock control account is credited with:

Returns to head office by the branch at cost
Branch closing stock at cost
Goods destroyed/stolen at cost
Credit and cash sales
The memorandum column shows the returns, closing stock and goods
destroyed at selling price.

Goods sent to branch account

This account is maintained at cost price and it is credited with goods sent to
the branch (at cost) and debited at cost price with goods returned to head
office by the branch and branch debtors.

Branch debtors account - this is maintained where the branch sells goods
on credit

Other accounts
Branch profit and loss
Branch cash and bank accounts
Branch expenses account

11.2.2 Fully integrated method

The necessary accounts are

The branch stock control account

This account is maintained at the branch selling price. It shows the same
information shown in the memorandum column under the memorandum
method. The branch stock amount by being entirely concerned with selling
prices acts as a control upon stock deficiencies.

The branch mark up / adjustment account

It is effectively a branch trading account. It is credited with the mark-up (gross

profit loading) on:
Branch opening stock
Goods sent to branch
Goods sent to branch in transit
The debit side includes the mark up on:
Branch stolen/destroyed
Returns to head office by branch or branch debtors
Mark-downs
The branch adjustment account shows the amount of gross profit earned during
the period.

Goods sent to branch account

This is the same as per memorandum method.

Branch debtors account

This is as per the memorandum method.

Other accounts

This is as per the memorandum method.

Where goods are transferred at cost price, the accounting entries can be
summarised as follows:

When goods are sent to branch - debit branch stock account and credit
goods sent to branch account.

When goods are sold - debit cash/bank or branch debtors and credit the
branch stock account.

When goods are returned to the branch by debtors - debit branch stock
account and credit branch debtors.

When the branch returns goods to head office - debit stock or purchases
and credit branch stock account.

Example 11.1

Ojay Zimbabwe operates a branch in Masvingo, with all accounts being

maintained at head office. All purchases are done at head office. The head
office adds a mark up of 33.33% (1/3) on cost when invoicing the branch.
The following transactions relate to the year ended 31 December 2011.

Branch opening stock (at cost) $675, Goods sent to branch (at cost) $6 000:
Branch debtors at January 2001, $880: Cash sales $6 000; Credit sales $1
068; Goods returned to head office (at cost) $180; Cash paid by branch
debtors $1 200; Bad debts written off branch debtors $48; Branch stock at
31 December 2011, $1 194.

Required

Write up the branch ledger accounts to record the above transactions in head
office books, assuming that
(a) The branch stock account is maintained at cost, but showing
memorandum columns at selling price.
(b) The branch stock control account is maintained at selling price, that is,
the fully integrated method.
Solution

(a) Memorandum method

Branch Stock Control Account

Selling Selling
price price
Opening stock 900 675 Cash sales 6 000 6 000
Goods sent to branch 8 000 6 000 Credit sales 1 068 1 068
8 900 6 675 Returns to head office 240 180
Less closing stock 1 592 1 194
7 308 5 481
Gross profit 1 767
7 308 7 248 7 308 7 248

Goods Sent To Branch Account

Branch stock 6 000

Branch Debtors
Balance b/d 880 Bank 1 200
Branch stock 1 068 Bad debts 48
Balance c/d 700
1 948 1 948
Balance b/d 700
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(b) Fully integrated method

Branch Stock Control Account

Selling Selling
prices prices
Balance d/d 900 Cash sales 6 000
Goods sent to branch 8 000 Credit sales 1 068
Returns to head office 240
Balance c/d 1 592
8 900 8 900
Balance b/d 1 592

Branch Adjustment Account

Mark up on returns to head 60 Balance 225
office
Gross profit 1 767 Mark up on goods sent to branch 2 000
Mark up on closing stock c/d 398
2 225 2 225

The other accounts will be the same as in the first method.

Activity 11.1
Bata Ltd operates a retail branch at Sanyati. All purchases are made
? by the head office in Kadoma. Goods are invoiced to the branch at
cost plus 50% mark up.
On January 2001stock at the branch at selling price amounted to $4
866 and debtors were $2 644. During the year ended 31 December
2011 the following transactions took place:
Details $
Goods sent to branch at selling price 15 180
Cash sales 6 415
Credit sales 5 728
Goods returned by branch to head office at selling price 1 056
Authorised reductions in selling prices of goods sold (mark downs) 97
Uninsured stock stolen at selling price 30
Branch stock destroyed by fire at selling price 1 500
Goods returned to branch by branch debtors at selling price 450
Goods returned to head office by branch debtors at selling price 150
Cash paid by debtors 4 266
Bad debts written off 65
Discount allowed on branch debtors 122

You also ascertain that

A consignment of goods dispatched to the branch in December 2011
with a selling price of $120 was not received till 10 January 2012 and
have not been included in its closing stock figure which at selling price
was $5 670.
Before 31 December 2011, the branch received a cheque from its
insurers amounting to three quarters the cost of stock destroyed by
fire. This represented the total amount recoverable under the policy.

Required
Prepare the necessary ledger accounts to record the above transactions
in the head office books, using the fully integrated method.

11.3 Where the Branch Maintains its Full Accounting

Records
In the case of very large branches it may be necessary that the branch maintains
a complete and independent set of books. In most cases the head office sets
up the branch by transferring to it the necessary assets, recording the details
in its own ledger through a branch current account. The branch, in opening its
ledger, records receipt of these assets in the head office current account.
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These two current accounts are used to record all transactions between the
head office and the branch, therefore if at any given time both parties have
recorded all transactions, the balances should be the same, but on opposite
sides on the ledger. However, in practice there are usually differences, due to
items in transit (for example, goods or remittances), which have been recorded
by one of the parties and not the other. It is, therefore, necessary to reconcile
these two accounts at the end of the financial period. Thus the position is just
like that of an ordinary debtor and creditor relationship, with the head office
usually being the creditor and the branch being the debtor.

Briefly, the accounting entries in the branch's books are:

For receipts from head office - debit the relevant account (for example, assets)
and credit head office current account.

For payment or transfers to head office - debit head office current account
and credit the relevant account.

Activity 11.2
In December 2001 TOM Ltd acquired additional premises at Sadza
? growth point at a cost of $30 000. On January 2002 the company
opened a new branch at Sadza growth point. The following assets
were transferred from the head office to the branch
Details Amount $
Freehold premises 30 000
Furniture and fittings 4 000
Motor vehicles 4 500
Cash at bank 3 000

Required
Show the entries to record the above transactions in:
a) The head office ledger
b) The branch ledger

Example 11.2

During 2002, the following transactions in respect of TOM (Sadza) branch

were recorded in head office books:
Goods sent to branch at cost 40 000
Goods returned to head office by branch at cost 1 500
Remittances from branch 38 000
Proportion of head office expenses chargeable to branch 2 800
Transactions recorded in the branch were:
Goods received from head office at cost 38 500
Goods returned from branch at cost 1 200
Remittances to head office 38 800

At the end of the year, goods in transit to the branch were $1 500 and cash in
transit to head office amounted to $800.

Required

Show the above transactions in the current accounts in the head office and
branch books.

Solution

In head office books

Branch Current Account

Balance b/d 41 500 Goods returned by branch 1 200
Goods sent to branch 40 000 Bank – branch remittance 38 000
Expenses charged to branch 2 800 Goods in transit c/d 1 500
Cash in transit c/d 800
Balance c/d 42 800
84 300 84 300
Goods in transit b/d 1 500
Cash in transit b/d 800
Balance b/d 42 800

In branch books

Head Office Current Account

Goods returned to head 1 200 Balance b/d 41 500
office
Remittances to head 38 800 Goods received from head 38 500
office office
Balance c/d 42 800 Expenses charged to branch 2 800
82 800 82 800
Balance b/d 42 800

11.4 Preparation of Annual Financial Statements

At the end of the accounting period, trial balances are extracted from both the
head office and branch ledgers. Statements of comprehensive income are
prepared for the branch and the head office and these are then combined, as
the organisation is a single entity, and the statement should be prepared for
the whole entity. Likewise, statements of financial position are prepared for
both the branch and the head office, and then combined to produce a single
statement for the whole organisation.

In transit items

At the end of the financial year, it will be necessary to ensure that the two sets
of books (head office and branch books) contain the same information. If this
is the case, the relevant current accounts will have the same balance, but on
opposite sides. It often happens that the two balances do not agree, because
of items in transit between the branch and the head office. A proper
reconciliation has to be done to identify the in transit items and agree the
balances. The following example illustrates the situation.

Example 11.3

Items in head office books

Goods sent to branch 37 000
Cheques received from branch 29 500
Returns received from branch 4 400
Items in the branch's books
Goods received from head office 35 000
Cheques sent to head office 30 300
Returns sent to head office 500
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130 Zimbabwe Open University
Unit 11 Branch Accounts

Assume that the opening balances on the current accounts was $78 500. And
that the branch had drawn up its statement of comprehensive income and
transferred $8 000 profit for the year to head office.

The two current accounts would look like this:

In the Branch's Books

Head Office Current Account
Bank 30 300 Balance b/d 78 500
Returns to head office 5 000 Goods from head office 35 000
Balance c/d 86 200 Profit 8 000
121 500 121 500
Balance b/d 86 200
In the books of the Head Office
Branch Current Account
Balance b/d 78 500 Bank (remitted by branch) 29 500
Goods sent to branch 37 000 Returns from branch 4 400
Profit 8 000 Balance c/d 89 600
123 500 123 500
Balance b/d 89 600

The differences between the two accounts are caused by the following:

Goods sent to branch - in transit - 37 000 - 35 000 = $2 000

Cheques in transit to head office - 30 300 - 29 500 = $800

Returns in transit to head office - 5 000 - 4 400 = $600

These reconciliation items are carried forward to the nest period in the head
office account, so that the two current accounts agree. The branch current
account in the head office books will now agree with the head office current
account as shown below.
Branch Current Account
Balance b/d 78 500 Bank 29 500
Goods to branch 37 000 Returns received 4 400
Profit 8 000 Goods in transit c/d 2 000
Cheques in transit/d 800
Returns in transit c/d 600
Balance c/d 86 200
123 500 123 500
Balance b/d 86 200

Having done this, let us further assume that the two trial balances at this point,
after both the head office and the branch have drawn up their statements of
comprehensive income are as follows:
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Head Office Branch

Dr Cr Dr Cr
Premises 100 000 50 000
Machinery 20 000 2 500
Fixtures 31 000 2 900
Motor vans 15 000 6 000
Stock 38 000 7 000
Debtors 11 000 8 000
Head office current account 86 200
Branch current account 86 200
Goods in transit 2 000
Cheques in transit 800
Returns in transit 600
Creditors 13 000 11 800
Capital 378 600
Bank 122 000 21 600
Profit (branch 8 000 + H.O 27 000) 35 000
426 600 426 600 98 000 98 000

The combined statement of financial position can now be compiled by adding

together the line items for the branch and the head office. Please note that the
two current accounts offset each other.

The resultant statement of financial position is shown below.

Statement of Financial Position as at 31 December 2010

$ $
Non-current assets
Premises 150 000
Machinery 22 500
Fixtures 33 900
Motor vans 21 000
227 400
Current assets
Stocks (Note 1) 47 600
Debtors 19 000
Bank (Note2) 144 400
211 000
438 400

Equity and liabilities

Capital 378 600
Retained income 35 000
413 600
Current liabilities
Creditors 24 800
438 400
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132 Zimbabwe Open University
Unit 11 Branch Accounts

Note 1 Stock = head office 38 000 + branch 7 000 + in transit 2 600

= $47 600
Note 2 Bank = head office 122 000 + branch 21 600 + in transit 800
= $144 400
Having gone through this example, I am sure you are now ready to try
the exercise below.

Activity 11.3
The following are trial balances of Pangolin enterprises and its branch
? Pangolin
Dr Cr
Branch
Dr Cr
$ 000 $ 000 $ 000 $ 000
Administrative expenses 380 30
Distribution costs 157 172
Capital 550
Cash at bank 25 2
Creditors 176 20
Current accounts 255 180
Debtors and prepayments 130 76
Moto vehicles at cost 470 230
Accumulated depreciation 280 120
Plant and equipment at cost 250 80
Accumulated depreciation 120 30
Drawings 64
Provision for unrealised profit on branch 5
stocks on 1 January 2009
Purchases 880
Sales 1 200 570
Stock at cost/ invoice amount at 1/1/09 80 30
Transfer of goods to branch form H.O. 360 300
2 691 2 691 920 920

Additional information
All goods are purchased by the head office. Goods are invoiced to the
branch at cost plus a profit loading of 20%.
Stocks on hand on 31 December 2009 were - head office $100 at
cost, and branch $48 at invoice cost. In addition $6 000 of stocks at
invoiced price had been dispatched to the branch on 28 December
2009, but were only received by the branch on 5 January 2010 and so
had not been included in the branch books of account.
On 31 December 2009, the branch had transferred $15 000 cash to
the head office bank, but this was not received until 2 January 2010.

Required
Prepare the head office and branch statements of comprehensive
income for the year ended 31 December 2009.
Prepare the combined statement of financial position as at 31 December
2009.
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11.5 Summary
You should now be able to deal with branch accounting in relation to the
following :goods to branch, returns by branch to head office, inter branch
transfers, branch closing stock, branch stock losses, returns by branch debtors
to branch, the branch stock adjustment account and the branch and head
office current accounts.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (2008). Business Accounting 1. 11th Edition. Prentice Hall.

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134 Zimbabwe Open University
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Unit Twelve
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Investment Accounts

12.0 Introduction

I nvestments can be divided into two main classes, that is, government stocks
and investments in limited companies. Investments in limited companies
may take the form of shares, stock or debentures. Companies normally invest
excess money in short and long-term securities. Short term investments include
investments in treasury bills, which have an average life of 3 months. Long
term investments include investment in the share capital of other companies
and investment in government stocks. There are two types of incomes, which
arise from investments. There is income, which comes in as a normal return
on investment e.g. interest. There is also the profit or loss on sale of investments.
In this unit we want to examine in detail the accounting requirements of
investment income.
Financial Accounting 2 BACC 106

12.1 Objectives
By the end of this unit, you should be able to:
z identify items which constitute capital and income
z calculate the closing value of capital
z calculate sales and purchases cum-dividend
z calculate sales and purchases ex-dividend

12.2 Nominal Value and Capital Value

With regard to shares or stocks, there is what is called the nominal value of
shares or stocks. The nominal value of a share or stock is the registered value
of each share of stock. The capital value is the amount actually spent on the
shares or stocks. Thus 100 shares of $1 each have a nominal value of $100.
If the shares are selling for $1.50 each, then the capital value per share is
$1.50

12.3 Investment Income

As has already been explained, the income from investment comes in the
form of interest or dividends and profit or loss on the sale of investments. The
double entry is simply to credit the interest or dividends account and debit
bank. In some instances an investment income account is opened and credited
with the interest or dividends so received.

An investment in stocks or shares is an asset like any other asset of the business.
At times the investments are sold to raise cash. Profit or losses arise from
such disposals. The profit or loss on disposal of investments is taken to the
statement of comprehensive income. The double entry is however different
from one followed on disposal of noncurrent assets, as the disposal account
is not required here. The investment (asset) account is credited with the actual
money received and the bank account is debited. The balance in the account
is a profit or loss on the sale of investments.

Sometimes the investing company may have a financial year end which differs
from that of the investee company. Confusion often arises on the declaration
of dividends and on the allocation of dividend or interest. Thus the investing
company, say Rhino Ltd may have a financial year ending 31 December each
year. At the same time Rhino Ltd may have shares in the invested company,
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136 Zimbabwe Open University
Unit 12 Investment Accounts

Tinto Ltd whose financial year ends on 30 June each year. On 31 December
2000, Tinto Ltd declared a dividend of say 5c per share for the year ending
30 June 2001, payable in January 2001. It must be noted that Rhino Ltd, the
investing company must account for this dividend in the year in which it is
declared and not received.

Another problem concerns bonus issues. It must be borne in mind that bonus
shares do not bring any cash into the business. They are a mere reallocation
of funds from reserves to share capital. Rights issues though bring cash into
the business.

Example 12.1

On January 2011, Shamiso Ltd had 10 000 ordinary shares of $1 each, fully
paid in Trevor Ltd, having a book value of $11 250.

On February 2011 Shamiso Ltd sold 2 000 shares in Trevor Ltd for $4 300.

At a meeting held on 31 March 2011, Trevor Ltd decided:

1. To make a bonus issue of two fully paid shares for every five held on
20 March 2011.
2. To give its members the right to apply for 1 share for every 2 shares
held on March 20, at a price of $1.25 per share of which 75c was
payable on application on or before 30 April 2011 and the balance of
50c on June 2011.
3. The new shares issued under 1 and 2 were not to rank for dividend for
the year ended 31 March 2011.
Shamiso Ltd duly received the bonus shares and took up the entitlement under
the rights issue making the payments on the due dates. Trevor Ltd declared
and paid dividends as follows:

20 July 2011, a final dividend of 10c per share for the year ended 31 March
2001, and 30 November 2001, an interim dividend of 5c per share for the
year ending 31 March 2011.

Required

Show the Investment account in the books of Shamiso Ltd for the year ended
32 December 2011.

Suggested solution
Cost per share = 11 250 / 10 000 = $1.125
(a) Number of shares held at 20 March 2011 = (10 000 - 2 000) = 8 000
(b) Bonus share issue =2/5 x 8 000 = 3 200 shares
(c) Rights issue shares =1/2 x 8 000 = 4 000 shares
(d) Amount received on rights issue = 4000 x .75 = $3000 and 4 000 x .5
= $2 000
Dividends received:
(a) 20 July 2011 = 8 000 x $0.10 = $800
(b) 30 November 2011 = 15 200 x $0.05 = $760
Value of closing investments:
Original investments = 8 000 x $1.25 = $9 000
Rights issue = 3 000 + 2 000 = $5 000
Closing value of shares $14 000

Investment Account
2011 2011
01 Jan Bal b/d 11 250 Bank 4 300
30 Apr Bank 3 000 Balance c/d 14 000
30 Jun Bank 2 000
31 Dec Statement of comp. in 2 050
18 300 18 300
Balance b/d 14 000

Investment Income Account

2011 2011
Dec 31 S of comp. income 1 560 Jul 20 Bank 800
Nov 20 Bank 760
1 560 1 560

12.4 Presentation Format

Because of the necessity to keep income separate from the capital cost of the
investment, each investment account has a column for income and a column
for capital. In addition, a column is used to show the nominal value of the
stock, this being used for convenience and does not form part of the double
entry system. The account will be illustrated below:

Shamiso Investment Account

Date Details Nominal Income Capital Date Details Nominal Income Capital
2011 2011
Jan 1 Bal b/d 10 000 11 250 Feb 01 Bank 2 000 430
Jab 20 Bonus 3 000 Jul 20 Bank 800
issue
Apr 30 Bank 4 000 3 000 Nov 30 Bank 760
Jun 30 Bank 2 000 Dec 31 Bal c/d 15 000 14 000
Dec 31 St. of 1 560 2 050
comp
income
17 000 1 560 18 300 17 000 1 560 18 300

Activity 12.1
On 1 January 2010, Richardson purchased 2 000 shares in Holds
? LTD., for $2 150. On 30 June, he sold 1000 of the shares at $2.50
per share. An interim dividend of 10c per share is paid on 30 June
each year, with a final dividend of 15c per share being paid on 31
December each year.

Required
Show the investment accounts in the books of Richardson

Cum dividend

Cum- dividend means that the price of the security includes the interest or
dividends due. Thus, if you were a holder of $10 000 government stocks with
an interest rate of 10%, the interest receivable for the whole year is $1 000.
Let us suppose the interest is payable on 31 December annually. On 1
December, you decide to sell the whole investment, which share price would
you quote? $10 000, if you do so, the buyer would pay $10 000 for the
stock, but get the $1 000 interest on 31 December. So that, in fact, the cost
of the investment to him is $10 000 - $1 000 interest received = $9 000,
which is not fair. To avoid such unjust enrichment some securities are sold
with the dividend due. In this particular case for instance we are entitled to 11
moths interest = 10 000 x 10% x 11/12 = 917.

So the fair price for the security is $10 000 + $917 = $10 917. The security
is then said to have been sold cum dividend.

Ex-dividend

Ex-dividend is the opposite of cum-dividend. It means that the price of the

security excludes dividends due. The interest or dividends due accrue to the
seller. Thus, the above cum- div example, even after selling the $10 000
government stock, $100 is received as interest instead of $917. The $83
which should not have been received is still received.
Sales cum-dividend
Securities can be sold cum-dividend or ex-dividend. When this happens, the
seller will be including the dividends or interest due in the price of the security.
This is the interest that he is forgoing by selling the security. The buyer will
then receive the interest. The price will be as follows:

Price = original cost of security + interest due but not yet received.

In the seller's books the whole amount received is credited to the asset account,
including the interest portion. An adjustment is, therefore, necessary to transfer
the interest portion of the selling price from the capital account to the interest
account.
Example 12.2
On 2 January 2011, Chivhu Ltd bought 10 000, 10% government stocks for
$9 000. Interest is received quarterly on 31 March, 30 June, 30 September
and 31 December each year. On 1 December 2011, Chivhu Ltd sold 1 000
government stocks cum dividend.
Required

Show the ledger accounts of Chivhu Ltd as they would appear at 31 December
2011.
Solution
Cost per stock = 9 000/10 000 = $0.90
Interest due:
30 March = $250
30 June = $250
30 September = $250
31 December = $250
Interest due on sold stock, but not received by the seller = $10 000 x 10% x
1/4 x 2/3 = n$17. The 2/3 is for the 2 months out of 3 months in a quarter.

The value of closing 10% government stocks = 9 000 x $0.9 = $8 100.

10% Government Stocks Account

2011 2011
Jan 02 9 000 Bank 980
Interest account 17 Balance c/d 8 100
St. of comp income 63
9 080 9 080
Balance b/d 81 000

Interest on 10%Government Stocks

2011 2011
Dec 31 St. of comp income 992 Mar 31 bank 250
Jun 30. Bank 250
Sept 30. Bank 2 550
Dec 31. Bank 225
Capital int. adjustment 17
992 992

Sales ex-dividend

This implies that the seller still receives the full interest even though he was not
an owner of the stocks in question during the full period under consideration.
What it means simply is that the interest, which is received by the seller when
he should not have received it, should not be regarded as interest, but as part
of the actual selling price of the stock.

Example 12.3

On 2 January 2011, Chivhu Ltd bought $10 000 10% government stocks for
$9000. Interest is received quarterly on 31 March, 30 June, 30 September,
and 31 December each year. On 1 December 2011, Chivhu Ltd sold 1 000,
10% government stocks ex-dividend.

Required

Show the ledger accounts to record the above transactions.

Solution

Workings

Cost per stock 9 000/10 000 = $0.90

Interest per quarter is $10 000 x 10% x 1/4 = $250. Therefore, interest on:

March 31, 2011 = $250

June 30, 2011 = $250

September 30, 2011 = $250

December 30, 2011 = $250

Interest received on sold stock which should not have been received is

$1 000 x 10% x ¼ x 1/3 = $8

The total interest for the quarter on 1 000, 10% government sticks is $25.
One third of that, for the month of December should not have been received,
but it was received. That is the reason why the December interest is still
$250.

10 %Government Stocks Account

2011 2011
Jan 02 Bank 9 000 Dec 01 Bank 980
Dec 31 St, of comp income 88 Dec 31 Interest adjustment 8
Balance c/d 8 100
9 088 9 088
Balance b/d 8 100

Purchases cum-dividend

When stocks are purchased cum-dividend, it implies that dividends or interest

is going to be received by the buyer irrespective of when the stock is purchased.
When the interest is finally received, it must be taken out of the interest account
and credited to the capital account because it was interest bought and not
earned. That part of interest that accrued to the buyer by virtue of him being
a legitimate holder of the stock is what remains.

Example 12.4

On January 2011 Chivhu Ltd bought 10 000, 10% government stocks of $1

each. Interest is received quarterly on 31 March, 30 June, 30 September and
31 December each year. On 1 December 2011, Chivhu Ltd bought a further
1000 10% government stocks for $980 cum dividend.

Required

The ledger accounts to record the above transactions

Solution

Workings

Cost of stock $9 000/10 000 = $0.90

Interest on old stock per quarter = $10 000 x10% x ¼ = $250

Interest on new stock =$1 000 x 10% x ¼ = $25

Interest that should have been received on new stocks = $25 x 1/3 = $8

Adjustment required = $25 - $8 = $17

10% Government Stocks Account

2011 2011
Jan 02. bank 9 000 Dec 01 Interest 17
Dec 10. Bank 980 Dec 31 Balance c/d 9 963
9 980 9 980
Balance b/d 9 963
Interest on 10% Government Stocks Account
2011 2011
Dec 31 Capital int. adjustment 17 Mar 31 250
St. of comp. income 1 008 Jun 30 250
Sept 30 250
Dec 31 275
1 025 1 025

Purchases ex-dividend

When stocks are purchased ex-dividend, the seller still retains the right to
receive the interest on the stock sold. The buyer thus is deprived of the interest
that he is duly entitled to receive. What therefore happens is that the interest,
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which the buyer is deprived of, then forms part of the actual cost of the stock
by debiting the capital account and crediting the income (interest) account.

Example 12.5

On 1 January 2011, Chivhu Ltd bought 10 000, 10%government stocks of

$1 each for $9 000. Interest is received every 3 months on 31 March, 30
June, 30 September, and 31 December each year. on 1 December 2011,
Chivhu Ltd bought 1 000, 10% government stocks for $980 ex-dividend.

Required

Show the ledger accounts to record the above transactions.

Solution

Workings

Interest per quarter = $10 000 x 10% x ¼ = $250

Therefore interest received during the year = $250 x 4 = $1 000

Interest that should have been received that was not received = $1 000 x
10% x ¼ x 1/3 = $8

10% Government Stocks Account

2011 2011
Jan 01 Balance b/d 9 000 Balance c/d 9 988
Dec 01 Bank 980
Dec 31 interest adjustment 8
9 988 9 988

Interest on 10%Government Stocks Account

2011 2011
Dec 31 St. of comp income 1008 Mar 31 Bank 250
Jun 30. Bank 250
Sept 30. Bank 250
Dec 31. Bank 250
Capital interest adjustment 8
1008 1 008

Activity 12.2
On 1 January 2011, a company purchased $10 000 of 4% bonds for
? $95 000, dividends being payable quarterly, the next one being due on
31 March 2011. On 1 July, $3 000 worth of the bonds were sold for
$2 910.

Required
Show the investment account for the above transactions and receipt of
dividends, showing the balances on 31 December, 2011.

12.5 Summary
The key concepts in this unit, which you need to know are: the items that
constitute capital and income, calculation of closing value of capital, sales and
purchases cum-dividend, and sales and purchases ex-dividend.

References
Cox, D. (1985). Success in Bookkeeping and Accounts. 1st Edition.
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood , F. (1993). Business Accounting 2. 6th Edition. Pitman.

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Unit Thirteen
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Consolidated Accounts:
Introduction

13.0 Introduction

T his unit deals with procedures for preparing consolidated financial

statements where a wholly owned subsidiary is involved. The preparation
of consolidated financial statements is governed by International accounting
standard 27 (IAS 27) Consolidated and separate financial statements with
which you must be familiar. This unit only covers wholly owned subsidiaries.
Financial Accounting 2 BACC 106

13.1 Objectives
By the end of this unit, you should be able to:
z define the criteria for parent-subsidiary relationship
z draw up consolidated statements involving a wholly owned subsidiary,
where the interest is acquired at net book value , at a discount and at
a premium at the date of acquisition..
z draw up consolidated statements involving a wholly owned subsidiary
after the date of acquisition

13.2 Key Definitions

Consolidated financial statements - the financial statements of a group
presented as those of a single economic entity.

Subsidiary - an entity, including an unincorporated entity such as a partnership,

that is controlled by another entity (known as the parent).

Parent - an entity that has one or more subsidiaries.

Control - the power to govern the financial and operating policies of an entity
so as to obtain benefits from its activities.

13.3 Criteria for Control

Control is presumed when the parent acquires more than half the voting rights
of the entity.

Control may also be evidenced by power:

Over more than half the voting rights by virtue of an agreement with
other investors
To govern the financial and operating rights by the entity under a statute
or an agreement
To appoint or remove the majority of the members of the board of
directors
To cast the majority vote at a meeting of the board of directors

13.4 Presentation of Consolidated Accounts

A parent is required to present consolidated financial statements in which it
consolidates its investments in subsidiaries.

Consolidation procedures

Intra group balances, transactions, income and expenses should be eliminated

in full.

13.5 Constitution of a Group

A group consists of a parent and all its subsidiaries

A simple group can be diagrammatically presented as

Parent

51%

S Ltd

Where the parent company holds 51% of the issued equity in S Ltd'

A complex group may have more subsidiaries and sub-subsidiaries

Parent

60% 58% 85%

S 1 Ltd S 2 Ltd S 3 Ltd

60%

SS 1 Ltd

In this group, the parent company has 3 subsidiaries and one sub-subsidiary.
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13.6 A Wholly Owned Subsidiary

This is a subsidiary having no other members except the parent company and
its wholly owned subsidiaries.

13.7 Basic Consolidation Techniques

The basic procedures comprise of the following:
Elimination of inter company or common items
The consolidation of the remaining items
Elimination of common items

This is done for two reasons: to prevent certain items from being added twice
in the consolidated statements, and to ensure that profits on intercompany
transactions, not realised at consolidation date are excluded.

For example, if S Ltd (the subsidiary) owes its parent company $25 000 for
merchandise (the cost of which was $20 000 to the parent company) which it
purchased from the parent company, and which is still in stock at consolidation
date, when consolidating.

The debtor/creditor items in the separate statements must be set off against
each other, and the profit of $5 000 by the parent company, included in the
value of S's stock must be eliminated on consolidation.

13.8 Acquisition of an Interest in another Company

The acquisition of shares in another company can be at:
Net book value
More than the net book value or
Less than the net book value

13.9 Consolidation of the Statement of Financial

Position of a Wholly Owned Subsidiary at the
Date of Acquisition
The consolidation procedures in respect of a wholly owned subsidiary at the
date of acquisition will be illustrated with the use of examples.

Example 13.1

Acquisition of an interest at net asset value

The following are the condensed statements of financial position of P Ltd and
its wholly owned subsidiary S Ltd at 1 January 2010, the date when P Ltd
acquired all the shares in S Ltd.
P Ltd S Ltd
Assets $ $
Noncurrent assets 91 000 65 000
Investment in S Ltd – 80 000 ordinary shares at cost 89 000
Current assets 28 000 24 000
208 000 89 000
Equity
Authorised and issued capital
Ordinary shares of $1 each 200 000 80 000
Retained income 8 000 9 000
208 000 89 000

The first step is to eliminate common balances. The item Investment in S Ltd
($89 000) represents the cost of acquiring owners equity in S Ltd, that is,
Share capital $80 000 and Retained income $9 000 and so these items must
be set off against each other.

The position can be analysed as follows:

Analysis of the Shareholders Equity of S Ltd

Total At Since
acquisition acquisition
Share capital 80 000 80 000 -
Retained income 9 000 9 000
Investment in S Ltd 89 000 89 000

This elimination can be shown by means of a pro forma journal entry as shown
below:

Pro Forma Consolidation Journal Entry

J1 Share capital (S Ltd) 80 000
Retained income (S Ltd) 9 000
Investment in S Ltd 89 000
Elimination of shareholder’s equity of S Ltd
against the investment account

After eliminating the common items, the remaining items can now be included
in the consolidated statement of financial position.

Consolidated Statement of Financial Position of P Ltd

Assets $
Noncurrent assets 156 000
Current assets 52 000
208 000
Equity
Share capital 200 000
Retained income 8 000
208 000
We will now examine the situation where the parent company pays more than
the net asset value of the shares it acquires.

Interest acquired at more than the net asset value (that is, at a premium)

The excess represents an intangible asset that does not appear in the books
of the subsidiary, and must be recognised in the consolidated statement of
financial position. This is known as goodwill or cost of control. We will illustrate
this by means of an example:

Example 13.2

The following are the condensed statements of financial position of P Ltd and
its wholly owned subsidiary S Ltd at 1 January 2010, the date of acquisition
of the shares in S Ltd by P Ltd.

P Ltd S Ltd
Assets $ $
Noncurrent assets 91 000 65 000
Investment in S Ltd – 80 000 ordinary shares at cost 95 000
Net current assets 22 000 24 000
208 000 89 000
Equity
Authorised and issued capital
Ordinary shares of $1 each 200 000 80 000
Retained income 8 000 9 000
208 000 89 000

We know that the investment in S Ltd is the amount paid to purchase the
entire shareholders equity in S Ltd. Lets briefly analyse the situation:
Shareholders equity purchased by P Ltd
(share capital + retained income) 89 000
Amount paid 95 000
Goodwill (Excess amount paid) 6 000
Analysis of Shareholders Equity of S Ltd
Total At Since
acquisition acquisition
Share capital 80 000 80 000 -
Retained income 9 000 9 000
89 000 89 000
Investment in S Ltd 95 000
Goodwill 6 000

The pro forma journal entry is shown below:

J1 Share capital (S Ltd) 80 000
Retained income (S Ltd) 9 000
Goodwill 6 000
Investment in S Ltd 95 000
Elimination of shareholder’s equity of S Ltd
against the investment account
After elimination of the common items, the remaining items are
included in the consolidated statement of financial position:

Consolidated Statement of Financial Position of P Ltd

Assets $
Noncurrent assets 156 000
Goodwill 6 000
Net current assets 46 000
208 000
Equity
Share capital 200 000
Retained income 8 000
208 000

Interest acquired at less than the net asset value.

Where the interest is acquired at less than the net asset value, the difference
between the amount paid and the net asset value (bargain purchase gain) is
immediately recognised to profit or loss.

Example 13.3

Use the same basic information as in the previous example, except that P Ltd
acquired its interest in S Ltd for $75 000

The following are the condensed statements of financial position of P Ltd and
S Ltd at 1 January 2010, the date of acquisition of the shares in S Ltd by P
Ltd.
P Ltd S Ltd
Assets $ $
Noncurrent assets 91 000 65 000
Investment in S Ltd – 80 000 ordinary shares at cost 75 000
Net current assets 42 000 24 000
208 000 89 000
Equity
Authorised and issued capital
Ordinary shares of $1 each 200 000 80 000
Retained income 8 000 9 000
208 000 89 000

Calculation of the Bargain Purchase Gain

Shareholders equity purchased by P Ltd 89 000
Amount paid 75 000
Bargain purchase gain 14 000

Analysis of the Shareholders Equity in S Ltd

Total At Since
acquisition acquisition
Share capital 80 000 80 000 -
Retained income 9 000 9 000
89 000 89 000
Investment in S Ltd 75 000
Bargain purchase gain 14 000

The pro forma journal entry is shown below:

J1 Share capital (S Ltd) 80 000
Retained income (S Ltd) 9 000
Investment in S Ltd 75 000
Retained income 14 000
Elimination of shareholder’s equity of S
Ltd against the investment account

After elimination of the common items, the remaining items are included in the
consolidated statement of financial position.

Consolidated Statement of Financial Position of P Ltd

Assets $
Noncurrent assets 156 000
Net current assets 66 000
222 000
Equity
Share capital 200 000
Retained income 22 000
222 000
222 000

13.10 Consolidation of a Wholly Owned Subsidiary

After the Date of Acquisition
We will now look at the situation where consolidation takes place after the
date of acquisition. The basic consolidation procedures remain the same, that
is, elimination of common items and then consolidation of the remaining items.
However, since the consolidation takes place after the date of acquisition, it is
necessary to analyse the position at acquisition, in order to determine whether
the interest was acquired at, above or below net asset value. It should also be
noted that from the group point of view, any reserves and unappropriated
profits of the subsidiary, before the date of acquisition should not be
consolidated since they are used to analyse the subsidiary's equity at acquisition.
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Profits of the subsidiary after the date of acquisition are distributable in the
group. Consequently it will be necessary to consolidate both the statement of
financial position and the statement of comprehensive income.

We will now examine three situations where shares in the subsidiary are
acquired:
At net asset value
At a premium and
At bargain purchase price
Again we will use examples to illustrate the procedures involved.

Interest acquired at net asset value

Example13.4

The following are the condensed statements of P Ltd and its wholly owned
subsidiary S Ltd on 30 June 2011, one year after P Ltd acquired the shares in
S Ltd,
P Ltd S Ltd
Assets
Noncurrent assets 20 000 80 000
Investment in S Ltd – 80 000 ordinary shares at cost 88 000
Net current assets 13 000 11 000
121 000 91 000
Equity
Authorised and issued share capital 100 000 80 000
Distributable reserves
General reserve 12 000 5 000
Retained income 9 000 6 000
Shareholders’ equity 121 000 91 000

On 1 July 2010, the date on which P Ltd acquired its interest in S Ltd, the
balance on the general reserve and retained income account of S Ltd were $3
000 and $5 000 respectively. There was no change in the capital of S Ltd
since July 2010.

The condensed statements of comprehensive income for the two companies

for the year ended 30 June 2003 are as follows:

Statements of Comprehensive Income for the Year Ended 30 June 2011

P Ltd S Ltd.
Net operating income 39 000 31 000
Dividends received from subsidiary 4 000
Other income 7 000 5 000
50 000 36 000
Expenses (34 000) (26 000)
Net income before tax 16 000 10 000
Tax (4 000) (3 000)
Net income after tax 12 000 7 000
Statement of changes in equity (extracts)
Retained income at the beginning of the year 8 000 5 000
Net income for the year 12 000 7 000
Transfer to general reserve 20 000 12 000
(6 000) (2 000)
Ordinary dividend (5 000) (4 000)
Retained income at the end of the year 9 000 6 000

Stages in the analysis of shareholders equity of S Ltd

The analysis of the shareholders equity of S Ltd is now separated into 3

stages:
At date of acquisition
Since date of acquisition to the beginning of the current financial year
The current year
Analysis of Shareholders Equity of S Ltd
Total P Ltd
At Since
At date of acquisition
Share capital 80 000 80 000
General reserve 3 000 3 000
Retained income 5 000 5 000
88 000 88 000
Investment in S Ltd 88 000

Since acquisition
Current financial year
Net income after tax 7 000 7 000
Ordinary dividend (4 000) (4 000)
91 000 3 000

The consolidation journal entries will be as follows

J1 Share capital S Ltd 80 000
General reserve S Ltd 3 000
Retained income S Ltd 5 000
Investment in S Ltd 88 000
Elimination of intra group balance at
acquisition of interest in S Ltd
The ordinary dividend has to be eliminated as well
J2 Ordinary dividend received 4 000
Ordinary dividend paid 4 000
Elimination of intra group transaction

Consolidation of the statement of comprehensive income

The procedures for consolidating the statements of comprehensive income

are the same, that is, eliminate common items and combine the remaining
items. Care should be taken to ensure that appropriate adjustments are made
in connection with the balances of the retained income and reserves of the
subsidiary at the date of acquisition.

Carefully study the following consolidation worksheet to see how the

consolidation procedures have been effected.

Consolidation Worksheet for Financial Statement of P Ltd and its

Subsidiary
P Ltd S Ltd Consolidation adjustment Consolidated
Dr Cr
Net operating income 39 000 31 000 70 000
Dividend from S Ltd 4 000 4 000 (J2)
Other income 7 000 5 000 12 000
50 000 36 000 82 000
Expenses (34 000) (26 000) (60 000)
Profit before tax 16 000 10 000 22 000
Tax (4 000) (3 000) (7 000)
Profit after tax 12 000 7 000 15 000
Transfer to general reserve (6 000) (2 000) (8 000)
Ordinary dividend (5 000) (4 000) 4 000 (J2) 4 000 (J2) (5 000)
Retained income
For the year 1 000 1 000 2 000
Beginning of the year 8 000 5 000 5 000 (J1) 8 000
End of the year 9 000 6 000 10 000
General reserve 12 000 5 000 3 000 (J1) 14 000
Share capital 100 000 80 000 80 000(J1) 100 000
121 000 91 000 124 000

Non current assets 20 000 80 000 100 000

Investments 88 000 88 000 (J1)
Net current assets 13 000 11 000 24 000
121 000 91 000 124 000
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158 Zimbabwe Open University
Unit 13 Consolidated Accounts: Introduction

The consolidated financial statement will appear as follows:

P Ltd and Its Subsidiary

Consolidated Statement of Comprehensive Income for the Year Ended

30 June 2011
Net operating income 70 000
Other income 12 000
82 000
Expenses 60 000
Profit before tax 22 000
Tax 7 000
Profit after tax 15 000
Statement of changes in equity (extracts)
Retained income at the beginning of the year 8 000
Profit for the year 15 000
23 000
Transfer to general reserve (8 000)
Ordinary dividend (5 000)
Retained income at the end of the year 10 000

Consolidated statement of financial position as at 30 June 2003

Assets
Noncurrent assets 100 000
Net current assets 24 000
124 000
Equity
Ordinary share capital 100 000
Distributable reserves
General reserve 14 000
Retained income 10 000
124 000

Interest acquired at a premium

Example 13.5

The following are the condensed statements of financial position of P Ltd and
its subsidiary at 31 December 2007, two years after P Ltd acquired the shares
in S Ltd.

P Ltd S Ltd
Authorised and issued capital $1 ordinary shares 100 000 40 00
General reserve 5 000 8 000
Retained income 10 000 4 000
115 000 52 000

Noncurrent assets 15 000 30 000

Investment in S Ltd – 40 000 shares at cost 50 000
Net current assets 50 000 22 000
115 000 52 000

On 31 December, 2005, the date at which P Ltd acquired the interest in S

Ltd, the credit balances on the general reserve account and the retained income
account were $2 000 and $500 respectively. There was no change in the
share capital of S Ltd since 31 December, 2005.

The condensed statements of comprehensive income of P Ltd and S Ltd for

the year ended 31 December were as follows:
P Ltd S Ltd
Net operating income 50 000 30 000
Dividend received from subsidiary 6 000
Other income 4 000 3 000
60 000 33 000
Expenses (20 000) (15 000)
Profit before tax 40 000 18 000
Tax (16 000) 8 000
Profit after tax 24 000 10 000
Statement of changes in equity (extracts)
Transfer to general reserve (2 000)
Ordinary dividend (19 000) (6 000)
Retained income for the year 5 000 2 000
Retained income at the beginning of the year 5 000 2 000
Retained income at the end of the year 10 000 4 000

Required

A consolidated statement of financial position of P Ltd and its subsidiary at 31

December 2007 as well as the consolidated statement of comprehensive income
for the year ended 31 December, 2007.

Solution

Analysis of Shareholders Equity of S Ltd

Total At Since
At acquisition
Share capital (dr) 40 000 40 000
General reserve (dr) 2 000 2 000
Retained income (dr) 500 500 J1
42 500 42 500
Investment in S Ltd (cr) 50 000
Goodwill (dr) 7 500

Since acquisition
To beginning of current year
General reserve 4 000 4 000
Retained income 1 500 1 500
5 500
Current financial year
Profit for the year 10 000 10 000
Ordinary dividend (6 000) (6 000)
52 000 9 500

The following pro forma journal entries will be necessary:

J1 Share capital (S) 40 000
General reserve (S) 2 000
Retained income (S) 500
Goodwill 7 500
Investment in S Ltd 50 000
Elimination of intra group balances at date of
acquisition and recording of cost of control

J2 Ordinary dividend received 6 000

Dividend paid S Ltd 6 000
Elimination of intra group transaction

P Ltd and its subsidiary

Consolidated Statement of Comprehensive Income for the Year Ended

31 December 2007
Operating income 80 000
Other income 7 000
87 000
Expenses (35 000)
Profit before tax 52 000
Tax 24 000
Profit after tax 28 000
Statement of changes in equity (extracts)
Transfer to general reserve (2 000)
Ordinary dividend (19 000)
Retained income 7 000
Retained income at the beginning of the year 6 500
Retained income at the end of the year 13 500

Consolidated Statement of Financial Position as at 31 December 2007

Assets $
Noncurrent assets 45 000
Cost of control 75 500
Current assets 72 000
124 500
Equity
Share capital 100 000
General; reserve 11 000
Retained income 13 500
124 500

Activity 13.1
Interest acquired at a bargain purchase price
? Use the same information as in the previous example with the following
exceptions:
a) In the statement of financial position of P Ltd at 31 December, 2007:
b) Investment in S Ltd: 40 000 shares at cost $40 000 (instead of
($50 000), and the amount of noncurrent assets changes to $25 000
(instead of $15 000).

Required
Draw up the consolidated financial statements of P Ltd and its subsidiary.

13.11 Summary
This Unit introduced you to the important topic of consolidation of financial
statements. You should always remember the basic consolidation procedure
of eliminating common items and then consolidating the remaining ones.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood, F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

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164 Zimbabwe Open University
14
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Unit Fourteen
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Budgeting and Budgetary

Control

14.0 Introduction

P lanning and control are perhaps the two most important functions of
management. Planning involves setting objectives and the means to achieve
those objectives, whilst controlling entails measures taken to ensure
achievement of the set objectives. Budgets are an important tool in planning
and control. In this unit, we examine the budgeting process.
Financial Accounting 2 BACC 106

14.1 Objectives
By the end of this unit, you should be able to:
z define key terms in budgeting and budgetary control
z explain the purpose of budgets
z describe the budgeting process

14.2 Definition of Terms

The Institute of Cost and Management Accountants (CIMA) gives the following
definitions:

A budget - A plan quantified in monetary terms, prepared and approved

prior to a defined period of time, usually showing planned income to be
generated and/or expenditure to be incurred during that period and the capital
to be employed to attain a given objective.

Budgetary control - The establishment of budgets relating the responsibilities

of executives to the requirements of a policy, and the continuous comparison
of actual with budgeted results, either to secure by individual action the
objective of that policy or provide a basis for its revision.

Budget centre - a section of an organisation for which separate budgets can

be prepared and control exercised.

Forecast - the prediction of relevant future factors affecting an entity and its
environment as a basis for formulation or reassessment of objectives and
strategies and as a means to facilitate the preparation of planning decisions.

A budget is an estimate of future operational and financial aspects of an entity.

It may include future costs, revenues and the entity's future financial position
Budgets are quantified in physical or monetary terms, prepared in advance
and derived from the entity's long term strategy. They are used as both a
planning tool and a control tool, in that actual performance is periodically
compared with the budget to see if budgeted targets were met, and take
corrective action where necessary.

14.3 Types of Budgets

There are three basic types of budgets:
Capital expenditure budgets for long term investments
Operational budgets for costs, revenues and other operations aspects
Financial budgets which show the entity's pro-forma financial position
Capital expenditure budgets

This represents estimate expenditure on non-current assets during the budget

period. They are a result of requests from managers, based on forecast
activities of their functions. Authority has to be obtained before commitment
of any expenditure. The following is an example of a capital expenditure budget:

Example 14.1
Project no. Short description Estimated Spent Balance to Allocated to years
total cost already spend
$ $ $ 1 2 3 4
25 Purchase motor vehicles 20 000 5 000 15 000 10 000 10 000
26 Reroofing shed 4 000 2 500 1 500 4 000
27 Boiler 5 000 5 000 2 500 2 500
28 Yard gates and fencing 2 000 2 000 2 000

Projects 27 and 28 have not yet commenced. Usually these are projects for
which authority is being sought. Expenditure reports on the approved projects
will be produced on a monthly basis and these will be compared with the
budget. It is normal practice to break down the budget to monthly expected
expenditure, to provide more effective monitoring.

Operational budgets

These outline forecast revenue and expected expenses related to the normal
operations over a period of time, usually a year. They are usually prepared in
the following order:
1. A forecast of units to be sold in the next year is made. Form this estimate,
the sales budget is compiled. The budget shows the quantities and
amounts of expected sales.
2. Given information in 1 above, a production budget is made. It details
the amounts and timing of units to be produced. The quantities to be
produced will normally be more than the forecast sales quantities, to
ensure that there are no stock outs,
3. Information given in 2 above facilitates the determination of resources
needed to produce the quantities required. This leads to the preparation

of the raw materials budget, the direct labour budget, and the overheads
budget
4. A budget is then prepared to cover the marketing and administrative
efforts required to achieve the budgeted sales figure.
The financial budgets

A cash forecast or budget is drawn up, summarising the forecast cash receipts,,
form which are e deducted expected cash payments to get to the expected
balance of cash at the end of each month. This information is used to determine
when the entity may be short of cash so that the necessary arrangements to
obtain funding can be made alternatively, arrangement to invest surplus funds
can be made.

The forecast income statement and statement of financial position are compiled
from the operational budgets and are termed pro forma financial statements.

Let us see how the above mentioned steps are followed in formulating a budget.

Example 14.2

MM Ltd is preparing its budgets for 2011, and the following information is
made available for this purpose:

The company manufactures 2 products, F and G

Prices of materials used

Material 111 $1.20 per unit

Material 112 $2.60 per unit

Overhead is applied on the basis of direct labour hours

Content in each finished product

Product F Product G
Material 111 12 units 12 units
Material 112 6 units 8 units
Direct labour 14 hours 20 hours

Statement of Financial Position for the Year Ended 31 December 2010

$ $ $
Assets
Non- current assets
Land 50 000
Building 380 000
Less accumulated depreciation 75 000
305000
Current assets
Finished goods 14 480
Materials 19 000
Accounts receivable 25 000
Cash 10 000 68 480
423 480
Less current liabilities
Accounts payable 8 200
Income tax payable 5 000 (13 200)
410 280

Equity
Ordinary share capital 350 00
Retained earnings 60 280
410 280

Other Information
Finished product
F G
Expected sales in units 5 000 1 000
Selling price per unit $105.40 $164
Desired closing stock 1 100 50
Opening stock 100 50

Direct materials
111 112
Opening stock 5 000 5 000
Desired closing stock 6 000 1 000

At anticipated volume levels, the following costs will be incurred

Factory overhead
Supplies 30 000
Indirect labour 70 000
Payroll fringe costs 25 000
Power – variable portion 8 000
Maintenance - variable portion 20 000
Depreciation 25 000
Property taxes 4 000
Property insurance 500
Supervision 20 000
Power – fixed portion 1 000
Maintenance – fixed portion 4 500
208 000
Selling and administrative expenses
Sales commissions 20 000
Advertising 3 000
Sales salaries 10 000
Travel 5 000
Clerical wages 10 000
Supplies 1 000
Executive salaries 21 000
Miscellaneous 5 000
75 000

Budgeted cash flows are

Quarters
1 2 3 4
Collections from customers 125 000 150 000 160 000 221 000
Disbursements
For materials 20 000 35 000 35 000 54 200
For other costs and expenses 25 000 20 000 20 000 17 000
For payroll 90 000 95 000 95 000 109 200
For income taxes 5 000 - - -
For machinery purchase - - - 20 000

Solution

Schedule 1

Sales Budget for the Year Ending 31 December, 2011

Units
Selling price Total sales
Product F 5 000
$105.40 $527 000
Product G 1 000
$164.00 $164 000
$691 000
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170 Zimbabwe Open University
Unit 14 Budgeting and Budgetary Control

Schedule 2

Production Budget in Units for the Year Ending 31 December, 2011

Products
F G
Planned sales 5 000 1 000
Desired closing stock 1 100 50
Totals needs 6 100 1 050
Less opening stock 100 50
Units to be produced 6 000 1 000

Schedule 3

Direct Material Purchase Budget for the Year Ending 31 December,

2011
Material Material Total
111 112
Desired closing stock 6 000 1 000
Units needed for production (note a) 84 000 44 000
Total needs 90 000 45 000
Less closing stock (5 000) (5 000)
Units to be purchased 85 000 40 000
Unit price $ 1.20 $ 2.60
Purchase cost 102 000 104 000 206 000

Note a

Usage of Direct Materials in Units

Production Total direct Material Cost of
Direct Product F (6 000 Product G (1 000 material unit cost materials
materials units) units) usage used
111 (12
units per 72 000 12 000 84 000 $1.20 $100 800
finished
product
112 (6
units per
product F 36 000 8 000 44 000 2.60 $114 400
8 units peer
product G
215 200

Schedule 4

Direct Labour Budget for the Year Ended 31 December, 2011

Units produced Direct labour Total hours Total budget at
hours per unit $2.05 per hour
Product F 6 000 14 84 000 172 200
Product G 1 000 20 20 000 41 000
104 000 213 200

Schedule 5

Factory Overhead Budget for the Year Ending 31 December, 2011 at

Anticipated Activity of 104 000 Direct Labour Hours
Supplies 30 000
Indirect labour 70 000
Payroll fringe costs 25 000
Power- variable portion 8 000
Maintenance – variable portion 20 000
Total variable overhead 153 000
Depreciation 25 000
Property taxes 4 000
Property insurance 500
Supervision 20 000
Power – fixed portion 1 000
Maintenance fixed portion 4 500
Total fixed overhead 55 000
Total factory cost ($208 000 /104 is; $2 per direct labour 208 000
hour)

Schedule 6

Cost of Goods Sold Budget for the Year Ending 31 December, 2011
From schedule
Direct materials used
Direct labour 3 215 200
Factory overhead 4 213 200
Total manufacturing cost 5 208 000
Add opening stock of finished goods 14 480 636 400
Less closing stock of finished goods (101 180)
(86 700)
Total 549 700

Schedule 7

Selling and Administrative Expense Budget for the Year Ending 31

December, 2011
$ $
Sales and commission 20 000
Advertising 3 000
Sales salaries 10 000
Travel 5000
Total selling expenses 38 000
Clerical wages 10 000
Supplies 1 000
Executive salaries 21 000
Miscellaneous 5 000
Total administrative expenses 37 000
Total selling and administrative expenses 75 000

Schedule 8

Budgeted Statement of Comprehensive Income for the Year Ended 31

December, 2011
Form $ $
schedule
Sales 1 691 000
Cost of goods sold 7 (549 700)
Gross profit 141 300
Selling and administrative expenses 8 75 000
Interest expense 9 1 775 (76 775)
Profit before tax 64 525
Tax Assumed (20 000)
Profit after tax 44 525

Schedule 9

Budgeted Statement of Cash Receipts and Payments for the Year

Ending 31 December, 2011
For the
whole
Quarters year
1 2 3 4
Cash balance beginning 10 000 15 000 15 000 15 325 10 000
Add receipts
Collections from customers 125 000 150 000 160 000 221 000 656 000
Total available before current 135 000 165 000 175 000 236 325 666 000
financing (a)
Less disbursements
For materials 20 000 35 000 35 000 54 200 144 200
For other costs and expenses 25 000 20 000 20000 17 000 82 000
For payroll 90 000 95 000 95 000 109 200 389 200
For income tax 5 000 - - - 5 000
For machinery purchases 20 000 20 000
Total disbursements (b) 140 000 150 000 150 000 200 400 640 400
Minimum cash balance desired
15 000 15 000 15 000 15 000 15 000
Total cash needed 155 000 165 000 165 000 215 400 655 400
Excess of total cash available
over total cash needed before
current financing (deficiency) 20 000 - 10 000 20 925 10 600
Financing
Borrowing (at beginning) 20 000 - - - 20 000
Repayment (at end) - - (9 000) (11 000) (20 000)
Interest at 10%per annum - - (675) (1 100) (1 775)
Total effects of financing (c) 20 000 - (9 675) (12 100) (1 775)
Cash balance (a) + (c) - (b) 15 000 15 000 15 325 23 825 23 825

Schedule 10
Budgeted Statement of Financial Position as at 31 December 2011
$ $
Assets
Non- current assets
Land (3) 50 000
Building and equipment (4) 400 000
Less accumulated depreciation (5) (100 000)
300 000
350 000
Current assets
Finished goods (2) 101 180
Materials (2) 9 800
Accounts receivable (1) 60 000
Cash (form schedule8) 23 825
194 805
Less current liabilities
Accounts payable (6)
70 000
Income tax payable (7) (90 000)
20 000
104 805
454 805

Equity
Ordinary share capital (8) 350 00
Retained earnings (9) 104 805
454 805

Notes
(1) 25 000 +691 000 sales - 656 000 receipts = $60 000
(2) See below
(3) Form the statement of financial position at 31 December, 2010
(4) 380 000 + 20 000 purchases
(5) 75 000 + 25 000 depreciation
(6) 8 200 + (206 000 purchases' 213 200 direct labour, 183 000 factory
overhead* 75 000 selling and administrative expenses) - (144 200
materials, 82 000 other costs and expenses, and 389 200 payroll) =
$70 000
(7) 5 000 + 20 000 current year - 5 000 payment
(8) From the opening statement of financial position
(9) 60 280 + 44 525 profit
*208 000 from schedule 5 - depreciation of 25 000
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Closing Stocks
Units Unit cost Amount
Direct materials
111 6 000 1.20 7 200
112 1 000 2.60 2 600
9 800
Finished goods
F 1 100 86.70 95 370
G 50 116.20 5 810
101 180

Budgets can also be classified in terms of the timescales covered, into:

Short-term - for the next year
Medium-term - for the next 3 years
Long-term - covering over three years
However, what is defined as short/medium/long term differs from one company
to another, and the periods shown above are just indicative.

The further in time they are, the less detailed the plans are.

14.4 The Budget Period

The budget period is usually related to two factors
1. The type of business - In industries where capital expenditure is high,
for example, shipping, long-term planning is necessary and budgets
may cover a period of up to 20 years. On the other hand firms which
experience seasonal fluctuations for the demand of their products must
adopt shorter budget periods of, say, six months.
2. The control aspect - It is obvious that long budget periods cannot be
effective as a means of controlling the business. It is therefore usually
arranged that the budget period be divided into months, so that actual
performance may be compared with budgets, to ensure that adverse
variances receive immediate attention.

14.5 Purpose of Budgets in Planning

They communicate plans to all levels of management and employees. They
quantify targets, and determine direction of the entity, in order to allocate
resources. They also promote forward thinking and specify means of achieving
set objectives.
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176 Zimbabwe Open University
Unit 14 Budgeting and Budgetary Control

14.6 Purpose of Budgets in Controlling

Budgets establish targets, assign responsibilities, and are a means of measuring
performance, and taking timely corrective action when necessary. They motivate
managers to achieve targets and improve efficiency.

14.7 Advantages of Budgeting and Budgetary

Control
Budgets force management to think about the future and look ahead, as well
as set out detailed plans for achieving targets for each unit. They also promote
team work, coordination and communication. The responsibility of each
manager is also clearly defined as they are put in control of budget centres,
for which they are responsible for achieving the targets set out for that centre.
Performance appraisal is also facilitated through the comparison of actual
performance against the budget and the investigation of any variances. This
process enables remedial action to be taken timeously where necessary. Where
employees are involved in the budgeting process, they own the budgets and
this motivates them to achieve set targets. The allocation of resources is also
improved, as it is based on targets to be achieved. The process results in
economies in time management by managers as they have to concentrate on
areas where there are exceptions that are highlighted by variances.

14.8 Disadvantages of Budgeting and Budgetary

Control
Benefits of producing budgets must exceed the costs thereof. Budget
information must also be accurate, and if not, the budget may need to be
changed. Budgets involve the allocation of resources to departments, and if
not properly handled, there may be departmental conflicts over the allocation
of resources, as well as instances of departments blaming each other for not
achieving their targets. There is also the danger that managers may deliberately
inflate estimates of their costs in order to avoid overspending. Alternatively
managers may feel obliged to spend all money allocated to them in order to
maintain their empires (we have to spend it or our next budget will be cut).
This results in unnecessary waste. Budgets can also demotivate employees, if
they are forced on them, are set too high and are unachievable, and where
punishment is meted out for missing targets.
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Financial Accounting 2 BACC 106

14.9 Budget Organisation and Administration

The organisation and administration of a budget is usually undertaken by a
budget officer as well as a budget committee and these are guided by provisions
of the budget manual. The functions of the officer, the committee as well as
the contents of the budget manual are briefly explained below.

14.10 Functions of the Budget Officer

This officer is responsible for the control of the budget administration process
and therefore, ensures that the budget timetable and deadlines are adhered
to. He also deals with all budgeting and control problems and is responsible
for educating people about budgeting and budgetary control.

14.11 The Budget Committee

This committee is usually chaired by the CEO of the organisation and the
other members are high ranking representatives of all the departments of the
organisation. It is responsible for coordinating the preparation of the budget,
including the issuing of the budget manual, and timetables for the preparation
of the budget. It also provides information to assist in the preparation of budgets
and is responsible for the approval of the final budget. It also reviews the
comparison of actual performance against budgets and decides on corrective
action to be taken including revision of budgets.

14.12 The Budget Manual

This manual sets out the procedures to be followed in the budgeting and
budgetary control process, and usually contains the following information:
A statement of the objectives of the organisation and how they can be
achieved through budgetary control
The timetable for each stage of the budget, documents to be used and
the number and rank of signatories on each document
The functions and responsibilities of each executive, by designation,
regarding the execution of the budget
Account classification codes for all items of revenue and expenditure

The reports, statements, forms and other records to be maintained,

and how they are to be used

14.13 The Budget Preparation Process

The process usually starts with the identification of the principal budget factor
or limiting factor or key factor. This is the factor that will limit the activities of
the organisation. This could be sales, materials or any other factor. The rest of
the budget is prepared with this factor in mind. It is desirable to prepare the
budget relating to this factor first and then prepare the other budgets.

It is usual for the sales budgets to be prepared first, and then the other budgets
are prepared around this budget. Various budgets are prepared and these are
combined to form the master budget, which is a pro forma annual financial
statement of the organisation.

The budget is broken down into budget centres, with a particular manager
responsible for each centre.

The annual budget is also broken down into shorter time periods, usually a
month for monitoring and control purposes. At the end of each month, a
comparison is made between the actual performance and the budgeted figures,
and variances are investigated and corrective action taken where necessary.

14.14 Summary
In this unit we introduced you to budgeting and budgetary control. The process
of budgeting and budgetary control, as well as the advantages and
disadvantages of the process, were discussed. The key personnel involved in
the process and their main duties and responsibilities were explained. You
should now be able, not only to describe the process, but also to contribute
meaningfully to the budgeting process in your organisation.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Horngren, C.T. Accounting - a Managerial Emphasis. Prentice Hall.
Owler, L.W.J., and Brown, J.L. (1987). Wheldon's Cost Accounting.15th
Edition. ELBS.
Wood , F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

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180 Zimbabwe Open University
15
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Unit Fifteen
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Flexible Budgets

15.0 Introduction

I n this unit, we introduce the concept of flexible budgets and how they are
prepared. We also examine the advantages of flexible budgets over the
fixed or static budgets.
Budgets are very important planning and control tools in any organisation.
The static or fixed budget is developed for a specific level of activity, prior to
the start of the period. As the period unfolds, the resulting inputs and outputs
may vary considerably from the fixed or static budget, giving rise to variances.
The static budget does not take the behaviour of costs into consideration,
and as a result, the variances derived do not reveal meaningful information for
control purposes. In order to avoid wide discrepancies which may arise when
actual performance is compared with the static budget, flexible budgets are
recommended. A flexible budget has been defined as a budget which, by
recognising the difference in behaviour between fixed and variable costs in
relation to fluctuations in output or turnover, is designed to change appropriately
with such fluctuations.
Financial Accounting 2 BACC 106

15.1 Objectives
By the end of this unit, you should be able to:
z define flexible budgets
z distinguish between a fixed and a flexible budget
z draw up flexible budgets

15.2 Shortcomings of a Fixed Budget

The fixed budget does not take into account the behaviour of costs. Costs
behave differently to changes in the level of activity. If a given cost changes in
total in proportion to changes in activity, it is a variable cost. If a cost remains
unchanged in total for a given time period despite wide fluctuations in activity,
it is a fixed cost. Failure to distinguish between variable and fixed costs in a
fixed budget means that it is difficult, if not impossible to determine if the
resultant variance is due to differences in volume, or due to efficiency in use of
resources or price differences. Furthermore, if the actual production is more
than the budgeted volume, this only causes costs to rise and generate an
unfavourable variance. There is therefore no incentive to increase production
beyond the budgeted volumes under the static budget.

15.3 The Flexible Budget

The flexible budgeting idea evolved to address the shortcomings of the static
budget. It is an attempt to compare like with like. It takes into consideration
the behaviour of costs, and is normally prepared at the end of the period,
when the actual production is known. It is therefore a good performance
evaluation tool.

15.4 Steps to Prepare a Flexible Budget

Determine the budgeted variable costs per unit of output, as well as the
sale price per Unit if the entity generates revenue
Determine the budgeted level of fixed costs
Determine the actual volume of output achieved
Build a flexible budget based on the above information
The example below will serve to illustrate the points noted above.
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182 Zimbabwe Open University
Unit 15 Flexible Budgets

Example 15.1

The following are details of a static budget based on anticipated production

of 100 000 Units per month:
Cost per Unit $ Total $
Direct materials 1.00 100 000
Direct labour 0.50 50 000
Variable factory overhead 1.50 150 000
Fixed factory overhead 205 000
Total budgeted manufacturing cost 505 000

Actual production was 105 000 Units, and the costs were as follows: direct
materials $105 000; direct labour $53 000; variable overheads $155 000;
and fixed overheads $200 000.

The budget/expense analysis is given below

Static Budget/Expense Analysis

Actual Budget (100 Variance
(105 000) 000 Units)
Direct materials 105 000 100 00 (5 000)
Direct labour 53 000 50 000 (3 000)
Variable factory overhead 155 000 150 000 (5 000)
Fixed factory overhead 200 000 205 000 5 000
Total budgeted manufacturing cost 513 000 505 000 (8 000)

More was produced than anticipated (budgeted), and the analysis reveals
unfavourable variances in all except the fixed overhead costs. Does this reflect
poor control of costs? Let us now look at what the flexible budget analysis
reveals.

Flexible Budget/Expense Analysis

Actual (105 Budget (105 Variance
000 Units) 000 Units)
Direct materials 105 000 105 000 0
Direct labour 53 000 52 500 (500)
Variable factory overhead 155 000 157 500 2 500
Fixed factory overhead 200 000 205 000 5 000
Total budgeted manufacturing 513 000 520 000 7 000
cost

Note. The budget figures are obtained by multiplying 105 000 units by the
rate per unit, while the fixed factory overhead is the budgeted figure as shown
on the first table. The figures in brackets in the variance column indicate an
unfavourable variance.

The analysis shows a very different picture. It shows that some good cost
control was exercised. The only unfavourable variance was on direct labour,
and could have been as a result of more direct hours or a higher labour rate.
This analysis gives a more realistic position, as like (105 000 units actually
produced) is compared with like (105 000 units budgeted). The manager can
now concentrate on the direct labour variance, and take corrective action.

15.5 Flexible Budgets for Performance Evaluation

As illustrated above, flexible budgets are an effective tool for performance
evaluation, because they take into account the behaviour of costs. It is therefore
possible to pinpoint where there are unfavourable variances and take corrective
action. They definitely have an edge over the fixed budgets, as shown above.
The other important factor is that the flexible budget analysis compares like
with like, as the same actual output is analysed.

Activity 15.1
ABC Ltd has the following performance report at the end of June
? 2007:
Actual Static/fixed Variance Cost per
budget Unit
Variable costs
Direct materials 21 350 27 000 5 650F 3.00
Direct labour 61 500 72 000 10 500F 8.00
Direct expenses 11 100 14 400 3 300F 1.60
Idle time 3 550 3 600 50F 0.40
Clean up time 2 500 2 700 200F 0.30
Other indirect labour 800 900 100F 0.10
Miscellaneous supplies 4 700 5 400 700F 0.60
Total variable manufacturing costs 105 500 126 000 20 500F 14.00
Fixed costs
Factory supervision 14 700 14 400 300U
Factory rent 5 000 5 000
Depreciation of equipment 15 000 15 000
Other fixed costs 2 600 2 600
Total fixed manufacturing costs 37 300 37 000 300U

Total manufacturing costs 142 800 163 000 20 200F

F = Favourable variances (when actual costs are less than budgeted
costs)
U = Unfavourable

Required
Prepare a report that might provide a better explanation of what has
happened. Indicate whether each variance is favourable or unfavourable.

15.6 Flexible Budgets for Planning Purposes

Flexible budgets are usually prepared at the end of the period, when the
actual production is known. However the organisation can prepare advance
flexible budgets based on different scenarios, for example, fluctuations in
customer demand. Such budgets can be very important in planning for inputs,
like materials, labour and even cash.

Example 15.2

The following is a pro forma flexible budget prepared for a month, prepared
at the beginning of the month, where three levels of sales were considered.
Amount Output levels
per Unit $
Units produced 10 000 20 000 30 000
Sales 40 400 000 800 000 1 200 000

Variable costs
Materials 15 150 000 300 000 450 000
Labour 10 100 000 200 000 300 000
Overheads 5 50 000 100 000 150 000
Total variable costs 30 300 000 600 000 900 000

Contribution margin 10 100 000 200 000 300 000

Fixed costs
Manufacturing overheads 100 000 100 000 100 000
Marketing costs 50 000 50 000 50 000
150 000 150 000 150 000

Operating income (50 000) 50 000 150 000

Activity 15.2
Using the information given in the above example, prepare a statement
? showing the variances if the actual units produced were 16 000.

15.7 Summary
In this unit we covered flexible budgets, and compared them with the static or
fixed budgets. You should now be aware of the advantages of flexible budgets
as a control tool and how they can also be used in the planning process. With
this knowledge you should be able to introduce flexible budgets in your
organisation, or take part in the process of compiling and using flexible budgets.

References
Brown, J.L., and Owler, L.W.J. (1987). Wheldon's Cost Accounting. 15th
Edition. Pitman.
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood , F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

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188 Zimbabwe Open University
16
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Unit Sixteen
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Alternative Budgeting Systems

16.0 Introduction

I n this unit, we discuss other budgeting systems, namely, zero base budgeting,
incremental budgets and rolling budgets, the rationale behind these systems,
as well as their advantages and disadvantages.
Financial Accounting 2 BACC 106

16.1 Objectives
By the end of this unit, you should be able to:
z state the advantages and disadvantages of these budgeting systems
z describe zero base budgeting, incremental budgeting and rolling budgeting

16.2 Zero Base Budgeting (ZBB)

Zero base budgeting has been defined as "an operating planning and budgeting
process which requires each manager to justify his entire budget request in
detail from scratch (hence Zero base) and shifts the burden of proof to each
manager to justify why he should spend any money at all. This approach
requires that all activities be identified in "decision packages" which will be
evaluated by systematic analysis and ranked in order of importance.

Methodology in compiling a ZBB

Before compiling the ZBB, decision packages must be formulated. They require
every manager to:
Establish goals for his function
Formulate alternative ways of achieving these goals
Identify the most practical way of achieving these goals
Analyse the chosen alternative in incremental levels of implementation
Assess the costs and benefits of each incremental level
Describe the consequence of disapproval
Key elements in the compilation of decision packages include the following:
a) A description of the objectives of the particular function
b) A brief description of the suggested approach
c) Alternatives considered and rejected
d) The cost and benefits of the suggested approach
e) The consequences of rejection or postponement resulting from lack of
funds

16.3 Advantages of ZBB

The efficient allocation of resources based on needs and benefits
It drives managers to find cost-effective ways to improve operations
Inflated budgets can be detected

It is useful for service departments where the output is difficult to identify

It improves staff motivation by providing greater initiative and
responsibility in decision making
It increases communication and coordination within the organisation
It identifies and eliminates wasteful and obsolete operations, as well as
opportunities for outsourcing
It forces cost centres to identify their mission and their relationship to
overall goals

16.4 Disadvantages of ZBB

It is difficult to define decision units and decision packages , as it is time
consuming
It might be difficult to justify necessary expenditure in some departments,
like R&D, and as a result such expenditure, though necessary, might
not be approved to the detriment of the organisation
The cost and time involved in the preparation may not justify the benefits
in the case of small organisations
For large organisations, the volume of forms is too large for one person
to go through, but compressing the information might remove critically
important details
The lack of flexibility might mean that opportunities may be lost, due to
the time it takes for budget requests to be granted

16.5 The Traditional or Incremental Budgeting

Having looked at ZBB one needs to also look at the traditional incremental
budgeting system which is used in most organisations. In this system the previous
year's budget or actual performance is used as a base for the current year's
budget, with incremental amounts being added for the new budget. The main
weakness of this system is that it fails to take into account the changed
circumstances, and encourages "spending up to the budget" to ensure a
reasonable allocation in the next period, i.e. the spend it or lose it mentality.

16.6 Advantages of Incremental Budgeting

It is relatively simple to compile and operate and easy to understand
The budget is stable and change is gradual, so managers can operate
their departments in a consistent basis
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Zimbabwe Open University 191
Financial Accounting 2 BACC 106

Inter departmental conflicts are avoided, as all departments appear to

be treated fairly
Coordination between budgets is easier to achieve

16.7 Disadvantages of Incremental Budgeting

It does not take into account any changes in the environment, and
assumes that activities and methods of working continue to be the
same
It does not offer incentives for developing new ideas
There is no incentive to reduce costs. Instead the system encourages
spending all amounts allocated in order to maintain or increase the budget
allocation for the nest year

16.8 Rolling Budgets

This is a method of budgeting in which as each month or quarter passes, it is
dropped and an additional month or quarter is added, such that there is always
a 12 month budget. The purpose is to give management a chance to revise
plans and also make more accurate forecasts and plans. This means that
budgeting is no longer a once a year affair but a continuous process, done
either monthly or quarterly. The cost of producing several budgets should
therefore be compared with the benefits of more accurate forecasting and
planning.

16.9 Advantages of Rolling Budgets

a) Because budgets are reassessed regularly, they always reflect the latest
available information, and are therefore more realistic and accurate
b) Managers do not just focus on the year end numbers, but continuously
reassess the long term health of the entity and focus on the future
c) Uncertainty is reduced and surprises at the end of the year are minimised
d) They encourage managers to react more quickly to changing economic
developments or business conditions

16.10 Disadvantages of Rolling Budgets

They are time consuming and expensive as a number of budgets have
to be prepared each year
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192 Zimbabwe Open University
Unit 16 Alternative Budgeting Systems

The volume of work for each reassessment can prove too much for the
managers, because the time between budgets has been compressed
and there is need to access and process information quickly

Activity 16.1
1. Discuss the advantages and disadvantages of zero base budgeting.
? 2. Explain why it is necessary to prepare rolling budgets.

16.11 Summary
In this unit we highlighted that budgets are necessary planning and control
tools in any organisation. They translate the strategy of an organisation into
quantified targets, and assign the responsibility of meeting those targets to
individual managers.

The control element of budgeting involves the comparison of actual

performance against the budget to determine any deviations from the expected
results. Such deviations or variances are then investigated, to determine the
causes, and resulting from this process, appropriate action is taken to correct
the situation.

We have also discussed three types of budgets. Advantages and disadvantages

of each type of budgeting were also discussed. However, it should be pointed
out that in practice, a combination of these types is usually used in an
organisation. The forecasting and budgeting process is also made easier by
the use of software packages.

References
Faul, M.A. (1998). Accounting - An Introduction. 5th Edition. Butterworths.
Wood , F. (2008). Business Accounting 2. 11th Edition. Prentice Hall.

Solutions to Selected Activity Questions

Only a few solutions to selected questions are given in this unit. You will have
to work out the rest of the solutions on your own or with some help form you
tutor or fellow students.

Activity 4.3
Realisation account
Premises 170 000 Provision for doubtful debts 1 265
Motor vehicle 22 000 Bank (premises) 200 000
Stock 68 250 Capital - Tom (stock and m.v) 90 250
Debtors 172 500 Bank (debtors) 170 000
Bank (legal charges) 10 000 Creditors - discount 4 000
Bank (realisation expenses) 10 000
Share of profit
John 2 553
Peter 2 553
Tom 7 659
465 515 465 515

Bank account
Balance b/d 26 065 Realisation (legal charges) 10 000
Realisation (premises) 200 000 Realisation (expenses) 10 000
Realisation (debtors) 170 000 Creditors 56 000
Loan- Tom 7 550
Capital accounts
John 132 553
Peter 32 553
Tom 147 409
396 065 396 065

Capital account – John

Bank 132 553 Balance b/d 100 000
Current account 30 000
Realisation (share of profit) 2 553
132 553 132 553

Capital account – Peter

Current account 10 000 Balance b/d 40 000
Bank 32 553 Realisation (share of profit) 2 553
42 553 42 553

Capital account –Tom

Realisation (stock and m.v) 90 250 Balance b/d 160 000
Bank 147 409 Current account 70 000
Realisation (share of profit) 7 659
237 659 237 659

Activity 8.1
Royalty Account
Year Year
1 Landlord 900 1 Stat. of comp income 900
2 Landlord 1 300 2 1 300
3 Landlord 1 450 3 1 450
4 Landlord 1 800 4 1 800
5 Landlord 1 900 5 1 900
6 Landlord 2 400 6 2 400

Landlord’s Account
Year Year
1 Bank 1 500 1 Royalty 900
Short workings 600
1 500 1 500
2 Bank 1 500 2 Royalty 1 300
Short working 200
1 500 1 500
3 Bank 1 500 3 Royalty 1 450
Short workings 50
1 500 1 500
4 Bank 1 500 4 Royalty 1 800
Short workings 300
1 800 1 800
5 Bank 1 500 5 Royalty 1 900
Short workings 400
1 900 1 900
6 Bank 2 400 6 Royalty 2 400

Short Workings
Year Year
1 Landlord 600 2 Balance c/d 800
2 Landlord 200
800 800
3 Balance b/d 800 3 Balance c/d 850
Landlord 50
850 850
4 Balance b/d 850 4 Landlord 300
Balance c/d 550
850 850
5 Balance b/d 550 5 Landlord 400
SCI (Loss written off) 150
550 550
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196 Zimbabwe Open University
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Bacc106 PDF

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Bacc106 PDF

Uploaded by

Bachelor of Commerce

Module BACC 106

Content Reviewer: Patrick Paradza

Editor: Calisto Munongi

P.O. Box MP1119

The Zimbabwe Open University is a distance teaching and open

Reprinted: November 2013

Cover design: T. Ndhlovu

Layout and design: D. Satumba Nyandowe

ISBN No: 978-1-77938-488-4

Printed by: ZOU Press

Typeset in Times New Roman, 12 point on auto leading

© Zimbabwe Open University. All rights reserved. No part of this

P.O. Box MP1119

The Zimbabwe Open University is a distance teaching and open

Reprinted: November 2013

Cover design: T. Ndhlovu

Layout and design: D. Satumba Nyandowe

ISBN No: 978-1-77938-488-4

Printed by: ZOU Press

Typeset in Times New Roman, 12 point on auto leading

© Zimbabwe Open University. All rights reserved. No part of this

The six hour tutorials should be so structured that the

Session I (Two Hours)

Session II (Two Hours)

Session III (Two Hours)

Conclusion for this course, but also to prepare yourself to

Module Overview ______________________________________________ 1

Unit One: Overview of Financial Analysis

1.0 _______ Introduction ____________________________________________________ 3

Unit Two: Interpretation and Analysis of Financial Statements

Unit Three: Bills of Exchange

Unit Four: Partnership Accounts

Unit Five: Company Accounting: Formation, Share Capital and

Unit Six: Company Published Financial Statements: An Introduction

Unit Seven: Statement of Cash Flows

Unit Eight: Consignment Accounts

Unit Nine: Royalty Accounts

Unit Ten: Joint Ventures

Unit Eleven: Branch Accounts

Unit Twelve: Investment Accounts

Unit Thirteen: Consolidated Accounts: Introduction

Unit Fourteen: Budgeting and Budgetary Control

Unit Fifteen: Flexible Budgets

Unit Sixteen: Alternative Budgeting Systems

The concept or concepts and standards from which accounting practices or

As a final word of advice, accounting is a "practical" subject. You are, therefore,

Overview of Financial Analysis

The auditors' report contains an opinion on whether the statements reveal a

1.2 Users of Financial Statements and Their

in prospects of growth in value of the company which will result in an increase

The government is concerned with the profits made by the company as a

1.3 Limitations of Financial Accounting Information

Only monetary transactions are recorded

Only past accounting information is recorded when management is concerned

Personal bias of the accountant

Accounting information is recorded using generally accepted accounting

1.4 Techniques in Financial Analysis

Common size or vertical analysis

Using this method, each item is expressed as a percentage of some total of

Interpretation and Analysis of

H aving looked at the various users of financial statements, and the

2.2 The Purpose of Ratio Analysis

2.3 Types of Ratios

2.3.1 Profitability ratios

Gross profit margin

Gross profit: Sales

This measures the gross profit in every dollar of sales.

Gross profit: Cost of sales.

Net profit: Sales

Return on capital employed

a) Return on ordinary shareholder equity is calculated as follows:

The higher the ratio, the more profitable the investment.

b) The return on capital employed by all long term suppliers of capital,

Return: capital employed

where return is = net profit + preference share dividend + interest on

1.0 _ Introduction ______________________________________________ 3