Tutorial Letter 501/3/2024

Elementary Financial Accounting and

Reporting

FAC1602

Semesters 1 & 2

Department of Financial Accounting

BARCODE
 FAC1602/501/3/2024

© 2021 University of South Africa

All rights reserved

Printed and published by the

University of South Africa
Muckleneuk, Pretoria

FAC1602/3/2021

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CONTENTS

Introduction and overview of the module ii

LEARNING UNIT 1
Introduction to the preparation of financial statements ................................ 1

LEARNING UNIT 2
Financial statements of a sole proprietorship .............................................. 45

LEARNING UNIT 3
Establishment and financial statements of a partnership ............................ 66

LEARNING UNIT 4
Changes in the ownership structure of partnerships ................................... 94

LEARNING UNIT 5
Close corporations....................................................................................... 118

LEARNING UNIT 6
Statement of cash flows .............................................................................. 166

LEARNING UNIT 7
Branches ..................................................................................................... 197

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 Introduction and overview of the module

1. Word of welcome

Dear Student

We are pleased to welcome you to this module and hope that you will find the content both
interesting and rewarding. We shall do our best to assist you to master this module and we
recommend that you start studying immediately after enrolment. Accounting is a subject that
requires continued exercise by working through many examples and you will be required to
work continually throughout the semester.

First-year accounting at Unisa consists of the modules FAC1502 and FAC1601 or FAC1602.
If you aim to become a chartered accountant (CA) or plan to include second- and third-year
Financial Accounting modules in your degree, and for other qualifications where second- and
third-year Financial Accounting is required, the FAC1601 module is compulsory. Completing
FAC1502 and FAC1601 successfully will allow you to enrol for the second-year modules
FAC2601 and FAC2602. If your focus is certain diplomas and other Bachelor of Commerce
degrees where you only need first-year Financial Accounting, we recommend that you enrol
for the FAC1602 module. However, ensure that FAC2601 and FAC2602 are not included in
your degree's curriculum as only the FAC1601 allows access to further studies in Financial
Accounting.

2. Overview of FAC1602 and assumed knowledge from FAC1502

FAC1602 concerns itself with the issues of accounting reporting for different entities and builds
on the learning outcomes of FAC1502. You will remember that in FAC1502 the following topics
were covered:

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 Basic principles of accounting
Including the nature of accounting, financial position and performance,
double entry and the accounting process

Collecting and processing accounting data

FAC1502

Including the processing of data and adjustments, closing-off

procedures and preparing financial statements

Accounting for current and non-current assets

Including cash and cash equivalents, trade and other receivables,
inventory, property, plant and equipment and other non-current assets

Accounting for current and non-current liabilities

Accounting reporting
Including the financial statements of a sole proprietor, non-profit entities
and incomplete records

FAC1502 taught the basic bookkeeping functions and introduced you to the concepts,
principles and procedures of accounting. It is important to realise that FAC1502 forms the
foundation for all other financial accounting modules. The knowledge that you gained in
FAC1502 forms the building block of this module and cannot be repeated. If you need to
refresh your memory on these topics, please refer to the FAC1502 study guide and other
supplementary learning material for that module.

3. Module objective of FAC1602

The main objective of this module is to teach you certain aspects of financial accounting and
reporting so that you are able to do the following:

• Discuss specified aspects of the Conceptual Framework for the preparation and
presentation of financial statements.
• Understand and apply the concept of International Financial Reporting Standards (IFRS).
• Prepare the financial statements for sole proprietors, partnerships and close corporations
according to certain of the requirements of International Accounting Standards 1 (IAS 1).
• Apply the accounting procedures to record changes in the ownership structure of
partnerships on the admittance, retirement or death of partners.

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• Prepare statements of cash flows for sole proprietors, partnerships and close corporations
according to the requirements of International Accounting Standard 7 (IAS 7). In this
course, only the direct method is prescribed and dealt with.

The FAC1602 module content is illustrated in the following diagram:

Learning Unit 1
Introduction to the preparation of financial statements
FAC1602 + applied knowledge from FAC1502

Learning Unit 2
Financial statements of a sole proprietorship

Learning Unit 3
Establishment and financial statements of a partnership

Learning Unit 4
Change in the ownership structure of partnerships

Learning Unit 5
Close corporations

Learning Unit 6
Statement of cash flows

Learning Unit 7
Branches

4. Using the study guide, Tutorial Letter 101 (TL101) and other learning
material

Before you start studying, please read the discussion section in Tutorial Letter 101 (TL101).
TL101 provides you with the contact and communication details of your lecturers for this
module and provides guidelines on the sections of work that must be covered in this study
guide to complete a given assessment.

This study guide is the primary source of learning content for this module. In the study guide,
each learning unit starts with several learning outcomes, which will direct your learning. The
learning outcomes indicate what is expected of you to understand, know, calculate, disclose
and apply and will help you to structure your learning. In each learning unit, keywords or key
concepts are provided and should give you an indication of the issues that are being dealt
with in the learning content. Activities, examples and exercises will get you involved in the
content of the learning unit. These are designed to find out if you have the necessary assumed
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knowledge, understand the work and can apply new knowledge gained. Activities can be in
the form of theory questions, multiple-choice questions, calculations, journal entries, true or
false questions, and so forth, whereas examples and exercises are detailed questions dealing
with the learning content. Exercises are indicative of the types of questions that can be
expected in assignments and the examinations. Activities, examples and exercises imply
"doing". They help you to cover the content of the module systematically. For you to become
an active learner, you should first do the activity, example and exercise before referring to the
feedback and solutions.

The following icons are used in this study guide to refer to the abovementioned concepts:

ICON DESCRIPTION

Learning outcomes. This icon indicates what aspects

of the particular topic you must master and be able to
show that you understand.

Key concepts. The learning content will address the

following issues.

Activity. This icon indicates activities that you must do

to develop a deeper understanding of the learning
material.

Self-assessment. This icon indicates that you will be

required to test your knowledge, understanding and
application of the material you have just studied.

Feedback. This icon indicates that you will receive

feedback on your answers to the activities.

Timeout. Well done – you have completed the learning

unit!

To indicate the length, scope and format of answers to questions, action verbs are deliberately
applied. An analysis of the action verbs in a question should enable you to

• plan the answer systematically

• ensure that you comply with the lecturer's/examiner's requirements

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A clear understanding of the meaning of certain words is required. The following
interpretations are given for this module:

WORD INTERPRETATION
Adjust To adapt to new conditions/environment; to put in order; add,
change

Apply Use practically; use as relevant or suitable

Calculate Ascertain by mathematical procedure/exact reckoning

Clarify Make clear the meaning of; explain the intention of; show by
reasoning/evidence

Compare Examine to observe resemblances, relationships and differences

Complete Finish/add what is required; show the necessary detail

Define State precisely the meaning/scope/total character of; make clear

(especially the outline of); give a concise description of; give the
distinguishing features of

Describe Give clearly the distinguishing details or essential characteristics of

Discuss Examine by argument, debate, hold a conversation about

Explain Set out in detail (interpret); the meaning of account for something;
make something understandable

List Record/itemise names or things belonging to a class

Mention/name/state Specify by name; cite names, characteristics, items, elements of

facts

Prepare Make ready/complete for a particular purpose; to put together using

parts; compose, construct; compile or complete what is required
based on prior knowledge

Reconcile To make or become visible, noticeable; to exhibit or present; to

indicate

Record Put in writing; set down for reference or retention

Show To make compatible or consistent with each other

At the end of each learning unit, there is an elementary self-assessment questionnaire that
you must complete to evaluate your knowledge of the learning content of each learning unit
and to monitor your progress. These questionnaires are presented in the form of questions to
which you must answer either "yes" or "no". If you have answered "yes" to all the questions,
you may proceed to the next learning unit. If you have any "no" answers, you must study that
particular section of the work again. Since a clear understanding of certain aspects in a
learning unit may be essential for your further understanding of the course, you are advised
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not to go on to the next learning unit until you have resolved all your problems in the preceding
one.

5. Calculations and cash transactions

It is very important that you show all your calculations in your answers to exercises and
questions. In this study guide, short calculations are disclosed in brackets after an entry in a
journal, ledger account or financial statement. Note that these calculations do not form part of
the actual accounting disclosures. They are disclosed as such for practical illustrative
purposes only. More elaborate calculations are referred to by encircled symbols; for example,
➀. Sub-calculations are referred to by shaded encircled symbols; for example, ❶. You may
follow the same or a similar approach when preparing your answers in the assignments and
examinations.

You should be aware that the books of the first entry in respect of cash transactions are the
cash receipts journal and the cash payments journal as taught in FAC1502. However, to
simplify matters in this module, cash transactions where required, are disclosed in the general
journal.

6. Feedback request

If there is anything discussed in this study guide that you feel needs to be explained in more
detail or in a different fashion, please notify us accordingly by e-mail. The e-mail address of
this module is provided in Tutorial Letter 101.

We trust that you will enjoy this module and wish you all the best!

Your Lecturers
FAC1602: Elementary Financial Accounting and Reporting

“Our greatest weakness lies in giving up.

The most certain way to succeed
is always to try just one more time.”

Thomas Edison

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LEARNING UNIT 1

1
Introduction to the preparation of financial statements

Learning outcomes ................................................................................................................ 2

Key concepts ......................................................................................................................... 3
1.1 Introduction ................................................................................................................... 4
1.2 Conceptual framework for financial reporting ............................................................... 5
1.3 Applicable International Financial Reporting Standards ............................................. 16
1.4 Presentation of financial statements: IAS 1 ................................................................ 16
1.5 Financial instruments .................................................................................................. 26
1.6 An illustration of disclosure according to the requirements of IAS 1 and IFRS 9 ....... 33
1.7 Exercises and solutions .............................................................................................. 39
Self-assessment .................................................................................................................. 43

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 Learning outcomes

After studying this learning unit, you should be able to do the following:

• Explain the acronyms IFRS, IAS, APB, FRSC and SAICA, and know what they entail.
• Describe what the concept "Conceptual Framework" entails.
• List the specific purposes of the Conceptual Framework regarding the preparation and
presentation of financial statements.
• Explain the main objectives of financial statements per the Conceptual Framework.
• Explain the underlying assumption when preparing financial statements per the
Conceptual Framework.
• Discuss the qualitative characteristics of financial statements per the Conceptual
Framework.
• Explain what the Conceptual Framework implies when it refers to the constraints in
preparing financial statements as it is referred to in the Conceptual Framework.
• Discuss the elements of financial statements as explained in the Conceptual Framework
and indicate which elements pertain to the statement of financial position and which to
the statement of profit or loss and other comprehensive income.
• Discuss the concepts of recognition and disclosure of the elements incorporated in
financial statements, as explained in the Conceptual Framework.
• Explain what is meant by the measurement of the elements of financial statements by
referring to the measurement methods discussed in the Conceptual Framework.
• Explain what type of business ownership must comply with IFRS.
• Define each of the following terms per IAS 1:
- Fair presentation
- Going concern
- Accrual basis of accounting
- Materiality and aggregation
- Offsetting
- Frequency of reporting
- Comparative information
- Consistency of presentation
• List the individual statements that, per IAS 1, form the complete set of financial statements
of a reporting entity.
• Explain what is meant by the identification of financial statements.
• Explain what is meant by reporting period.
• Explain which items comprise current assets and current liabilities per IAS 1.
• List the items that must be presented on the face of the statement of financial position
and the statement of profit or loss and other comprehensive income respectively, by
referring to IAS 1.
• List the items that can be presented on either the face of the statement of financial position
and the statement of profit or loss and other comprehensive income or in the notes to
these statements for the particular reporting period per IAS 1.
• Discuss the purpose of notes by referring to IAS 1.
• Discuss, according to IAS 1, the order in which items are disclosed as notes to financial
statements.

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• Explain or define the following:
- Financial instrument
- Financial asset
- Financial liability
- Fair value
- Contract
• Distinguish between financial instruments, financial assets and financial liabilities.
• Recognise, measure and present certain financial assets and liabilities in the financial
statements.

Key concepts

• Conceptual Framework
• Underlying assumption
• Qualitative characteristics
• Components of financial statements
• Elements of financial statements
• Recognition
• Measurement of elements
• Capital
• Capital maintenance
• Reporting period
• Financial instruments
• Financial assets
• Financial liabilities
• Fair value

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1.1 Introduction

In FAC1502, we learnt that every business entity usually uses some accounting system to
collect financial data from a multitude of financial transactions. The entity then uses the data
and processed information about the entity's financial performance and financial position to
present the information in a usable format (for example, financial statements and budgets)
that will assist the users to make economically viable decisions. Remember that the
accounting system covered in FAC1502 forms the foundation for reporting the information to
users. In the introduction to this learning unit, we will briefly explain the regulatory framework
applicable to financial reporting in South Africa and give you an overview of why financial
statements must comply with certain requirements and who is responsible for issuing and
overseeing compliance with the regulatory framework.

To have financial information available that is meaningful and comparable across different
types of entities in countries around the world, the quest became to develop a set of
prescriptive standards that will provide guidance and prescribe certain principles that can be
used to prepare financial statements. Most countries established governing bodies with a
mandate to develop these standards. One of the many governing bodies mandated to embark
on this quest was the Accounting Practices Board (APB), which was established in South
Africa in 1973. The APB issued accounting standards that were collectively known as South
African Statements of Generally Accepted Accounting Practice or SA GAAP. All listed and
unlisted companies in South Africa were required to use SA GAAP as their reporting
framework when preparing financial statements.

In the 1990s, the APB decided to incorporate South Africa into the international accounting
standards arena and to harmonise SA GAAP with the standards issued by the International
Accounting Standards Board (IASB) and its predecessor, which issued International
Accounting Standards (IASs) from 1973 until 2001, when the IASB was established. These
IASs are now designated as part of International Financial Reporting Standards (IFRSs) as
these international standards are currently called. As from January 2005, the Johannesburg
Stock Exchange (JSE) requires all listed companies to comply with IFRS. The Companies Act
71 of 2008 that came into effect in May 2011 established a body known as the Financial
Reporting Standards Council (FRSC), which is now the South African governmental
accounting standard-setting body. The South African Institute of Chartered Accountants
(SAICA) serves as the technical advisor to the FRSC.

Because of the high regard of the usefulness of these standards to prepare financial
statements that are usable and comparable across countries, it became common practice to
apply these statements, either in full or to a limited extent, when preparing the financial
statements of entities other than companies. IFRSs deal with identification, recognition,
measurement, presentation and disclosure requirements in general-purpose financial
statements. These financial standards are directed at a wide range of users such as
investors, shareholders, creditors, banks, the South Africa Revenue Service (SARS),
employees and other interest parties. There are currently two reporting frameworks available,
namely full IFRS or IFRS, for SMEs.

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FAC1502 introduced you to the Conceptual Framework, which is the starting point of this
learning unit.

1.2 Conceptual framework for financial reporting

1.2.1 Introduction

The Conceptual Framework for Financial Reporting was issued by the International
Accounting Standards Board (IASB). This document contains a group of interrelated rules and
standards that serve as a frame of reference for financial accounting, and more specifically,
financial reporting. These rules and standards set out the nature, function and limits of financial
accounting and financial statements.

The purpose of the Conceptual Framework is to assist the International Accounting Standards
Board (IASB) in developing and revising International Financial Reporting Standards (IFRS)
that are based on consistent concepts, to assist preparers to develop consistent accounting
policies for areas that are not covered by a standard or where there is choice of accounting
policy, and to assist all parties to understand and interpret IFRS. The framework is not an
IFRS and does not override any specific IFRS requirement. The framework is simply a
foundation on which all the international accounting and financial accounting and financial
reporting standards are based. Should the IASB decide to issue a new or revised
pronouncement that is in conflict with the framework, the IASB will highlight the fact and
explain the reasons for the departure in the basis for conclusions.

Activity 1.1

a) Describe in your own words what you perceive a framework to be.

b) Describe the purpose of the Conceptual Framework. Would you say that the Conceptual
Framework is similar to an IFRS?

Feedback 1.1

a) A framework serves as a reference for an area of enquiry and often provides a set of
theoretical concepts and principles, which forms the basis for establishing and
developing reporting practices.

b) The purpose of the Conceptual Framework is, inter alia, to assist

• in developing future standards
• in harmonising legislation and reducing the number of alternative accounting
treatments
• users in interpreting the information in financial statements when compiled
according to IFRS

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 The Conceptual Framework is not an IFRS and does not override any particular
disclosure or measurement requirement in any IFRS. It is the foundation on which
principle-based IFRSs is founded.

1.2.2 Objective of general-purpose financial reporting

The objective of general-purpose reporting is to provide financial information about the

reporting entity that is useful to existing and potential investors, lenders, government agencies
(South African Revenue Services, Statistics South Africa, etc) and other creditors in making
decisions about providing resources to the entity. These decisions involve buying, selling or
holding equity and debt instruments, and providing or settling loans and other forms of credit.
Potential and existing investors are interested in the returns they expect, while creditors and
other lenders are interested in principal repayments and interest payments they expect.

Activity 1.2

Who do you think are the users of financial statements? Name a few.

Feedback 1.2

The primary users of financial statements are present and potential investors of the entity,
lenders, customers and creditors. Other users include the owners/shareholders of the entity,
trade unions (for collective bargaining), entity's management, government, and its agencies
such as the SARS and the public.

1.2.3 Qualitative characteristics of useful financial information

If external decision makers are to be able to use the information contained in the financial
statements, these statements should possess certain qualitative characteristics.

[Link] Fundamental qualitative characteristics

The two fundamental qualitative characteristics are:

• Relevance
The information provided must be relevant to the user of that financial information.
Relevance implies usefulness. The user must be able to make relevant decisions on the
basis of the information supplied in the financial statements.

Materiality
Materiality is noted as an entity-specific aspect of relevance and is used to decide what
information would be relevant to users. Information is deemed to be material if it is likely
to influence the decision of the user of financial information.

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• Faithful representation
Information presented in the financial statements should faithfully represent the
transaction and events that occurred during the reporting period. Faithful representation
requires that transactions and events be accounted for in a manner that represent their
true economic substance rather than the mere legal form. This concept is known as
substance over form.

The rationale behind this is that financial information contained in the financial statements
should represent the business essence of transactions and events, and not merely their
legal aspects in order to present a true and fair view. Substance over form requires that if
the substance of a transaction differs from its legal form, such transaction should be
accounted for in accordance with its substance and economic reality. For example, a
machine is leased to the entity for the entire duration of its useful life. Although the entity
is not the legal owner of the machine, it may be recognised as an asset in its financial
information since the entity has control over the economic benefits that would be derived
from the use of the asset for the duration of its useful life. The legal form of the transaction
is that the title deed of the asset is with the original owner (lessor), even though control of
the asset has been passed to the entity (lessee). This is the application of the accounting
concept of substance over legal form, where economic substance of a transaction takes
precedence over its legal aspects.

Faithful representation is achieved when the financial information is complete, neutral

and free from error. Completeness means disclosure of all information necessary for
proper understanding of the presented financial information. Neutrality requires an
unbiased depiction of financial information, meaning that such information may not be
manipulated to influence the behaviour of the users of the information; either favourably
or unfavourably. Free from error means there are no errors and inaccuracies in the
description of the phenomenon and no errors made in the process by which the financial
information was produced (no inaccuracies and omissions). The standards expect that the
estimates are made on a realistic basis and not arbitrarily.

[Link] Enhancing qualitative characteristics

• Comparability
Comparability is a qualitative characteristic that enables users to identify and
understand similarities in and differences between items. Information about a reporting
entity is more useful if it can be compared with similar information about other entities, with
similar information about other entities and with similar information about the same entity
for another period or date.

Consistency is not the same as comparability but is an important element that assists to
achieve comparability. Consistency refers to the use of the same methods for the same
items either from period to period within a reporting entity or in a single period across
entities. Users must be able to distinguish between different accounting policies in order
to be able to make a valid comparison of similar items in the accounts of different entities.

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• Verifiability
An entity's accounting results are verifiable when they are reproducible, so that, given the
same data and assumptions, an independent observer can produce the same result on
the same set of accounting information. Verifiability means that different knowledgeable
and observers could reach consensus that a particular depiction is a faithful
representation.

• Timeliness
The timeliness of accounting information refers to the provision of information to users in
time for them to take action. Information becomes obsolete and useless if it is not reported
within time.

• Understandability
Classifying, characterising and presenting information clearly and concisely makes it
understandable. Understandability implies that an entity’s financial information should be
presented in such a way that a person with a reasonable knowledge of business and
finance, and the willingness to study the information, should be able to comprehend it.

[Link] The cost constraints on useful financial reporting

A cost constraint arises when it is excessively expensive to report certain information in

the financial statements. When it is too expensive to do so, the framework (Conceptual
Framework: 2.39–2.40) allows a reporting entity to avoid the related reporting. The
objective of allowing the cost constraint is to ensure that the benefits of providing financial
information outweigh the costs as part of their financial reporting obligations.

You must be able to explain in your own words what each qualitative characteristic entails.

Activity 1.3

a) Name the fundamental and enhancing qualitative characteristics of financial reporting

as stipulated in the Conceptual Framework.
b) Should one report all the matters irrespective of the cost of reporting?

Feedback 1.3

a)
Fundamental qualitative Enhancing qualitative
characteristics characteristics

1. Comparability
1. Relevance 2. Verifiability
2. Faithful representation 3. Timeliness
4. Understandability

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b) The cost of providing reporting information must be justified by the benefits derived
from the information.

1.2.4 Financial statements and reporting entity

Financial statements provide information about economic resources of the reporting entity,
claims against the entity, and changes in those resources and claims, that meet the definitions
of the elements of financial statements (Conceptual Framework 3.1).

[Link] Objective and scope of financial statements

The objective of financial statements is to provide information about an entity's assets,

liabilities, equity, income and expenses that is useful to financial statements users in
assessing the prospects for future net cash inflows to the entity and in assessing
management's stewardship of the entity's resources (Conceptual Framework 3.2)

This information is provided in the statement of financial position and the statement of profit
or loss and other comprehensive income as well as in other statements and notes (Conceptual
Framework 3.3).

[Link] Reporting period

Financial statements are prepared for a specified period of time (usually a year) and provide
comparative information (for at least one preceding year) and under certain circumstances,
forward-looking information (Conceptual Framework 3.4 – 3.6).

[Link] Going concern assumption

Financial statements provide information about transactions and other events viewed from the
perspective of the reporting entity as a whole and are normally prepared on the assumption
that the reporting entity is a going concern and will continue in operation for the foreseeable
future (Conceptual Framework 3.8 – 3.9).

[Link] The reporting entity

A reporting entity is an entity that is required, or chooses, to prepare financial statements. It

can be a single entity or a portion of an entity or can comprise more than one entity. A reporting
entity is not necessarily a legal entity (Conceptual Framework 3.10). Determining the
appropriate boundary of a reporting entity is driven by the information needs of the primary
users of the reporting entity’s financial statements. (Conceptual Framework 3.13 – 3.14). Each
financial statement must clearly mention the name and type of reporting entity to which it
pertains in its heading.

1.2.5 Elements of financial statements

Financial statements show the financial effects of transactions and other events by grouping
them into broad classes according to their economic characteristics. These broad classes are
termed the elements of financial statements.

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The elements directly related to financial position are

• assets
• liabilities
• equity

The elements directly related to performance are

• income
• expenses

The statement of cashflows reflects both financial performance elements and some
changes in the financial position elements.

[Link] Definition of elements relating to financial position

Asset: An asset is a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce economic
benefits (Conceptual Framework 4.3 – 4.4).

Liability: A liability is a present obligation of a reporting entity to transfer an economic

resource as a result of past events. An obligation is a duty that a reporting entity
has that it cannot practically avoid (Conceptual Framework 4.26 – 4.29)

Equity: Equity is the residual interest in the assets of the entity after deducting all its
liabilities (Conceptual Framework 4.63)

[Link] Definition of elements relating to financial performance

Income: Income is increases in assets, or decreases in liabilities, that result in increases in

equity, other than those relating to contributions from holders of equity claims
(Conceptual Framework 4.68).

Expense: Expenses are decreases in assets, or increases in liabilities, that result in

decreases in equity, other than those relating to distributions to holders of equity
claims (Conceptual Framework 4.69).

The definition of income encompasses both revenue and gains. Revenue arises in the course
of the ordinary activities of an entity and is referred to by a variety of terms including sales,
fees, interest, dividends, royalties and rent. Gains represent other items that meet the
definition of income and may, or may not, arise in the course of the ordinary activities of an
entity. Gains represent increases in economic benefits and as such are no different in nature
from revenue (Conceptual Framework 4.70).

The definition of expenses encompasses losses as well as those expenses that arise in the
course of the ordinary activities of the entity. Expenses that arise in the course of the ordinary
activities of the entity include, for example, cost of sales, wages and depreciation. They usually
take the form of an outflow or depletion of assets such as cash and cash equivalents,

10
inventory, property, plant and equipment. Losses represent other items that meet the definition
of expenses and may, or may not, arise in the course of the ordinary activities of the entity.
Losses represent decreases in economic benefits and as such they are no different in nature
from other expenses. Hence, they are not regarded as a separate element in this (Conceptual
Framework 4.71).

Activity 1.4

Define an asset, liability and equity according to the Conceptual Framework.

Feedback 1.4

An asset is

• a present economic resource

• controlled by a reporting entity
• as a result of past events.

A liability is

• a present obligation of a reporting entity

• to transfer an economic resource
• as a result of past events.

Equity is the residual interest in the assets of the entity after deducting all the liabilities.
Remember to also learn the definition of income and expenses as they are defined in in
this study guide. Income encompasses revenue and gains, and it is important to understand
the difference between revenue and gains and to give examples. Revenue and gains are
normally separately reported. Expenses, on the other hand, encompass losses that are also
normally separately reported.

1.2.6 Recognition of the elements of financial statements

[Link] The recognition process

Recognition is the process of including in the financial statements an item that meets the
definition of an asset, a liability or equity which is recognised in the statement of financial
position. Similarly, only items that meet the definition of income or expenses are recognised
in the statement of profit or loss and other comprehensive income. However, not all recognised
items are disclosed in the financial statements (Conceptual Framework 5.1).

Materiality considerations should be taken into account when assessing whether an item
meets the above criteria and, therefore, qualifies for recognition in the financial statements.
Because elements are interrelated, an element that is recognised, for example, as an asset,
automatically required the recognition of another element as, for example, income or a liability.

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[Link] Recognition criteria

In order to be recognised as an element of financial statements, an item must meet all of the
following criteria:

• It must meet the definition of one of the elements of financial statements.

• It should be probable that future economic benefits associated with the item will flow
to or from the entity.
• It must have a cost or value that can be measured reliably.

An asset or liability is recognised only if recognition of that asset or liability and of any resulting
income, expenses or changes in equity provides users of financial statements with information
that is useful (Conceptual Framework 5.7). Useful information must be relevant and faithfully
represented.

An asset is recognised in the statement of financial position when it is probable that the future
economic benefits will flow to the entity and the asset has a cost or value that can be measured
reliably.

A liability is recognised in the statement of financial position when it is probable that an

economic benefit will flow from the entity when an obligation is settled and the amount of the
benefit to be given up can be measured reliably.

Income is recognised in the statement of profit or loss and other comprehensive income when
an increase in future economic benefits related to an increase in an asset or a decrease of a
liability has arisen that can be measured reliably. This means, in effect, that recognition of
income occurs simultaneously with the recognition of increases in assets or decreases in
liabilities (for example, the net increase in assets arising on a sale of goods or services or the
decrease in liabilities arising from the waiver of a debt payable).

Expenses are recognised when a decrease in future economic benefits related to a decrease
in an asset or an increase of a liability has arisen that can be measured reliably. This means,
in effect, that recognition of expenses occurs simultaneously with the recognition of an
increase in liabilities or a decrease in assets (for example, the accrual of employee
entitlements or the depreciation of equipment).

Activity 1.5

When will an asset, liability, income and expense be recognised in the appropriate financial
statement?

Feedback 1.5

An asset or liability is recognised in the statement of financial position only if that asset or
liability, and of any resulting income, expenses or changes in equity, provide the users of the

12
financial statements with useful information. Useful information, in turn, must be relevant and
faithfully represented.

[Link] Derecognition

Derecognition is the removal of all or part of a recognised asset or liability from an entity’s
statement of financial position. Derecognition normally occurs when that item no longer meets
the definition of an asset or of a liability. An asset derecognition normally occurs when the
entity loses control of all or part of the recognised asset; and a liability derecognition normally
occurs when the entity no longer has a present obligation for all or part of the recognised
liability (Conceptual Framework 5.26).

1.2.7 Measurement of the elements of financial statements

"Measurement" means the process of determining the monetary value (amounts) at which the
elements of the financial statements are to be recognised and disclosed. Two bases of
measurement are listed in the Conceptual Framework, namely (1) historical costs and
(2) current value.

The historical cost of an asset when it is acquired or created is the value of the costs incurred
in acquiring or creating the asset, comprising the consideration paid to acquire or create the
asset plus transaction costs. The historical cost of a liability when it is incurred or taken on is
the value of the consideration received to incur or take on the liability minus transaction costs
(Conceptual Framework 6.5).

The current value measurement basis includes the following:

• Fair value
• Value in use (for assets)
• Fulfilment value (for liabilities)
• Current cost

Current value measures provide monetary information about assets, liabilities, income and
expenses, using information updated to reflect conditions at the measurement date. Because
of the updating, current values reflect changes since the previous measurement date. Unlike
historical cost, the current value of an asset or liability is not derived, even in part, from the
price of the transaction or event that gave rise to the asset or liability (Conceptual Framework
6.10). Current value measurement bases, except for an introduction to fair value
measurement, fall outside the scope of this module.

The fair value is the price that would be received to sell an asset, or paid to transfer a liability,
in an orderly transaction between market participants at the measurement date (Conceptual
Framework 6.12). The asset or liability is measured using the same assumptions that market
participants would use when pricing the asset or liability if those market participants act in their
economic best interest (Conceptual Framework 6.13). Fair value can be determined directly
by observing prices in an active market (Conceptual Framework 6.14) or indirectly using
measurement techniques (such as time value of money, future cash flow estimations, etc).
The measurement of financial assets such as investments in listed shares is mostly done at

13
fair value and you will encounter this in paragraph 1.5 of this study guide. Fair value is not
increased by any transaction costs incurred when acquiring the asset. Fair value is also not
decreased with transaction costs when a liability is incurred (Conceptual Framework 6.16).
Value in use is the present value of the cash flows, or other economic benefits, that an entity
expects to derive from the use of an asset and from its ultimate disposal. Fulfilment value is
the present value of the cash, or other economic resources, that an entity expects to be obliged
to transfer as it fulfils a liability (Conceptual Framework 6.17). The current cost of an asset is
the cost of an equivalent asset at the measurement date, comprising the consideration that
would be paid at the measurement date plus the transaction costs that would be incurred at
that date. The current cost of a liability is the consideration that would be received for an
equivalent liability at the measurement date minus the transaction costs that would be incurred
at that date (Conceptual Framework 6.21).

Activity 1.6

Name five measurement bases that are often encountered in a set of financial statements.

Feedback 1.6

Historical cost, current value, fair value, present value and current cost

[Link] Factors to consider when selecting a measurement basis

One of the difficulties encountered with the selection the measurement bases is that no
guidance is provided on how to choose between the different bases, or how to address
subsequent measurement in the case of, for example, revaluation, impairment and
depreciation. Thus, in selecting a measurement basis for an asset or liability and for the related
income and expenses, it is necessary to consider the nature of the information that the
measurement basis will produce in both the statement of financial position and the statement
of profit or loss and other comprehensive income (Conceptual Framework 6.43). The
information provided by a measurement basis must be useful to users of financial statements.
To achieve this, the information must be relevant, and it must faithfully represent what it
purports to represent (Conceptual Framework 6.45). When choosing a measurement basis,
professional judgement is required in all situations, for both the initial and subsequent
measurements of the elements pertaining to financial statements.

[Link] The measurement of equity

The total carrying amount of equity (total equity) is not measured directly. It equals the total of
the carrying amounts of all recognised assets, less the total of the carrying amounts of all
recognised liabilities (Conceptual Framework 6.87).

The Conceptual Framework, paragraph 6.88, stipulates that because general purpose
financial statements are not designed to show an entity’s value, the total carrying amount of
equity will not generally equal

14
 • the aggregate market value of equity claims on the entity
• the amount that could be raised by selling the entity as a whole on a going concern
basis; or
• the amount that could be raised by selling all of the entity’s assets and settling all of its
liabilities

1.2.8 Presentation and disclosure

A reporting entity communicates information about its assets, liabilities, equity, income and
expenses by presenting and disclosing information in its financial statements (Conceptual
Framework 7.1). Paragraph 7.2 of the Conceptual Framework states that effective
communication of information in financial statements makes that information more relevant
and contributes to a faithful representation of an entity’s assets, liabilities, equity, income and
expenses. It also enhances the understandability and comparability of information in financial
statements. Effective communication of information in financial statements requires

• focusing on presentation and disclosure objectives and principles rather than focusing
on rules
• classifying information in a manner that groups similar items and separates dissimilar
items
• aggregating information in such a way that it is not obscured either by unnecessary
detail or by excessive aggregation

In making decisions about presentation and disclosure, it is important to consider whether the
benefits provided to users of financial statements by presenting or disclosing particular
information are likely to justify the costs of providing and using that information (Conceptual
Framework 7.3).

Activity 1.7

When is information effectively communicated in the financial statements?

Feedback 1.7

• When it focuses on presentation and disclosure objectives and principles.

• When it classifies information in a manner that groups similar items and separates
dissimilar items.
• When it aggregates information in such a way that it is not obscured by unnecessary
detail.

1.2.9 Concepts of capital and capital maintenance

The selection of a measurement basis and the concepts of capital and capital maintenance
determine the model according to which financial statements are prepared. There are two

15
basic concepts of capital and capital maintenance, namely (1) the financial concept and (2)
the physical concept.

According to the financial concept of capital, capital is equal to the net assets or equity of an
entity. In terms of the physical concept of capital, capital is equal to the production capacity of
an entity.

The selection of the appropriate concept of capital by an entity should be based on the needs
of the users of its financial statements. Thus, a financial concept of capital should be adopted
if the users of financial statements are primarily concerned with the maintenance of nominal
invested capital or the purchasing power of invested capital. If, however, the main concern of
users is with the operating capability of the entity, a physical concept of capital should be used.
The concept chosen indicates the goal to be attained in determining profit, even though there
may be some measurement difficulties in making the concept operational (Conceptual
Framework 6.2).

1.3 Applicable International Financial Reporting Standards

IFRS must be applied when the financial statements of entities that are incorporated under
the Companies Act 71 of 2008 (hereinafter referred to as the Companies Act) are prepared.
The fact that such compliance is not required by any other form of business ownership does
not mean that the requirements of these statements cannot be applied when the financial
statements of business entities other than companies are prepared. In the remainder of your
accounting studies, IFRS is taught and made applicable to all types of reporting entities.

The remainder of this learning unit deals with some important IFRSs issued to assist us to
present financial statements in a useful and comparable way, namely IAS 1, IFRS 7 and 9
and IAS 32 and 39. In IAS 1, many of the concepts that you have encountered in the
Conceptual Framework are enforced; for example, the purpose of general-purpose financial
statements, the users thereof, the elements of financial statements and the underlying
principle of going concern. Although you will encounter financial instruments (IFRS 7 and 9
and IAS 32 and 39) in more advanced accounting studies, this learning unit introduces the
concept and the main definitions. The aim is to lay a foundation as all entities encounter
financial instruments in some form and have to include them in their respective financial
statements. Ensure that your foundation on financial instruments as presented in this learning
unit is solid and that you know and understand the content as presented.

1.4 Presentation of financial statements: IAS 1

1.4.1 Introduction

The objective of IAS 1 is to prescribe the basis for the presentation of general-purpose
financial statements to ensure comparability with

• an entity's financial statements of previous financial periods

• the financial statements of other comparable entities

16
1.4.2 Definitions

IAS 1 sets out the following definition of terms used in this Standard:

General purpose financial statements are those financial statements released to a broad
group of users. They are intended for a wide range of uses, such as credit analysis and
different forms of valuations.

Applying a requirement is impracticable when the entity cannot apply it after making every
reasonable effort to do so.

International Financial Reporting Standards (IFRSs) are Standards and Interpretations

adopted by the International Accounting Standards Board (IASB). They comprise

a) International Financial Reporting Standards (IFRSs)

b) International Accounting Standards (IASs)
c) Interpretations developed by the International Financial Reporting Interpretations
Committee (IFRIC) or the former Standing Interpretations Committee (SIC)

The definition of material, an important accounting concept in IFRS Standards, assists in

deciding whether information should be included in their financial statements. Information is
material if omitting, misstating or obscuring it could reasonably be expected to influence the
decisions that the primary users of general purpose financial statements make on the basis of
those financial statements, which provide financial information about a specific reporting
entity.

The notes
• present information about the basis of preparation of the financial statements and the
specific accounting policies used
• disclose any information required by IFRSs that is not presented elsewhere in the
financial statements
• provide additional information that is not presented elsewhere in the financial
statements but is relevant to an understanding of any of them

Other comprehensive income is defined as comprising items of income and expense

(including reclassification adjustments) that are not recognised in profit or loss as required or
permitted by other International Financial Reporting Standards (IFRS). The Standards list ten
components of other comprehensive income, but in this module the discussion will only focus
on the following:

a) The gains on the revaluation of land and buildings accounted for in accordance
with IAS 16, Property Plant and Equipment
b) Gains and losses on the financial asset of equity investments designated at fair
value through other comprehensive income accounted for in accordance with IFRS
9, Financial Instruments (IFRS 9)

Owners are holders of instrument classified as equity.

17
Profit or loss is the total of income less expenses, excluding the components of other
comprehensive income.

Total comprehensive income is defined as “the change in equity during a period resulting
from transactions and other events, other than those changes resulting from transactions with
owners in their capacity as owners”.

Activity 1.8

Make a list of the new definitions that you will encounter in IAS 1. You do not have to define
them for this activity.

Feedback 1.8

• General-purpose financial statements

• Impracticable
• Material omissions
• Notes
• Owners
• Profit or loss
• Other and total comprehensive income.

1.4.3 The objective of financial statements

The objective of general purpose financial statements 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. To meet that objective, financial statements
provide information about an entity's (IAS 1.9)

• assets
• liabilities
• equity
• income and expenses, including gains and losses
• contributions by and distributions to owners (in their capacity as owners)
• cash flows

That information, along with other information in the notes, assists users of financial
statements in predicting the entity's future cash flows and, in particular, their timing and
certainty.

1.4.4 General features

A complete set of financial statements includes (IAS 1.10)

• a statement of financial position at the end of the period

18
 • a statement of profit or loss and other comprehensive income for the period
• a statement of changes in equity for the period
• a statement of cash flows for the period
• notes, comprising a summary of significant accounting policies and other explanatory
notes
• comparative information prescribed by the standard

An entity may use titles for the statements other than those stated above. All financial
statements are required to be presented with equal prominence (IAS 1.10).

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, it must also present a statement of financial position as at the beginning of the
earliest comparative period. Reports that are presented outside of the financial statements –
including financial reviews by management, environmental reports, and value-added
statements – are outside the scope of IFRSs (IAS 1.14).

[Link] Fair presentation and compliance with IFRS

The financial statements must "present fairly" the financial position, financial performance and
cash flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the Framework. The application
of IFRS, with additional disclosure when necessary, is presumed to result in financial
statements that achieve a fair presentation (IAS 1.15).

IAS 1 requires an entity whose financial statements comply with IFRS to make an explicit and
unreserved statement of such compliance in the notes. Financial statements cannot be
described as complying with IFRS unless they comply with all the requirements of IFRS (which
include International Financial Reporting Standards, International Accounting Standards,
IFRIC Interpretations and SIC Interpretations) (IAS 1.16).

Inappropriate accounting policies are not rectified either by disclosure of the accounting
policies used or by notes or explanatory material (IAS 1.18).

IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that
compliance with an IFRS requirement would be so misleading that it would conflict with the
objective of financial statements set out in the Framework. In such a case, the entity is required
to depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and
impact of the departure (IAS 1.19 – 1.21).

[Link] Going concern

The Conceptual Framework notes that financial statements are normally prepared assuming
the entity is a going concern and will continue in operation for the foreseeable future.
(Conceptual Framework 4.1)

IAS 1 requires management to make an assessment of an entity's ability to continue as a

19
going concern. If management has significant concerns about the entity's ability to continue
as a going concern, the uncertainties must be disclosed. If management concludes that the
entity is not a going concern, the financial statements should not be prepared on a going
concern basis, in which case IAS 1 requires a series of disclosures (IAS 1.25).

[Link] Accrual basis of accounting

IAS 1 requires that an entity prepare its financial statements, except for cash flow information,
using the accrual basis of accounting (IAS 1.27). Accrual basis of accounting requires that
entities recognise the elements of financial statements when they satisfy the definitions and
recognition criteria in the Conceptual Framework. This implies that transactions are accounted
for when they occur, not when cash is received or paid.

[Link] Materiality and aggregation

Information is material if omitting, misstating or obscuring it could reasonably be expected to

influence decisions that the primary users of general purpose financial statements make on
the basis of those financial statements, which provide financial information about a specific
reporting entity (IAS 1.7).

According to (IAS 1.29) each material class of similar items must be presented separately in
the financial statements. Dissimilar items may be aggregated only if they are individually
immaterial.

However, information should not be obscured by aggregating or by providing immaterial

information. Materiality considerations apply to all the parts of the financial statements, and
even when a standard requires a specific disclosure, materiality considerations do apply (IAS
1.30).

[Link] Offsetting

Assets and liabilities, and income and expenses, may not be offset unless required or
permitted by an (IAS 1.32). It states that assets and liabilities, and income and expenses, shall
not be offset unless required or permitted by an IFRS. One exception is the netting of income
with related expenses on the same transaction such as on the disposal of non-current assets,
investments and operating assets. A gain or loss on disposal is presented, by deducting from
the proceeds on disposal, the carrying amount of the asset and related selling expenses (IAS
1.34). Measuring the assets net of valuation allowances, for example provision for credit
losses and depreciation, or showing inventories at a lower value than their cost price, is not
seen as offsetting (IAS 1.33).

[Link] Frequency of reporting

Financial statements should be published at least annually. In exceptional cases, in which an

entity’s reporting date changes with the result that the financial statements are presented for
a period shorter or longer than one year, the following information should be provided:

• the reason why the reporting period is not one year

20
 • the fact that the amounts in the various components of the financial statements are not
comparable.

[Link] Comparative information

IAS 1 requires that comparative information to be disclosed in respect of the previous period
for all amounts reported in the financial statements, both on the face of the financial statements
and in the notes, unless another Standard requires otherwise. Comparative information is
provided for narrative and descriptive where it is relevant to understanding the financial
statements of the current period (IAS 1.38).

[Link] Consistency of presentation

The presentation and classification of items in the financial statements shall be retained from
one period to the next unless a change is justified either by a change in circumstances or a
requirement of a new Standard (IAS 1.45).

1.4.5 Structure and content of financial statements

Structure and contents have to do with the format in which financial statements must be
presented and with the items that must be disclosed. Structure and contents are essential
aspects that pertain to the preparation of financial statements. IAS 1 requires an entity to
clearly identify

• the financial statements, which must be distinguished from other information in a

published document
• each financial statement and the notes to the financial statements

[Link] Identification of financial statements

Each financial statement and its component(s) must be identified by giving it a name that
pertains to its particular function. There is a presumption that financial statements will be
prepared at least annually. If the annual reporting period changes and financial statements
are prepared for a different period, the entity must disclose the reason for the change and
state that amounts are not entirely comparable (IAS 1.36). In addition, the following
information must be displayed prominently, and repeated as necessary (IAS 1.51):

• the name of the reporting entity and any change in the name
• whether the financial statements are a group of entities or an individual entity
• information about the reporting period
• the presentation currency
• the level of rounding used (for example, thousands, millions, etc)

[Link] Statement of financial position

Remember that the purpose of a statement of financial position is to report on the financial
position of an entity. It consists of three elements, namely assets, liabilities and equity. In this
paragraph, the minimum line items that must be included in a statement of financial position

21
are listed. Study them by heart. The classification of assets into non-current and current
assets, and of liabilities into non-current and current liabilities, is highlighted. Make sure that
you know when assets or liabilities must be classified as "current".

Current and non-current classification

An entity must normally present a classified statement of financial position, separating current
and non-current assets and liabilities, unless presentation based on liquidity provides
information that is reliable (IAS 1.60). In either case, if an asset (liability) category combines
amounts that will be received (settled) after 12 months with assets (liabilities) that will be
received (settled) within 12 months, note disclosure is required that separates the longer-term
amounts from the 12-month amounts (IAS 1.61)

Current assets are assets that are (IAS 1.66):

• expected to be realised in the entity's normal operating cycle

• held primarily for the purpose of trading
• expected to be realised within 12 months after the reporting period
• cash and cash equivalents (unless restricted)

All other assets are non-current assets (IAS 1.66).

Current liabilities are those (IAS 1.69)

• expected to be settled within the entity's normal operating cycle

• held for purpose of trading
• due to be settled within 12 months
• for which the entity does not have the right at the end of the reporting period to defer
settlement beyond 12 months

All other liabilities are non-current liabilities.

When a long-term debt is expected to be refinanced under an existing loan facility, and the
entity has the discretion to do so, the debt is classified as non-current, even if the liability would
otherwise be due within 12 months (IAS 1.73).

If a liability has become payable on demand because an entity has breached an undertaking
under a long-term loan agreement on or before the reporting date, the liability is current, even
if the lender has agreed, after the reporting date and before the authorisation of the financial
statements for issue, not to demand payment as a consequence of the breach (IAS 1.74).
However, the liability is classified as non-current if the lender agreed by the reporting date to
provide a period of grace ending at least 12 months after the end of the reporting period, within
which the entity can rectify the breach and during which the lender cannot demand immediate
repayment (IAS 1.75).

Settlement by the issue of equity instruments does not impact classification (IAS 1.76).

22
The following are line items that must be presented on the face of or in the notes to the
statement of financial position

• property, plant and equipment

• investment property
• intangible assets
• financial assets (for example an equity instrument of another entity held for investment
purposes or a cash investment)
• inventories
• trade and other receivables
• cash and cash equivalents
• trade and other payables
• financial liabilities (for example a contractual obligation to deliver cash or another
financial asset to another entity or to exchange financial assets or financial liabilities
under conditions that are potentially unfavourable to the entity)
• issued capital and reserves

[Link] Statement of profit or loss and other comprehensive income

A statement of profit or loss and other comprehensive income provides information about the
results of its operations. In simple terms, it shows whether the entity made a profit or loss on
its operating activities during a financial period. All income and expense items recognised in
a period should be presented in either a single statement of profit or loss and other
comprehensive income or in two separate statements, where one statement displays the items
of profit or loss (statement of profit or loss) and the other displays the items of other
comprehensive income together with the total profit or loss as an opening amount.

According to IAS 1.81A, the statement of profit or loss and other comprehensive income must
present the following two sections:

• profit or loss for the year

• other comprehensive income for the year

In addition to the above, the statement of profit or loss and other comprehensive income
should also present

• profit or loss
• total other comprehensive income
• comprehensive income for the period, being the total of profit or loss and other
comprehensive income

Information to be presented in the profit or loss section:

The following minimum line items must be presented in the profit or loss section (or separate
statement of profit or loss, if presented) (IAS 1.82A).

• revenue
• finance cost

23
 • tax expense

Information to be presented in the other comprehensive income section:

The other comprehensive income section is required to present line items which are classified
by their nature, and grouped into the following categories, in accordance with other IFRSs:

• items that will not subsequently be reclassified to profit or loss

• items that will subsequently be reclassified to profit or loss when specific conditions
are met

Additional line items may be needed to fairly present the entity's results of operations (IAS
1.85). Items cannot be presented as “extraordinary items” in the financial statements or in the
notes (IAS 1.87).

Note that for this module, expenses are disclosed in a statement of profit or loss and other
comprehensive income according to their function, and that IAS 1 requires certain minimum
disclosures when this method is applied.

Information to be presented in the statement of profit or loss and other comprehensive

income or in the notes:

The following items must be disclosed separately either in the statement of comprehensive
income or in the notes, if material (IAS 1.98).

• write-downs of inventories to net realisable value or of property, plant and equipment

to recoverable amount, as well as reversals of such write-downs
• disposals of items of property, plant and equipment
• disposals of investments

[Link] Statement of changes in equity

A statement of changes in equity is a statement of changes in the capital structure of an entity

and shows the movement in equity (ownership) between two reporting periods. Information
can again be presented (disclosed) either on the face of or in the notes to a statement of
changes in equity.

Note that the format of the statement of changes in equity depends on the type of business
ownership for which it is prepared. Also note that if this statement is prepared for a close
corporation, the name of the statement is shown as: "Statement of changes in net investment
of members". The learning unit on close corporations will discuss this statement in greater
detail.

[Link] Statement of cash flows

According to IAS 1.111, cash flow information provides users of financial statements with a
basis to assess the ability of the entity to generate cash and cash equivalents and the needs
of the entity to utilise those cash flows. IAS 7 Statement of cash flows sets out the
requirements for the presentation and disclosure of cash flow information. The statement of

24
cash flows is dealt with in learning unit 6.

[Link] Notes

The notes must (IAS 1.112)

• present information about the basis of preparation of the financial statements and the
specific accounting policies used
• disclose any information required by IFRSs that is not presented elsewhere in the
financial statements
• provide additional information that is not presented elsewhere in the financial
statements but is relevant to an understanding of any of them

Notes are presented in a systematic manner and cross-referenced from the face of the
financial statements to the relevant note (IAS 1.113).

IAS 1.114 suggests that the notes should normally be presented in the following order:

• a statement of compliance with IFRSs

• a summary of significant accounting policies applied, including (IAS 1.117)
• supporting information for items presented on the face of the statement of financial
position (balance sheet), statement(s) of profit or loss and other comprehensive
income, statement of changes in equity and statement of cash flows, in the order in
which each statement and each line item is presented
• other disclosures, including contingent liabilities and unrecognised contractual
commitments (both of which falls outside the scope of this module)

Please take note that a calculation, for example, the calculation of depreciation, is NOT a note
to a financial statement and must not be indicated as such.

Activity 1.9

When are assets regarded as being current and when are liabilities regarded as being
current per IAS 1?

Feedback 1.9

An asset is classified as current when it satisfies any of the following criteria:

• It is expected to be realised, or intended for sale or consumption, in the entity's normal

operating cycle.
• It is held primarily for trade.
• It is expected to be realised within 12 months after the statement of financial position
date.

25
• It is cash or a cash equivalent unless it is restricted from being exchanged or used to
settle a liability for at least 12 months after the statement of financial position date.

A liability is classified as current when it satisfies any of the following criteria:

• It is expected to be settled in the entity's normal operating cycle.

• It is held primarily to be traded.
• It is due to be settled within 12 months after the statement of financial position date.

1.5 Financial instruments

IAS 32, IFRS 7 and IFRS 9 are standards that outlines the accounting requirements for the
presentation of financial instruments, particularly as to the classification of such instruments
into financial assets, financial liabilities and equity instruments. The mentioned standards also
provide guidance on the classification of related interest, dividends and gains/losses, and
when financial assets and financial liabilities can be offset.

The objective of IAS 32 is to establish principles for presenting financial instruments as

liabilities or equity and for offsetting financial assets and liabilities (IAS 32.1). The standard
prescribes requirements for

• presentation of financial instruments as liabilities or equity

• offsetting financial assets and liabilities
• classification of financial instruments into financial assets, financial liabilities and equity
instruments
• classification of related interest, dividends, losses and gains
• circumstances in which financial assets and financial liabilities should be offset

The objective of IFRS 7 is to require entities to provide disclosures in their annual financial statements
that enable users to evaluate (IFRS 7.1)

• the significance of financial instruments for the entity's financial position and
performance
• the nature and extent of risks arising from financial instruments to which the entity is
exposed during the period and at the reporting date, and how the entity manages those
risks

The objective of IFRS 9 is to establish principles for the financial reporting of financial assets
and financial liabilities that will present relevant and useful information to users of annual
financial statements for their assessment of the amounts, timing and uncertainty of the entity’s
future cash flows (IFRS 9.1.1).

1.5.1 Definitions (IAS 32.11)

[Link] Financial instrument

A financial instrument is a contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity (IAS 32.11). To be classified as a

26
financial instrument, all of the above elements must be present. Primary instruments such
as receivables, payables and equity, as well as derivative instruments such as futures,
option and swaps are included in this definition. In this module, the focus is placed on
measurement and presentation, and primary instruments.

[Link] Financial asset

A financial asset is any asset that is

• cash
• an equity instrument of another entity
• a contractual right
- to receive cash or another financial asset from another entity; or
- to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favourable to the entity; or
• a contract that will or may be settled in the entity's own equity instruments and is
- a non-derivative for which the entity is or may be obliged to receive a variable
number of the entity's own equity instruments
- a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity's own equity
instruments. For this purpose, the entity's own equity instruments do not include
instruments that are themselves contracts for the future receipt or delivery of the
entity's own equity instruments.
- puttable instruments classified as equity or certain liabilities arising on liquidation
classified by IAS 32 as equity instruments

[Link] Financial liability

A financial liability is any liability that is

• a contractual obligation
- to deliver cash or another financial asset to another entity; or
- to exchange financial assets or financial liabilities with another entity under conditions
that are potentially unfavourable to the entity; or
• a contract that will or may be settled in the entity's own equity instruments and is
- a non-derivative for which the entity is or may be obliged to deliver a variable number
of the entity's own equity instruments; or
• a derivative that will or may be settled other than by the exchange of a fixed amount of
cash or another financial asset for a fixed number of the entity's own equity
instruments. For this purpose, the entity's own equity instruments do not include: (1)
instruments that are themselves contracts for the future receipt or delivery of the
entity's own equity instruments; (2) puttable instruments classified as equity or (3)
certain liabilities arising on liquidation classified by IAS 32 as equity instruments.

[Link] Equity instrument

An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities.

27
[Link] Fair value

Fair value is an amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm's length transaction.

[Link] Contract

A contract is an agreement between two or more parties with clear economic results (IAS
32.13). The parties involved in a contract agreement have limited discretion to avoid their
contractual obligations and the contract is usually enforceable by law. Contracts may be in a
variety of forms and need not be in writing.

Activity 1.10

Make a list of the definitions that you will encounter in dealing with financial instruments. You
do not have to define them for purposes of this activity.

Feedback 1.10

• Financial asset
• Financial liability
• Equity instrument
• Fair value
• Contract

1.5.2 Identification of financial assets and liabilities

• Currency (cash) is a financial asset because it represents the medium of exchange and is
therefore the basis on which all transactions are measured and recognised in financial
statements. A deposit of cash with a bank or similar financial institution is a financial asset
because it represents the contractual right of the depositor to obtain cash from the
institution or similar instrument against the balance in favour of a creditor in payment of a
financial liability (IAS 32.AG3).

• Any other type of asset that can be interchanged for cash or a cash equivalent should be
classified as financial asset if a contractual right to receive cash or any other financial
instrument exists. A contractual right to receive cash in the future and corresponding
financial liabilities representing a contractual obligation to deliver cash in the future, for
example, trade receivable and payable accounts, loans receivable and payable, etc (IAS
32.AG3).

• Physical assets (such as inventories, property, plant and equipment), right-of-use assets
and intangible assets (such as patents and trademarks) are not financial assets. Control
of such physical assets, right-of-use assets and intangible assets creates an opportunity
to generate an inflow of cash or another financial asset, but it does not give rise to a
present right to receive cash or another financial asset (IAS 32.AG10).

28
• Assets (such as prepaid expenses) for which the future economic benefit is the receipt of
goods or services, rather than the right to receive cash or another financial asset, are not
financial assets. Similarly, items such as deferred revenue and most warranty obligations
are not financial liabilities because the outflow of economic benefits associated with them
is the delivery of goods and services rather than a contractual obligation to pay cash or
another financial asset (IAS 32.AG11).

• Liabilities or assets that are not contractual (such as income taxes that are created as a
result of statutory requirements imposed by governments) are not financial liabilities or
financial assets. Accounting for income taxes is dealt with in IAS 12. Similarly, constructive
obligations, as defined in IAS 37 Provisions, Contingent Liabilities and Contingent Assets,
do not arise from contracts and are not financial liabilities (IAS 32.AG12).

Activity 1.11

Classify the following financial statement line items as financial assets, financial liabilities or
other (indicate if it is a non-current assets/liability or a current asset/liability):

• Cash deposit with a bank or in a stokvel

• Inventory
• Trade receivable accounts
• Trade payable accounts
• Loans receivable
• Bank overdraft
• Property plant and equipment
• Trademark; for example, Apple or Dell
• Prepaid rent
• Income received in advance
• VAT payable

29
 Feedback 1.11

Financial assets Financial liabilities Other

• Cash deposit with a • Trade payable • Inventory – current asset
bank or in a stokvel accounts
• Property plant and equipment –
• Trade receivable • Bank overdraft non-current asset
accounts
• Trademark; for example, Apple
• Loans receivable or Dell – non-current asset

• Prepaid rent – current asset

• Income received in advance –

current liability

• VAT payable – current liability

1.5.3 Classification, recognition and measurement of financial assets and

financial liabilities

IFRS 9 specifies how an entity should classify and measure financial assets, financial
liabilities, and some contracts to buy or sell non-financial items.

IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement
of financial position when it becomes party to the contractual provisions of the instrument. At
initial recognition, an entity must measure a financial asset or a financial liability at its fair value
plus or minus – in the case of a financial asset or a financial liability not at fair value through
profit or loss – transaction costs that are directly attributable to the acquisition or issue of the
financial asset or the financial liability. Fair value is defined in IFRS 13 as the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.

[Link] Financial assets

When an entity first recognises a financial asset, it classifies it based on the entity’s business
model for managing the asset and the asset’s contractual cash flow characteristics, as follows:

• financial assets at fair value through profit or loss

• financial assets at amortised cost
• fair value through other comprehensive income

A financial asset is measured at fair value through profit or loss when it is (a) held for
trading; or (b) designated as “fair value through profit or loss” on initial recognition. “Fair value
through profit or loss” means that at the end of each accounting period the asset is revalued
to fair value and any movement in that fair value is taken directly to the statement of profit or

30
loss and other comprehensive income. Examples of financial assets that can be classified and
accounted for at fair value through profit or loss in accordance with IFRS 9 include

- investments in the shares of a listed company

- investments in the shares of unlisted companies only if the investment was designated
to be at fair valued through profit or loss (if not, the investment could be valued at fair
value through other comprehensive income)
- investments in government bonds

IFRS 9 defines the amortised cost of a financial asset or a financial liability as the amount at
which the financial asset or financial liability is measured at initial recognition minus principal
repayments, plus or minus the cumulative amortisation using the effective interest method of
any difference between that initial amount and the maturity amount, and for financial assets,
adjusted for any loss allowance (for example, impairment). Examples of financial assets that
can be classified and accounted for at amortised cost under IFRS 9 include

- trade receivables
- loan receivables
- investments in government bonds not held for trading
- investments in term deposits at standard (normal) interest rates

A financial asset is measured at fair value with changes in other comprehensive income
if the entity intends to hold the financial asset to obtain the contractual flows and/or keep it for
trading, and within its contractual terms the financial asset leads to cash flows, where only the
payment of principal and interest on the outstanding amount, on a given date, will be
remunerated. Changes in fair value are recognised in other comprehensive income. Financial
assets measured a fair value with changes in other comprehensive income fall outside the
scope of this module.

[Link] Financial liabilities

A financial liability is an instrument that obligates an entity to deliver cash or another financial
asset, or the holder has a right to demand cash or another financial asset. Paragraph 4.2.1 of
IFRS 9 states that an entity shall classify all financial liabilities as subsequently measured at
amortised cost using the effective interest method, except for financial liabilities at fair value
through profit or loss (which falls outside the scope of this module).

The effective interest rate is the rate that exactly discounts estimated future cash payments
or receipts through the expected life of the financial asset or financial liability, to the gross
carrying amount of the financial asset or the amortised cost of a financial liability (IFRS 9
Appendix A).

Examples of financial liabilities that can be classified as measured at amortised costs under
IFRS 9 include

- trade payables
- loans payable with standard (normal) interest rates
- bank overdrafts

31
[Link] Recognition

The process of recording of financial assets and liabilities in the financial statements of a
reporting entity is referred to as recognition of financial assets and liabilities. An entity shall
recognise a financial asset or a financial liability in its statement of financial position when,
and only when, the entity becomes a party to the contractual provisions of the instrument
(IFRS [Link]).

[Link] Measurement

(a) Initial measurement of financial assets and financial liabilities

When a financial asset or financial liability is recognised initially, an entity shall measure it at
its fair value plus or minus transaction costs, unless it is carried at fair value through profit or
loss, in which case transaction costs are immediately expensed. The transactions costs are
expenses that are directly attributable to the acquisition or issue of the financial asset or
financial liability. Transaction costs include fees and commissions paid to agents, advisors,
brokers and dealers, levies by regulatory agencies and security exchanges and transfer taxes
and duties. Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm’s length transaction. Note that
financing costs and internal administrative costs are specifically excluded from transaction
costs (IFRS 9 Appendix A).

(b) Subsequent measurement of financial assets and liabilities

After initial recognition, a financial asset or liability is subsequently measured at fair value or
amortised cost, as discussed in paragraphs [Link] and [Link] of this study guide.

(c) Gains and losses

A gain or loss arising from a change in the fair value of a financial asset or financial liability
classified as at fair value through profit or loss shall be recognised in profit or loss. This is
with the exception of a financial liability that is an equity instrument and when an entity has
elected to present gains and losses on that instrument in other comprehensive income.

A gain or loss on financial assets classified as at fair value through other comprehensive
income shall be recognised in other comprehensive income until the financial asset is
derecognised. At that time, the cumulative gain or loss previously recognised in other
comprehensive income shall be reclassified from equity to profit or loss as a reclassification
adjustment.

For financial assets and financial liabilities carried at amortised cost, a gain or loss is
recognised in profit or loss when the financial asset or financial liability is derecognised or
impaired, and through the amortisation process.

The method of accounting for gains or losses from subsequent measurement depends on the
category of financial asset or financial liability. This can be summarised as follows:

32
 SUBSEQUENT GAINS AND
CATEGORY
MEASUREMENT LOSSES

Financial Assets:

Financial assets at fair value through Fair value Profit or loss

profit or loss

Financial assets at fair value through Fair value Other comprehensive

other comprehensive income income

Loans and receivables Amortised cost using Profit or loss

effective interest method

Financial Liabilities:

Financial liabilities at fair value Fair value Profit or loss

through profit or loss

Other financial liabilities Amortised cost using Profit or loss

effective interest method

1.6 An illustration of disclosure according to the requirements of

IAS 1 and IFRS 9

The following example is a framework of the financial statements of an entity that is prepared
according to the descriptions and prescriptions of IAS 1. These financial statements do not
apply to a specific type of entity. Only those line items that are of importance to the learning
content of this module are shown.

The approach followed in this module is to present financial statements in the following order:

• Statement of profit or loss and other comprehensive income

• Statement of changes in equity
• Statement of financial position
• Statement of cash flows
• Notes to the financial statements

33
 MALANDELA CC (Name of reporting entity)
Statement of profit or loss and other comprehensive income for the year ended 31 December 20.1
(Name of component of financial statements) + (Period covered by this component) (Presentation currency)

Note R R
20.1 20.0
Revenue (This number refers to the note number in the component: 3 (Figures of
“Notes for the year ended ...”) previous year to
assist with
comparability)
Cost of sales
Gross profit
Other income
Profit on sale of non-current asset: Vehicle
Dividend income: Listed share investment1 4
Interest income
Fair value adjustments: Listed share investment2 5
(Expenses listed according to their function in the entity)
Distribution, administrative and other expenses
Advertising
Bank charges
Telephone expenses
Water and electricity
Salaries
Insurance
Delivery expenses
Credit losses
Stationery consumed
Investment expenses
Depreciation
Loss on sale of non-current asset: Machinery
Fair value adjustments2:: Listed share investment 5
Finance costs
Interest on long-term loan
Interest on mortgage
Interest on bank overdraft
Profit before tax3
Income tax expense3
Profit for the year
Other comprehensive income for the year
Fair value adjustments2 5
Total comprehensive income for the year

Comment:

1. Dividends received (from listed and unlisted shares).

2. Increase/decrease in fair value of listed share investments. An increase and decrease in
the fair value of unlisted investments shall only be disclosed here if the unlisted investment
was designated at fair value through profit or loss. If it is not the case, any fair value
adjustment in unlisted shares must be disclosed in other comprehensive income.
3. Depending on the type of ownership of the entity, income tax expense can or cannot be
part of the statement of profit or loss and other comprehensive income.

34
 MALANDELA CC
Statement of changes in equity for the year ended 31 December 20.1

Comment:

As the statement of changes in equity for each type of business ownership differs substantially,
it will be shown when the financial statements of partnerships, close corporations and
companies are addressed. Please refer to the FAC1502 course material for the presentation
of this statement for sole traders. The minimum requirements of IAS 1.106 must be adhered
to when preparing a statement of changes in equity.

MALANDELA CC (name of reporting entity)

Statement of financial position as at 31 December 20.1
(Name of component of financial statements) + (Period covered by this component) (Presentation currency)

Note R R
20.1 20.0
ASSETS
Non-current assets (Classified according to the criteria set
out in IAS 1 .66)
Property, plant and equipment
Fixed deposit 7
Unlisted share investment 7
Current assets (Classified according to the criteria set out
in IAS 1 .66)
Inventories
Trade and other receivables1 7
Prepayments
Callable fixed deposit 7
Listed share investment held 7
Cash and cash equivalents 7
Current tax receivable
Total assets
EQUITY AND LIABILITIES
Total equity (Classified according to the specific criteria
of the entity. Refer to IAS 1 .79 and .80)
Members’ contributions
Retained earnings
Other components of equity
Total liabilities
Non-current liabilities (Classified according to the criteria
set out in IAS 1 .69)
Long-term borrowings 10

Current liabilities (Classified according to the criteria set

out in IAS 1 .69)
Income received in advance
Trade and other payables 10
Short-term borrowings 10
Current portion of long-term borrowings 10
Bank overdraft
Current tax payable
Total equity and liabilities

35
 MALANDELA CC
Statement of cash flows for the year ended 31 December 20.1

Comment:

The framework for the presentation of the statement of cash flows will be outlined in learning
unit 6. The minimum requirements of IAS 1.111 must be adhered to when preparing a
statement of changes in equity. IAS 7 Statement of cash flows sets out the requirements for
the presentation and disclosure of cash flow information.

MALANDELA CC
Notes for the year ended 31 December 20.1

Comment:

Only the notes regarding some of the accounting policies and financial assets and liabilities
are shown. Other notes will be discussed when the financial statements of partnerships, close
corporations and companies are prepared.

Accounting policy
1. Basis of presentation
The annual financial statements have been prepared in accordance with International
Financial Reporting Standards (IFRS) appropriate to the business of the entity and the
Close Corporations Act 69 of 1984. The annual financial statements have been prepared
on the historical cost basis, modified for the fair valuation of certain financial instruments,
and incorporate the principal accounting policies set out below. The financial statements
are presented in South African rand.
2. Summary of significant accounting policies
The annual financial statements incorporate the following significant accounting policies
which are consistent with those applied in previous years except where otherwise stated.
2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation
is written off on land. Plant, equipment and vehicles are subsequently measured at
cost less accumulated depreciation and accumulated impairment losses.
Depreciation on plant, equipment and vehicles are written off at a rate deemed to be
sufficient to reduce the carrying amount of the assets over their estimated useful life
to their estimated residual value. The depreciation rates are as follows:
Plant: 2% per annum according to the straight-line method
Equipment: 10% per annum according to the straight-line method
Vehicles: 20% per annum according to the diminishing balance method
Depreciation is charged to profit or loss for the period. Gains or losses on disposal
are determined by comparing the proceeds with the carrying amount of the asset.
The net amount is included in profit or loss for the period.

36
 2.2 Financial instruments
Financial instruments are recognised in the entity’s statement of financial position
when the entity becomes a party to the contractual provisions of the instrument.
Financial instruments are initially measured at the transaction price, which is fair
value plus transaction costs, except for “Financial assets at fair value through profit
or loss”, which is measured at fair value, transaction costs excluded. The entity’s
classification depends on the purpose for which the entity acquired the financial
instruments. Financial instruments are subsequently measured at fair value unless it
is measured at amortised cost as required by IFRS.
Financial instruments that are subsequently measured at amortised cost are done
so using the effective interest rate method.
Debt instruments that are classified as current assets or current liabilities are
measured at the undiscounted amount of the cash expected to be received or paid,
unless the arrangement effectively constitutes a financing transaction.
2.3 Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost
or net realisable value. Cost is calculated using the first-in-first-out method. Net
realisable value is the estimated selling price in the ordinary course of business less
any costs of completion and disposal.
2.4 Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the transfer of promised goods and services to customers in an
amount that reflects the consideration which the entity expects to be entitled in
exchange for those goods and services. Revenue from the sale of inventory consists
of the total net invoiced sales, excluding value-added tax and settlement discount
granted and any allowance for settlement discount. Revenue is recognised when
performance obligations are satisfied.
3. Revenue
R R
20.1 20.0
Sale of goods
Settlement discount granted ( ) ( )
Allowance for settlement discount granted ( ) ( )

4. Dividend income
R R
20.1 20.0
Listed share investments
Unlisted share investments
Total dividend income

37
5. Fair value adjustments
R R
20.1 20.0
Unlisted share investment designated as at fair value
through profit or loss
Listed investment held for trading
Net fair value adjustments

6. Financial assets
R R
20.1 20.0
Non-current financial assets
Fixed deposit at amortised cost: Capitol Bank at 8% p.a. callable at
31 December 20.4
Unlisted share investment designated at fair value through profit or loss:
1 000 ordinary shares in GRAP (Pty) Ltd (consideration R100 000)
Current financial assets
Trade and other receivables:
Trade receivables control
Allowance for credit losses [amount must be between ()]
Allowance for settlement discount granted [amount must be between ()]
Callable fixed deposit: Shaka Bank at 10% p.a. callable at 30 June 20.2
Listed share investment held for trading at fair value through profit or loss:
10 000 ordinary shares in ACCA Limited (consideration R15 000)
Cash and cash equivalents:
Bank
Petty cash

7. Financial liabilities
R R
20.1 20.0
Non-current financial liabilities at amortised cost
Long-term borrowings: Mortgage:
The mortgage was acquired from Broek Bank Ltd at 1 March 20.0 at an interest
rate of prime plus 1,5%. The loan is repayable in monthly instalments and the
final payment is due on 31 March 20.9. The loan is secured by a first mortgage
over land and buildings (refer note xx).1, 2
Current financial assets
Trade and other payables:
Trade payables control
Short-term borrowings
Current portion of long-term borrowings at amortised cost
Bank overdraft3

38
1.7 Exercises and solutions

EXERCISE 1.1 – Conceptual framework (adapted from Introduction to the understanding

of accounting question book)

Vusi Mailane was a famous sculptor who recently passed away. His daughter, Grace Modise,
bequeathed a sculpture of one of the founder members in distance education to Unisa. The
cost of creating the sculpture amounted to R25 000. A few weeks ago, while his estate was
being finalised, a similar sculpture from Mailane was sold for £80 000 (£ = British pound),
which when converted to rand, amounted to R1 240 000 on 28 February 20.17, which is also
the date of the donation. The University approached your audit firm for advice on the treatment
of the sculpture in the financial statements at year-end on 28 February 20.17.

REQUIRED

Regarding the Conceptual Framework only, discuss the treatment of the sculpture in the
financial statements of Unisa on 28 February 20.17. Explain which measurement base would
be appropriate to use to determine the value at which the sculpture can be recorded in the
financial statements of Unisa.

SOLUTION 1.1

Recognition of the The sculpture has the potential to produce an economic

element as an asset: resource in the form of cash when it is sold.
Present an economic
resource (a right that has
the potential to produce
economic benefits)
Controlled by the reporting Unisa has the right to the economic resources from the sculpture
entity as the sculpture is donated to them.
As a result of a past event The past event is the donation of the sculpture to Unisa.
Recognition criteria: There is no measurement uncertainty, the asset can be faithfully
Faithful representation represented. The value of the sculpture can be determined by
looking at the value of similar sculptures that the artist sold. It
has a value of R1 240 000.
Relevance Only relevant information may be recognised. Low probability of
economic resources may affect relevance. It is probable that the
sculpture will retain its value and that it may be sold, which would
result in an inflow of economic benefits (money) to the
University.
Conclusion The sculpture must be treated as an asset in the financial
statements of Unisa because it complies with the recognition
criteria as well as the definition of an asset.
Measurement basis The asset should be measured at its realisable value, which is
the cash or cash equivalents that could currently be obtained by
selling the sculpture in an orderly disposal. Because Unisa did

39
 not pay for the sculpture, it cannot be recorded at its historical
cost of R25 000 and it should be accounted for at R1 240 000.

EXERCISE 1.2 – Financial instruments

On 1 March 20.14, Louis CC purchased 100 ordinary shares of R100 each in Marble Ltd, a
company listed on the Johannesburg Securities Exchange (JSE). The purpose of this
investment was speculative. The transaction costs amounted to R500. On 28 February 20.15,
the end of Louis CC's financial year, the shares were trading at R125 per share on JSE.

REQUIRED

Record the transactions in the general journal of Louis CC.

SOLUTION 1.2

LOUIS CC
GENERAL JOURNAL
Debit Credit
R R
20.14
Mar 1 Investment: Shares in Marble Ltd (R100 x 100) 10 000
Investment expenses (transaction costs) 500
Bank 10 500
Initial recognition of investment at cost and recording of
investment expenses
20.15
Feb 28 Profit or loss account 500
Investment expenses 500
Closing off of investment expenses
Investment: Shares in Marble Ltd (R25 x 100) 2 500
Fair value adjustment: Listed share investment 2 500
Adjustment on subsequent measurement of investment
in the shares of Marble Ltd at the financial year-end
Fair value adjustment: Listed share investment 2 500
Profit or loss account 2 500
Closing-off of fair value adjustment of listed investment

40
EXERCISE 1.3 – IAS 1

Ms N Naidoo purchased a diamond cutting machine for her jewellery manufacturing business
on 2 March 20.16. She incurred the following costs to get the machine installed and ready for
use:
- Cost of the machine: R632 500
- Delivery cost: R1 495
- Installation cost: R4 370
- Training cost to operate the machine: R920

During the year she also paid R2 750 for repairs to fix the machine. The repairs were not
subjected to VAT.

Ms N Naidoo currently depreciates all manufacturing equipment at 30% according to the

diminishing balance method. The residual value of the machine is R5 000 (VAT exclusive).

Ms N Naidoo is a registered VAT vendor and VAT at 15% is included except where stipulated
to the contrary.

REQUIRED

Disclose the machine and related costs in the financial statements of Ms N Naidoo at
31 December 20.16 to comply with the requirements of IAS 1. The accounting policy note is
not required.

SOLUTION 1.3

1. Calculation of the cost of the machine

R
Purchase price (R632 500 x 100/115) 550 000
Delivery cost (R1 495 x 100/115) 1 300
Installation cost (R4 370 x 100/115) 3 800
Training cost (R920 x 100/115) 800
Total cost of the machine 555 900

2. Calculation of depreciation

R (555 900 – 5 000) x 30% x 10/12 137 725

41
SOLUTION 1.3 (continued)

N NAIDOO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20.16 (EXTRACT)

Other expenses R
Depreciation - machinery 137 725
Repair costs 2 750

N NAIDOO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.16 (EXTRACT)

ASSETS Note R
Non-current assets
Property, plant and equipment R (555 900 – 137 725) 3 418 175

N NAIDOO
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER
20.16 (EXTRACT)

Property, plant and equipment Machinery

R
Carrying amount – 1 January 20.16 xxx
Cost xx
Accumulated depreciation (x)
Movement during the year
Additions 555 900
Disposals (x)
Depreciation (137 725)
Carrying amount – 31 December 20.16 xxx
Cost xxx
Accumulated depreciation (xx)

42
 Self-assessment

After having worked through this learning unit, are you able to do the following?

Yes No
Explain the acronyms IFRS, IAS, APB, FRSC and SAICA.

Describe what the concept "Conceptual Framework" entails.

List the specific purposes of the Conceptual Framework regarding the

preparation and presentation of financial statements.

Explain the main objectives of financial statements per the Conceptual

Framework.

Explain the underlying assumption when preparing financial statements per

the Conceptual Framework.

Discuss the qualitative characteristics of financial statements per the

Conceptual Framework.

Explain what the Conceptual Framework implies when it refers to the

constraints in preparing financial statements as it is referred to in the
Conceptual Framework.

Discuss the elements of financial statements as explained in the

Conceptual Framework and indicate which elements pertain to the
statement of financial position and which to the statement of profit or loss
and other comprehensive income.

Discuss the concepts of recognition and disclosure of the elements

incorporated in financial statements, as explained in the Conceptual
Framework.

Explain what is meant by the measurement of the elements of financial

statements by referring to the measurement methods discussed in the
Conceptual Framework.

Explain what type of business ownership must comply with IFRS.

Define what each of the following terms implies per IAS 1:

- Fair presentation
- Going concern
- Accrual basis of accounting
- Materiality and aggregation
- Offsetting
- Frequency of reporting
- Comparative information

43
 Yes No
- Consistency of presentation

List the individual statements that, per IAS 1, form the complete set of
financial statements of a reporting entity.

Explain what is meant by the identification of financial statements.

Explain what is meant by reporting period.

Explain which items comprise current assets and current liabilities per
IAS 1.

list the items that must be presented on the face of the statement of
financial position and the statement of profit or loss and other
comprehensive income respectively by referring to IAS 1.

List the items that can be presented on either the face of the statement of
financial position and the statement of profit or loss and other
comprehensive income or in the notes to these statements for the
particular reporting period per IAS 1.

Discuss the purpose of notes, by referring to IAS 1.

Discuss, according to IAS 1, the order in which items are disclosed as notes
to financial statements.

Explain or define the following:

- Financial instrument
- Financial asset
- Financial liability
- Fair value
- Contract
Distinguish between financial instruments, financial assets and financial
liabilities.

Recognise, measure and present certain financial assets and liabilities in

the financial statements.

If you answered "yes" to all of the assessment criteria, you can move on to learning
unit 2. If your answer was "no" to any of the criteria, revise those sections concerned
before progressing to learning unit 2.

44
LEARNING UNIT 2

2
Financial statements of a sole proprietorship

Learning outcomes .............................................................................................................. 46

Key concepts ....................................................................................................................... 46
2.1 Introduction ................................................................................................................. 47
2.2 Establishment of a sole proprietorship ....................................................................... 48
2.3 Statement of profit or loss and other comprehensive income .................................... 49
2.4 Statement of changes in equity .................................................................................. 50
2.5 Statement of financial position and notes ................................................................... 50
2.6 Exercises and solutions .............................................................................................. 52
Self-assessment .................................................................................................................. 65

45
 Learning outcomes

After studying this learning unit, you should be able to do the following:

• Record adjustments in the financial statements of a sole proprietorship.

• Prepare a statement of profit or loss and other comprehensive income of a sole
proprietorship.
• Prepare a statement of changes in equity of a sole proprietorship.
• Prepare a statement of financial position of a sole proprietorship.
• Draft the notes to the financial statements of a sole proprietorship.

Key concepts

• Sole proprietor/sole trader

• Investment in a sole proprietorship
• Equity
• Capital
• Profit/loss for the period/year
• Drawings

46
2.1 Introduction

In the FAC1502 module, the financial accounting cycle concerning input and processing was
dealt with and you were introduced to the preparation of financial statements of a sole
proprietorship.

In FAC1601, we deal specifically with the preparation of the output (financial statements) for
different entities such as sole proprietorships (revision), partnerships, close corporations and
companies.

The accounting process that presents the output can be illustrated as follows:

Input § Transaction data is recorded on

FAC1502 § Source documents, which are used to prepare

§ Subsidiary journals, which are posted to

§ General ledger, which is used to
Processing § Prepare a pre-adjustment trial balance
FAC1502 § Adjustments are done
§ Post-adjustment trial balance is prepared
§ Closing transfers are done

§ Statement of profit or loss and other comprehensive

Output income
FAC1601 § Statement of financial position
§ Statement of changes in equity
§ Statement of cash flows (dealt with in learning unit 8)
§ Notes

When closing transfers are done as part of the accounting process, two accounts are created
in the general ledger, namely the trading account and the profit or loss account. Generally, the
gross profit of the entity is calculated in the trading account, whilst the profit and loss account
presents the income and expenditure of the entity. These two accounts pave the way to
prepare financial statements. Financial statements are prepared to provide information on the
state of financial affairs of the entity and to enable decision making.

47
This learning unit is a revision of the preparation of the financial statements of a sole
proprietorship (also known as a sole trader). A sole proprietorship is the simplest form of
business ownership and is often managed by the owner. There is no legislation prescribing
how a sole proprietorship should be established. The accounting process and preparation of
financial statements have been dealt with extensively in FAC1502 and we therefore mainly
provide you with additional questions and suggested solutions to refresh your knowledge.

Cash and/or any other type of asset, for example, a motor vehicle, is required to start the
business entity. The equity simply consists of the capital invested in the business entity plus
the profit made (or less a loss suffered), and less any money and/or goods withdrawn by the
owner for personal use.

2.2 Establishment of a sole proprietorship

A sole proprietor usually contributes capital in the form of cash, and/or non-current assets in
the form of property, plant and equipment towards the starting of the business. The following
example illustrates the accounting entries that are made when a sole proprietorship is
established.

Activity 2.1

On 1 March 20.1, J Manjane invests R125 000 to start a taxi business. The name of the
business is JM Taxis. His investment consists of R3 000 cash, equipment valued at R8 000
and a motor vehicle valued at R114 000.

Prepare the general journal entry that will be made to record the relevant information of JM
Taxis on the date of the investment.

Feedback 2.1

JM TAXIS
GENERAL JOURNAL
Debit Credit
R R
20.1
Mar 1 Bank 3 000
Equipment 8 000
114 000
Motor vehicles
125 000
Capital
Deposit of cash in the bank account of the entity and
recording of other assets brought into the entity at
valuation

In the activity, no other journals were requested. Normally the cash portion of the capital is
recorded in the cash receipts journal.

48
2.3 Statement of profit or loss and other comprehensive income

Once the sole proprietorship is established, the accounting cycle commences. At the end of
the accounting period, a trial balance is prepared. As explained in the introduction, in this
module you will be required to do some adjustments whilst preparing the financial statements
and accompanying notes. It is therefore in your interest to study the layout of a statement of
profit or loss and other comprehensive income to present the accounting information in the
required format as prescribed by IAS 1.

Activity 2.2

Study the layout illustrated in paragraph 1.6 of this study guide.

A statement of profit or loss and other comprehensive income is the statement that indicates
the result of the operating performance of the entity for a specific period.

You will recall that revenue (in the example revenue consists of net sales) is calculated as the
balance of the sales account in the general ledger minus settlement discount granted and less
any adjustments that may apply to sales that have not been considered yet. Assuming that
the sole proprietorship is also a registered VAT vendor, you have to realise that VAT is already
excluded from applicable amounts such as sales, purchases, and so forth. The reason is that
in the journals of first entry, VAT input and VAT output have been separately accounted for
and transferred to a VAT control account, which is either a VAT receivable (debit control
account) or a payable (credit control account).

When the perpetual inventory system is used, cost of sales in the statement of profit or loss
and other comprehensive income is the balance of the cost of sales account in the general
ledger less settlement discount received plus an inventory deficit (if a deficit exists when the
physical inventory count shows less closing inventory than the inventory account at the end
of the accounting period). When the periodic inventory system is in use, the calculation of the
cost of sales is shown on the face of the statement of profit or loss and other comprehensive
income.

Interest paid is a separate line item and is referred to as finance costs. Interest income is
shown separately as part of other income, and for this module, it is never offset against interest
paid.

Activity 2.3

Based on your FAC1502 knowledge, prepare the layout of the gross profit section of the
statement of profit or loss and other comprehensive income of Bibi Traders for the year ended
28 February 20.17. Assume that a periodic inventory system is used.

49
 Feedback 2.1

BIBI TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.17
Notes R
Revenue xxx xxx
Cost of sales (xx xxx)
Inventory – 1 March 20.16 xx xxx
Purchases (net purchases – after purchase returns and settlement
discount received) xxx xxx
Carriage on purchases xx xxx
xxx xxx
Inventory – 28 February 20.17 (xx xxx)
Gross profit xxx xxx

2.4 Statement of changes in equity

You will remember that a statement of changes in equity is compiled to show the movement
in equity during the financial period. This implies that you commence with the balance of equity
at the beginning of the accounting period (normally a year) and you disclose the movements
that caused a difference in the opening and closing balance of equity. For a sole
proprietorship, we also refer to equity as capital.

Activity 2.4

Based on your FAC1502 knowledge, prepare the layout of a statement of changes in equity
for a sole proprietorship, Wong Chu Traders. Assume year-end at 30 June 20.17.

Feedback 2.1

WONG CHU TRADERS

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.17
R
Balance as at 1 July 20.16 xxx
Profit for the year xx
Additional capital contribution xxx
Drawings (x)
Balance as at 30 June 20.17 x xxx

2.5 Statement of financial position and notes

The statement of financial position indicates the financial position of the owner of the sole
proprietorship at a specific date, which is normally year-end. Notes are prepared to explain

50
the accounting policies implemented when presenting the financial statements and how the
amounts in the financial statements were calculated. Examples of accounting policies are the
basis on which the statements are presented (for example, historical cost) as well as the
accounting framework adapted in the preparation of the financial statements, the methods
used to calculate depreciation and value property, plant and equipment, the valuation methods
adopted to account for inventory, the valuation methods adopted to account for financial
assets/liabilities, and many more. Notes must be presented systematically and cross-
referenced to the line items in the statement of profit or loss and other comprehensive income,
the statement of financial position, statement of changes in equity and the statement of cash
flows. Similar to what you encountered in FAC1502 as notes, we will again introduce you to
the most significant notes applicable to first-year accounting. The notes become more
complicated in later years, and it will ensure a good foundation if you can present the notes
that we illustrate in the different learning units.

Activity 2.5

Study the example of a layout of the statement of financial position and the
applicable notes to the financial statements in paragraph 1.6 of this study guide

In FAC1601, you will mostly be presented with a pre-adjustment trial balance prepared from
the general ledger of the entity. You will then have to do the adjustments and prepare the
required financial statements.

The questions and time for completion will not always allow you to do the adjustments in a
journal and to post it to a ledger. You will thus be required to do the adjustments while
preparing the financial statements; therefore, you must know the journal entries that can be
applied to account for adjustments, by heart. This will enable you to know which account is
debited and which is credited to prepare the financial statements with the double-entry in mind
and without physically posting to a general journal and prepare a post-adjustment trial
balance. In paragraph 2.6 of this learning unit, we present you with revision exercises and
solutions where you will apply your knowledge of adjustments with and without the aid of a
general journal in preparing the financial statements of sole proprietors.

Always remember the accounting equation:

Assets = Equity + Liabilities

The adjustments that were covered in FAC1502 and that you may encounter in FAC1601
are:

Adjustments
• Inventory on hand
• Depreciation
• Expenses payable

51
 • Prepaid expenses
• Income receivable
• Income received in advance (prepaid income)
• Credit losses
• Allowance for credit losses
• Allowance for settlement discount received
• Allowance for settlement discount granted

2.6 Exercises and solutions

EXERCISE 2.1

The following information relates to Lebombo Distributors, which is a sole proprietorship of

L Lebombo:

Pre-adjustment trial balance of Lebombo Distributors as at 31 December 20.1

Debit Credit
R R
Capital (1 January 20.1) ............................................................... 141 700
Land and buildings (at cost) .......................................................... 263 240
Vehicles (at cost) .......................................................................... 40 000
Equipment (at cost) ....................................................................... 9 000
Accumulated depreciation: Vehicles (1 January 20.1) ................. 11 200
Accumulated depreciation: Equipment (1 January 20.1) ............. 1 710
Fixed deposit: NBC Bank Ltd (1 January 20.1) ............................. 50 000
Inventory: Merchandise ................................................................. 8 500
Trade receivables control .............................................................. 5 200
Bank .............................................................................................. 3 100
Petty cash ..................................................................................... 100
Cash float ...................................................................................... 500
Trade payables control ................................................................. 8 800
VAT control ................................................................................... 750
Long-term borrowing: Bean Ltd .................................................... 25 000
Allowance for credit losses ........................................................... 300
Sales ............................................................................................. 381 790
Cost of sales ................................................................................. 165 400
Sales returns ................................................................................. 1 200
Wages ........................................................................................... 2 000
Salaries ......................................................................................... 25 000
Assessment rates ......................................................................... 1 500
Settlement discount granted ......................................................... 380
Licences ........................................................................................ 1 000
Vehicle expenses .......................................................................... 3 500
Credit losses ................................................................................. 550
Packaging materials ...................................................................... 4 700
Insurance ...................................................................................... 2 250
Continued on the next page

52
 Debit Credit
Water and electricity ..................................................................... 2 100
Telephone expenses ..................................................................... 1 400
Advertising .................................................................................... 2 000
Rental income ............................................................................... 15 600
Settlement discount received ........................................................ 650
Interest on investment ................................................................... 5 000
Credit losses recovered ................................................................ 120
592 620 592 620

The following adjustments must still be accounted for:

1. Packaging material on hand at 31 December 20.1 to the value of R980.

2. The long-term borrowing was obtained on 1 October 20.1. According to the agreement,
interest is payable biannually at a rate of 18% per annum.
3. Advertisements includes an amount of R400 paid for January 20.2.
4. Rental income includes an amount in respect of January 20.2. Rental income was
earned evenly throughout the year.
5. Interest on the fixed deposit has not yet been received for the last two months of the
financial year. Interest is calculated at a rate of 12% per annum.
6. Insurance includes an amount of R750 paid for the period 1 November 20.1 to
31 October 20.2.
7. The telephone account of R165 for December 20.1 has not yet been paid.
8. Equipment of R2 000 (cost price) was purchased on 1 July 20.1.
9. Depreciation must be provided as follows:
• Vehicles: 20% per annum on the diminishing balance method.
• Equipment: 10% per annum on the diminishing balance method.
10. The account of Loose-Ends Ltd, a debtor who owes the entity R200, must be written
off as irrecoverable.
11. It was determined that on 31 December 20.1, the allowance for credit losses should
amount to R250.
12. Lebombo Distributors uses a perpetual inventory system.

REQUIRED

a) Prepare the journal entries to record the adjustments above.

b) Prepare the closing journal entries. Post these journal entries to the trading and the
profit or loss accounts on 31 December 20.1.
c) Prepare the statement of profit or loss and other comprehensive income of Lebombo
Distributors for the year ended 31 December 20.1.
d) Prepare the statement of changes in equity of Lebombo Distributors for the year ended
31 December 20.1.
e) Prepare the statement of financial position of Lebombo Distributors as at
31 December 20.1.

53
f) Prepare the following notes to the financial statements of Lebombo Distributors for the
year ended 31 December 20.1:
• Accounting policy for the basis of presentation, property, plant and equipment
and financial assets
• Property, plant and equipment
• Financial assets

Your answer must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the sole trader.

SOLUTION 2.1

a) LEBOMBO DISTRIBUTORS
GENERAL JOURNAL - 31 DECEMBER 20.1
Debit Credit
R R
20.1 Inventory: Packaging material 980
Dec 31 Packaging material 980
Packaging material on hand at 31 December 20.1
Interest on loan (R25 000 x 18% x 3/12) 1 125
Accrued expenses 1 125
Interest on loan still payable
Prepaid expenses 400
Advertisements 400
Advertisements paid in advance
Rental income (R15 600 x 1/3) 1 200
Income received in advance 1 200
Rent received in advance
Accrued income 1 000
Interest on investment (R50 000 x 12% x 2/12) 1 000
Interest on investment not yet received
Prepaid expenses 625
Insurance (R750 x 10/12) 625
Insurance prepaid
Telephone expenses 165
Accrued expenses 165
Telephone account for December brought into
account
Depreciation 6 389
Accumulated depreciation on vehicles 5 760
Accumulated depreciation on equipment  629
Depreciation provided at 20% per annum on the
diminishing balance of vehicles and at 10% per
annum on the diminishing balance of equipment.
Credit losses 200
Loose-Ends/Trade receivables control 200
Account written off as irrecoverable
Allowance for credit losses 50
Credit losses 50
Adjustment of allowance for credit losses

54
SOLUTION 2.1 (continued)

Calculation

 Depreciation

The accumulated depreciation is on the equipment owned by the entity at the beginning of the
financial year. Two calculations are therefore needed:

1.1 Equipment purchased in previous years

[(R9 000 – R2 000) – R1 710] x 10% = R529

1.2 Equipment purchased in the current year

R2 000 x 10% x 6/12 = R100

Total depreciation for equipment:

(R529 + R100) = R629

b) LEBOMBO DISTRIBUTORS
GENERAL JOURNAL – Closing journal entries

Debit Credit
R R
20.1 Sales 380
Dec 31 Settlement discount granted 380
Closing off and transfer of settlement discount
granted to sales
Sales 1 200
Sales return 1 200
Closing off and transfer of sales returns to sales
Sales R(381 790 – 380 – 1 200) 380 210
Trading account 380 210
Closing off and transfer of sales to trading account
Settlement discount received 650
Cost of sales 650
Closing off and transfer of settlement discount to cost
of sales
Trading account 164 750
Cost of sales R(165 400 – 650) 164 750
Closing off and transfer of cost of sales account to
trading account
Trading account 215 460
Profit or loss 215 460
Transfer of gross profit
Rental income R(15 600 – 1 200) 14 400
Interest on investment R(5 000 + 1 000) 6 000
Credit losses recovered 120
Profit or loss 20 520
Closing off of above accounts against profit or loss

Continued on the next page

55
 Debit Credit
Profit or loss 51 824
Wages 2 000
Salaries 25 000
Assessment rates 1 500
Licences 1 000
Vehicle expenses 3 500
Credit losses R(550 + 200 – 50) 700
Packaging material R(4 700 – 980) 3 720
Insurance R(2 250 – 625) 1 625
Water and electricity 2 100
Telephone expenses R(1 400 + 165) 1 565
Advertising R(2 000 – 400) 1 600
Interest on loan 1 125
Depreciation 6 389
Closing off of above accounts against profit or loss
account
Profit or loss R(215 460 + 20 520 – 51 824) 184 156
Capital 184 156
Transfer of profit to capital account

Dr Trading account Cr
R R
20.1 20.1
Dec 31 Cost of sales 164 750 Dec 31 Sales 380 210
Profit or loss account 215 460
(Gross profit)
380 210 380 210

Dr Profit or loss account Cr

R R
20.1 20.1
Dec 31 Wages 2 000 Dec 31 Trading account 215 460
Salaries 25 000 (Gross profit)
Assessment rates 1 500 Rental income 14 400
Licences 1 000 Interest on investment 6 000
Vehicle expenses 3 500 Credit losses
Credit losses 700 recovered 120
Packaging material 3 720
Insurance 1 625
Water and electricity 2 100
Telephone expenses 1 565
Advertising 1 600
Interest on loan 1 125
Depreciation 6 389
Capital (Total 184 156
comprehensive
income for the year)

235 980 235 980

56
SOLUTION 2.1 (continued)

c) LEBOMBO DISTRIBUTORS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.1
R
Revenue 380 210
Cost of sales (164 750)
Gross profit 215 460
Other income 20 520
Rental income 14 400
Credit losses recovered 120
Interest income 6 000
235 980
Distribution, administrative and other expenses (50 699)
Wages 2 000
Salaries 25 000
Assessment rates 1 500
Licences 1 000
Vehicle expenses 3 500
Credit losses 700
Packaging material 3 720
Insurance 1 625
Water and electricity 2 100
Telephone expenses 1 565
Advertising 1 600
Depreciation 6 389
Finance costs (1 125)
Interest on long-term loan 1 125
Profit for the year 184 156
Other comprehensive income for the year –
Total comprehensive income for the year 184 156

d) LEBOMBO DISTRIBUTORS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 DECEMBER 20.1
Capital
R
Balance at 1 January 20.1 141 700
Total comprehensive income for the year 184 156
Balance at 31 December 20.1 325 856

57
SOLUTION 2.1 (continued)
e) LEBOMBO DISTRIBUTORS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1
ASSETS Notes R
Non-current assets 342 941
Property, plant and equipment 2.1, 3 292 941
Fixed deposit: NBC Bank 2.2, 4 50 000
Current assets 19 955
Inventories 9 480
Trade and other receivables R(5 200 – 200 – 250 + 1 000) 5 750
Prepayments R(625 + 400) 1 025
Cash and cash equivalents R(3 100 + 500 + 100) 4 3 700
Total assets 362 896

EQUITY AND LIABILITIES

Equity 325 856
Capital 325 856
Total liabilities 37 040
Non-current liabilities 25 000
Long-term borrowings 25 000
Current liabilities 12 040
Trade and other payables R (8 800 + 750 + 1 125 + 165) 10 840
Income received in advance 1 200
Total equity and liabilities 362 896

f) LEBOMBO DISTRIBUTORS
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED
31 DECEMBER 20.1

Accounting policy

1. Basis of presentation

The annual financial statements have been prepared according to International Financial
Reporting Standards appropriate to the business of the entity. The annual financial
statements have been prepared on the historical cost basis, modified for the fair valuation
of certain financial instruments and incorporate the principle accounting policies set out
below. The statements are presented in South African rand.

2. Summary of the significant accounting policies

2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings. Vehicles and equipment are subsequently measured at
cost less accumulated depreciation. Depreciation on equipment and vehicles are written
off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their
estimated useful life. The depreciation rates are as follows:
Vehicles: 20% per annum using the diminishing balance method
Equipment: 10% per annum using the diminishing balance method
2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument.

58
SOLUTION 2.1 (continued)

Financial instruments are initially measured at the transaction price, which is fair value plus
transaction costs, except for "Financial assets at fair value through profit or loss", which is
measured at fair value, transaction costs excluded. The entity's classification depends on
the purpose for which the entity acquired the financial instruments. Financial instruments
are subsequently measured at fair value unless it is measured at amortised cost as
required by IFRS.

Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

3. Property, plant and equipment

Land and Equip-
Vehicles Total
buildings ment
R R R R
Carrying amount – 1 Jan 20.1 263 240 28 800 5 290 297 330
Cost 263 240 40 000 7 000 310 240
Accumulated depreciation – (11 200) (1 710) (12 910)
Additions – – 2 000 2 000
Depreciation for the year – (5 760) (629) (6 389)
Carrying amount – 31 Dec 20.1 263 240 23 040 6 661 292 941
Cost 263 240 40 000 9 000 292 240
Accumulated depreciation – (16 960) (2 339) (19 299)

4. Financial assets
R
Non-current financial assets 50 000
Fixed deposit at amortised cost: NBC Bank Ltd at 12% p.a. 50 000
Current financial assets 8 450
Trade and other receivables 4 750
Trade receivables control R(5 200 – 200) 5 000
Allowance for credit losses (250)
Cash and cash equivalents 3 700
Bank 3 100
Petty cash 100
Cash float 500

59
EXERCISE 2.2

At 31 March 20.15, Cartoon Traders had the following general ledger balances before any
adjustments were made:

CARTOON TRADERS
BALANCES AS AT 31 MARCH 20.15
R
Rental income .............................................................................................. 64 000
Stationery ..................................................................................................... 3 350
Capital .......................................................................................................... 149 000
Drawings ...................................................................................................... 6 084
Accumulated depreciation: Equipment......................................................... 15 000
Commission income ..................................................................................... 2 700
Credit losses ................................................................................................ 1 600
Property (at cost).......................................................................................... 350 000
Equipment (at cost) ...................................................................................... 34 000
Bank (favourable) ........................................................................................ 24 208
Trade receivables control ............................................................................. 26 100
Interest on mortgage .................................................................................... 23 870
Municipal taxes ............................................................................................ 4 333
Insurance ..................................................................................................... 2 405
Mortgage ...................................................................................................... 248 000
Water and electricity..................................................................................... 2 750

The following adjustments must still be accounted for:

1. Cartoon Traders has five tenants, each paying different rental amounts. At the end of
March 20.15, one of the tenants owed two months' rent to the entity. The monthly rental
payable by the tenant is R1 750.
2. Stationery on hand at 31 March 20.15 amounted to R1 550.
3. Commission income of R750 was earned for April and May 20.15.
4. Mr D Poor disappeared, and the management decided to write off his debt amounting
to R2 650 as irrecoverable.
5. Provision should still be made for depreciation on equipment at 10% per annum on the
diminishing balance method.
6. The water and electricity account for March 20.15 amounting to R310, has not yet been
paid.
7. The insurance premium for April 20.15 was paid in advance. The premiums are paid in
equal monthly amounts.
8. Interest on the mortgage is calculated at a rate of 10,5% per annum. The interest for
March 20.15 is still to be accounted for.

60
EXERCISE 2.2 (continued)

REQUIRED

a) Calculate the total comprehensive income or loss of Cartoon Traders for the year
ended 31 March 20.15.
b) Prepare the statement of financial position of Cartoon Traders as at 31 March 20.15.

All calculations must be shown.

Your answer must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the entity.

SOLUTION 2.2

a) Calculation of total comprehensive income or loss:

R
Rental income R(64 000 + 3 500) 67 500
Commission income R(2 700 – 750) 1 950
69 450
Less: Expenses (43 603)
Interest on mortgage (R248 000 x 10.5%) 26 040
Water and electricity R(2 750 + 310) 3 060
Municipal taxes 4 333
Insurance R(2 405 – (2 405/13)) 2 220
Stationery R(3 350 – 1 550) 1 800
Credit losses R(1 600 + 2 650) 4 250
Depreciation R(34 000 – 15 000) x 10% 1 900
Profit for the year 25 847
Other comprehensive income for the year –
Total comprehensive income for the year 25 847

b) CARTOON TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20.15
R
ASSETS
Non-current assets
Property, plant and equipment R(350 000 + 34 000 – 15 000 – 1 900) 367 100

Current assets 52 893

Inventories 1 550
Trade and other receivables R(26 100 – 2 650 + 3 500) 26 950
Prepayments 185
Cash and cash equivalent 24 208

TOTAL ASSETS 419 993

Continued on the next page

61
SOLUTION 2.2 (continued)

EQUITY AND LIABILITIES

Equity 168 763
Capital R(149 000 – 6 084 + 25 847) 168 763

Total liabilities 251 230

Non-current liabilities 248 000
Long-term borrowings 248 000
Current liabilities 3 230
Trade and other payables R(310 + 26 040 – 23 870) 2 480
Income received in advance 750
Total equity and liabilities 419 993

EXERCISE 2.3

BOJANE TRADERS
PRE-ADJUSTMENT TRIAL BALANCE AT 30 JUNE 20.15
Debit Credit
R R
Capital .............................................................................................. 202 000
Drawings .......................................................................................... 27 000
Trade receivables control ................................................................. 18 560
Vehicles (at cost) ............................................................................. 202 100
Accumulated depreciation: Vehicles ................................................ 19 100
Inventory: Trading (1 July 20.14) ..................................................... 28 300
Bank ................................................................................................. 56 520
Mortgage .......................................................................................... 105 000
Loan from Africa Bank ..................................................................... 15 000
Sales ................................................................................................ 272 195
Carriage on purchases ..................................................................... 750
Import duty on purchases ................................................................ 782
Insurance on purchases ................................................................... 329
Commission income ......................................................................... 18 000
Depreciation ..................................................................................... 19 100
Insurance ......................................................................................... 8 575
Packaging materials ......................................................................... 4 600
Purchases ........................................................................................ 190 800
Purchases returns ............................................................................ 245
Rental income .................................................................................. 6 500
Sales returns .................................................................................... 1 860
Settlement discount granted ............................................................ 465
Settlement discount received ........................................................... 225
Telephone expenses ........................................................................ 2 420
Carriage on sales ............................................................................. 1 250
Repairs……………… .. …………………………………………………. 2 160
Fuel……………… ……………………………………………………… 3 479
Wages .............................................................................................. 64 115
Water and electricity ........................................................................ 5 100
638 265 638 265

62
EXERCISE 2.3 (continued)

The following information must still be considered for the year ended 30 June 20.15:

1. On 1 July 20.15, trading inventory had a balance of R22 750.

2. Rental income for the year should have been R6 000.
3. Packaging material on hand at 30 June 20.15 amounted to R1 200.
4. Commission income of R3 600 is still outstanding.
5. An account in respect of water and electricity amounting to R500 must still be paid.
6. The mortgage was obtained from XYZ Bank during the previous financial year and bears
interest at a rate of 11,5% per annum. Interest for the current year must still be provided
for.
7. The loan from Africa Bank is unsecured and bears interest at 19,5% per annum. Interest
for the current year must still be provided for.

8. A debtor who owes the business R4 640 was declared insolvent and his account must be
written off as irrecoverable.
9. The insurance amount includes the premiums for July and August 20.15.

REQUIRED

a) Prepare the statement of profit or loss and other comprehensive income of Bojane
Traders for the year ended 30 June 20.15.
b) Prepare the statement of changes in equity of Bojane Traders for the year ended
30 June 20.15.

Please note:

Your answers must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the entity. All calculations must be shown.

63
SOLUTION 2.3

a) BOJANE TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 JUNE 20.15
R
Revenue R(272 195 – 1 860 – 465) 269 870
Cost of sales (197 741)
Inventory - 1 July 20.14 28 300
Purchases R(190 800 – 245 – 225) 190 330
Carriage on purchases 750
Import duty on purchases 782
Insurance on purchases 329
220 491
Less: Inventory - 30 June 20.15 (22 750)
Gross profit 72 129
Other income 27 600
Rental income R(6 500 – 500) 6 000
Commission income R(18 000 + 3 600) 21 600
99 729
Distribution, administration and other expenses (113 514)
Repairs 2 160
Insurance R(8 575 – (8 575/14 x 2)) 7 350
Wages 64 115
Water and electricity R(5 100 + 500) 5 600
Petrol 3 479
Packing materials R(4 600 – 1 200) 3 400
Depreciation 19 100
Telephone expenses 2 420
Carriage on sales 1 250
Credit losses 4 640
Finance costs (15 000)
Interest on mortgage (R105 000 x 11,5%) 12 075
Interest on short-term loan (R15 000 x 19,5%) 2 925
Loss for the year (28 785)
Other comprehensive income for the year –
Total comprehensive loss for the year (28 785)

b) BOJANE TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.15
Capital
R
Balance as at 1 July 20.14 202 000
Comprehensive loss for the year (28 785)
Less: Drawings (27 000)
Balance as at 30 June 20.15 146 215

64
 Self-assessment

After having worked through this learning unit, are you able to do the following?

Yes No
Record applicable adjustments in the financial statements of a sole
proprietorship.

Prepare a statement of profit or loss and other comprehensive income for

a sole proprietorship.

Prepare a statement of changes in equity for a sole proprietorship.

Prepare a statement of financial position for a sole proprietorship.

Prepare the required notes to the financial statements of a sole

proprietorship.

If you answered "yes" to all of the assessment criteria, you can move on to learning
unit 3. If your answer was "no" to any of the criteria, revise those sections concerned
before progressing to learning unit 3.

65
LEARNING UNIT 3

3
Establishment and financial statements of a partnership

Learning outcomes .............................................................................................................. 67

Key concepts ....................................................................................................................... 67
3.1 Introduction ................................................................................................................. 68
3.2 Reasons for the formation of partnerships ................................................................. 68
3.3 The legal position of a partner .................................................................................... 69
3.4 Establishment of a partnership ................................................................................... 69
3.5 The partnership agreement ........................................................................................ 70
3.6 Dissolution of a partnership ........................................................................................ 71
3.7 Accounting procedures and specialised accounts ...................................................... 72
3.8 Financial statements of a partnership ......................................................................... 77
3.9 Exercises and solutions .............................................................................................. 78
Self-assessment .................................................................................................................. 93

66
 Learning outcomes

Learning outcomes

After studying this learning unit, you should be able to do the following:

• Define a partnership.
• Explain the reasons why a partnership is formed.
• Discuss the contents of a partnership agreement.
• Explain how a partnership can be established.
• Explain the factors that can lead to the dissolution of a partnership.
• Record the transactions of a partnership in the accounting records.
• Prepare the financial statements of a partnership according to the requirements of IFRS,
appropriate to the business of the partnership.

Key concepts

• Partnership
• Partners
• Partnership agreement
• Profit-sharing ratio
• Dissolution
• Legal approach
• Entity approach
• Equity
• Appropriation account
• Financial statement

67
3.1 Introduction

Because a sole trader has only one owner and usually limited capital resources, two or more
entrepreneurs often opt to form a business entity that can accommodate more than one
owner. If their requirement is to establish an entity without the judicial complications
associated with a company or close corporation, the formation of a partnership is an
appropriate choice of business ownership.

A partnership is a legal relationship which arises when an agreement is entered into by two
or more natural persons. Each partner contributes something to the business entity and in
many instances is with the aim to make profit, which is then shared by the partners. The
formation of a partnership requires few or no formalities. The agreement between the
partners, called a “partnership agreement”, can be oral or in writing. For obvious reasons,
however, it is customary to have a written agreement, especially if disputes between partners
have to be resolved.

Activity 3.1

State whether the following statements are true or false:

a) A partnership is a legal entity.

b) A partnership agreement must be in writing.

Feedback 3.1

a) False: A partnership has no legal status. Only the owners have legal status.

b) False: An oral agreement is also binding.

3.2 Reasons for the formation of partnerships

There are many reasons why entrepreneurs enter into a partnership agreement. The following
are some of the reasons:

To increase the amount of capital in the business:

It is obvious that two or more people would be able to contribute more capital than one; it is
also to be expected that with more capital in the enterprise relatively higher profits would be
earned. Furthermore, it would be far easier to finance the operations of the business.

To eliminate competition

If two or more people run separate but identical businesses, it is obvious that competitions
will reduce the profits. If these persons enter into a partnership and put all their labour and
capital into a single business, they would be assured of greater profits in future. Forming a

68
partnership also makes it possible to save on certain expenses, such as rent and salaries,
because it may be possible for the partnership to conduct its business on single premises.

To unite capital and technical expertise in a single business

One person may have the necessary capital while, another has the technical expertise but
does not have the required capital. It may therefore be prudent for the two individuals to
combine the resources they possess by forming a partnership, where one person will
contribute funds and the other expertise.

Activity 3.2

Name three reasons for the formation of a partnership.

Feedback 3.2

• Increased access to capital

• Eliminating competition
• Uniting capital and expertise

3.3 The legal position of a partner

In South Africa, there is no legislative framework that governs the partnership. The principles
of common law are applied to guide the formation and existence of a partnership business.
For example, in terms of common law, partners have equal rights in the management of the
entity and their ownership in the partnership is in the same ratio as the ratio in which they
share the profits/losses of the partnership. If the agreement does not specify the ratio in which
the profits/losses should be shared, the partners will share the profits/losses in the same ratio
as their capital contributions to the partnership.

A partnership is not a juristic person and therefore has no independent legal identity. The
individual partners are the joint bearers of the rights and obligations of the partnership. Each
partner incurs unlimited liability for all the debts and obligations of the partnership. Since a
partnership is not a separate legal person or taxpayer, each partner is individually taxed on
his or her share of the partnership profits.

3.4 Establishment of a partnership

There are no formalities required to establish a partnership. In other words, there is no need
for a written agreement to be completed before a partnership is formed. Partners can establish
a business of a partnership by actions that give rise to the assumption that the parties involved
are in a partnership. For example, if a person receives a portion of the profits from a business
entity, the receipt of the profits is evidence of a partnership. If, however, a person receives a
share of profits as repayment of a debt, wages, rent, or an annuity, such transactions are

69
considered “protected relationships” and do not lead to a legal inference that a partnership
exists.

Although there are no formal requirements for the establishment of a partnership, it is both
customary and desirable to draw up a written agreement that states how certain situations
are to be handled.

3.5 The partnership agreement

The partnership agreement must include, amongst others, the following:

Ø The name of the business (name of the firm) and the nature of the business that will
be conducted (the latter should be clearly spelled out since the activities of the partners
and their consequent liability are closely related to this)
Ø The address or addresses where the business will be conducted and the names of the
partners
Ø The commencement and duration of the partnership
Ø The retirement or resignation of partners, and provision for the continuation of the
business by remaining partners
Ø The capital of the partnership and the contribution to be made by each partner, and an
agreement on whether or not the capital of the partners will remain constant
Ø Future contributions and changes in capital, as well as provision for the capitalisation
of accumulated profits
Ø Loans to the partnership by partners, or loans from outside, for example, from financial
institutions
Ø Withdrawals by partners
Ø Interest on capital, loans, withdrawals and current accounts
Ø Partners’ salaries, commissions, or any other form of remuneration which accrues to
them
Ø The keeping of proper books and accounts (according to the double entry system); the
compiling of financial statements and the auditing of such financial statements if
required by the partners
Ø The proportion in which profits and losses will be divided, the manner in which they will
be withdrawn or otherwise dealt with
Ø Any observation about the manner in which the business will be conducted, or any
financial policy to be followed, as well as provisions governing the dissolution, the
winding up of the business and paying out of the partners respective interests
Ø The valuation of assets and in particular the valuation of the goodwill and its treatment
in the accounting records
Ø The division of power and obligations among the partners and procedures to be
followed in settling disputes between partners, for example, arbitration

The above is a short summary of some of the matters which are usually covered in the
partnership agreement. As it has already been mentioned, each agreement should be drawn

70
up to suit the particular circumstances and it may well happen that certain of the above-
mentioned points may be omitted or that provisions which have not been mentioned may be
added.

It should be noted that the terms and conditions of the partnership agreement may be changed
at any time by mutual consent. A change of this kind can be put in writing or may be affected
by verbal agreement, for example, where the partners agree to pay a certain partner a bigger
monthly salary than the partnership agreement makes provision for. The payment of a larger
amount to the partner in question is sufficient to affect an amendment to the provisions of the
agreement.

Activity 3.3

a) It is advisable that a partnership agreement must be verbal.

True or False?

b) What is the common law principle concerning the ownership and management of a
partnership?

c) What is the common law principle if the partnership agreement does not stipulate a
profit-sharing ratio?

Feedback 3.3

a) False: A written agreement is advisable.

b) Partners share ownership in the same ratio as their profit-sharing ratio and have equal
rights in the management of the entity.

c) Partners will share the profits/losses in the same ratio as their capital contribution ratio
to the partnership.

3.6 Dissolution of a partnership

Unlike a company or close corporation, a partnership has a limited life span. The following
could lead to the termination of a partnership:

Ø Mutual agreement: The partners could decide among themselves to dissolve the
partnership at any time, that is, to terminate their association.
Ø Attainment or lapse of the purpose: A partnership may be formed to fulfil a certain
project and once that objective has been attained, the partnership comes to an end.
For example, the partners may have undertaken to build a house in partnership. Upon
completion of the house the partnership is automatically dissolved.

71
 Ø Passage of time. A partnership may be formed for a certain period, such as five years.
When this period has elapsed, the partnership is automatically dissolved.
Ø The death of one of the partners: The partnership would have to be dissolved as a
result of the death of one of the partners.
Ø Retirement of old partners and admission of a new partner: This means a change
of partners. When an old partner retires or when a new partner is admitted to the
partnership, this means a termination of the partnership. For example, when one
member of a partnership of three retires and the remaining two continue with the
business, the old partnership is terminated in its entirety and a new partnership is
formed, in this case, between the two remaining partners. The same thing happens
when a new partner is admitted, the old partnership is dissolved, and a new partnership
is entered into by all the partners.
Ø Illicit or unlawful acts by partners: When one of the partners commits an act that is
contrary to the provisions of the partnership agreement, or which is illegal and capable
of damaging the good name of the partnership, the other partners are entitled to insist
on the dissolution of the partnership or alternatively on the expulsion of the guilty
partner.
Ø Insolvency: Insolvency of the partnership or of one of the partners terminates the
partnership.
Ø Other reasons: Any other event which necessitates the termination of a partnership,
as stipulated in the partnership agreement, may result in the dissolution of the
partnership.

Can you name all the factors that lead to the ending of a partnership?

3.7 Accounting procedures and specialised accounts

Just like a sole proprietorship, a partnership is a separate accounting entity (without legal
status). It also keeps record of its accounting transactions in journals, subsidiary journals and
ledgers and must prepare financial statements as an output. Refer to the accounting process
in learning unit 2.

Just like any other type of business entity, the owners’ equity in a partnership is represented
by the net assets of the partnership. In partnerships, the equity of each partner must be
recorded separately. The recording of owners’ equity in partnerships is done mainly through
the use for the following accounts:

Capital accounts:
Capital accounts represent the contribution made by the partners in the partnership. These
contributions need not necessarily be of the same nature. They may take the form of cash,
assets, knowledge or skills. A price or value is then placed on the partner’s contribution. A
separate capital account must be opened for each partner. The balances in their respective
capital accounts represent the interests of each partner in the assets and liabilities of the
partnership.

72
Current accounts or drawings accounts:
In addition to the capital account, which shows each partner’s permanent investment in the
partnership, a current account must be opened for each partner. This account is a record of
all current transactions affecting the partners’ ownership interest. Transactions that will be
recorded in these accounts include partners’ shares in profits or losses, interest on capital,
interest on current accounts and drawings. The balances on partners’ capital accounts plus
(minus in the case of a deficit) the balances on their current accounts represent their total
interest in the partnership.

Occasionally, a separate account is used to record withdrawals by partners. The balance on

these withdrawal accounts is then transferred to the current account at the end of each
financial year. During the financial year, when a partner withdraws, for example, part of his or
her salary, bonus or any form of an allowance in cash, the drawings account (or salary, bonus
or allowance account, if no drawings account is kept) is debited and the bank account
credited. The entries are recorded when they occur. At the end of the financial year, the
amount payable as a salary, bonus or allowance to a partner is debited to the salary account,
bonus or allowance account of the partner and credited to his or her current account. If a
drawings account is not used, only the remainder of the total salary, bonus or allowance
payable for the year is debited to the salary, bonus or allowance account and the current
account credited with the remainder of the amount that has not been withdrawn in cash
already. These entries are regarded as year-end adjustments.

Loan accounts:
In addition to partners’ capital contribution, a partner can make a loan to a partnership in his
or her personal capacity. The loan does not form part of his or her permanent investment (his
or her capital) in the partnership. Loans are usually repayable and bear interest at a
predetermined rate, which should be take into account before the distributable profit or the
partnership can be determined.

The appropriation account:

A partnership appropriation account is a final account that is created after the partnership’s
profit and loss account has been finalised. It shows how the profits or losses of the partnership
are distributed among the partner, including components such as the interest that each
partner earned on their capital accounts, interest earned or payable on their current accounts,
the salaries and bonuses that were paid to each partner, and the share of remaining profits
or losses that each partner is entitled to.

There are basically two approaches that can be followed with regard to the accounting
treatment of interest on capital and partners’ salaries, namely the entity approach and the
legal approach. The entity approach threats the partners and the partnership as separated
accounting entities. Applying the entity approach, interest on capital and partners’ salaries
are treated as operating expenses in the determination of profits in the statement of profit or
loss and other comprehensive income. The capital invested is regarded as finance from a
separate accounting entity and the related interest is treated like any finance cost. Salaries
paid to partners are treated in the same way as any other operating expenses and accounted
for together with salaries paid to other employees.

73
However, when the legal approach is followed, the partners and the partnership are treated
as the same legal entity. A partner may not be the debtor or creditor of the partnership or be
an employee of the partnership because a partner cannot enter into a contractual relationship
with same partnership that he/she owns. The implications of the legal approach, from the
accounting point of view, are that the interest on the capital and partners’ salaries are treated
as appropriations of profit and not as finance costs and expenses in the determination of profit
or loss of the partnership.

In this module, the legal approach to accounting for partnership is adopted. From taxation
point of view, it does not really matter which approach is followed, as each partner will end
up with the same taxable income received from the partnership, on which he or she will be
taxed in his personal capacity.

The appropriation account is finalised by allotting profits or losses to the partners. If there is
no definite written agreement between the partners regarding the appropriation of profit/loss,
it is assumed that the profits/losses will be apportioned to the partners in the ratio of their
capital contributions. If such capital contributions have not been specified, it is assumed that
the partners share profits or losses equally.

Activity 3.4

a) Which approach is followed when the partners and partnership are two different
accounting entities?

b) How would interest paid on a capital investment be treated when an entity approach is
followed and how would it be treated when the legal approach is followed in the
accounting records of the partnership?

c) In which account is the initial investment of a partner in a partnership captured? How

can a partner increase this account?

d) When is it compulsory to use a drawings account for each partner? If the drawings
account is not compulsory, which other account can be used to record, for example,
cash drawings of partners?

e) When is a loan account used in the accounting records of a partnership? How is the
interest payable or receivable treated in the statement of profit or loss and other
comprehensive income of the partnership?

f) What is the purpose of an appropriation account?

74
 Feedback 3.4

a) The entity approach

b) According to the entity approach, capital is regarded as finance (from a separate entity
– the partner) and the related interest on capital is treated as finance costs.

According to the legal approach, capital is not regarded as finance from a separate entity
(the partner) and interest on capital is an appropriation/distribution of profit to the partner
and not a finance cost.

c) The initial investment in a partnership is captured in a capital account. The capital

account can only increase with an additional investment into the partnership.

d) It is only compulsory when the partnership agreement states the use of drawings
accounts. The current account can be used.

e) When a partner, in his/her personal capacity, grants a repayable loan to or receives a

repayable loan from the partnership. The interest paid is treated as finance cost,
whereas the interest received is treated as other income in the statement of profit or loss
and other comprehensive income.

f) The appropriation account is a final account used to appropriate the profit/loss of the
partnership to its partners according to the profit-sharing ratio.

Activity 3.5

Monte and Carlos are partners in Montecarlo Traders. The profit of the partnership for the year
28 February 20.7 amounted to R960 000 before taking the following provisions of the
partnership agreement into account:

1. Partners are entitled to 15% interest on the opening balances of their capital accounts.
2. The partners share equally in a profit/loss.
3. Monte receives a salary of R7 000 per month.

The opening balances of the capital accounts amounted to R350 000 for Monte and R450 000
for Carlos.

REQUIRED

Prepare the appropriation account in the general ledger of Montecarlo Traders on

28 February 20.7.

75
 Feedback 3.5

MONTECARLO TRADERS
GENERAL LEDGER
Dr Appropriation account Cr
20.7 R 20.7 R
28 Feb Interest on capital 120 000 28 Feb Profit or loss account 960 000
[(R350 000 x15%) + (15%
R450 000 x 15%)]
Salary: Monte 84 000
(R7 000 x 12 months)
Current account: Monte 378 000
R[(960 000 - 120 000 -
84 000) x 50%]
Current account: Carlos 378 000
R[(960 000 - 120 000 -
84 000) x 50%]
960 000 960 000

You can apply the following steps when recording the sharing of profits or losses:
• Allocate the interest on the partners' capital and current accounts with credit balances.
The interest payable will reduce the profit available for distribution, but it is not disclosed
in the statement of profit or loss and other comprehensive income, the reason being that
it forms part of the partnership agreement and does not influence the external parties of
the entity.
• Calculate the interest on drawings (if applicable) and the interest on current accounts with
debit balances. The interest receivable will increase the profit available for distribution
amongst the partners, but it is not disclosed in the statement of profit or loss and other
comprehensive income.
• Allocate salaries, commissions and bonuses for services rendered by the partners. These
expenses will reduce the profit available for distribution, but it is not disclosed in the
statement of profit or loss and other comprehensive income.
• Divide the remaining profit/loss according to the agreed profit-sharing ratio.

Activity 3.7

DJ Black and CJ Coffee are partners in Black Coffee Music; they contributed R180 000 and
R270 000 respectively. The total profit for the year amounted to R225 000.

REQUIRED

Calculate the profit distribution for the following three scenarios:

a) DJ Black and CJ Coffee share profits in their capital contribution ratio.

b) DJ Black and CJ Coffee share profits equally.
c) DJ Black and CJ Coffee share profits in the ratio of 2:1.

76
 Feedback 3.7

a) The capital contribution ratio is calculated as follows:

Capital contribution R180 000: R270 000. Find the greatest common denominator.
90 000 can be divided into both and equals 2:3.
DJ Black's profit = 2/5 x R225 000 = R90 000
CJ Coffee's profit = 3/5 x R225 000 = R135 000

b) Each partner receives an equal share, which is 50:50 or 1:1; this is also equal to ½:½.
DJ Black's profit = 1/2 x R225 000 = R112 500
CJ Coffee's profit = 1/2 x R225 000 = R112 500

c) DJ Black receives R2 for every R1 that CJ Coffee receives and is stated as 2:1 or 2/3: 1/3.
DJ Black's profit = 2/3 x R225 000 = R150 000
CJ Coffee's profit = 1/3 x R225 000 = R75 000

3.8 Financial statements of a partnership

Once the profit and loss and appropriation entries have been completed, the financial
statements of the partnership can be prepared. The financial statements of a partnership must
be prepared in line with the International Financial Reporting Standards (IFRS) appropriate to
the business of the partnership.

The statement of profit or loss and other comprehensive income is presented in the same
format as for a sole proprietor. The format of the statement of financial position differs only on
the equity section, which discloses the capital and current accounts of the partners, and other
components of equity (where applicable). The statement of changes in equity is expanded to
include the columns for the capital and current accounts of each partner, revaluation surplus
and appropriation of profit.

77
3.9 Exercises and solutions
EXERCISE 3.1

The following information was taken from the accounting records of Bluered Traders, a
partnership with B Blue and R Red as partners. The partnership's financial year ended on
30 September 20.15.

BLUERED TRADERS
BALANCES AS AT 30 SEPTEMBER 20.15
R
Capital: B Blue ............................................................................................... 20 000
Capital: R Red ................................................................................................ 5 000
Current account: B Blue (1 October 20.14) (Cr) ............................................. 1 060
Current account: R Red (1 October 20.14) (Cr) .............................................. 2 800
Drawings: B Blue ............................................................................................ 9 000
Drawings: R Red ............................................................................................. 3 000
Mortgage ......................................................................................................... 10 000
Trade payables control ................................................................................... 24 150
Bank overdraft ................................................................................................. 6 160
Land and buildings at cost .............................................................................. 19 500
Equipment at cost ........................................................................................... 19 840
Accumulated depreciation: Equipment (1 October 20.14) .............................. 5 000
Motor vehicles at cost ..................................................................................... 900
Accumulated depreciation: Motor vehicles (1 October 20.14) ........................ 500
Office furniture at cost ..................................................................................... 350
Accumulated depreciation: Office furniture (1 October 20.14) ........................ 50
Inventory (30 September 20.15) ..................................................................... 21 069
Trade receivables control ................................................................................ 16 020
Allowance for credit losses (1 October 20.14) ................................................ 600
Petty cash ....................................................................................................... 32
Sales ............................................................................................................... 340 628
Cost of sales ................................................................................................... 306 000
Advertising costs ............................................................................................. 4 409
Salaries and wages ......................................................................................... 12 189
Administrative expenses ................................................................................. 2 622
Insurance expenses ........................................................................................ 364
Carriage on sales ............................................................................................ 203
Interest on mortgage ....................................................................................... 450

Additional information

1. Terms of the partnership agreement

1.1 The partners share profits and losses in the ratio of their fixed capital contributions.
1.2 Interest at 5% per annum is to be allowed on the opening balances of the partners'
capital and current accounts.
1.3 Interest is to be charged at 5% per annum on the average monthly amount outstanding
on the partners' drawings accounts.
1.4 R Red is entitled to a salary of R1 000 per annum plus a management commission of
10% of the comprehensive income for the financial year after his salary and the

78
 adjustments for the interest on the capital, current and drawing account have been
considered.

2. Year-end adjustments

2.1 An outstanding debt of R20 is irrecoverable and must be written off.

2.2 The allowance for credit losses must be adjusted to R800.
2.3 Depreciation is to be provided as follows:
Equipment: 15% per annum according to the diminishing-balance method
A new machine was purchased on 1 April 20.15 for R1 560.
Motor vehicles: 20% per annum according to the straight-line method.
Office furniture: 10% per annum according to the diminishing balance method.
2.4 Interest on the mortgage up to 30 September 20.15 amounts to R600.
R4 000 of the loan is repayable during the 20.16 financial year. The loan is secured by
a mortgage over land and buildings. Corner Bank granted the loan on 1 October 20.14.
The terms of the loan provide for interest on the loan to be charged at a rate of 6% per
annum.
2.5 Salaries to employees of R69 have not been paid or taken into account.
2.6 The following expenses have been prepaid:
Insurance R62
Advertising R948
2.7 Interest correctly calculated on the partners' average monthly drawings accounts
amounted to R320 for B Blue and R80 for R Red.
2.8 In terms of the partnership agreement, the following must still be provided for:
- Interest on the partners' capital and current account
- R Red's salary and management commission

REQUIRED

Prepare the following in respect of Bluered Traders to comply with the requirements of the
IFRS appropriate to the business of the partnership. Show all calculations but ignore
comparatives:

a) Statement of profit or loss and other comprehensive income for the year
ended 30 September 20.15.
b) Statement of changes in equity for the year ended 30 September 20.15.
c) Statement of financial position as at 30 September 20.15.
d) Notes for the year ended 30 September 20.15.
e) Prepare the current accounts of the partners, properly balanced, in the general ledger of
Bluered Traders for the year ended 30 September 20.15. Show the correct contra ledger
accounts.

79
SOLUTION 3.1

a) BLUERED TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 SEPTEMBER 20.15
Note R
Revenue 2.5 340 628
Cost of sales (306 000)
Gross profit 34 628
Distribution, administrative and other expenses (21 385)
Salaries and wages R(12 189 + 69) 12 258
Advertising costs R(4 409 – 948) 3 461
Delivery expenses 203
Administrative expenses 2 622
Insurance expenses R(364 – 62) 302
Credit losses ➀ 220
Depreciation ➁ 2.1 2 319
Finance costs (600)
Interest on mortgage ➂ 600
Profit for the year 12 643
Other comprehensive income for the year –
Total comprehensive income for the year 12 643

b) BLUERED TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
30 SEPTEMBER 20.15
Capital Current
Appro- Total
accounts accounts
priation equity
B Blue R Red B Blue R Red
R R R R R R
Balances at 1 October 20.14 20 000 5 000 1 060 2 800 – 28 860
Total comprehensive income
for the year 12 643 12 643
Salaries to partners 1 000 (1 000)
Interest on capital ➃ 1 000 250 (1 250)
Interest on current accounts ➄ 53 140 (193)
Interest on drawings (320) (80) 400
Commission to partners ➅ 1 060 (1 060)
Drawings (9 000) (3 000) (12 000)
Partners' share of total compre-
hensive income ➆ 7 632 1 908 (9 540)
Balances at 30 September 20.15 20 000 5 000 425 4 078 – 29 503

80
SOLUTION 3.1 (continued)

c) BLUERED TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20.15
Note R
ASSETS
Non-current assets 32 721
Property, plant and equipment 2.1, 3 32 721
Current assets 37 311
Inventories 2.3 21 069
Trade receivables R(16 020 – 20 – 800) 4 15 200
Prepayments R(948 + 62) ➇ 1 010
Cash and cash equivalents 4 32

Total assets 70 032

EQUITY AND LIABILITIES

Total equity 29 503
Capital R(20 000 + 5000) 25 000
Current accounts R(425 + 4 078) 4 503

Total liabilities 40 529

Non-current liabilities 6 000

Long-term borrowings 5 6 000
Current liabilities 34 529
Trade and other payables 5 24 369
Current portion of long-term borrowings 5 4 000
Bank overdraft 5 6 160

Total equity and liabilities 70 032

d) BLUERED TRADERS
NOTES FOR THE YEAR ENDED 30 SEPTEMBER 20.15

Accounting policy

1. Basis of presentation
The annual financial statements have been prepared according to the IFRS appropriate
to the business of the entity. The annual financial statements have been prepared on
the historical cost basis, modified for the fair valuation of certain financial instruments,
and incorporate the principal accounting policies set out below. The statements are
presented in South African rand.

2. Summary of significant accounting policies

The annual financial statements incorporate the following principal accounting policies,
which are consistent with those applied in previous years, except where otherwise
stated.

81
2.1 Property, plant and equipment

Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings. Equipment, furniture and vehicles are subsequently
measured at cost less accumulated depreciation and accumulated impairment losses.
Depreciation on equipment, furniture and vehicles is written off at a rate deemed to be
sufficient to reduce the carrying amount of the assets over their estimated useful life to
their estimated residual value. The depreciation rates are as follows:
Equipment: 15% per annum according to the diminishing balance method
Motor vehicles: 20% per annum according to the straight-line method
Furniture: 10% per annum according to the diminishing balance method

2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument. The entity
classification depends on the purpose for which the entity acquired the financial assets.

Financial instruments are initially measured at the transaction price, which is fair value
plus transaction costs, except for "Financial assets at fair value through profit or loss",
which is measured at fair value, transaction costs excluded. Financial instruments are
subsequently measured at fair value unless it is measured at amortised cost as required
by IFRS. Cash and cash equivalents consist of cash in bank and short-term deposits.
Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

Debt instruments that are classified as current assets or current liabilities are measured
at the undiscounted amount of the cash expected to be received or paid, unless the
arrangement effectively constitutes a financing transaction.

2.3 Inventories

Inventories are initially measured at cost and subsequently valued at the lower of cost
or net realisable value. Cost is calculated by using the first-in-first-out method. Net
realisable value is the estimated selling price in the ordinary course of business less any
costs of completion and disposal.

2.4 Financial liabilities

Financial liabilities are recognised in the entity's statement of financial position when the
entity becomes a party to the contractual provisions of the instrument. The classification
depends on the purpose for which the financial liabilities were obtained.

2.5 Revenue

Revenue is measured at the fair value of the consideration received or receivable.

Revenue represents the transfer of promised goods to customers in an amount that
reflects the consideration which the entity expects to be entitled to in exchange for those
goods. Revenue from the sale of inventory consists of the total net invoiced sales,

82
 excluding value-added tax and settlement discount granted. Revenue is recognised
when performance obligations are satisfied.

3. Property, plant and equipment

Land and Equip- Motor Office
Total
buildings ment Vehicles Furniture
R R R R R
Carrying amount at
1 October 20.14 19 500 13 280 400 300 33 480
Cost 19 500 18 280 900 350 39 030
Accumulated depreciation – (5 000) (500) (50) (5 550)
Additions – 1 560 – – 1 560
Disposals* – – – – –
Depreciation for the year – (2 109) (180) (30) (2 319)
Carrying amount at
30 September 20.15 19 500 12 731 220 270 32 721
Cost 19 500 19 840 900 350 40 590
Accumulated depreciation – (7 109) (680) (80) (7 869)

* Included for illustrative purposes. In cases where there are no disposals, this item is excluded from the note. Disposals are
disclosed at carrying amount.

The partnership has pledged land and buildings with a carrying amount of R19 500 as
security for the mortgage obtained from Corner Bank.

4. Financial assets
20.15
R
Current financial assets
Trade and other receivables: 15 200
Trade receivables control R(16 020 – 20) 16 000
Allowance for credit losses (800)
Cash and cash equivalents: 32
Petty cash 32

5. Financial liabilities
20.15
R
Non-current financial liabilities at amortised cost 6 000
Long-term borrowings: Mortgage 6 000
The mortgage was acquired from Corner Bank on 1 October 20.14
at an interest rate of 6% per annum. This loan is secured by a first
mortgage over land and buildings (refer to note 3).
Total loan 10 000
Current portion of the loan (4 000)

Current financial liabilities 34 529

Trade and other payables: 24 369
Trade payables control 24 150
Accrued expenses:
Salaries payable 69
Interest payable on mortgage 150
Current portion of long-term borrowings at amortised cost 4 000
Bank overdraft 6 160

83
SOLUTION 3.1 (continued)

Calculations

➀ Credit losses: R
Credit losses written off 20
Increase in allowance for credit losses 200
Credit losses 220

R
Allowance for credit losses (30 September 20.15) 800
Allowance for credit losses (1 October 20.14) (600)
Increase in allowance for credit losses 200

➁ Depreciation: R
On equipment
Old equipment R(19 840 – 1 560) = R18 280
R(18 280 – 5 000) x 15% 1 992
New equipment R(1 560 x 15% x 6/12 ) 117
On office furniture: R(350 – 50) x 10% 30
On motor vehicles: R900 x 20% 180
2 319
➂ Interest payable on mortgage:
R(600 – 450) 150

➃ Interest on capital accounts: R

B Blue – R20 000 x 5% 1 000
R Red – R5 000 x 5% 250
1 250

➄ Interest on current accounts: R

B Blue – R1 060x 5% 53
R Red – R2 800 x 5% 140
193

➅ Management commission: R Red R

Total comprehensive income for the year 12 643
Less: Salary to R Red (1 000)
Interest on capital (1 250)
Interest on current accounts (193)
Add: Interest on drawings 400
Comprehensive income before commission 10 600
\ R10 600 x 10% = R1 060

84
SOLUTION 3.1 (continued)

➆ Partners' share of total comprehensive income R

Total comprehensive income for the year
(before commission to R Red) 10 600
Commission to R Red (1 060)
Comprehensive income available for distributions 9 540

B Blue: R9 540 x (R20 000/R25 000) = R7 632

R Red: R9 540 x (R 5 000/R25 000) = R1 908

➇ Prepayments: R
Advertising costs 948
Insurance expenses 62
1 010
e) BLUERED TRADERS
GENERAL LEDGER

Dr Current account: B Blue Cr

20.15 R 20.14 R
Sep 30 Interest on drawings 320 Oct 1 Balance b/d 1 060
Drawings (for the year) 9 000 20.15
Balance c/d 425 Sept 30 Interest on capital 1 000
Interest on current account 53
Appropriation account 7 632
9 745 9 745
20.15
Oct 1 Balance b/d 425

Dr Current account: R Red Cr

20.15 R 20.14 R
Sep 30 Interest on drawings 80 Oct 1 Balance b/d 2 800
Drawings (for the year) 3 000 20.15
Balance c/d 4 078 Sept 30 Salary to partner 1 000
Interest on capital 250
Interest on current account 140
Commission 1 060
Appropriation account 1 908
7 158 7 158
20.15
Oct 1 Balance b/d 4 078

85
EXERCISE 3.2

The following information was taken from the accounting records of Toypore Traders, a
partnership with T Toy and P Pore as partners on 28 February 20.15, the financial year-end
of the partnership.

TOYPORE TRADERS
BALANCES AS AT 28 FEBRUARY 20.15
R
Sales ................................................................................................................ 97 600
Settlement discount received ........................................................................... 1 450
Purchases returns ............................................................................................ 850
Administrative expenses .................................................................................. 33 750
Sales returns .................................................................................................... 860
Purchases ........................................................................................................ 44 000
Credit losses .................................................................................................... 2 440
Drawings: T Toy ............................................................................................... 3 880
Drawings: P Pore ............................................................................................. 1 800
Depreciation ..................................................................................................... 3 940
Land and buildings ........................................................................................... 20 000
Motor vehicles at cost ...................................................................................... 36 000
Furniture and fittings at cost ............................................................................. 12 000
Inventory (1 March 20.14) ................................................................................ 21 530
Trade receivables control ................................................................................. 23 520
Allowance for settlement discount received ..................................................... 400
Current account: T Toy (1 March 20.14) (Dr) ................................................... 500
Current account: P Pore (1 March 20.14) (Dr) ................................................. 600
Capital: T Toy (1 March 20.14) ........................................................................ 40 000
Capital: P Pore (1 March 20.14) ...................................................................... 20 000
Bank overdraft .................................................................................................. 4 922
Accumulated depreciation: Furniture and fittings ............................................. 5 298
Accumulated depreciation: Motor vehicles ...................................................... 14 800
Allowance for settlement discount granted ...................................................... 500
Allowance for credit losses .............................................................................. 2 300
Trade payables control .................................................................................... 17 500

Additional information

1. T Toy and P Pore share profits and losses in the ratio of 2:1.
2. On 28 February 20.15, salaries for services rendered according to the partnership
agreement were paid to the partners as follows: T Toy: R6 000 and P Pore R4 000. Both
these amounts were recorded as administrative expenses.
3. Interest on the partners' capital accounts amounted to R2 140 for T Toy and R1 070 for
P Pore.
4. Inventory on 28 February 20.15 amounted to R19 100.
5. Depreciation amounted to R940 on furniture and fittings and R3 000 on motor vehicles.

REQUIRED

Prepare the following in respect of Toypore Traders to comply with the requirements of the
IFRS appropriate to the business of the partnership. Show all calculations but ignore
comparatives:

86
EXERCISE 3.2 (continued)

a) Statement of profit or loss and other comprehensive income for the year ended
28 February 20.15.
b) Statement of changes in equity for the year ended 28 February 20.15.
c) Statement of financial position as at 28 February 20.15.
d) The note about property, plant and equipment for the year ended 28 February 20.15.
e) Prepare the appropriation account of the partners, properly balanced, in the general
ledger of Toypore Traders for the year ended 28 February 20.15. Show the correct
contra ledger accounts.

SOLUTION 3.2

a) TOYPORE TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 28 FEBRUARY 20.15
Note R
Revenue R(97 600 – 860) 96 740
Cost of sales (44 130)
Inventory (1 March 20.14) 21 530
Purchases R(44 000 – 850 – 1 450) 41 700
63 230
Inventory (28 February 20.15) (19 100)
Gross profit 52 610
Distribution, administrative and other (30 130)
expenses
Administrative expenses R(33 750 – 10 000) 23 750
Credit losses 2 440
Depreciation 2 3 940
Profit for the year 22 480
Other comprehensive income for the year –
Total comprehensive income for the year 22 480

b) TOYPORE TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
28 FEBRUARY 20.15
Current
Capital Appro- Total
accounts
priation Equity
T Toy P Pore T Toy P Pore
R R R R R R
Balances at 1 March 20.14 40 000 20 000 (500) (600) – 58 900
Total comprehensive income for the year 22 480 22 480
Salaries to partners 6 000 4 000 (10 000)
Interest on capital 2 140 1 070 (3 210)
Drawings (3 880 + 6 000) (1 800 + 4 000) (9 880) (5 800) (15 680)
Partners' share of total comprehensive
income ➀ 6 180 3 090 (9 270)

Balances at 28 February 20.15 40 000 20 000 3 940 1 760 – 65 700

87
SOLUTION 3.2 (continued)

c) TOYPORE TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note R
ASSETS
Non-current assets 47 902
Property, plant and equipment 3 47 902
Current assets 39 820
Inventories 19 100
Trade receivables R(23 520 – 2 300 – 500) 20 720
Total assets 87 722

EQUITY AND LIABILITIES

Total equity 65 700
Capital R(40 000 + 20 000) 60 000
Current accounts R(3 940 + 1 760) 5 700
Total liabilities 22 022
Current liabilities 22 022
Trade payables R(17 500 – 400) 17 100
Bank overdraft 4 922
Total equity and liabilities 87 722

d) TOYPORE TRADERS
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.15

3. Property, plant and equipment

Furniture
Motor
Land and and
Total
buildings
vehicles
fittings
R R R R
Carrying amount at 1 March 20.14 20 000 7 642 24 200 51 842
Cost 20 000 12 000 36 000 68 000
Accumulated depreciation ➁ – (4 358) (11 800) (16 158)
Depreciation for the year – (940) (3 000) (3 940)
Carrying amount at 28 February 20.15 20 000 6 702 21 200 47 902
Cost 20 000 12 000 36 000 68 000
Accumulated depreciation – (5 298) (14 800) ( 20 098)

Calculations

➀ Partners' share of total comprehensive income

Remaining total comprehensive income to be shared by partners:
R22 480 – R(10 000 + 3 210) = R9 270

T Toy: R9 270 x 2/3 = R6 180

P Pore: R9 270 x 1/3 = R3 090

88
SOLUTION 3.2 (continued)

➁ Accumulated depreciation at 1 March 20.14:

Furniture Motor
and fittings Vehicles

R R
Accumulated depreciation at 28 February 20.15 5 298 14 800
Depreciation for the year (940) (3 000)
4 358 11 800

e) TOYPORE TRADERS
GENERAL LEDGER

Dr Appropriation account Cr
20.15 R 20.15 R
Feb 28 Interest on capital: T Toy 2 140 Feb 28 Profit or loss account 22 480
Interest on capital: P Pore 1 070
Salary: T Toy 6 000
Salary: P Pore 4 000
Current account: T Toy 6 180
Current account: P Pore 3 090
22 480 22 480

EXERCISE 3.3

Shoestring Corner Shop is a partnership, with S Shoe and S String as partners. The following
information pertains to the business activities of the partnership for the year ended
28 February 20.15.

SHOESTRING CORNER SHOP

BALANCES AS AT 28 FEBRUARY 20.15
R
Land and buildings ........................................................................................... 100 000
Motor vehicles at cost ...................................................................................... 99 000
Trade receivables control ................................................................................. 82 000
Inventory .......................................................................................................... 135 000
Bank (Dr) .......................................................................................................... 98 000
Accumulated depreciation: Motor vehicles (1 March 20.14) ............................ 49 000
Allowance for credit losses (1 March 20.14) .................................................... 1 000
Capital: S Shoe (fixed) ..................................................................................... 240 000
Capital: S String (fixed) .................................................................................... 160 000
Current account: S Shoe (Cr: 1 March 20.14) ................................................. 50 000
Current account: S String (Dr: 1 March 20.14) ................................................ 40 000
Drawings: S Shoe ............................................................................................ 55 000
Drawings: S String ........................................................................................... 11 000
Administrative expenses .................................................................................. 80 000
Trading account (gross profit for the year) ....................................................... 200 000

89
EXERCISE 3.3 (continued)

Additional information

1. The partnership agreement stipulates the following:

• Interest is to be calculated at 7,5% per annum on the opening balances of the capital
accounts.
• Interest is to be calculated at 10% per annum on the opening balances of the current
accounts.
• S String is entitled to a monthly salary of R1 250.
• Profits/losses are to be shared equally.

2. The following must still be accounted for:

• Depreciation on motor vehicles at 30% per annum, according to the diminishing
balance method.
• Credit losses to the amount of R2 000.
• Interest on drawings for the current financial year amounted to R5 000 for S Shoe
and R1 000 for S String.
• An investigation indicated that credit losses could be as much as R4 000 during the
next financial period. The allowance for credit losses must be adjusted accordingly.

REQUIRED

Prepare the following in respect of Shoestring Corner Shop to comply with the requirements
of the IFRS appropriate to the business of the partnership. Show all calculations but ignore
comparatives:

a) Statement of profit or loss and other comprehensive income for the year
ended 28 February 20.15.

b) Statement of changes in equity for the year ended 28 February 20.15.

90
SOLUTION 3.3

a) SHOESTRING CORNER SHOP

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 28 FEBRUARY 20.15
Note R
Gross profit 200 000
Administrative and other expenses (100 000)
Administrative expenses 80 000
Credit losses ➀ 5 000
Depreciation R(99 000 – 49 000) x 30% 15 000
Profit for the year 100 000
Other comprehensive income for the year –
Total comprehensive income for the year 100 000

b) SHOESTRING CORNER SHOP

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
28 FEBRUARY 20.15
Capital Current accounts Appro- Total
S Shoe S String S Shoe S String priation Equity
R R R R R R
Balances at 1 March 20.14 240 000 160 000 50 000 (40 000) – 410 000
Total comprehensive income
for the year 100 000 100 000
Salaries to partner ➁ 15 000 (15 000)
Interest on capital ➂ 18 000 12 000 (30 000)
Interest on current accounts ➃ 5 000 (4 000) (1 000)
Interest on drawings (5 000) (1 000) 6 000
Drawings (55 000) (11 000) (66 000)
Partners' share of total
comprehensive income ➄ 30 000 30 000 (60 000)

Balances at
28 February 20.15 240 000 160 000 43 000 1 000 – 444 000

Calculations

➀ Credit losses:
R
Credit losses written off 2 000
Increase in allowance for credit losses * 3 000
Credit losses 5 000

R
Allowance for credit losses (28 February 20.15) 4 000
Allowance for credit losses (1 March 20.14) (1 000)
Increase in allowance for credit losses* 3 000

➁ Salary to partner: S String

R1 250 x 12 = R15 000

91
SOLUTION 3.3 (continued)

➂ Interest on capital:
S Shoe: R240 000 x 7,5% = R18 000
S String: R160 000 x 7,5% = R12 000

➃ Interest on current accounts:

S Shoe: R50 000 (Cr) x 10% = R5 000 (payable)
S String: R40 000 (Dr) x 10% = R4 000 (receivable)

➄ Partners' share of total comprehensive income:

S Shoe: R60 000 x 50% = R30 000
S String: R60 000 x 50% = R30 000

92
 Self-assessment

After having worked through this learning unit, are you able to do the following?

Yes No
Define a partnership.

Explain the reasons why partnerships are formed.

Discuss the contents of a partnership agreement in general.

Explain how a partnership can be established.

Explain the factors that can result in the dissolution of a partnership.

Record the transactions of a partnership in its books.

Prepare the financial statements of a partnership to comply with the
requirements of International Financial Reporting Standards (IFRS),
appropriate to the business of the partnership.

If you answered "yes" to all of the assessment criteria, you can move on to learning
unit 4. If your answer was "no" to any of the criteria, revise those sections concerned
before progressing to learning unit 4.

93
LEARNING UNIT 4

4
Changes in the ownership structure of partnerships

Learning outcomes .............................................................................................................. 95

Key concepts ....................................................................................................................... 95
4.1 Introduction ................................................................................................................. 96
4.2 Valuation adjustments ................................................................................................ 96
4.3 Goodwill ...................................................................................................................... 99
4.4 The calculation of new profit-sharing ratios .............................................................. 101
4.5 Recording a change in ownership structure by way of a personal transaction ......... 103
4.6 Recording a change in ownership structure by way of a transaction with the
partnership ................................................................................................................ 104
4.7 Exercises and solutions ............................................................................................ 107
Self-assessment ................................................................................................................ 117

94
 Learning outcomes

After studying this learning unit, you should be able to do the following:

• Briefly describe what a change in the ownership structure of a partnership entails.

• Mention events that cause a change in the ownership structure of a partnership.
• Calculate the new profit-sharing ratio of a partnership.
• Record a change in the ownership structure of a partnership by way of a personal
transaction.
• Record a change in the ownership structure of a partnership by way of a transaction
with the partnership as a business entity by applying the accounting procedure that is
based on the legal perspective.
• Prepare a statement of financial position for a new partnership at the date of its
formation according to the requirements of the IFRS appropriate to the business of the
partnership, based on the legal perspective.

Key concepts

• Change in ownership structure

• Dissolution
• Valuation adjustment
• Goodwill acquired
• Revaluation surplus
• Adjustment of the profit-sharing ratio
• Personal transaction
• Transaction with a partnership as a business entity
• Accounting procedure based on the legal perspective

95
4.1 Introduction

In terms of common law practices, a change in the ownership structure of a partnership ends
the existing partnership and a new partnership comes into existence. A change in ownership
structure can occur when a new partner is admitted to the partnership or when one of the
partners retires from the partnership.

A new partner can be admitted to the partnership in one of the following ways:

Ø The person may buy an interest from one or more of the existing partners.
Ø The person contributes cash and/or assets to the existing partnership in exchange for
the acquisition of an interest.
Ø The person is admitted without any form of payment.

The retirement of a partner occurs when one or more of the existing partners decide(s) to
withdraw from the partnership. The retirement from an existing partnership may be as a result
of a partner selling his or her assets to a new partner. The partner could also sell his or her
interest to the remaining partners. If the remaining partners take over the interest of the retiring
partner, they are entitled to settle the retiring partner’s interest by utilising partnership funds.

In both instances, when a partner is admitted to or retires from the partnership, the old
partnership ceases to exist as soon as the admission or retirement transactions are finalised.
When a change in the ownership structure of a partnership occurs, the interest of the partners
who have been in the partnership prior to admission or retirement of partner, has to be
evaluated to determine the value of their interest in the partnership. As a result, adjustments
on the assets and liabilities of the partnership business become necessary. Adjustments
would relate to any appreciation or depreciation in value of assets and liabilities not yet
recognised in the books. Otherwise, the incoming partner may be credited with a share of the
assets that is below their current value and the retiring partner may not receive an accurate
amount of repayment of his or her investment in the partnership.

Accounting for a change in the ownership structure of a partnership can be an intricate

process. There are basically two approaches that can be applied to account for the admission
and/or retirement of a partner, namely the legal and the going concern perspectives.
According to the legal perspective, the dissolved and the subsequent new partnership are
viewed and accounted for as two separate business entities. This approach asserts that the
books of an existing partnership are closed off entirely and the new partnership commences
with a new set of books. In contrast, the going concern perspective views the business
activities of a dissolved partnership and the new partnership as those of a single business
entity. According to going concern perspective, the books of the dissolved partnership are
taken over by a new partnership. In this module, only the legal perspective will be applied to
record a change in the ownership structure of a partnership.

4.2 Valuation adjustments

As previously mentioned, when a change in the ownership structure is effected, it is necessary

to ensure that the equity of the existing partners is fairly stated. This involves revaluing the

96
assets and liabilities of the partnership. The assets and liabilities are revalued with the aim of
determining the selling price to be paid by the incoming partner, and to recognise any changes
in the values of assets and liabilities of the partnership. The selling price of the partnership is
determined by the fair value, and not the cost price of the partnership. It must be remembered
that fair value is the amount for which an asset can be exchanged, or a liability can be settled
between knowledgeable, willing parties in an arm's length transaction.

A valuation account is prepared to record the adjustments in the values of assets and liabilities,
as agreed by the partners. The accounting entries to record valuation adjustments can be
illustrated as follows:

Ø Increase in asset item:

Dr - Asset account
Cr - Valuation account

Ø Decrease in asset item:

Dr - Valuation account
Cr - Asset account

Ø Increase in liability item:

Dr - Valuation account
Cr - Liability account

Ø Decrease in liability item:

Dr - Liability account
Cr - Valuation account

The balance (profit or loss) or valuation surplus or deficit, on the valuation account, is then
allocated to the old partners in their profit-sharing ratio.

Activity 4.1

The partnership A and B owns a building that cost them R50 000 and in which the partners
have an equal interest.

In terms of the partnership agreement, the partners A and B annually withdraw their total net
profit, which is derived from the rental income of the building, so that their statement of
financial position at the end of each year remains constant and takes the following form:

97
A AND B PARTNERSHIP
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.0
R
ASSETS
Non-current assets 50 000
Property, plant and equipment 50 000
Total assets 50 000

EQUITY AND LIABILITIES

Total equity 50 000
Capital: A 25 000
B 25 000
Total equity and liabilities 50 000

For some years, the two partners had been running the risk that the value of the partnership’s
asset could drop as a result of depreciation due to obsolescence. Due to increasing demand
for land in the area, the land value rose sharply, and the value of the building dropped. The
combined effect of the appreciation and depreciation of land and buildings reflected a market
value of R75 000 on the property of the partnership.

If the partners were to sell the building at that price, they would obviously get an extra R25 000
profit on sale of the property, when the market value is compared with the book value thereof.

Suppose that at this stage they decided to admit C to the partnership. It would be unfair to A
and B to expect them to admit C for a consideration based on the original cost price or carrying
amount of the property. They would first have to adjust the partnership’s financial position to
the true value of their business, and then use this as the basis for determining the price that
C would have to pay.

Feedback 4.1

To adjust the value of the partnership assets, the following entries will be made in the books
of the partnership:

Journal entries to record valuation adjustment:

Dr Cr
R R
Land and buildings 25 000
Valuation account 25 000
Revaluation of assets to market value before admission of C
Valuation account 25 000
Capital: A 12 500
Capital: B 12 500
Allocation of valuation surplus to A and B

98
The assets of the partnership are now worth R75 000. Suppose C is admitted and acquires a
20% interest in the partnership. He, therefore, has to pay R15 000 (R75 000 x 20%) for his
share. The partners may decide to keep the R15 000 in the business for future business
expansion or it may be paid out to them in cash.

4.3 Goodwill

It is the aim of any trading entity to build a good reputation with its stakeholders. The reputation
can be based on the quality of the service or products supplied, the efficiency of good
management, the ownership of valuable patents and copyrights, and the fact that the business
premisses are located in a prime and convenient area. The value of the reputation of a
business entity is an intangible asset; as such, it is not reflected in the financial statements as
no price is paid for it. In accounting terms, this form of asset is referred to as goodwill.

The International Financial Reporting Standards (IFRS 3) defines goodwill as “an asset
representing the future economic benefits arising from other assets that are not capable of
being individually identified and separately recognised”. As previously mentioned, goodwill is
an intangible asset that relates to the good name of a business entity. It relates to the value
of business that is attached to those factors which enable a business to earn a better return
on capital employed than other businesses operating in the same market. There are many
indirect advantages that can be derived from goodwill. These advantages include, amongst
others, customer loyalty and other good relationships that will ensure the long-term
success of the business. The presence of goodwill implies that a business entity value is
greater than its net assets. When a new partner is admitted, the existing partners would also
require the incoming partner to make an additional monetary contribution in return for the
existing goodwill.

Goodwill acquired is initially recognised at cost, being the excess of the cost of the business
over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and
contingent liabilities. After initial recognition, goodwill acquired is measured at cost less any
accumulated impairment losses. Goodwill acquired is disclosed separately as a non-current
asset on the statement of financial position. In this module, the calculation of goodwill is
discussed only under the circumstance where a new partner is going to be admitted to a
partnership and where no goodwill was recorded in the books of the existing partnership
immediately prior to the admittance of the new partner. To determine the amount of goodwill
acquired, the capital contribution of the new partner is multiplied by the inverse of the new
partner’s share in the equity of the new partnership, minus the equity of the new partnership.

Activity 4.2

a) Define goodwill in terms of IFRS 3.

b) Goodwill is classified as a non-current asset in the statement of financial position.

True or False?

99
c) After initial recognition of goodwill at cost, how is goodwill subsequently measured?

Feedback 4.2

a) Goodwill is a future economic benefit arising from assets that are not capable of being
individually identified and separately recognised.

b) True. Goodwill is also an intangible asset compared to property, plant and equipment,
which are tangible assets.

c) Goodwill is subsequently measured at cost less impairment.

The following activity illustrates the calculation of goodwill:

Activity 4.3

Peter and Tom are partners and share profits and losses in the ratio of 2:3 respectively. Sizwe
is admitted as a partner, and it is agreed that he should pay R60 000 for his one-third interest
in the partnership and that goodwill will be shown in the books of the partnership. At the date
of Sizwe’s admission, Peter's and Tom's capital is R40 000 and R60 000 respectively. At the
same date the favourable bank balance amounts to R10 000 and other tangible assets to
R90 000.

Feedback 4.3

Because Sizwe has to pay R60 000 for a one-third interest in the partnership, the fair value of
the partnership can be calculated as follows:

Proposed profit share for Sizwe 1/3, therefore, the inverse of his profit share is 3/1.

R60 000 x 3/1 = R180 000

The goodwill of the partnership:

R
Fair value of the partnership 180 000
(160 000)
Capital: Peter 40 000
Tom 60 000
Sizwe 60 000
Goodwill 20 000

Since the goodwill was created by the old partners, it must be apportioned to them according
to the old profit-sharing ratio.

100
Journal entries to record goodwill upon admission of Sizwe:
Dr Cr
R R
Goodwill 20 000
Capital: Peter (R20 000 x 2/5) 8 000
Capital: Tom (R20 000 x 3/5) 12 000
Goodwill created on admission of new partner Sizwe

4.4 The calculation of new profit-sharing ratios

The manner in which the profits and losses of a partnership will be distributed should be
specified in the partnership agreement. On change in the partnership ownership structure, the
existing partners must agree on the basis of relinquishing profit share and all the partners
must agree on the profit share to be allocated to the new partner. The profit or loss can be
distributed in any way the partners decide on and need not necessarily be linked to their capital
ratios.

There are various methods according to which the new profit-sharing of the partners in a new
partnership is calculated. Remember your school mathematics when you work with fractions.
Anything multiplied by 1 remains the same (unchanged) and any numerator divided by the
same denominator is equal to 1. You can only work with fractions if they have the same
denominator. Thus, 2/3 – 1/4 must be converted to have the same denominator and you do that
by multiplying each ratio with a ratio equal to 1 (to remain unchanged) that will enable the
fractions to have the same denominator. In this case, the same denominator will be 12 (3x4).

Thus, each ratio is multiplied with the ratio (1) that will make their denominator 12.

Thus [2/3 x 4/4] = 8/12 – [1/4 x 3/3] = 8/12 – 3/12 = 5/12.

A and B were in a partnership, sharing profits and losses equally. They formed a new
partnership by admitting C. It was agreed that C would obtain a 1/5 share interest in the
partnership. After the admission of C, the profit-sharing ratio of A and B will be as follows:

C = 1/5
A + B = 4/5 (1 + 4) = 5

The new profit-sharing ratio is as follows:

A: 1/2 x 4/5 = 4/10 = 2/5 (A and B share the 4/5 equally)

B: 1/2 x 4/5 = 4/10 = 2/5
C: 1/5

The profit-sharing ratio after the admission of C becomes [Link].

101
 Activity 4.4

King and Jama were in a partnership with a profit-sharing ratio of 2:3 respectively. The
partners decided that KaNdaba be admitted to the partnership. KaNdaba obtained a 20%
share in the profits/losses of the new partnership. King and Jama agreed to relinquish the 20%
share to KaNdaba according to their previous profit-sharing ratio, namely 2:3 respectively.

Required:

Calculate the profit-sharing ratio of the partners of the new partnership (that is of
King, Jama and KaNdaba).

Feedback 4.4

KaNdaba’s 20% profit share must be deducted from the previous profit shares of King and
Jama according to an agreed upon ratio. In this example, the agreed upon ratio was given as
the previous profit-sharing ratio of King and Jama, which was 2:3 respectively. This means
that the individual previous profit-sharing ratio of King was (2/5) or 40%, and that of Jama, (3/5)
or 60%.

The new profit-sharing ratio of King and Jama is calculated as follows:

2
King : /5 – (1/5 x 2/5) = 2/5 – 2/25 = 10/25 – 1/25 = 8/25
3
Jama: /5 – (1/5 x 3/5) = 3/5 – 3/25 = 15/25 – 3/25 = 12/25
1
KaNdaba: /5 = 5/25

The new profit-sharing ratio is [Link] respectively.

Activity 4.5

Queen, Nandi and Zulu were in a partnership with a profit-sharing ratio of [Link] respectively.
Due to ill health, Zulu decided to retire from the partnership. Queen and Nandi decided to
continue with the partnership and formed a new partnership. Queen and Nandi agreed to take
over Zulu’s profit share according to their previous profit-sharing ratio.

Required:

Calculate the profit-sharing ratio of the new partnership.

102
 Feedback 4.5

The new profit-sharing ratio of King and Jama is as follows:

2
Queen : /10 + (5/10 x 2/10) = (2/10 + 10/50) = 10/50 + 10/50 = 20/50
3
Nandi: /10 + (5/10 x 3/10) = (3/10 + 15/50) = 15/50 + 15/50 = 30/50

The new profit-sharing ratio is 2:3 respectively.

It must be noted that the new profit-sharing ratio of Queen and Nandi is now 2:3 or 40% and
60% respectively. The retirement of Zulu has increased the share of the Queen from 20% to
40% and that of Nandi from 30% to 60%.

4.5 Recording a change in ownership structure by way of a personal

transaction

A new partner can purchase all or part of the interest of a current partner, making payment
directly to the partner and not to the partnership. The purchase of an existing partner’s
ownership by a new partner is dealt with as a personal transaction that involves the existing
partner and the new partner without otherwise affecting the records of the partnership.
Accounting for this type of admission is very straightforward. The process does not require the
revaluation of assets and liabilities. Therefore, no valuation adjustment or goodwill acquired
is recorded in the books of an existing partnership. However, the fair value of the partnership
must still be determined to determine a fair selling price for the interest of the exiting or selling
partner in the partnership. The only accounting entries that are recorded in the partnership’s
books occur in the two partners’ capital accounts. The existing partner’s capital account is
debited and, after being created, the new partner’s capital account is credited.

Activity 4.6

Johnny and Walker are in a partnership sharing profits and losses in the ratio of 2:3. They
decided to admit Green to the partnership. The balance on the capital account of Johnny is
R10 000, and that of Walker is R15 000. Green will be admitted on condition that he acquires
on half of Walker’s share for R20 000 cash, which he has to pay directly to Walker and not
into the partnership.

Required:

Record the above information in the books of the partnership.

103
 Feedback 4.6

One half of B’s share is equal to R10 000 and the entries in the books are as follows:

Dr Cr
R R
Capital: Walker 7 500
Capital: Green 7 500
Recording the purchase of half of Walker’s interest by Green

Note that there is no entry in respect of the R20 000, as this is a private matter between Walker
and Green. Although Green purchased one half of Walkers’ interest, it does not necessarily
mean that this portion of the profits or losses becomes his. The partners must now formulate
a new agreement in which the new profit-sharing will be determined.

4.6 Recording a change in ownership structure by way of a

transaction with the partnership

Where a new partner contributes assets (cash or other assets) into the partnership, the journal
entries are more complex than recording a change in the ownership structure by way of a
personal transaction. The assets and liabilities have to be revalued and valuation adjustments
be recorded. Goodwill must also be determined and credited to the old partners in their old
profit-sharing ratio.

The process of accounting for a change in the ownership structure can be summarised as
follows:

• Close off the books of the existing partnership. (This includes doing the necessary year-
end adjustments, the closing off of nominal accounts and the closing off of drawings
accounts to current accounts and was dealt with comprehensively in learning unit 3.) All
that remain, will be accounts that must be disclosed in the statement of financial position
and if required, a preliminary statement of financial position can be constructed. You will
see that in most questions the closing adjustments have been dealt with and only entries
affecting the change in the degree of control will have to be made.
• Close off the balances of current accounts of the existing partners to their respective
capital accounts.
• If a revaluation surplus existed, it forms part of the equity of the partners and must be
allocated to the capital accounts of the existing partners in their existing profit-sharing
ratio.
• Record any valuation adjustments (refer to section 4.2) of existing assets and liabilities in
a valuation account.
• Record goodwill initially acquired (refer to section 4.3). Remember the formula to calculate
if an incoming partner paid for goodwill that must be captured.
• Record the dissolution of the partnership. We use a transferral account to close off the
accounting records of the existing partnership and open the accounting records of the
new partnership.

104
Accounting entries to be made in the books of the new partnership:

• Record the formation of the new partnership.

• Adjust the capital account balances if required by the partners in the new partnership.

Activity 4.7

Pinky and Debbie are in a partnership sharing profits and losses in the ratio of 2:3 respectively.
They decided to admit Ericca to the partnership. The following balances appeared in the
accounting records of the partnership prior to the admission of Ericca:

R
Capital: Pinky 20 000
Debbie 30 000
Trade receivables control 100 000
Trade payables control 50 000

In preparation for the admission of Ericca, Pinky and Debbie agreed that Ericca would pay
R20 000 for a 25% (1/4) interest and profits and losses of the partnership. Pinky and Debbie
agreed to each relinquish a portion of their interest in the profits/losses to Ericca according to
their profit-sharing ratio of 2:3 respectively. Pinky, Debbie and Ericca decided to keep their
capital account balances in the same ratio as their profit-sharing ratio. Any refunds or
contributions to the capital accounts must be made in cash. Assume that the assets and
liabilities of the partnership are fairly valued.

Required:

Record the above information in the books of the partnership.

Feedback 4.6

Since assets and liabilities are fairly valued, valuation adjustment will not be necessary. The
next step will be to determine goodwill.

(a) Calculations of goodwill acquired:

R
Fair value of the partnership (R20 000 x 4/1) 80 000
(75 000)
Capital: Pinky 20 000
Debbie 30 000
Ericca 25 000
Goodwill 5 000

105
(b) Journal entries to prepare for the admission of Ericca:
Dr Cr
R R
Goodwill 5 000
Capital: Pinky (R5 000 x 2/5) 2 000
Capital: Debbie (R5 000 x 3/5) 3 000
Goodwill created on admission of new partner

(c) Journal entries to record the dissolution of Pinky and Debbie partnership:
Dr Cr
R R
Transferral account
Goodwill 105 000
Trade receivables control 5 000
Closing off the balances of asset accounts to the transferral account 100 000
record dissolution of the partnership
Capital: Pinky 22 000
Debbie 33 000
Trade payables control 50 000
Transferral account 105 000
Closing off the balances of equity and liabilities accounts to the
transferral account record dissolution of the partnership

(d) Journal entries to record the formation of Pinky, Debbie and Ericca partnership:
Dr Cr
R R
Trade receivables control R[100 000 x (22 000/55 0000)] 40 000
Goodwill R[5 000 x (22 000/55 0000)] 2 000
Bank R[20 000 x (22 000/55 0000)] 8 000
Trade payables control R[50 000 x (22 000/55 0000)] 20 000
Capital: Pinky 30 000
Recording the capital contribution of Pinky
Trade receivables control R[100 000 x (33 000/55 0000)] 60 000
Goodwill R[5 000 x (33 000/55 0000)] 3 000
Bank R[20 000 x (33 000/55 0000)] 12 000
Trade payables control R[50 000 x (33 000/55 0000)] 30 000
Capital: Debbie 45 000
Recording the capital contribution of Debbie
Bank 20 000
Capital: Ericca 20 000
Recording the cash contribution of Ericca

(e) Calculation of new profit-sharing ratio:

2
Pinky: /5 – (1/4 x 2/5) = 2/5 – 2/20 = 8/20 – 2/20 = 6/20
3
Debbie: /5 – (1/4 x 3/5) = 3/5 – 3/20 = 12/20 – 3/20 = 9/20
Ericca: (1/4 x 2/5) + (1/4 x 3/5) = 2/20 + 3/20 = 5/20

New profit-sharing ratio = [Link].

106
(f) Adjusting capital accounts balances to be in the same ratio as profit-sharing ratio:
Dr Cr
R R
Capital - Pinky: [R30 000 – (R80 000 x 6/20)] 6 000
Bank 6 000
Recording the cash repayment to “Pinky” so as to bring the capital
account ratio in the same ratio as the profit-sharing ratio
Capital - Debbie: [R45 000 – (R80 000 x 9/20)] 9 000
Bank 9 000
Recording the cash repayment to “Debbie” so as to bring the capital
account ratio in the same ratio as the profit-sharing ratio

Comment:

The fair value of the partnership business is R80 000 (see the calculation of goodwill). After
the admission of Ericca, each partner must in the capital account maintain a balance that is
the same as his/her profit-sharing ratio. The amount to be paid to or by the partner is calculated
as follows:

Pinky Debbie Ericca

Goodwill 2 000 3 000
Trade receivables control 40 000 60 000
Trade payables control (20 000) (30 000)
Bank 8 000 12 000
Ericca’s capital contribution - - 20 000
Partners balances after the admission of “Ericca” 30 000 45 000 20 000
Amount to be re-paid (to) or by partner:
R30 000 – (R80 000 x 6/20) (6 000)
R45 000 – (R80 000 x 9/20) (9 000)
Required balance as per new partnership agreement 24 000 36 000 20 000

4.7 Exercises and solutions

EXERCISE 4.1:

Recording valuation adjustments in the books of an existing partnership

Work through the exercise and take note of how valuation adjustments are recorded in the
books of an existing partnership in preparation for its change in ownership structure.

Stevie and Bob are in a partnership, Wonder Traders, and they share profits and losses in the
ratio of 3:2 respectively. They decided to admit Tina as a partner as from 1 March 20.15; the
profit-sharing ratio for Stevie, Bob and Tina will be [Link] respectively. The following information
appeared in the accounting records of Wonder Traders, immediately prior to the recording of
any valuation adjustments.

107
EXERCISE 4.1 (continued)

WONDER TRADERS
BALANCES AS AT 28 FEBRUARY 20.15
R
Land and buildings ............................................................................................ 30 000
Trade receivables control .................................................................................. 26 000
Inventory ........................................................................................................... 44 000
Bank (Dr) ........................................................................................................... 20 000
Capital: Stevie ................................................................................................... 60 000
Capital: Bob....................................................................................................... 40 000
Trade payables control...................................................................................... 20 000

Additional information

To prepare for the change in the ownership structure of Wonder Traders, the following
agreement was reached on 28 February 20.15:

1. An allowance of R2 600 must be created for credit losses.

2. Inventory must be recorded at R50 000.
3. Land and buildings must be recorded at R50 000.

REQUIRED

Prepare the following accounts, properly balanced or closed off, in the general ledger of
Wonder Traders to record the valuation adjustments on 28 February 20.15:

• Land and buildings

• Inventory
• Trade receivables control and allowance for credit losses
• Valuation account
• Capital: Stevie
• Capital: Bob

SOLUTION 4.1

WONDER TRADERS
GENERAL LEDGER

Dr Land and buildings Cr

20.15 R
Feb 28 Balance b/d 30 000
Valuation account 20 000
R(50 000 – 30 000)
50 000

108
SOLUTION 4.1 (continued)

Dr Inventory Cr
20.15 R
Feb 28 Balance b/d 44 000
Valuation account 6 000
R(50 000 – 44 000)
50 000

Dr Trade receivables control Cr

20.15 R
Feb 28 Balance b/d 26 000

Dr Allowance for credit losses Cr

20.15 R
Feb 28 Valuation account 2 600

Dr Valuation account Cr
20.15 R 20.15 R
Feb 28 Allowance for credit Feb 28 Land and buildings 20 000
losses 2 600 Inventory 6 000
Capital: Stevie (3/5) 14 040
Capital: Bob (2/5) 9 360
26 000 26 000

Dr Capital: Stevie Cr
20.15 R
Feb 28 Balance b/d 60 000
Valuation account 14 040
74 040

Dr Capital: Bob Cr
20.15 R
Feb 28 Balance b/d 40 000
Valuation account 9 360
49 360

109
EXERCISE 4.2:

Recording a change in the ownership structure of a partnership

Mahatma and Lerato were trading as The House Care Specialists, and they shared
profits/losses equally. They decided to admit Enoch as a partner from 1 July 20.15 and to
trade as Home Care and Butler Services. Enoch had to deposit a capital sum of R6 500 into
the partnership's bank account for a 1/3 share in the net assets (equity) of the new partnership.
The partners will share in the profits/losses equally and the capital accounts' ratio of the
partners must be in the same ratio as their profit-sharing ratio. On 1 July 20.15, Enoch
deposited R6 500 into the bank account of the partnership and to ensure that the capital
accounts' ratio of the partnership is in the same ratio as his profit-sharing ratio, a cash
repayment to Mahatma and a cash contribution received from Lerato were recorded in their
capital accounts.

On 30 June 20.15, the books of The House Care Specialists were closed off. At that date, the
following items appeared in the preliminary statement of financial position of the partnership
and the assets of The House Care Specialists were valued in preparation of the change in its
ownership structure:

Items from the list of balances and valued amounts:

Statement
of Valued
Item
financial amounts
position
R R
Capital: Mahatma ............................................................................ 4 200
Capital: Lerato ................................................................................. 3 200
Current account: Mahatma (Dr) ...................................................... 100
Current account: Lerato (Cr) ........................................................... 200
Revaluation surplus ........................................................................ 1 000
Land and buildings .......................................................................... 4 500 7 500
Goodwill .......................................................................................... 2 100
Inventory: Cleaning materials ......................................................... 1 500 1 200
Trade receivables control ................................................................ 2 000 2 000
Bank (Dr) ......................................................................................... 500 500
Allowance for credit losses ............................................................. 300

REQUIRED
a) Prepare the journal entries on 30 June 20.15 in the general journal of The House Care
Specialists to prepare for the admission of Enoch as a partner and to record the
dissolution of the partnership.

b) Prepare the journal entries on 1 July 20.15 in the general journal of Home Care and
Butler Services to record its formation and to give effect to the decisions that pertain to
the accounting policy and/or the partnership agreement.

c) Prepare the statement of financial position of Home Care and Butler Services as at
1 July 20.15 according to the requirements of the IFRS appropriate to the business of
the partnership. Notes and comparative figures are not required.

110
SOLUTION 4.2

a) THE HOUSE CARE SPECIALISTS

GENERAL JOURNAL
Debit Credit
R R
20.15
June 30 Capital: Mahatma 100
Current account: Lerato 200
Current account: Mahatma 100
Capital account: Lerato 200
Closing off the balances of the current accounts of Mahatma
and Lerato
Revaluation surplus 1 000
Capital: Mahatma (R1 000 x ½) 500
Capital: Lerato 500
Revaluation surplus apportioned to the capital accounts of
Mahatma and Lerato according to their profit-sharing ratio
Land and buildings R(7 500 – 4 500) 3 000
Inventory: Cleaning materials R(1 500 – 1 200) 300
Allowance for credit losses 300
Valuation account (balancing amount) 2 400
Recording the valuation adjustments
Valuation account 2 400
Capital: Mahatma (R2 400 x ½) 1 200
Capital: Lerato (R2 400 x ½) 1 200
Closing off the balance amount of the valuation account to the
capital accounts of Mahatma and Lerato according to their
profit-sharing ratio
Goodwill 2 100
Capital: Mahatma (R2 100 x ½) 1 050
Capital: Lerato (R2 100 x ½) 1 050
Recording goodwill in preparation for the admission of
Enoch
Transferral account 13 300
Land and buildings 7 500
Goodwill 2 100
Inventory: Cleaning materials 1 200
Trade receivables control 2 000
Bank 500
Closing off the balances of the assets accounts to the
transferral account to record the dissolution of the
partnership
Capital: Mahatma 6 850
Capital: Lerato 6 150
Allowance for credit losses 300
Transferral account 13 300
Closing off the balances of the equity and allowance accounts
to the transferral account to record the dissolution

111
SOLUTION 4.2 (continued)

Calculation

 Capital account balances of partners

Mahatma: R(4 200 – 100 + 500 + 1 200 + 1 050) = R6 850
Lerato: R(3 200 + 200 + 500 + 1 200 + 1 050) = R6 150

b) HOME CARE AND BUTLER SERVICES

GENERAL JOURNAL
Debit Credit
R R
20.15
July 1 Land and buildings R7 500 x (R6 850 ÷ R13 000) 3 952
Goodwill R2 100 x (R6 850 ÷ R13 000) 1 107
Inventory: Cleaning materials R1 200 x (R6 850 ÷ R13 000) 632
Trade receivables control R2 000 x (R6 850 ÷ R13 000) 1 054
Bank R500 x (R6 850 ÷ R13 000) 263
Allowance for credit losses R300 x (R6 850 ÷ R13 000) 158
Capital: Mahatma  6 850
Recording the capital contribution of Mahatma
Land and buildings R7 500 x (R6 150 ÷ R13 000) 3 548
Goodwill R2 100 x (R6 150 ÷ R13 000) 993
Inventory: Cleaning materials R1 200 x (R6 150 ÷ R13 000) 568
Trade receivables control R2 000 x (R6 150 ÷ R13 000) 946
Bank R500 x (R6 150 ÷ R13 000) 237
Allowance for credit losses R300 x (R6 150 ÷ R13 000) 142
Capital: Lerato  6 150
Recording the capital contribution of Lerato
Bank 6 500
Capital: Enoch 6 500
Recording the capital contribution of Enoch
Capital: Mahatma 350
Bank 350
Recording the cash repayment to Mahatma to bring the capital
account ratio in the same ratio as the profit-sharing ratio
Bank 350
Capital: Lerato 350
Recording the cash contribution of Lerato to bring the capital
account ratio in the same ratio as the profit-sharing ratio

Calculation

 Adjustment of capital account balances of Mahatma and Lerato

Calculation of capital account balances according to profit-sharing ratio:
Capital: Mahatma R19 500* x 1/3 = R6 500
Capital: Lerato R19 500* x 1/3 = R6 500
Capital: Enoch R19 500* x 1/3 = R6 500
* Total amount of capital in the new partnership
R(6 850 + 6 150 + 6 500) = R19 500
OR
Enoch's capital contribution multiplied by the inverse of his share in the net assets of
the new partnership (R6 500 x 3) = R19 500

112
SOLUTION 4.2 (continued)

Difference between recorded and calculated capital account balances:

Calculated capital
Recorded capital account balance
Difference
account balance according to profit-
sharing ratio
R R R
Mahatma  6 850 6 500 350
Lerato  6 150 6 500 (350)
Enoch  6 500 6 500 –

The recorded capital account balance of Mahatma is greater than his calculated capital
account balance. Mahatma's capital account balance must be reduced by R350. The
recorded capital account balance of Lerato is smaller than her calculated capital
account balance; therefore, Lerato has to increase her capital contribution by R350.

c) HOME CARE AND BUTLER SERVICES

STATEMENT OF FINANCIAL POSITION AS AT 1 JULY 20.15
Note R
ASSETS
Non-current assets 9 600
Property, plant and equipment R(3 952 + 3 548) 7 500
Goodwill R(1 107 + 993) 2 100
Current assets 9 900
Inventories R(632 + 568) 1 200
Trade receivables R(1 054 + 946 – 158 – 142 ) 1 700
Cash and cash equivalents R(263 + 237 + 6 500 – 350 + 350) 7 000

Total assets 19 500

EQUITY AND LIABILITIES

Total equity 19 500
Capital R(6 850 + 6 150 + 6 500 – 350 + 350) 19 500

Total equity and liabilities 19 500

113
EXERCISE 4.3:

Preparation of a partner's capital account and valuation account in preparation of the

change in the ownership structure of a partnership

Work through the exercise and take note of the following:

• When goodwill is created, it is not recorded in the valuation account.

• When the legal perspective is applied, the valuation and capital accounts are closed off
to the transferral account.
• The retired partner's capital account is closed off to a loan account on the last date of
the existing partnership if the capital account was not settled by the partnership.

Kally, Rocky and Mike are in a partnership, trading as Fighting Fists, and share profits or
losses in the ratio of [Link] respectively. Kally decided to retire from the partnership. His last
day as a partner in the partnership will be 31 May 20.15, which is also Fighting Fists' financial
year-end. The new partnership will pay out Kally's capital in cash on 30 November 20.15.
Rocky and Mike decided to admit Gerrie as a partner as from 1 June 20.15. The new
partnership will trade as Fighting Fit. The profit-sharing ratio between Rocky, Mike and Gerrie
will be [Link] respectively. Gerrie will contribute R80 000 in cash for a 1/6 share in the equity
(net assets) of the new partnership.

The following information is taken from the accounting records of Fighting Fists at
31 May 20.15, immediately prior to the recording of valuation adjustments in preparation of
the change in the ownership structure of the partnership:

List of balances as at 31 May 20.15

R
Capital: Kally .......................................................................................................... 56 000
Capital: Rocky ........................................................................................................ 74 000
Capital: Mike .......................................................................................................... 38 000
Land and buildings ................................................................................................. 80 000
Inventory ................................................................................................................ 48 000
Trade receivables control ....................................................................................... 36 000
Trade payables control........................................................................................... 14 000
Bank (favourable) ................................................................................................... 18 000

Additional information

1. To prepare for the change in the ownership structure of Fighting Fists, the following
agreement was reached on 31 May 20.15:
1.1 Goodwill must be recorded in the books.
1.2 An allowance for credit losses must be created at R3 600.
1.3 Inventories must be valued at R60 000.
1.4 Land and buildings must be valued at R140 000.

2. The change in the ownership structure of the partnership is viewed from a legal
perspective.

114
EXERCISE 4.3 (continued)

REQUIRED

Prepare the valuation account and the capital accounts of Kally, Rocky and Mike (properly
closed off) in the general ledger of Fighting Fists at 31 May 20.15.

SOLUTION 4.3

FIGHTING FISTS
GENERAL LEDGER
Dr Valuation account Cr
20.15 R 20.15 R
May 31 Allowance for credit May 31 Land and buildings 60 000
Losses 3 600 R(140 000 – 80 000)
Capital: Kally ➀ 27 360 Inventory 12 000
Capital: Rocky ➀ 27 360 R(60 000 – 48 000)
Capital: Mike ➀ 13 680
72 000 72 000

Dr Capital: Kally Cr
20.15 R 20.15 R
May 31 Loan: Kally 182 144 May 31 Balance b/d 56 000
Valuation account 27 360
Goodwill ➁ 98 784
182 144 182 144

Dr Capital: Rocky Cr
20.15 R 20.15 R
May 31 Transferral account 200 144 May 31 Balance b/d 74 000
Valuation account 27 360
Goodwill ➁ 98 784
200 144 200 144

Dr Capital: Mike Cr
20.15 R 20.15 R
May 31 Transferral account 101 072 May 31 Balance b/d 38 000
Valuation account 13 680
Goodwill ➁ 49 392
101 072 101 072

Dr Loan: Kally Cr
20.15 20.15 R
May 31 Transferral account 182 144 May 31 Capital: Kally 182 144
182 144 182 144

115
SOLUTION 4.3 (continued)

Comment

The loan account of Kally was not required and is shown for illustration purposes.

Calculations

➀ Apportionment of the balance of the valuation account to the capital account of

the partners of the existing partnership

Balance of valuation account to be apportioned: R(72 000 – 3 600) = R68 400

Kally: R68 400 x 2/5 = R27 360

Rocky: R68 400 x 2/5 = R27 360
Mike: R68 400 x 1/5 = R13 680

➁ Goodwill

Goodwill acquired = (Capital contribution of new partner multiplied by the inverse of new
partner's share in the equity [net assets] of new partnership) – Equity of new partnership

= (R80 000 x 6/1) – R(101 360* + 51 680* + 80 000)

= R(480 000 – 233 040)
= R246 960

* Balances of capital accounts

Rocky = Opening balance + apportionment of profit of valuation account

= R(74 000 + 27 360)
= R101 360
Mike = Opening balance + apportionment of profit of valuation account
= R(38 000 + 13 680)
= R51 680

Note that the capital account balance of Kally is excluded from the calculation of goodwill
because Kally will not be a partner in the new partnership. A portion of the goodwill is,
however, credited in the capital account of Kally (as he is a partner of the existing partnership
Fighting Fists) and hence attributed to the creation of the goodwill.

Kally: R246 960 x 2/5 = R98 784

Rocky: R246 960 x 2/5 = R98 784
Mike: R246 960 x 1/5 = R49 392

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 Self-assessment

After having worked through this learning unit, are you able to do the following?

Yes No
Briefly describe what a change in the ownership structure of a partnership
entails.

Mention events that cause a change in the ownership structure of a

partnership.

Calculate the new profit-sharing ratio of a partnership.

Record a change in the ownership structure of a partnership by way of a

transaction with the partnership as a business entity by applying the
accounting procedure which is based on the legal perspective.

If an accounting procedure is based on the legal perspective, prepare a

statement of financial position of a new partnership at the date of its
formation according to the requirements of the IFRS appropriate to the
business of the partnership.

If you answered "yes" to all of the assessment criteria, you can move on to learning
unit 5. If your answer was "no" to any of the criteria, revise those sections concerned
before progressing to learning unit 5.

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LEARNING UNIT 6

5
Close corporations

Learning outcomes ............................................................................................................ 119

Key concepts ..................................................................................................................... 119
5.1 Introduction ............................................................................................................... 120
5.2 Characteristics of a close corporation ...................................................................... 120
5.3 Advantages of a close corporation ........................................................................... 121
5.4 Disadvantages of a close corporation ...................................................................... 121
5.5 Prescribed forms of a close corporation ................................................................... 122
5.6 Membership and management of a close corporation ............................................. 122
5.7 Taxation, deregistration and liquidation of a close corporation ................................ 126
5.8 Accounting records and financial reporting .............................................................. 128
5.9 Exercises and solutions ............................................................................................ 131
Self-Assessment ................................................................................................................ 165

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 Learning outcomes

After studying this learning unit, you should be able to do the following:

• Briefly discuss the Close Corporations Act 69 of 1984 (Close Corporations Act)
regarding matters concerning the attributes, registration, internal and external relations,
accounting records and annual financial statements, joint liability of members and others
for certain debts, the tax position of the close corporation and its members, and the
deregistration of a close corporation.
• Prepare the financial statements (except for a statement of cash flows) of a close
corporation according to IFRS or IFRS for SMEs.

Key concepts

• Close Corporations Act 69 of 1984

• Juristic person
• Unlimited existence
• Limited liability
• Member's contribution
• Member's interest
• Accounting officer
• Financial statements
• Profit distribution
• Loan to members
• Loan from members
• Retained earnings
• South African Revenue Service (SARS)
• Profit before tax

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5.1 Introduction

Learning unit 5 concluded with the partnership as a form of business entity and you should
now have a clear understanding of the disadvantages of using this form of entity to conduct
business. Because of the disadvantages such as dependent corporate status and restricted
capital resources, the close corporation (CC) as a form of business entity was introduced when
the Close Corporations Act 69 of 1984 was legislated. In terms of this Act, a business entity
registered as a close corporation is allowed to acquire independent corporate status and
unlimited existence (among other things).

When the Companies Act 71 of 2008 came into effect on 1 May 2011, it introduced certain
amendments that impacted on the existence of close corporations. These amendments
included the discontinuation of registration of new close corporations. However, existing close
corporations are allowed to continue to exist under the Close Corporation Act, as amended,
until such time that their members decide to convert it into another form of business entity or
discontinue operations.

5.2 Characteristics of a close corporation

Ø A close corporation enables smaller enterprises to acquire legal status with a juristic
personality distinct from its members and with a limited liability a perpetual succession.
Ø Membership in the close corporation could be obtained by buying an existing CC,
which is less cumbersome than having to register a company.
Ø The general principle is that only natural persons can be members of a close
corporation. The number of members can be as few as one but is limited to maximum
of ten natural persons.
Ø The limitation of the membership of a close corporation to natural persons has a
consequence that a close corporation cannot be a subsidiary of a company.
Ø A company cannot have a membership in a close corporation.
Ø A close corporation is a separate legal entity having an existence apart from that of its
members. A close corporation can therefore
• acquire rights and obligations in its own name
• own assets in the name of the close corporation
• sue and be sued in its own name

Ø Because of this separate legal entity, the liability of the members are limited to the
contribution they have made to the capital of the close corporation.
Ø The close corporation has, as a result of its separate legal existences, perpetual
succession and its existence is not reliant on that of its individual member liquidation
or by de-registration.
Ø The management and decision making in a close corporation is relatively simple. The
management is the responsibility of the members. There is no annual meeting
prescribed by the Close Corporations Act. This Act does not make provision for
members’ meetings. Discussions can also be informal on the basis of consultation
between members. A resolution in writing, signed by all the members and entered into

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 the minute book, shall be as if it was passed at a meeting of the members duly covered
and held.

5.3 Advantages of a close corporation

Advantages of a close corporation include the following:

Ø There are only a few regulations that govern the administration of a close corporation
(CC).
Ø A CC does not have any of the legal complications that a company has. For example,
a CC is not required to have annual financial statements audited (subject to certain
provisions in the Act) and a CC is not required to hold annual general meetings. This
makes running a CC easier than a company.
Ø The CC is regarded as a legal entity/person, which is an advantage because it means
that the continuity of a CC is not linked to the status and life of the members.
Ø Income distributed to the members of the CC is exempted from normal income tax.
Ø A CC may give financial assistance to a member to acquire an interest in the
corporation
Ø Liability of members for debts is limited except under certain exceptional
circumstances.
Ø There is no separate board of directors in a CC, and management is the responsibility
of the members.
Ø No transfer duties are payable on the transfer of the interest of a member.

5.4 Disadvantages of a close corporation

Ø Every member is an agent of the corporation and can act on its behalf and can
participate in its management and bind it with credit, ultimately creating a fisk for
other members, as insolvency of the corporation can give rise to personal liability of
members.

Ø The simplicity and informality of the corporate structure can facilitate fraud and
unauthorised or improper action within the close corporation.

Activity 5.1

Name the characteristics of a close corporation as a form of business ownership.

Feedback 5.1

Refer to paragraph 5.2 of this study guide.

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5.5 Prescribed forms of a close corporation

Prior to the implementation of the Companies Act, which outlawed the formation of new close
corporations, a close corporation was formed when the founder member(s) filed a founding
statement (CK1) with the Registrar of Close Corporations. The use of a CK1 has since been
terminated and no new close corporations can be registered. All changes to existing close
corporations are now managed by the Companies Intellectual Property Commission (CIPC).
The Commission, appointed in terms of Section 189 of the Companies Act, is tasked with
managing all the administrative matters previously handled by the Registrar of Close
Corporations.

Depending on the circumstances that require the completion of a form, currently the
prescribed forms that can be filed with the Commission are:

• CK2 Registration of an amended founding statement

• CK2A Amendment regarding Accounting Officer and Addresses
• CK5 Court order for alteration of founding statement
• CK6 Voluntary liquidation
• CoR 9.1 Application for name/translated/shortened (only for existing CCs)
• CoR 40.1 Notice of resolution to wind up solvent CC
• CM26 Special resolution to wind up an insolvent CC
• CoR 123.1 Notice of Start of Business Rescue Proceedings
• CoR 123.2 Notice of appointment of Practitioner
• CoR 125.1 Notice concerning status of Business Rescue Proceedings
• CoR 125.2 Notice of Termination of Business Rescue Proceedings
• CoR 125.3 Notice of Substantial Implementation of a Business Rescue Plan

All the documentation held by the Commission are available for public inspection subject to
the payment of prescribed fees.

5.6 Membership and management of a close corporation

5.6.1 Membership

The Close Corporations Act sets out specific requirements in respect of the number of
members that a close corporation may have and the qualifications for membership. A close
corporation may have one or more members, but at no time may the number of members
exceed ten. The general principle that applies is that only natural persons may be members.
Juristic persons are, however, eligible for membership in the following cases:

Ø A juristic person who is the trustee of a testamentary trust which is entitled to

member’s interest, provided this juristic person is not directly or indirectly controlled
by a beneficiary of the trust
Ø A juristic person who, in the case of a member who is insolvent, deceased, mentally
ill or otherwise incompetent to manage his or her own affairs, is a curator of his or

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 her insolvent estate or an administrator, executor or curator for such a member, or
someone who for some other reason is his or her duly appointed legal representative

5.6.2 Members’ contributions and members’ interest

Every member must make an initial contribution either of money or other assets or services
rendered in connection with, and for the purpose of the formation of the close corporation.
A practical consideration is that a monetary value should be attached to a non-monetary
contribution.

Any member’s interest in a close corporation is a single interest expressed as a percentage.

The term “single interest” means that two or more persons may not jointly hold a member’s
interest in a close corporation. It is not a requirement that a member’s percentage interest
be in proportion to his or her share of total members’ contribution. A member’s interest
normally represents his or her right to share in the profits of the corporation.

A new member can acquire his members’ interest by

Ø buying it from one of the existing members

Ø making a contribution to the close corporation

Such member’s percentage interest will then be determined by agreement with the existing
members.

A close corporation may extend financial assistance to any person with the objective to
acquire his or her member’s interest. In such a case there are strict requirements regarding
solvency and liquidity criteria (see paragraph 5.6.3). If any member wishes to sell his or her
interest or a portion of such interest, he or she may do so only with the consent of all the
other members or in accordance with the provisions of the association agreement.

The aggregate of members’ interest in a close corporation corresponds to shareholders’

equity in the case of a limited company. The components of members’ interest are:

Ø Contributions by members
Ø Surplus on the revaluation of property, plant and equipment
Ø Retained earnings

A member’s interest is expressed as a percentage. The total members’ interest must always
be 100%. To each member of a close corporation, a certificate signed by or on behalf of
each member, must be issued stating his or her percentage interest in the corporation. The
following example illustrates how the membership in the corporation is expressed:

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 Activity 5.2

Thabo and Matlaba are the only members of T’Bose CC. According to the founding statement
of T’Bose CC, a member’s interest of 60% is allocated to Thabo, and 40% to Matlaba. On
30 June 20.1, the members signed the founding statement, which stipulated that Thabo would
contribute cash to the amount of R200 000, and Matlaba would contribute a vehicle with an
estimated retail value of R300 000 to the close corporation.

Required:

Record the contribution made by Thabo and Matlaba in the general journal of T’Bose CC.

Feedback 5.2

T’BOSE CC
GENERAL JOURNAL
Debit Credit
R R
20.1
June 30 Bank 200 000
Vehicle 300 000
Member’s contribution: Thabo 200 000
Member’s contribution: Matlaba 300 000
Recording of members’ contributions to T’Bose CC

Activity 5.2 illustrates that the members’ contributions to the close corporation are not in the
same ratio as the members' interest in the close corporation.

5.6.3 Distribution of profits

A close corporation can only make a distribution of profits to its members if the following
solvency and liquidity requirements, as laid down by the Close Corporation Act, are adhered
to:

Ø Solvency requirements: After any distribution of profit to members has been made,
the assets of the corporation, fairly valued, must exceed its liabilities.
Ø Liquidity requirements: This requirement contains two criteria that must be met after
a distribution to its members:

• The corporation must be able to pay its debts as they become due in the
ordinary course of business,
• Such payment must in the particular circumstance not in fact render the
corporation unable to pay its debts as they become due in the ordinary
course of business.

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A member is not entitled to any payment out of profits available for distribution until such
payment has been approved by a formal resolution or validated by the approval of the annual
financial statements in which such distribution of profits is proposed.

5.6.4 Management of a close corporation

The management of a close corporation is in the hands of its members, and they are able
to carry on the day-to-day business of the corporation with minimum formalities. The
members can, however, decide to conduct the management within the formal framework of
an association agreement. An association agreement is a written agreement between
members of a close corporation, regulating the internal affairs amongst the members and
between the members and the close corporation.

The rules governing the internal affairs of a close corporation pertain mainly to the fiduciary
relationship of members and their liability in the case of negligent conduct. Minimum
legislative requirements exist in respect of the managerial duties of members. The members
may decide to manage the close corporation within a more formal framework by using a
written association agreement, which they may enter into at any time. Such an agreement
must be signed by every member and must be kept at the registered office.

The association agreement regulates matters such as

Ø participation of members in the management of the close corporation

Ø settlement of members’ disputes
Ø borrowing powers
Ø procedure and voting at meetings and proxy votes
Ø repayment of members’ contributions
Ø sale and transfer of members’ interest

If no association agreement exists, the Close Corporation Act provided that

Ø every member is entitled to participate in the carrying on of the business of the

corporation
Ø subject to certain provisions, members shall have equal rights with regard to the
power to represent the corporation in the carrying on of its business

Another important aspect that must be taken note of is that a close corporation may grant
loans and provide security to members and others only when certain legislative requirements
have been met.

Activity 5.3

a) What is the maximum number of members of a close corporation?

b) Are profits usually distributed in accordance with members’ interests or members’
contributions?

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 Feedback 5.3

a) The maximum number of members is ten.

b) Profits are distributed according to members’ interests.

5.7 Taxation, deregistration and liquidation of a close corporation

5.7.1 Taxation

A close corporation is defined as a company in the South African Income Tax Act and is
therefore regarded as a private company for tax purposes. The taxable profit of a close
corporation is taxed at the prevailing company tax rate in accordance with normal income tax
procedures. The profit distributed to members is not taxable in the hands of the members.
Every close corporation is also liable for the payment of provisional tax as well as for dividend
tax on companies. Provisional tax is not a separate tax but rather a method of payment used
to collect in advance income tax payable for the year. The South African Revenue Services
(SARS) calls it “an advance payment of a taxpayer’s normal tax liability”. Provisional tax is
payable twice a year. Dividend tax is another form of tax that a close corporation is subjected
to and is imposed on the company declaring the dividend and not on the shareholder.
Distributions to members of a close corporation are subject to dividend tax because a member
of a close corporation, for tax purposes, is deemed to be a shareholder.

We will not require you to calculate the provisional tax, the taxable income or dividend tax for
a financial year of a close corporation. You only need to know how provisional tax payments
are recorded and how tax matters are disclosed in the financial statements of a close
corporation. These are illustrated in the detailed examples in this study guide. You will be
provided with the taxable income and the tax rate. To record a provisional tax payment, the
journal entry in the books of a close corporation is as follows:

GENERAL JOURNAL
Debit Credit
R R
20.1
Aug 31 SARS (Current income tax) xxx
Bank xxx
Provisional income tax paid

At the end of the accounting period, the actual income tax expense for the period is recorded
as follows:

GENERAL JOURNAL
Debit Credit
R R
20.2
Feb 28 Current income tax expense xxx
SARS (Income tax) xxx
Actual current income tax for the current year

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 Activity 5.3

a) Name the debit and credit entries in the accounting records of a close corporation to
account for the payment of provisional tax.

b) Name the debit and credit entries in the accounting records of a close corporation to
account for the current tax payable by the entity.

Feedback 5.3

a) Debit SARS (income tax) and credit Bank.

b) Debit income tax expense and credit SARS (income tax).

Comment
The first journal entry indicates that the close corporation is owed by SARS; in this case SARS
is a debtor as a result of amounts paid in the form of provisional tax payment. At the end of
the tax year (28 February), the corporation is assessed and the tax amount due is determined.
If the amount of tax due is more than what has been paid by the corporation then the status
of SARS changes to that of a creditor. This is because the close corporation owes the SARS
tax on taxable profits. Provisional tax was merely an estimation of the tax liability for the year,
and in this case would reduce the amount payable to SARS. Once the actual tax payable is
calculated at the end of the financial period, the current tax expense is debited, and the creditor
SARS credited, as illustrated in the second journal. SARS can have a debit or credit balance
at this point and it is disclosed in the statement of financial position of the close corporation
under current assets/liabilities as either current tax receivable (debit balance) or current tax
payable (credit balance).

5.7.2 Deregistration and liquidation

Any person, organ of state or close corporation itself may initiate the deregistration of a close
corporation. The grounds on which a close corporation may be deregistered are as follows:

Ø Upon application by any party subject to the requirements for a request for
deregistration
Ø If annual returns are outstanding for more than 2 successive years
Ø If the Commission believes that the close corporation has been inactive for 7 years

The deregistration of a close corporation can also be considered when a close corporation
has no assets or, because of the inadequacy of its assets, there is no reasonable probability
of the corporation being liquidated.

A statement confirming the above is required by the Commission to process the

deregistration request. This information must be presented on an original letterhead of the
close corporation or any other third person applying for deregistration. The letter must be

127
signed by each active member of the corporation, or otherwise by the person who is
requesting the deregistration. During the deregistration process notifications are mailed to
the close corporation’s registered postal address as per the CIPC records, informing it of the
intended deregistration and with a request to either provide confirmation that it is still active
or to file outstanding annual returns. At the time of notification, the close corporation’s juristic
persona is not yet removed. The notification only serves to inform the close corporation of
the intention to deregister it, if no objection or filing of annual returns occurs.

When a close corporation is deregistered, the Commission gives notice of this fact in the
Government Gazette and the date of the Government Gazette in which the notice appears
is considered to be the date of deregistration.

Although the detailed provisions that apply to liquidation fall outside the scope of this module,
it should be noted that the provisions for the liquidation of a close corporation largely
correspond to those that apply to a limited company.

5.8 Accounting records and financial reporting

A close corporation must keep, in one of the official languages of the Republic, accounting
records which fairly represent the state of affairs and the operations of the close corporation,
and explain the transactions and the financial transactions and the financial position of the
business of the close corporation.

5.8.1 Accounting and reporting requirements

[Link] Keeping accounting records

In terms of the Close Corporation Act, a close corporation must keep accounting records
similar to the records required of companies. The records must include the following:

Ø Records showing assets and liabilities

Ø A register of property, plant and equipment
Ø Records containing daily entries of all cash received and disbursed (paid out)
Ø Records of all credit purchases or sales of goods and service received or rendered
on credit in sufficient detail to make it possible to identify the nature of the transaction
and the parties concerned
Ø Statements of annual inventory taking
Ø Records which make it possible to determine the value of inventory at the end of the
accounting period
Ø Vouchers supporting entries in the accounting records
Ø Records of members’ contributions, retained earnings, revaluations of non-current
assets and amounts of loans to and from members

These records must also be sufficiently detailed for the nature and purpose of the individual
transactions to be clearly identified. They must be kept in such a manner that they are
adequately protected against any attempts to falsify them, and any such attempts should be
easy to identify. A close corporation that fails to take all reasonable steps to prevent records
from being falsified, is guilty of an offence. However, if the members have entrusted the duty

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of keeping accounting records or maintaining a system of internal control to another
“competent and reliable” person, this would be sufficient defence if a case involving falsified
records were ever brought to court.

[Link] Financial year and annual financial statements

The date of the end of the financial year of a close corporation must be specified in the
founding statement. Financial statements must be prepared within a maximum period of nine
months after the end of the financial year. The Close Corporation Act requires that annual
financial statements should fairly present the state of affairs of the corporation at the end of
the relevant financial year and the results of its activities for that year, in accordance with
the International Financial Reporting Standards (IFRS), appropriate to the business of the
corporation. The financial statements should include the following:

Ø Statement of financial position

Ø Statement of profit or loss and other comprehensive income
Ø Statement of changes in equity
Ø Statement of cash flows
Ø Notes to the financial statements

The Close Corporation Act provides that the annual financial statements must disclose
separately the total amounts at the end of the year and the movements in these amounts
during the year of each of the following:

Ø Contributions by members (members’ interest)

Ø Retained earnings
Ø Revaluations (if any) of non-current assets
Ø Amounts of loans to or from members
Ø Percentage interest of members

In February 1991, the South African Institute of Chartered Accountants issued an amended
Auditing and Accounting Guideline which, over and above the compulsory requirements in
respect of disclosure, set out the following additional requirements:

Ø A statement of the net investment of members as a note in respect of members’

interest on the statement of financial position
Ø A description of transactions with members that were taken into account to
determining net profit

You should recall that for a sole proprietorship and partnerships, a statement of changes in
equity was required. In the case of a close corporation, a statement disclosing the
contributions by members, the retained earnings (undrawn profits), revaluation surplus,
loans from members and loans to members (debit balance) is required. We refer to this
statement as a statement of changes in the net investment of members.

Also note that the Companies Act Regulations applicable to close corporations, state that
IFRS or IFRS for SMEs apply to every close corporation with a financial year-end starting
on or after the effective date of the Act. Therefore, close corporations with a year-end after

129
1 May 2011 (year-end of 30 April 2012 and later) are required to prepare annual financial
statements in line with IFRS or IFRS for SMEs according to their Public Interest Score (PIS).
The determination of the PIS falls outside the scope of this module.

[Link] The accounting officer

Every close corporation must appoint an accounting officer, who is a member of a

recognised accounting profession. The professional body must require entrance
examinations in accounting and related studies and must have the power to take disciplinary
action against members guilty of negligence in the performance of their duties or of conduct
which discredits their profession.

The accounting officer must

Ø determine whether the annual financial statements are in agreement with the
accounting records of the corporation
Ø determine the accounting policies applied in the preparation of the annual financial
statements
Ø report to the members of the corporation in respect of the above

Activity 5.4

K Khoi and S San established a close corporation Khoi CC in 20.1, trading in gemstones
mined in the Karoo. The following balances were extracted from the financial records of Khoi
close corporation on 1 July 20.16:
R
Members' contributions 500 000
Retained earnings – 1 July 20.16 341 800
Revaluation surplus 30 000
Loan to K Khoi 10 000
Loan from S San 24 000
Profit and loss account 49 200

Additional information

1. On 15 August 20.16 K Khoi and S San each paid R50 000 of their personal funds into
the close corporation's bank account to increase their contributions and to assist with
the cash flow position of the close corporation.
2. A cash distribution of profit of R10 000 to each member was agreed upon on
30 June 20.17. The distribution is payable to the members on 3 July 20.17.
3. Khoi CC borrowed an additional R4 000 from S San on 15 June 20.17 that was lent to
K Khoi to pay towards funeral costs of a close relative.
4. The provision of current tax to the amount of R13 776 must still be considered.
5. Khoi CC repaid the first annual instalment of R 6 000 of the loan from S San on
2 January 20.17. The loan to K Khoi is repayable in full on 1 July 20.20.

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REQUIRED

Prepare the statement of changes in net investment of members of Khoi CC for the year
ended 30 June 20.17 according to the requirements of the IFRS appropriate to the business
of the close corporation.

Feedback 5.4

KHOI CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 30 JUNE 20.17
Members' Revalua- Loan
Retained Loan from Total net
contri- tion to a
earnings a member investment
butions surplus member
R R R R R R
Balances at
1 July 20.16 500 000 30 000 341 800 24 000 (10 000) 885 800
Additional
contributions  100 000 100 000
Total comprehensive
income for the year ‚ 35 424 35 424
Distribution to
members ƒ (20 000) (20 000)
Increase/Decrease in
loans „ (2 000) (4 000) (6 000)
Balance at
30 June 20.17 600 000 30 000 357 224 22 000 (14 000) 995 224

Non-current liability
16 000
Current liability 6 000

 R(50 000 + 50 000) = R100 000

‚ R(49 200 – 13 776) = R35 424
ƒ R(10 000 + 10 000) = R 20 000
„ R(4 000 increase less 6 000 repayment) = R2000 repayment

5.9 Exercises and solutions

Work through the following exercises and solutions and take note of the following:

Ø A close corporation discloses its normal income tax expense in the statement of
profit or loss and other comprehensive income.
Ø The statement of changes in equity, which you studied in the section dealing with
the preparation of the financial statements of partnerships, is replaced by a similar
statement (namely the statement of changes in net investment of members). Take
note of how the format of the statement of changes in net investment of members
differs from the format of the statement of changes in equity. Note also how the
profits of a close corporation can be retained in a retained earnings account, and

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 that in the statement of changes in net investment no distinction is made between
the members, as is done between the partners in the statement of changes in equity.
Ø Note how the total equity section of the statement of financial position of a close
corporation differs from that of a partnership. The reason for these differences in
disclosure between a partnership and a close corporation is that a partnership is not
a legal entity, whereas a close corporation is.
Ø Study the notes to the financial statements of a close corporation. Notes are a
component of financial statements, and they form an important part of financial
reporting in the FAC1601 syllabus.

EXERCISE 5.1

Mr L Left and Mr R Right are the only two members of Centre CC with equal interest of 50%
each. On 30 June 20.15, the end of the financial year, the bookkeeper presented the
following trial balance, together with additional information, to you as the accounting officer:

CENTRE CC
TRIAL BALANCE AS AT 30 JUNE 20.15
Debit Credit
R R
Member's contribution: Mr L
R Left
Right 10 000
Loan to member: Mr L Left 18 000
Loan to member: Mr R Right (1 July 20.14) 6 000
Machinery at cost price 51 000
Accumulated depreciation: Machinery (1 July 20.14) 7 000
Mortgage (1 July 20.14) 40 000
Land and buildings 200 000
Improvements to buildings (31 January 20.15) 55 000
Trade receivables control 16 000
Telephone expenses 1 260
Stationery consumed 380
Petrol 4 000
Services rendered 382 000
Water and electricity 5 800
Salary: Mr L Left (paid) 24 000
Salary: Mr R Right (paid) 36 000
Remuneration: Accounting officer 12 000
Deposit: Petrol 1 500
Retained earnings (1 July 20.14) 9 200
Bank 6 260
SARS (income tax) 21 000
458 200 458 200

Additional information

1. Provision must still be made for depreciation on the machinery at 10% per annum,
calculated according to the straight-line method. Machinery with a cost price of R16 000
was purchased on 30 September 20.14 and recorded in the books.

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2. The members decided to capitalise the improvements to the buildings. Land
and buildings consist of Plot 166, Laudia, purchased on 1 August 20.13 for R200 000.
No depreciation is provided for on land and buildings.
3. Interest on the mortgage (from T Bank) at 20% per annum must still be taken
into account. The interest is payable on 1 July 20.15. The loan was obtained on
1 July 20.14 and is secured by a first mortgage over land and buildings. The loan is
repayable on 1 July 20.22.
4. The following accounts were received and were payable at 30 June 20.15 but must still
be accounted for:
Telkom, for telephone expenses, R150
Pen & Pencil Stationery, for stationery, R120
5. Mr D Down, a debtor of the close corporation, had a balance of R2 500 on his account
on 30 June 20.15. This amount must be written off as irrecoverable.
6. The members decided that as from 1 July 20.14, interest at a rate of 18% per annum
will be taken into account on their loan accounts. A new loan of R10 000 was granted to
Mr Left on 31 January 20.15. Interest on these loans is capitalised. Both loans are
unsecured and immediately callable.
7. The actual current income tax for the year amounted to R83 044 and must still be
recorded.
8. The members decided to distribute R60 000 of the total comprehensive income of the
close corporation for the year ended 30 June 20.15 equally between them. These
amounts will not be paid out in cash but will be left in the close corporation as loans to
the corporation. These loans are unsecured and an interest rate of 20% per annum is
applicable. It was further decided that 50% of these loans must be repaid on
31 March 20.16. The balances on these accounts are repayable on 31 December 20.22.
9. The members' contributions were paid in full and no additional contributions were made
during the year.

REQUIRED

With regard to Centre CC:

a) Prepare the statement of profit or loss and other comprehensive income for the year
ended 30 June 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
30 June 20.15.
c) Prepare the statement of financial position as at 30 June 20.15.
d) Prepare the notes for the year ended 30 June 20.15.

Your answer must comply with the provisions of the Close Corporations Act 69 of 1984 and
the requirements of IFRS. Comparative figures are not required.

NB: Show all calculations.

133
SOLUTION 5.1

a) CENTRE CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 JUNE 20.15
Notes R
Revenue 2.3 382 000
Other income 3 270
Interest income  4 3 270
385 270
Administrative and other expenses (90 910)
Depreciation 2.1, 3 4 700
Telephone expenses R(1 260 + 150) 1 410
Stationery consumed R(380 + 120) 500
Petrol 4 000
Salaries to members 8 60 000
Remuneration: Accounting officer 12 000
Credit losses 2 500
Water and electricity 5 800
Finance costs (8 000)
Interest on mortgage  5 8 000
Profit before tax 286 360
Income tax expense (83 044)
Profit for the year 203 316
Other comprehensive income for the year –
Total comprehensive income for the year 203 316

Comment
Because there is no cost of sales, there can be no gross profit or any distribution
expenses. Remember that this is a service entity and not a retail entity.

b) CENTRE CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 30 JUNE 20.15
Loans
Members' Retained Loans to
from Total
contributions earnings members
members
R R R R R
Balances at 1 July 20.14 20 000 9 200 – (14 000) 15 200
Total comprehensive income
for the year 203 316 203 316
Distribution to members (60 000) 60 000
Loans to members (13 270) (13 270)
Balances at 30 June 20.15 20 000 152 516 60 000 (27 270) 205 246
Non-current liability 30 000
Current liability 30 000

134
SOLUTION 5.1 (continued)

c) CENTRE CC
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.15
Note R
ASSETS
Non-current assets 294 300
Property, plant and equipment 2.1, 3 294 300
Current assets 48 530
Trade receivables ƒ 4 13 500
Loans to members 4, 6 27 270
Cash and cash equivalents 4 7 760
Total assets 342 830

EQUITY AND LIABILITIES

Total equity 172 516
Members' contributions 20 000
Retained earnings 152 516
Total liabilities 170 314
Non-current liabilities 5, 7 70 000
Long-term borrowings 70 000
Current liabilities 100 314
Trade and other payables „ 5 8 270
Current portion of long-term borrowings 5, 7 30 000
Current tax payable 62 044
Total equity and liabilities 342 830

d) CENTRE CC
NOTES FOR THE YEAR ENDED 30 JUNE 20.15

1. Basis of presentation

The financial statements have been prepared according to the requirements of the IFRS
appropriate to the business of the entity. The annual financial statements have been prepared
on the historical cost basis, modified for the fair valuation of certain financial instruments, and
incorporate the principal accounting policies set out below.

2. Summary of significant accounting policies

The financial statements incorporate the following significant accounting policies that are
consistent with those applied in previous years except where otherwise stated.

2.1 Property, plant and equipment

Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings. Machinery is subsequently measured at historical cost
less accumulated depreciation and accumulated impairment losses.

135
SOLUTION 5.1 (continued)

Depreciation on machinery is written off at a rate deemed to be sufficient to reduce the

carrying amount of the assets over their estimated useful life to their estimated residual
value. The depreciation rate is as follows:
Machinery: 10% per annum according to the straight-line method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are
determined by comparing the proceeds with the carrying amount of the asset. The net
amount is included in profit or loss for the year.

2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument.

Financial instruments are initially measured at the transaction price, which is fair value
plus transaction costs, except for "Financial assets at fair value through profit or loss",
which is measured at fair value, transaction costs excluded. The entity classification
depends on the purpose for which the entity acquired the financial assets. Financial
instruments are subsequently measured at fair value unless they are measured at
amortised cost as required by IFRS.

Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

Debt instruments that are classified as current assets or current liabilities are measured
at the undiscounted amount of the cash expected to be received or paid, unless the
arrangement effectively constitutes a financing transaction.

2.3 Revenue

Revenue is measured at the fair value of the consideration received or receivable.

Revenue represents the delivery of services to customers of an amount that reflects the
consideration the entity expects to be entitled to in exchange for the services and is
recognised when performance obligations are satisfied.

3. Property, plant and equipment

Land and Equip-
Total
buildings ment
R R R
Carrying amount at 1 July 20.14 200 000 28 000 228 000
Cost 200 000 35 000 235 000
Accumulated depreciation – (7 000) (7 000)
Additions 55 000 16 000 71 000
Depreciation for the year ‚ – (4 700) (4 700)
Carrying amount at 30 June 20.15 255 000 39 300 294 300
Cost 255 000 51 000 306 000
Accumulated depreciation – (11 700) (11 700)

136
SOLUTION 5.1 (continued)

The land and buildings consist of offices on Plot 166, Laudia, and were purchased on
1 August 20.13. The CC has pledged land and buildings with a carrying amount of
R255 000 as security for the mortgage obtained from T Bank.

4. Financial assets
20.15
R
Current financial assets 48 530
Trade and other receivables:
Trade receivables control 13 500
Loans to members 27 270
The loans are unsecured and carry interest at 18% per annum. The
loans are immediately callable.
Cash and cash equivalents: 7 760
Bank 6 260
Short-term deposit: Petrol 1 500

5. Financial liabilities
20.15
R
Non-current financial liabilities at amortised cost 70 000
Long-term borrowings: Mortgage 40 000
The mortgage was acquired from T Bank on 1 July 20.14 at
an interest rate of 20% per annum. The loan is repayable
on 1 July 20.22. The loan is secured by a first mortgage over land
and buildings (refer to note 3).
Loans from members: 30 000
The loans from members are unsecured and carry interest at a
rate of 20% per annum. 50% of the loans are repayable on
31 March 20.16, and the remainder on 31 December 20.22.
Total loans from members 60 000
Current portion of loans from members (30 000)
Current financial liabilities 38 270
Trade and other payables: –
Accrued expenses: 8 270
Interest on long-term loan 8 000
Telephone expenses 150
Stationery 120
Current portion of loans from members at amortised cost 30 000

137
SOLUTION 5.1 (continued)

6. Loans to members
Mr L Left Mr R Right Total
R R R
Balance at 1 July 20.14 8 000 6 000 14 000
Advances during the year 10 000 – 10 000
Repayments during the year – – –
Interest capitalised 2 190 1 080 3 270
Balance at 30 June 20.15 20 190 7 080 27 270

7. Loans from members

Mr L Left Mr R Right Total
R R R
Balance at 1 July 20.14
Advances during the year 30 000 30 000 60 000
Repayments during the year – – –
Balance at 30 June 20.15 30 000 30 000 60 000
Current portion (15 000) (15 000) (30 000)
Non-current portion 15 000 15 000 30 000

8. Transactions with members

Mr L Left Mr R Right Total
R R R
Salaries 24 000 36 000 60 000
Interest earned on loans to members (2 190) (1 080) (3 270)
21 810 34 920 56 730

Calculations

 Interest on loans
Loans to members
Interest on loans Mortgage
Mr L Left Mr R Right
R R R
Balance (1 July 20.14) 40 000 8 000 6 000
Interest
(R40 000 x 20%) 8 000
(R 6 000 x 18%) 1 080
(R 8 000 x 18%) 1 440
(R10 000 x 5/12 x 18%) 750
Interest expense 8 000
Interest income 2 190 1 080

R(2 190 + 1 080) = R3 270

138
SOLUTION 5.1 (continued)

‚ Depreciation
Old New
machinery machinery
R R
Cost price 35 000 16 000
Depreciation (3 500)
(R35 000 x 10%)
(R16 000 x 10% x 9/12) (1 200)
Accumulated depreciation (1 July 20.14) (7 000)
Carrying amount (30 June 20.15) 24 500 14 800

ƒ Trade and other receivables R

Trade receivables control: 30 June 20.15 16 000
Credit losses written off (2 500)
13 500

„ Trade and other payables R

The amount on the statement of financial position was calculated as
follows:
Interest in arrears on long-term loan 8 000
Telephone expenses in arrears 150
Stationery in arrears 120
8 270

Current tax payable R

Income tax expense for the year 83 044
Current tax paid during the year (21 000)
Current tax payable 62 044

139
EXERCISE 5.2

The bookkeeper presented you with the following information relating to Note Book CC for the
financial year ended 31 December 20.15:

NOTE BOOK CC
BALANCES AS AT 31 DECEMBER 20.15
R
Member's contribution: N Note (60%) 120 000
Member's contribution: B Book (40%) 80 000
Land and buildings at cost 560 000
Equipment at cost 40 000
Vehicles at cost 200 000
Accumulated depreciation on equipment (1 January 20.15) 12 000
Accumulated depreciation on vehicles (1 January 20.15) 72 000
Trade receivables control 35 000
Trade payables control 48 000
Bank (Dr) 14 000
Fixed deposit 80 000
Mortgage 320 000
Allowance for credit losses 1 500
Retained earnings (31 December 20.14) 18 000
SARS (income tax) (Dr) 52 000
Loan to N Note 40 000
Loan from B Book 60 000
Sales 668 300
Purchases 210 000
Inventory (1 January 20.15) 30 000
Salaries and wages 96 000
Water and electricity 16 000
Stationery consumed 2 900
Carriage on purchases 6 500
Telephone and fax expenses 8 200
Insurance expenses 4 000
Maintenance of vehicles 4 400
Credit losses 800

Additional information

1. The inventory on 31 December 20.15 amounted to R42 000.

2. An additional amount of R2 000 must be written off as irrecoverable. The allowance
for credit losses must be adjusted to R1 650.
3. The land and buildings consist of a shop and offices on Plot 157, situated in Mainland,
and were purchased on 8 January 20.13 for R560 000. It is the policy of the close
corporation not to depreciate land and buildings.
4. Depreciation must be provided for as follows:
Vehicles: 20% per annum according to the diminishing balance method
Equipment: 10% per annum according to the straight-line method
5. On 31 December 20.15, a trade debtor who owes R1 600 will be entitled to a
10% discount if he settles his account before 15 January 20.16. The bookkeeper
recorded the sale transaction correctly but forgot to account for the allowance for
settlement discount granted.

140
EXERCISE 5.2 (continued)

6. Provision must still be made for interest on the fixed deposit at 14% per annum
receivable on 1 January of each year. The fixed deposit was made on 1 January 20.15
at Fair Bank for three years.
7. During the financial year, an amount of R15 000 was paid to member N Note
as remuneration for specialised services rendered to the corporation. This amount was
included in salaries and wages.
8. Interest on the mortgage from CT Bank at 12% per annum must still be considered. The
interest is payable on 2 January 20.16. The loan was obtained on 2 January 20.13 and
is secured by a mortgage over land and buildings. The loan is repayable in total on
2 January 20.22.
9. The loan to member N Note was granted on 1 April 20.13. Interest is calculated at
12% per annum and is payable by the member in January 20.16. The loan is unsecured
and immediately callable.
10. On 1 July 20.15, an amount of R60 000 was borrowed from member B Book. The first
repayment of R20 000 will be made on 30 June 20.16 and the remainder on
30 June 20.19. Interest is calculated on 31 December at a rate of 10% per annum and
is paid in January of every year. The loan is unsecured.
11. Provision must be made for a distribution of 80% of the total comprehensive income for
the financial year to the members.
12. The actual current income tax for the financial year amounted to R79 515 and must
still be recorded.

REQUIRED

With regard to Note Book CC:

a) Prepare the statement of profit or loss and other comprehensive income for the year
ended 31 December 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
31 December 20.15.
c) Prepare the statement of financial position as at 31 December 20.15.
d) Prepare the notes for the year ended 31 December 20.15.

Your answer must comply with the provisions of the Close Corporations Act 69 of 1984 as well
as the requirements of International Financial Reporting Standards (IFRS). Comparative
figures are not required.

NB: Show all calculations.

141
SOLUTION 5.2

a) NOTE BOOK CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.15
Notes R
Revenue R(668 300 – 160➀) 2.4 668 140
Cost of Sales (204 500)
Inventory (1 January 20.15) 30 000
Purchases 210 000
Carriage on purchases 6 500
246 500
Inventory (31 December 20.15) (42 000)
Gross profit 463 640
Other income 16 000
Interest income R(4 800 + 11 200) ➁ 4 16 000
479 640
Distribution, administrative and other expenses (164 050)
Salaries R(96 000 – 15 000) 81 000
Salaries to members 8 15 000
Water and electricity 16 000
Credit losses ➂ 2 950
Depreciation ➃ 2.1, 3 29 600
Stationery consumed 2 900
Telephone and fax expenses 8 200
Maintenance of vehicles 4 400
Insurance expenses 4 000
Finance costs ➄ (41 400)
Interest on mortgage 38 400
Interest on loan from members 8 3 000
Profit before tax 274 190
Income tax expense (79 515)
Profit for the year 194 675
Other comprehensive income for the year –
Total comprehensive income for the year 194 675

b) NOTE BOOK CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.15
Members' Loans
Retained Loans to
contribu- from Total
earnings members
tions members
R R R R R
Balances at 1 January 20.15 200 000 18 000 (40 000) 178 000
Total comprehensive income for the year 194 675 194 675
Distribution to members ➆ (155 740) (155 740)
Loans from/to members 60 000 60 000
Balances at 31 December 20.15 200 000 56 935 60 000 (40 000) 276 935

Non-current liability 40 000

Current liability 20 000

142
SOLUTION 5.2 (continued)

c) NOTE BOOK CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.15
Note R
ASSETS
Non-current assets 766 400
Property, plant and equipment 2.1, 3 686 400
Fixed deposit 2.2, 4 80 000
Current assets 143 190
Inventories 2.3 42 000
Trade and other receivables ➈ 4 47 190
Loans to members 4, 6 40 000
Cash and cash equivalents 4 14 000
Total assets 909 590
EQUITY AND LIABILITIES
Total equity 256 935
Members' contributions 200 000
Retained earnings 56 935
Total liabilities 652 655
Non-current liabilities 360 000
Long-term borrowings ➅ 5, 7 360 000
Current liabilities 292 655
Trade and other payables 5 89 400
Current portion of long-term borrowings 5, 7 20 000
Distribution to members payable 5 155 740
Current tax payable ➇ 27 515

Total equity and liabilities 909 590

d) NOTEBOOK CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.15

1. Basis of presentation

The financial statements have been prepared according to the requirements of the IFRS
appropriate to the business of the entity. The financial statements have been prepared
on the historical cost basis, modified for the fair valuation of certain financial instruments,
and incorporate the principal accounting policies set out below.

2. Summary of significant accounting policies

The annual financial statements incorporate the following significant accounting policies,
which are consistent with those applied in previous years except where otherwise stated.

2.1 Property, plant and equipment

Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings. Equipment and vehicles are subsequently measured
at historical cost less accumulated depreciation and accumulated impairment losses.

143
SOLUTION 5.2 (continued)

Depreciation on equipment and vehicles is written off at a rate deemed to be sufficient

to reduce the carrying amount of the assets over their estimated useful life to their
estimated residual value. The depreciation rates are as follows:
Equipment: 10% per annum according to the straight-line method
Vehicles: 20% per annum according to the diminishing balance method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are
determined by comparing the proceeds with the carrying amount of the asset. The net
amount is included in profit or loss for the year.

2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument.

Financial instruments are initially measured at the transaction price, which is fair value
plus transaction costs, except for "Financial assets at fair value through profit or loss",
which is measured at fair value, transaction costs excluded. The entity classification
depends on the purpose for which the entity acquired the financial assets. Financial
instruments are subsequently measured at fair value unless they are measured at
amortised cost as required by IFRS.

Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

Debt instruments that are classified as current assets or current liabilities are measured
at the undiscounted amount of the cash expected to be received or paid, unless the
arrangement effectively constitutes a financing transaction.

2.3 Inventories

Inventories are initially measured at cost and subsequently valued at the lower of cost
or net realisable value. Cost is calculated by using the first-in-first-out method. Net
realisable value is the estimated selling price in the ordinary course of business less any
costs of completion and disposal.

2.4 Revenue

Revenue is measured at the fair value of the consideration received or receivable.

Revenue represents the transfer of promised goods to customers in an amount that
reflects the consideration which the entity expects to be entitled to in exchange for those
goods. Revenue from the sale of goods consists of the total net invoiced sales excluding
settlement discount granted. The entity is not registered as a VAT vendor. Revenue from
sales is recognised when performance obligations are satisfied.

144
SOLUTION 5.2 (continued)

3. Property, plant and equipment

Land and Equip-
Vehicles Total
buildings ment
R R R R
Carrying amount at 1 January 20.15 560 000 128 000 28 000 716 000
Cost 560 000 200 000 40 000 800 000
Accumulated depreciation – (72 000) (12 000) (84 000)
Depreciation for the year – (25 600) (4 000) (29 600)
Carrying amount at
31 December 20.15 560 000 102 400 24 000 686 400
Cost 560 000 200 000 40 000 800 000
Accumulated depreciation – (97 600) (16 000) (113 600)

The land and buildings consist of a shop and offices on Plot 157, Mainland, and were
purchased on 8 January 20.13. The CC has pledged land and buildings with a carrying
amount of R560 000 as security for the mortgage from CT Bank.

4. Financial assets
20.15
R
Non-current financial assets 80 000
Fixed deposit: 80 000
The fixed deposit was made on 1 January 20.15 for three years
at Fair Bank at 14% interest per annum. The deposit is callable
at 31 December 20.17.

Current financial assets 101 190

Trade and other receivables: 47 190
Trade receivables control ➈ 32 840
Allowance for credit losses (1 650)
Accrued income:
Interest on loan to members 4 800
Interest on fixed deposit 11 200
Loans to members: 40 000
The loans are unsecured and carry interest at 12% per annum.
The loans are immediately callable.
Cash and cash equivalents: 14 000
Bank 14 000

145
SOLUTION 5.2 (continued)

5. Financial liabilities
20.15
R
Non-current financial liabilities at amortised cost 360 000
Long-term borrowings: Mortgage 320 000
The mortgage was acquired from CT Bank on 2 January 20.13
at an interest rate of 12% per annum. This loan is secured by a
first mortgage over land and buildings (refer to note 3) and is
repayable on 2·January 20.22.
Loans from members: 40 000
The loans are unsecured and carry interest at 10% per annum.
R20 000 of the loans are repayable on 30 June 20.16 and the
remainder on 30 June 20.19.
Total loans from members 60 000
Current portion of loans to members (20 000)

Current financial liabilities 265 140

Trade and other payables: 89 400
Trade payables control 48 000
Accrued expenses:
Interest on mortgage 38 400
Interest on loan from members 3 000
Current portion of loans from members at amortised cost 20 000
Distribution to members payable 155 740

6. Loans to members
N Note B Book Total
R R R
Balance at 1 January 20.15 40 000 – 40 000
Advances during the year – – –
Repayments during the year – – –
Balance at 31 December 20.15 40 000 – 40 000

7. Loans from members

N Note B Book Total
R R R
Balance at 1 January 20.15 – – –
Advances during the year – 60 000 60 000
Repayments during the year – – –
Balance at 31 December 20.15 – 60 000 60 000
Current portion – (20 000) (20 000)
Non-current portion – 40 000 40 000

146
SOLUTION 5.2 (continued)

8. Transactions with members

B
N Note Total
Book
R R R
Salaries 15 000 – 15 000
Interest incurred on loan from members – 3 000 3 000
Interest earned on loan to members (4 800) – (4 800)
10 200 3 000 13 200

Calculations

➀ Allowance for settlement discount granted

R1 600 x 10/100 = R160

➁ Interest income
Interest on loan to members
R40 000 x 12/100 = R4 800
Interest on fixed deposit
R80 000 x 14/100 = R11 200

➂ Credit losses
R
Original amount written off 800
Additional amount written off 2 000
Increase in allowance for credit losses * 150
2 950

* New allowance 1 650

Old allowance (1 500)
Increase in allowance 150

➃ Depreciation
Vehicles = R(200 000 – 72 000)
= R128 000 x 20/100
= R25 600
Equipment = R40 000 x 10/100
= R4 000
Total = R(25 600 + 4 000)
= R29 600
➄ Finance costs
Interest on mortgage
R320 000 x 12/100 = R38 400
Interest on loan from members
R60 000 x 10/100 x 6/12 = R3 000

147
SOLUTION 5.2 (continued)

➅ Long-term borrowings
R
Mortgage 320 000
Loan from B Book 60 000
Portion to be repaid in 20.16 financial year (20 000) 40 000
360 000
Current portion of loans from members
The current portion of loans from members represents that portion of the loan of
R60 000 that will be repaid in the 20.16 financial year (refer to calculation).

➆ Distribution to members payable

R194 675 x 80/100 = R155 740

➇ Current tax payable

R
Income tax for the year 79 515
SARS (income tax) (52 000)
Current tax payable 27 515

➈ Trade receivables
R(35 000 – 2 000 – 160) = R32 840

148
EXERCISE 5.3

After the bookkeeper had recorded the transactions during the year, he handed you the
following trial balance and additional information with regard to Trade Acc CC:

TRADE ACC CC
TRIAL BALANCE AS AT 31 DECEMBER 20.15
Debit Credit
R R
Land and buildings at cost 95 000
Furniture and equipment at cost 33 000
Vehicles at cost 21 000
Accumulated depreciation: Furniture and equipment (1 January 6 700
20.15)
Accumulated depreciation: Vehicles (1 January 20.15) 8 400
Inventory (1 January 20.15) 54 600
Mortgage 50 000
Trade receivables control 20 500
Allowance for credit losses (1 January 20.15) 955
Bank 24 000
Trade payables control 37 100
SARS (income tax) 6 900
Sales 319 950
Purchases 224 700
Import duty on purchases 1 550
Railage on purchases 2 500
Repairs and maintenance 1 315
Assessment rates 1 710
Commission on sales 1 500
Delivery expenses 650
Salaries and wages 36 615
Stationery consumed 520
Credit losses 460
Loss on sale of equipment 220
Insurance expenses 475
Water and electricity 2 100
Dividends received 450
Settlement discount received 1 000
Investment 10 000
Loan from member: A Adam 10 000
Loan from member: C Charles 8 000
Interest expenses (in respect of loans) 9 660
Member's contribution: A Adam 40 000
Member's contribution: B Ben 35 000
Member's contribution: C Charles 25 000
Retained earnings (1 January 20.15) 6 220
Allowance for settlement discount granted (1 January 20.15) 200
548 975 548 975

149
EXERCISE 5.3 (continued)

Additional information

1. The interest of the members in the CC is in the same ratio as their contributions.
2. The land and buildings consist of a shop and offices on Plot 32, situated in Clarence,
and were purchased on 15 March 20.14 for R95 000. It is the policy of the close
corporation not to depreciate land and buildings.
3. The investment in Vicks Limited consists of 10 000 ordinary shares at R1 each and was
acquired in 20.14. On 31 December 20.14, the fair value of the investment was
determined at R10 000. On 31 December 20.15, the fair value was determined at
R11 000 and is still to be recorded.
4. Included in salaries and wages is an amount of R10 000 that was paid to member B Ben
as remuneration for his special contribution to the management of the enterprise.
5. Provision for depreciation of R1 650 on furniture and equipment and R2 100 on vehicles
must still be made. Depreciation is written off according to the straight-line method on
furniture and equipment and vehicles and no sales or purchases of furniture and
equipment or vehicles occurred in the year.
6. The interest paid includes R2 160, which represents 12% interest paid to A Adam and
C Charles in respect of the loans they made to the close corporation. The loans are
unsecured and are repayable on 31 December 20.19.
7. The mortgage was acquired on 2 January 20.15 from Bug Bank at 15% interest per
annum. Interest is payable on 31 December. The loan is secured by a first mortgage
over land and buildings and is repayable in five equal annual instalments as from
2 January 20.18.
8. The allowance for credit losses must be adjusted to R1 025.
9. On 31 December 20.15, the inventory on hand amounted to R58 300.
10. The actual current income tax in respect of the financial year amounted to R11 166 and
must still be recorded.
11. Distribution of income of R20 000 must be made to the members.
12. The allowance for settlement discount granted on 1 January 20.15 must be written back
since the debtor did not settle his account on time. On 31 December 20.15, a trade
debtor who owes R1 500 is entitled to a 5% discount provided he settles his account
before 10 January 20.16. The bookkeeper recorded the sales transaction correctly but
forgot to account for the allowance for settlement discount granted.
13. Trade Acc CC was offered a discount of 6% on an amount of R 1 200 owing to a supplier
provided the supplier is paid before 15 January 20.16. The close corporation intends
taking advantage of the discount offered.
14. On 31 December 20.15, the land and buildings were revalued to R150 000 by Mr Sono,
an independent sworn appraiser. This information must still be recorded in the
accounting records of Trade Acc CC.

REQUIRED

With regard to Trade Acc CC:

a) Prepare the statement of profit or loss and other comprehensive income for the
year ended 31 December 20.15.

150
EXERCISE 5.3 (continued)
b) Prepare the statement of changes in net investment of members for the year ended
31 December 20.15.
c) Prepare the statement of financial position as at 31 December 20.15.

d) Prepare the notes for the year ended 31 December 20.15.

Your answer must comply with the provisions of the Close Corporations Act 69 of 1984,
as well as the requirements of International Financial Reporting Standards (IFRS).

Comparative figures are not required.

NB: Show all calculations.

151
SOLUTION 5.3

a) TRADE ACC CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.15
Note R
Revenue R(319 950 – 75 ➀ + 200) 2.4 320 075
Cost of Sales (223 978)
Inventory (1 January 20.15) 54 600
Purchases R(224 700 – 1 072 ➁) 223 628
Import duty 1 550
Railage on purchases 2 500
282 278
Inventory (31 December 20.15) (58 300)
Gross profit 96 097
Other income 1 450
Dividend income: Listed share investment 450
Fair value adjustment: Listed share investment 1 000
97 547
Distribution, administrative and other expenses (49 385)
Repairs and maintenance 1 315
Assessment rates 1 710
Commission on sales 1 500
Delivery expenses 650
Salaries and wages R(36 615 – 10 000) 26 615
Salary to member 7 10 000
Stationery consumed 520
Credit losses ➂ 530
Loss on sale of equipment 220
Insurance expenses 475
Water and electricity 2 100
Depreciation ➃ 2.1, 3 3 750
Finance costs (9 660)
Interest on mortgage 5 7 500
Interest on loan from members 7 2 160
Profit before tax 38 502
Income tax expense (11 166)
Profit for the year 27 336
Other comprehensive income for the year 55 000
Revaluation surplus 55 000

Total comprehensive income for the year 82 336

152
SOLUTION 5.3 (continued)

b) TRADE ACC CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.15
Members' Revalua- Loans
Retained
contri- tion from Total
earnings
butions surplus members
R R R R R
Balances at 1 January 20.15 100 000 6 220 – 18 000 124 220
Profit for the year 27 336 27 336
Revaluation surplus 55 000 55 000
Distribution to members (20 000) (20 000)
Balances at 31 December 20.15 100 000 13 556 55 000 18 000 186 556

c) TRADE ACC CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.15
Notes R
ASSETS
Non-current assets 185 150
Property, plant and equipment 2.1, 3 185 150
Current assets 112 700
Inventories 2.3 58 300
Trade receivables ➄ 4 19 400
Listed share investment 2.2, 4 11 000
Cash and cash equivalents 4 24 000
Total assets 297 850
EQUITY AND LIABILITIES
Total equity 168 556
Members' contributions 100 000
Retained earnings 13 556
Revaluation surplus 55 000
Total liabilities 129 294
Non-current liabilities 68 000
Long-term borrowings 5, 6 68 000
Current liabilities 61 294
Trade payables ➅ 5 37 028
Distribution to members payable 20 000
Current tax payable ➆ 4 266

Total equity and liabilities 297 850

d) TRADE ACC CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.15

1. Basis of presentation

The financial statements have been prepared according to the requirements of the IFRS
appropriate to the business of the entity. The financial statements have been prepared on
the historical cost basis, modified for the fair valuation of certain financial instruments, and
incorporate the principal accounting policies set out below.

153
SOLUTION 5.3 (continued)

2. Summary of significant accounting policies

The financial statements incorporate the following significant accounting policies that are
consistent with those applied in previous years, except where otherwise stated.

2.1 Property, plant and equipment

Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings that are revalued at regular intervals by an independent
sworn appraiser. Vehicles, furniture and equipment are subsequently measured at
historical cost less accumulated depreciation and accumulated impairment losses.

Depreciation on vehicles and furniture and equipment is written off at a rate deemed to
be sufficient to reduce the carrying amount of the assets over their estimated useful life
to their estimated residual value. Depreciation is written off as follows:
• Vehicles: 10%* per annum according to the straight-line method
• Furniture and equipment: 5%** per annum according to the straight-line method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are
determined by comparing the process with the carrying amount of the asset. The net
amount is included in profit or loss for the year.

* R(2 100/21 000) x 100%

** R(1 650/33 000) x 100%

2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument.

Financial instruments are initially measured at the transaction price, which is fair value
plus transaction costs, except for "Financial assets at fair value through profit or loss",
which is measured at fair value, transaction costs excluded. The entity classification
depends on the purpose for which the entity acquired the financial assets. Financial
instruments are subsequently measured at fair value unless they are measured at
amortised cost as required by IFRS.

Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

Debt instruments that are classified as current assets or current liabilities are measured
at the undiscounted amount of the cash expected to be received or paid, unless the
arrangement effectively constitutes a financing transaction.

2.3 Inventories

Inventories are initially measured at cost and subsequently valued at the lower of cost or
net realisable value. Cost is calculated by using the first-in-first-out method. Net realisable
value is the estimated selling price in the ordinary course of business less any costs of
completion and disposal.

154
SOLUTION 5.3 (continued)

2.4 Revenue

Revenue is measured at the fair value of the consideration received or receivable.

Revenue represents the transfer of promised goods to customers in an amount that
reflects the consideration which the entity expects to be entitled to in exchange for those
goods. Revenue from the sale of goods consists of the total net invoiced sales excluding
settlement discount granted. The entity is not registered as a VAT vendor. The revenue
from sales is recognised when the performance obligations are satisfied.

3. Property, plant and equipment

Furniture
Land and
and equip- Vehicles Total
buildings
ment
R R R R
Carrying amount at 31 January 20.15 95 000 26 300 12 600 133 900
Cost 95 000 33 000 21 000 149 000
Accumulated depreciation – (6 700) (8 400) (15 100)
Revaluation surplus 55 000 55 000
Depreciation for the year – (1 650) (2 100) (3 750)
Carrying amount at 31 December 20.15 150 000 24 650 10 500 185 150
Cost/Valuation 150 000 33 000 21 000 204 000
Accumulated depreciation – (8 350) (10 500) (18 850)

The land and buildings consist of a shop and offices on Plot 32, Clarence, and were
purchased on 15 March 20.14. The CC has pledged land and buildings with a carrying
amount of R95 000 as security for the mortgage from Bug Bank. The land and buildings
were revalued by R55 000 on 31 December 20.15 by an independent sworn appraiser.

4. Financial assets
20.15
R
Current financial assets 54 400
Trade and other receivables: 19 400
Trade receivables control R(20 500 – 75) 20 425
Allowance for credit losses (1 025)
Listed investment: 11 000
Listed share investments held for trading at fair value through
profit or loss: 10 000 R1 ordinary shares in Vicks Limited
Cash and cash equivalents: 24 000
Bank 24 000

155
SOLUTION 5.3 (continued)

5. Financial liabilities
20.15
R
Non-current financial liabilities at amortised cost 68 000
Long-term borrowings: Mortgage 50 000
The mortgage was acquired from Bug Bank on 2 January 20.15 at
an interest rate of 15% per annum. The loan is repayable in five
equal payments from 2 January 20.18. The loan is secured by a first
mortgage over land and buildings.
Loans from members: 18 000
The loans are unsecured and carry interest at 12% per annum.
R20 000 of the loans are repayable on 31 December 20.19.

Current financial liabilities 57 028

Trade payables: 37 028
Trade payables control 37 028
Distribution to members payable 20 000

6. Loans from members

A Adam B Ben C Charles Total
R R R R
Balance at 1 January 20.15 10 000 – 8 000 18 000
Advances during the year – – – –
Repayments during the year – – – –
Balance at 31 December 20.15 10 000 – 8 000 18 000

The loans are unsecured and an interest rate of 12% per annum is applicable. The loans
are repayable on 31 December 20.19.

7. Transactions with members

A Adam B Ben C Charles Total
R R R R
Interest on loans from members 1 200 – 960 2 160
Salaries – 10 000 – 10 000
1 200 10 000 960 12 160

Calculations

➀ Allowance for settlement discount granted

R1 500 x 5/100 = R75

156
SOLUTION 5.3 (continued)

➁ Settlement discount received R

Settlement discount received for the period 1 000
* Allowance for settlement discount received 72
1 072
Allowance for settlement discount received
R1 200 x 6/100 = R72

➂ Credit losses
R[460 + (1 025 – 955)]
= R(460 + 70)
= R530

➃ Depreciation
R(1 650 + 2100) = R3 750

➄ Trade and other receivables

R
Trade receivables control 20 500
Allowance for settlement discount granted (75)
20 425
Allowance for credit losses (1 025)
19 400

➅ Trade and other payables

R
Trade payables control 37 100
Allowance for settlement discount received (72)
37 028

➆ Current tax payable

R
Income tax for the year 11 166
Current tax paid during the year (6 900)
Current tax payable 4 266

157
EXERCISE 5.4

The bookkeeper has provided you with the following trial balance and additional information
regarding Loga CC for the year ended 28 February 20.15:

LOGA CC
TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Debit Credit
R R
Member's contribution: L Lock 252 000
Member's contribution: G Gate 245 000
Land and buildings at valuation 500 000
Vehicles at cost 54 000
Equipment at cost 18 000
Inventory 172 080
Trade receivables control 50 184
Trade payables control 83 304
Loan to G Gate 12 000
Investment (Fixed deposit at ABC bank) 25 000
Bank 6 956
Accumulated depreciation: Equipment (1 March 20.14) 3 600
Sales 1 168 236
Cost of Sales 778 812
Retained earnings (1 March 20.14) 6 420
Revaluation surplus 140 000
Rental expenses 14 400
Advertising expense 4 800
Salaries and wages 168 020
Water and electricity 8 640
Telephone expenses 2 160
Income from investment 1 500
Credit losses 540
Administrative expenses 2 868
Remuneration: Accounting officer 4 320
SARS (income tax) 30 000
Interim profit distribution to members 48 000
Interest income 720
1 900 780 1 900 780

Additional information

1. A debtor cannot be traced and his debt of R184 must be written off as irrecoverable. At
year-end, the members decided to create an allowance for credit losses of R1 000.
2. The electricity account for February, R785, was received on 20 March 20.15.
3. On 1 June 20.14, an insurance contract was entered into. The premium of R800,
payable annually on 1 June, is included in administrative expenses.
4. The loan to G Gate was made on 1 March 20.14 at 12% interest per annum, payable
every six months. The loan is unsecured and immediately callable.

158
EXERCISE 5.4 (continued

5. Included in salaries and wages is an amount of R20 000, paid to L Lock as remuneration
for his special contribution to the management of the entity.
6. The investment at ABC Bank was made on 1 May 20.14 for 60 months at 12% interest
per annum, which is receivable every six months on 31 October and 30 April.
7. The land and buildings were acquired on 31 March 20.13 for R300 000 and consist of
shops and offices situated at number 23 Rhavi Road, Dealsville. Additions to buildings
were completed at a cost of R60 000 on 31 July 20.14.
8. On 28 February 20.14, the land and buildings were revalued for the first time to
R340 000. The land and buildings are not depreciated.
9. Provision must still be made for the following:
• Depreciation on the vehicle and equipment at 20% per annum on the diminishing
balance. The vehicle was acquired on 1 September 20.14.
• Actual current income tax for the financial year amounted to R51 494.
• Additional distribution to members of R36 000. Members share profits equally.

REQUIRED

With regard to Loga CC:

a) Prepare the statement of profit or loss and other comprehensive income for the year
ended 28 February 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
28 February 20.15.
c) Prepare the statement of financial position as at 28 February 20.15.
d) Prepare only the following notes for the year ended 28 February 20.15:
• Accounting policy
• Property, plant and equipment
• Transactions with members

Your answer must comply with the provisions of the Close Corporations Act 69 of 1984, as
well as the requirements of International Financial Reporting Standards (IFRS). Comparative
figures are not required.

NB: Show all calculations.

159
SOLUTION 5.4

a) LOGA CC
STATEMENT OF PROFIT OR LOSS AND COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Notes R
Revenue 2.4 1 168 236
Cost of Sales (778 812)
Gross profit 389 424
Other income 3 940
Interest income R(1 440 + 2 500) ➀ 3 940
393 364
Distribution, administrative and other expenses (215 797)
Rental expenses 14 400
Advertising expense 4 800
Salaries and wages R(168 020 – 20 000) 148 020
Salary to member 4 20 000
Water and electricity ➁ 9 425
Telephone expenses 2 160
Credit losses ➂ 1 724
Administrative expenses ➃ 2 068
Insurance expense ➄ 600
Remuneration: Accounting officer 4 320
Depreciation ➅ 2.1, 3 8 280
Profit before tax 177 567
Income tax expense (51 494)
Profit for the year 126 073
Other comprehensive income for the year 100 000
Revaluation surplus 100 000
Total comprehensive income for the year 226 073

b) LOGA CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15
Members' Revalua-
Retained Loans to
contri- tion Total
Earnings Members
butions surplus
R R R R R
Balances at 1 March 20.14 497 000 6 420 40 000 – 543 420
Total comprehensive income for
the year 126 073 100 000 226 073
Profit for the year 126 073 126 073
Revaluation surplus 100 000 100 000
Loan to a member (12 000) (12 000)
Distribution to members (84 000) (84 000)
Balances at 28 February 20.15 497 000 48 493 140 000 (12 000) 673 493

160
SOLUTION 5.4 (continued)

c) LOGA CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Notes R
ASSETS
Non-current assets 585 120
Property, plant and equipment 2.1, 3 560 120
Fixed deposit 2.2 25 000
Current assets 241 956
Inventories 2.3 172 080
Trade and other receivables ➇ 50 720
Prepayments ➈ 200
Loan to a member 12 000
Cash and cash equivalents 6 956
Total assets 827 076
EQUITY AND LIABILITIES
Total equity 685 493
Members' contributions 497 000
Retained earnings 48 493
Revaluation surplus 140 000
Total liabilities 141 583
Current liabilities 141 583
Trade and other payables ⑩ 84 089
Distribution to members payable ➆ 36 000
Current tax payable ⑪ 21 494

Total equity and liabilities 827 076

d) LOGA CC
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.15

1. Basis of presentation

The financial statements have been prepared according to the requirements of the IFRS
appropriate to the business of the entity. The financial statements have been prepared
on the historical cost basis, modified for the fair valuation of certain financial instruments,
and incorporate the principal accounting policies set out below.

2. Summary of significant accounting policies

The financial statements incorporate the following significant accounting policies that
are consistent with those applied in previous years, except where otherwise stated.

2.1 Property, plant and equipment

Property, plant and equipment are initially recognised at cost price. No depreciation is
written off on land and buildings that are revalued at regular intervals by an independent
appraiser. Equipment and vehicles are subsequently measured at historical cost less
accumulated depreciation and accumulated impairment losses.

161
SOLUTION 5.4 (continued)

Depreciation on equipment and vehicles is written off at a rate deemed to be sufficient

to reduce the carrying amount of the assets over their estimated useful life to their
estimated residual value. The depreciation rates are as follows:
• Equipment: 20% per annum according to the diminishing balance method
• Vehicles: 20% per annum according to the diminishing balance method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are
determined by comparing the proceeds with the carrying amount of the asset. The net
amount is included in profit or loss for the year.

2.2 Financial instruments

Financial instruments are recognised in the entity's statement of financial position when
the entity becomes a party to the contractual provisions of an instrument.

Financial instruments are initially measured at the transaction price, which is fair value
plus transaction costs, except for "Financial assets at fair value through profit or loss",
which is measured at fair value, transaction costs excluded. The entity classification
depends on the purpose for which the entity acquired the financial assets. Financial
instruments are subsequently measured at fair value unless they are measured at
amortised cost as required by IFRS.

Financial instruments that are subsequently measured at amortised cost are done so by
using the effective interest rate method.

Debt instruments that are classified as current assets or current liabilities are measured
at the undiscounted amount of the cash expected to be received or paid, unless the
arrangement effectively constitutes a financing transaction.

2.3 Inventories

Inventories are initially measured at cost and subsequently valued at the lower of cost
or net realisable value. Cost is calculated by using the first-in-first-out method. Net
realisable value is the estimated selling price in the ordinary course of business less any
costs of completion and disposal.

2.4 Revenue

Revenue is measured at the fair value of the consideration received or receivable.

Revenue represents the transfer of promised goods to customers in an amount that
reflects the consideration which the entity expects to be entitled to in exchange for those
goods. Revenue from the sale of goods consists of the total net invoiced sales excluding
value-added tax and settlement discount granted. The revenue from sales is recognised
when the performance obligations are satisfied.

162
SOLUTION 5.4 (continued)

3. Property, plant and equipment

Land and Furniture
buildings and Vehicles Total
equipment
R R R R
Carrying amount at 1 March 20.14 340 000 14 400 – 354 400
Cost/Valuation 340 000 18 000 – 358 000
Accumulated depreciation – (3 600) – (3 600)
Revaluation surplus for the year 100 000 – – 100 000
Additions 60 000 – 54 000 114 000
Depreciation for the year – (2 880) (5 400) (8 280)
Carrying amount at 28 February 500 000 11 520 48 600 560 120
20.15
Cost 500 000 18 000 54 000 572 000
Accumulated depreciation – (6 480) (5 400) (11 880)

Land and buildings consist of shops and offices at 23 Rhavi Road, Dealsville. An
independent sworn appraiser revalues land and buildings annually.

4. Transactions with members

L Lock G Gate Total
R R R
Salary 20 000 – 20 000
Interest on loan to member – (1 440) (1 440)
20 000 (1 440) 18 560

Calculations

➀ Interest on loan to member

R12 000 x 12% = R1 440
Interest on investment
R25 000 x 12% x 10/12 = R2 500

➁ Water and electricity

R(8 640 + 785) = R9 425

➂ Credit losses
R
Original amount written off 540
Further amount written off 184
Allowance for credit losses 1 000
1 724

➃ Administrative expenses
R(2 868 – 800) (R800 = insurance premium) = R2 068

➄ Insurance
The R800 was paid for one year, starting on 1 June 20.14. Only nine months of this
period falls within the current financial year. Therefore, only R800 x 9/12 = R600 of the
expense was incurred during the current financial year. The R200 that falls outside this
financial period must be shown in the statement of financial position as a prepayment
for the next financial period.

163
SOLUTION 5.4 (continued)

➅ Depreciation
Equipment:
R
Equipment 18 000
Accumulated depreciation (3 600)
Diminished balance (carrying amount) 14 400
R14 400 x 20% = R2 880
Vehicle:
R54 000 x 20% x 6/12 = R5 400
Total depreciation:
= R(2 880 + 5 400) = R8 280

➆ Distribution to members and distribution to members payable

R
Distribution to members R(48 000 + 36 000) 84 000
Interim distribution paid to members (48 000)
Distribution to members payable 36 000

➇ Trade receivables
R
Trade receivables control R(50 184 – 184) 50 000
Allowance for credit losses (1 000)
49 000
Accrued interest on loan to member R(1 440 – 720) 720
Accrued interest on investment R(2 500 – 1 500) 1 000
50 720

➈ Prepayments
R
Prepayments represent insurance prepaid (refer to Insurance) 200

⑩ Trade payables
R
Trade payables control 83 304
Accrued expenses (water and electricity) 785
84 089

⑪ Current tax payable

R
Income tax for the year 51 494
SARS: Income tax paid during the year (30 000)
Current tax payable 21 494

164
 Self-assessment

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly discuss the Close Corporations Act regarding matters concerning the
attributes, registration, internal and external relations, accounting records
and annual financial statements, joint liability of members and others for
certain debts of a close corporation, tax position of a close corporation and
its members, as well as the deregistration of a close corporation.

Prepare the financial statements (except for a statement of cash flows) of a

close corporation according to the provisions of the Close Corporations Act
and the requirements of IFRS and, where applicable, the guidelines as
presented in the Guide on Close Corporations and Companies Act No. 71
of 2008 Regulations (as issued by SAICA, December 2001).

If you answered "yes" to all of the assessment criteria, you have completed your
studies on close corporations and can move on to learning unit 7. If you answered
"no" to any of the criteria, you must revise those sections before progressing to
learning unit 7.

Food for thought:

Do you think that you would prefer to establish a partnership if you had the
opportunity, or would you have preferred to establish a close corporation instead?

165
LEARNING UNIT 9

6
Statement of cash flows

Learning outcomes ............................................................................................................ 167

Key concepts ..................................................................................................................... 167
6.1 Introduction ............................................................................................................... 168
6.2 Main objective and advantages of a statement of cash flows .................................. 168
6.3 Format of a statement of cash flows ......................................................................... 169
6.4 Relationship between a statement of cash flows and other financial statements..... 170
6.5 Identification of non-cash entries in financial statements prepared on the accrual
basis of accounting ................................................................................................... 171
6.6 Preparation of a statement of cash flows from financial statements prepared on
the accrual basis of accounting ................................................................................ 173
6.7 Exercises and solutions ............................................................................................ 181
Self-assessment ................................................................................................................ 196

166
 Learning outcomes

After studying this learning unit, you should be able to do the following:

• Discuss, in general terms, the purpose and importance of a statement of cash flows.
• Explain the relationship between a statement of cash flows and the other financial
statements.
• Prepare a statement of cash flows and the note regarding non-cash transactions
pertaining to investing activities and financing activities of a sole proprietor, partnership
close corporation and company according to the requirements of IAS 7 by utilising
information that is mainly obtained from the other financial statements and relevant notes
thereto.

Key concepts

• Cash and cash equivalents

• Non-cash transactions
• Operating activities
• Direct and indirect methods
• Investing activities
• Financing activities

167
6.1 Introduction
According to IAS 1, which was covered in learning unit 1, the objective of financial statements
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. The information
reported on in a statement of profit or loss and other comprehensive income, a statement of
financial position and a statement of changes in equity cannot meet all the informational needs
of the users. More so in respect of the liquidity of a business entity. A liquidity analysis of a
business entity, inter alia, indicates how a business is managing its cash flows. Such
information is of great importance, since it shows, for example, from which resources the
transactions of a business entity are financed.

Making a profit is one side of the coin for a successful business, but cash management is
essential to keep on trading. Cash flow and profit are not necessarily the same – the crucial
difference between the two concepts is timing. For example, when an entity sells to a customer
on credit, the sale is immediately accounted for in the statement of profit or loss and other
comprehensive income (referred to as the accrual accounting concept) and will result in a
profit if the sale was above the cost of the inventory. However, the entity does not receive the
cash immediately and a statement of cash flows will include this credit transaction only when
the actual cash is received. Furthermore, the sustainability of a business, for example, will be
questioned when its operating activities are predominantly financed with external funds (such
as long-term borrowings). The purpose of a statement of cash flows (as prescribed by IAS 7)
is to provide information on the cash position of the entity about the inflow and outflow of cash
during the year.

You will encounter the statement of cash flows throughout your accounting studies. It is
therefore very important that your foundational knowledge of cash flows is good.

6.2 Main objective and advantages of a statement of cash flows

Other financial statements (the statement of financial position, the statement of changes in
equity, the statement of profit or loss and other comprehensive income) may include
amounts that result from non-cash transactions, and therefore do not necessarily represent
an equal amount of cash flow. For example, it is highly unlikely that all of the assets of an
entity may be obtained by cash purchases. The revenue figure could include both cash and
credit transactions. Non-cash transactions are included in the other financial statements
owing to the application of the accrual concept, which implies that income must be
recognised when it is earned and expenses when they are incurred (and not when cash is
received or paid).

The statement of cash flows, on the other hand, deals only with cash received and cash
payments. The statement of cash flows provides users with the following valuable
information:

• The cash that was generated through operating activities

• Cash used to acquire non-current assets and cash obtained from the disposal of non-
current assets

168
• The amount of money invested during the year or money received from the maturity of
investments previously made
• Any amounts borrowed and repaid during the financial year
• The extent to which the entity used borrowed funds or obtained equity in the period under
review

6.3 Format of a statement of cash flows

IAS 7 prescribes two methods for the preparation of a statement of cash flows, namely the
direct or indirect method. Only the direct method is discussed in detail further on in this
learning unit as the indirect method falls outside the scope of this module. Note that the format
(framework) presented below is a comprehensive illustration of entries that can be included in
a statement of cash flows for different types of entities. Further references to the format of a
statement of cash flows pertain to this framework.

The statement of cash flows is divided into three activities, namely operating, investing and
financing activities. The net cash inflow/(outflow) of each of these three activities determines
the net increase/(decrease) in the cash and cash equivalents for the given period. The cash
and cash equivalents at the beginning of the period are then brought into account in order
to close off with the cash and cash equivalents at the end of the period.

It is important to take note of the fact that in a statement of cash flows, cash outflows are
indicated by showing the figures in brackets and cash inflows are shown without brackets.

The following is the framework of the statement of cash flows:

NAME OF BUSINESS
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED (Direct method)
R R
CASH FLOWS FROM OPERATING ACTIVITIES
Cash receipts from customers (all entities) xxx
Cash paid to suppliers and employees (all entities) (xxx)
Cash generated from/(used in operations) xxx
Interest received (all entities)
Interest paid (all entities) (xxx)
Dividends received (all entities) xxx
Distribution paid (close corporations) (xxx)
Drawings (cash and inventory) by owner/partner(s)
(sole proprietor/partnership) (xxx)
Income tax paid (close corporations and companies) (xxx)
Loans to members (close corporations) (xxx)
Repayment of loans to members xxx
Proceeds from the sales of financial assets at fair value through
profit or loss: Held for trading (such as listed share investments) xxx

Continued on the next page

169
 CASH FLOWS FROM OPERATING ACTIVITIES (continued)

Acquisition of financial assets at fair value through profit or loss:

Held for trading (such as listed share investments) (xxx)
Net cash from/(used in) operating activities xxx

CASH FLOWS FROM INVESTING ACTIVITIES

Investments in property, plant and equipment to maintain
operating capacity: Replacement of property, plant and
equipment (xxx)
Investments in property, plant and equipment to expand
operating capacity: Additions of property, plant and equipment (xxx)
Proceeds from the sale of property, plant and equipment xxx
Acquisition of investments (unlisted share investments) (xxx)
Proceeds from the sale/collection/maturity of investments
(unlisted share investments and loans and receivables) xxx
Net cash from/(used in) investing activities xxx

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from capital contributions (sole proprietorship/partnership) xxx
Proceeds from members’ contributions (close corporations) xxx
Proceeds from shares issued (company) xxx
Proceeds from loans from members (close corporation) xxx
Proceeds from loans, mortgages, etc. (all entities) xxx
Repayment of short-term borrowings (all entities) (xxx)
Repayment of long-term borrowings (all entities) (xxx)
Net cash from/(used in) financing activities xxx
Net increase/(decrease) in cash and cash equivalents xxx
Cash and cash equivalents at the beginning of year xxx
Cash and cash equivalents at end of year xxx

* Cash inflows are shown without brackets, and cash outflows and profit loss with brackets

6.4 Relationship between a statement of cash flows and other

financial statements
Apart from a statement of cash flows, financial statements consist of the following:

• Statement of profit or loss and other comprehensive income

• Statement of financial position
• Statement of changes in equity
• Notes to the financial statements

The statement of cash flows is complementary to other statements and can be prepared
from information in the various statements and notes. Because statements of cash flows
contain only cash flow entries, it is very important to be able to distinguish between cash
and non-cash entries.

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6.5 Identification of non-cash entries in financial statements
prepared on the accrual basis of accounting
Non-cash transactions (entries) are those transactions that do not involve movement in cash
or cash equivalents during a specific financial period. As the statement of cash flows only
discloses cash flow items, these non-cash transactions must be identified and disregarded
when a statement of cash flows is prepared. Examples of non-cash transactions are:

Ø Depreciation is an operating expense that causes a non-cash decrease in profits of

a reporting entity. The general journal entries in respect of creating and making an
additional provision thereof for the current year include only the depreciation and
accumulated depreciation accounts. The bank account is not influenced, and no
cash movement takes place when the provision is made.
Ø The profit on sale of property, plant and equipment is a non-operating item resulting
from the sale of an asset for more than the amount shown in the entity's accounting
records. The profit is the difference between the proceeds from the sale and the
carrying amount shown on the accounting records. When the profit on sale is
accounted for in the books of a reporting entity, the applicable journal entries do not
influence the cash and cash equivalents because the realisation account is debited
with the amount of the profit and the profit on sale of the property, plant and equipment
are applicable. If property, plant and equipment were sold on credit and no payment
was received during the current year, no proceeds will be shown in the statement of
cash flows. With the calculation of the changes in current assets and current liabilities,
the closing balance of the trade and other receivables of the current year must first be
adjusted by decreasing it by the selling price before the change in the trade and other
receivables can be calculated. The cash received from customers will not be
influenced by this sales transaction (whether on cash or credit) because only cash
received which is not disclosed in the statement of cash flows at a later stage must be
considered. (The cash received from customers relates only to the operating
activities.)
Ø When assets are purchased on credit, no cash flow takes place until payments to the
creditor(s) have been made. The accounts that are affected relating to the purchase
of an asset are the asset concerned account and creditors control account. For the
purpose of preparing a statement of cash flows, such purchase transactions must be
omitted by cancelling this journal entry through a calculation (which does not form part
of the accounting system). The cost price of the asset and the balance of the creditors
at the end of the year must therefore be reduced by the purchase price. Only
payments made to the creditor(s) must be disclosed in the statement of cash flows as
either an investment or financing activity. If the purchase price of the asset which was
purchased on credit is material, the details regarding the transaction must be
disclosed through a note to the statement of cash flows.
Ø The writing-off of credit losses. When a credit loss is written off, the credit losses
account is debited, and debtors (trade receivables) credited. Again, no cash
movement takes place.

171
 Ø The creation of an allowance for credit losses account, or a change in the balance
thereof. The following example illustrates how the creation of the allowance for credit
losses is recorded in the books:

Assume the following:

- The balance of the allowance for credit losses account at the end of the financial
years 20.1 and 20.2 were R1 000 and R2 000 respectively.
- Credit losses were disclosed as an expense of R1 000 in the statement of profit or
loss and other comprehensive income for the year ended 28 February 20.11. This
entry was the result of the increase of R1 000 (R2 000 – R1 000) in the allowance
account.

The general journal entry which must be cancelled out for cash flow statement
purposes is:
Dr Cr
R R
Credit losses 1 000
Allowance for credit losses 1 000
Increase in the allowance for credit losses

Unlike the credit losses that were written off against the debtors, this journal entry does
not influence the cash receipts from customers, because the debtors’ account was not
involved. The balances of the trade and other receivables in the statement of financial
position of the current and the previous year must be adjusted to determine the
balances of this account before the provision was deducted. The effect of this is to
eliminate the non-cash effect of the provision account. In the above example, the
balances will be adjusted from R15 000 to R16 000 (R15 000 + R1 000) and from
R25 000 to R27 000 (R25 000 + R2 000).

The effect of the writing-off of credit losses and the change in the balance of the
allowance for credit losses account is summarised as follows:

Creating the allowance for

Effect of the calculation of: Credit losses written off
credit losses account
Cash receipts from customers Should the trade receivables Only if the trade and other
control account be receivables figures as
reconstructed, the credit loss indicated in the statement of
written off will decrease the financial position is going to be
balancing figure (Bank). used for the calculation. In
such a case the balances of
the allowance account must be
added to the balances of the
debtors account.
Cash paid to suppliers and The credit loss as indicated in The credit loss as indicated in
employees the statement of profit or loss the statement of profit or loss
and other comprehensive and other comprehensive
income must not be income must not be
considered. considered.

172
The following is an additional list of non-cash transactions that must be eliminated when
preparing a statement of cash flows:

• An entry in the sales, purchases, sales returns or purchases returns journal

• Accrual based year-end adjustment
• Credit sales and purchases
• Drawings of inventory by a sole proprietor
• The recording of rental expenses in arrears at the end of a financial year
• The recording of salaries attributable to partners according to a partnership agreement
• The recording of rental income in arrears at the end of a financial year
• The closing-off of a prepaid expense to a related expense account at the beginning of
a financial year
• Losses with the writing-off of inventory
• Revaluation of assets and fair value adjustments
• Recording a profit or loss made on the sale of a non-current asset

Activity 6.1

Make a list of seven or eight non-cash transactions.

Feedback 6.1

• Depreciation
• Allowance for credit losses/increases or decreases in the allowance
• Profit or loss on sale of assets
• Losses with the writing-off of inventory
• Revaluation of assets and fair value adjustments
• Credit losses written off
• Certain adjustments such as expenses in arrears or income in arrears
• Credit sales and credit purchases

6.6 Preparation of a statement of cash flows from financial

statements prepared on the accrual basis of accounting
A statement of cash flows is normally prepared directly from the financial statements of a
reporting entity. It is also possible to prepare a statement of cash flows from the cash journals
or from the cash and cash equivalent accounts in the general ledger of a business entity
(e.g. the bank and petty cash accounts). In this module, a statement of cash flows is
prepared according to the information obtained from the financial statements and from any
additional information that is required.

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6.6.1 Cash flows from operating activities

Cash from operating activities is the first section of the statement of cash flows. This section
focuses on the cash inflows and outflows from an entity’s main business activities of buying
and selling inventories or providing services. According to paragraph 13 of IAS 7, the cash
flows arising from operating activities is a key indicator of the extent to which the operations
of a business entity have generated sufficient cash to maintain its operating capability, repay
loans, pay dividends and make new investments without recourse to external sources of
financing. Basically, the cash from operating activities includes the entity's cash flows except
for those reported as cash flows from

• investing activities (buying and selling property, plant and equipment, buying and selling
long-term investments)
• financing activities (borrowing and repaying short-term and long-term debt, issuing and
buying back shares, paying dividends)

The "cash flows from operating activities" section of a statement of cash flows can be reported
on according to either the direct or the indirect method.

[Link] Cash generated from or used in operations according to the direct method

When using the direct method, the starting point is the cash receipt from customers. The cash
payments made to suppliers and employees are deducted from the cash receipts from
customers to arrive at the cash generated from operations. Payments to suppliers include
suppliers of inventories for resale as well as all suppliers relating to operating activities.
Amounts paid for all distribution, administrative and other expenses are therefore included.
The cash effects on non-operating items such as interest, dividends and taxation are then
taken into account in order to arrive at the net cash flow from/(used in) operations.

Applicable extraction from the statement of cash flows – Direct method:

CASH FLOWS FROM OPERATING ACTIVITIES

Cash receipts from customers (all entities) xxx
Cash paid to suppliers and employees (all entities) (xxx)
Cash generated from/(used in operations) xxx
Interest received (all entities) xxx
Interest paid (all entities) (xxx)
Dividends received (all entities) xxx
Distribution paid (close corporations) (xxx)
Drawings (cash and inventory) by owner/partner(s)
(sole proprietor/partnership) (xxx)
Income tax paid (close corporations and companies) (xxx)
Loans to members (close corporations) (xxx)
Repayment of loans to members xxx

Continued on the next page

174
 CASH FLOWS FROM OPERATING ACTIVITIES (continued)

Proceeds from the sales of financial assets at fair value through

profit or loss: Held for trading (such as listed share investments) xxx
Acquisition of financial assets at fair value through
profit or loss: Held for trading (such as listed share investments) (xxx)
Net cash from/(used in) operating activities xxx

IAS 7 requires that the gross cash receipts from customers and the gross payments to
suppliers and employees should be disclosed separately. The net result is indicated as the
cash generated by or used in operations.

An important point to remember is that these cash receipts and payments are applicable to
determine the cash generated from or utilised in operations. This implies that other cash
receipts and payments which must be disclosed later in the statement of cash flows must not
be considered when these calculations are made.

Cash receipts from customers:

To calculate the cash receipts from customers, a reconstruction of the trade receivables
control account will be necessary. Assume that the statement of profit or loss and other
comprehensive income shows revenue (net sales) to the amount of R50 000 and that the
statement of financial position shows the opening and closing balances of trade receivables
as R25 000 and R45 000 respectively. Further, assume that all sales were on credit and that
no credit losses were shown in the statement of profit or loss and other comprehensive
income.

The cash receipts from customers can be determined as follows:

Dr Trade receivables control Cr

20.10 R 20.11 R
Mar 1 Balance b/d 25 000 Feb 28 Bank* 30 000
20.11 Balance c/d 45 000
Feb 28 Sales 50 000
75 000 75 000
Mar 1 Balance b/d 45 000

* Balancing figure

The balancing figure “Bank” represents the cash receipts from customers.

Now further assume that the statement of profit or loss and other comprehensive income
indicates an amount of R2 000 was written off as credit losses during the year. The trade
receivables control account will then be drawn up as follows:

175
 Dr Trade receivables control Cr
20.10 R 20.11 R
Mar 1 Balance b/d 25 000 Feb 28 Bank* 28 000
20.11 Credit losses 2 000
Feb 28 Sales 50 000 Balance c/d 45 000
75 000 75 000
20.11
Mar 1 Balance b/d 45 000

* Balancing figure

Cash paid to suppliers and employees

IAS 7 requires the cash paid to suppliers and employees be reported as one figure. To
calculate cash paid to suppliers and employees, an examination of several expense items
will be necessary. The first item to be looked at is the purchases for the year. This must be
analysed in conjunction with the movements in the trade creditors account to determine cash
payments to suppliers. Next up, is the examination of the statement of profit or loss and
other comprehensive income and to extract all operating expenses, other than non-cash
items such as depreciation, loss on sale of assets, etc. These expenses will include cash
paid for all operating expenses as well as cash paid for salaries. If any of the operating
expenses have a corresponding statement of financial position item, movements of the
statement of financial position item must be tracked to calculate the cash payment of the
relevant operating expense item.

Assume that the statement of profit or loss and other comprehensive income shows
purchases (net purchases) to the amount of R25 000 and that the statement of financial
position shows the opening and closing balances of trade receivables as R12 500 and
R22 500 respectively. Further, assume that all purchases were on credit. To calculate the
cash paid to suppliers of inventory for resale (purchases), a reconstruction of the trade
payables control account will be necessary.

Dr Trade payables control Cr

20.11 R 20.10 R
Feb 28 Balance c/d 22 500 Mar 1 Balance b/d 12 500
Bank* 15 000 20.11
Feb 28 Purchases 25 000
75 000 37 500
Mar 1 Balance b/d 22 500
* Balancing figure

The balancing figure “Bank” represents the cash paid to suppliers of trade inventory
(purchases).

The next step in the calculation of cash paid to suppliers and employees, is to compute the
cash paid for distribution, administrative and other expenses, including employees. Assume
that in the statement of profit or loss and other comprehensive income an amount of R2 000
is reflected as insurance expense for the current financial year. If there is no corresponding

176
statement of financial position amount for the insurance expense, the R2 000 will simply be
added to cash paid to suppliers of inventory (purchases), R15 000, to arrive at cash paid to
suppliers and employees.

However, should there be a corresponding item in the statement of financial position, the
determination of the cash paid in respect of insurance will be different. Assume that the
insurance expense for the year amounted to R2 000 and that the opening and closing
balances of accrued insurance expense amounted to R500 and R200 respectively. The
calculation of insurance paid (cash) will be as follows:

Dr Insurance expense Cr
20.11 R 20.10 R
Feb 28 Balance (Accrued) c/d 200 Mar 1 Balance (Accrued) 500
20.11 20.11
Feb 28 Bank* 2 300 Feb 28 Profit and loss 2 000
2 500 2 500
20.11
Mar 1 Balance b/d 200
* Balancing figure

Considering the accrued amounts at the beginning and end of the year, the cash amount
paid for insurance is R2 300. This amount will be added to cash paid to suppliers of inventory
(purchases).

Cash effects on non-operating items

A non-operating item is a business income or expense that is unrelated to the core

operations of a business. In the preparation of the statement of cash flows, the non-operating
items that typically need to be considered are the interest and dividends, both of which can
be income or expense. Once again, it will be necessary to examine and track these items
from the statement of profit or loss and other comprehensive income to the statement of
financial position. The starting point will be to determine the income or expense amount for
the current year. Then add the opening balance and/or subtract the closing balance of the
accrued amount. The inverse will be applied on corresponding prepayments, that is, add the
closing balance of corresponding prepaid item and deduct opening balance of corresponding
prepaid item. The cash flow effects of non-operating items are disclosed separately after
cash generated from/(used in operations, in the statement of cash flows.

6.6.2 Cash flows from investing activities

IAS 7 requires an entity to disclose the classes of gross cash receipts and gross cash
payments made to acquire assets and/or investments. This is collectively referred to as the
investing activities of an entity.

The cash flows from investing activities are calculated by using information given in the
statement of financial position for the current and preceding financial years. If there is a
difference between the amounts of an entry from year to year, it is possible that a cash flow
took place. The difference must be analysed further to determine whether a cash flow occurred
or not; the use of T-accounts is very helpful here.

177
Applicable extraction from the statement of cash flows framework – Investing activities:
R R
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in property, plant and equipment to maintain
operating capacity: Replacement of property, plant and
equipment (xxx)
Investments in property, plant and equipment to expand
operating capacity: Additions of property, plant and
equipment (xxx)
Proceeds from the sale of property, plant and equipment xxx
Acquisition of investments (unlisted share investments) (xxx)
Proceeds from the sale/collection/maturity of investments
(unlisted share investments and loans and receivables) xxx
Net cash from/(used in) investing activities xxx

As mentioned, the cash flows from investing activities result from the acquisition or disposal
of property, plant and equipment and investments, that is, non-current assets. The cash flow
from investing activities can be calculated by using the relevant information given in the
statement of financial position of the current year and the preceding year. The difference in
the figure for an item from year to year will indicate the cash flow. For example, an increase
in investments will indicate a cash outflow, as more investments were made (paid) during the
year.

Examples of cash inflows from investing activities are:

Ø cash receipts from the sale(s) of property, plant and equipment

Ø cash receipts from the sale(s) of investments
Ø cash receipts from the repayments/realisation of loans made to other parties as
investments
Ø cash receipts on maturity of fixed deposits

Take note that only the cash proceeds of sales/repayments/realisations should be

considered and not the profit made, or the dividends/interest received.

Examples of cash outflows from investing activities are:

Ø cash payments to acquire property, plant and equipment

Ø cash payments to acquire investments
Ø cash payments when loans are granted to other parties
Ø cash payments when fixed deposits are made

Two kinds of cash flows from activities that relate to the acquisition of property, plant and
equipment can sometimes be clearly distinguished: those that relate to the maintenance of
the operating activities, and those that relate to the expansion of operating activities. An
example of a cash flow to maintain the operating activities is the replacement of property,
plant and equipment. An example of a cash flow outflow to expand operating activities is the
purchase of additional property, plant and equipment. Note that the non-cash transactions

178
must be omitted as not all the changes in the non-current assets relate to cash transactions.
A change in the valuation of land and buildings, for example, do not result in a cash flow, as
no additional land and building were purchased for cash.

6.6.3 Cash flows from financing activities

Cash flows from financing activities disclose future claims on cash and how activities and
investments were financed.

The cash flows from financing activities can be determined by comparing the statements of
financial position of the current year and the preceding year and/or by using the information
given in the statement of the changes in equity (or the statement of changes in net investment
of members for CCs).

Applicable extraction from the statement of cash flows framework – Financing activities:
R R
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from capital contributions (sole proprietorship/partnership) xxx
Proceeds from members’ contributions (close corporations) xxx
Proceeds from loans from members (close corporation) xxx
Proceeds from loans, mortgages, etc. (all entities) xxx
Repayment of short-term borrowings (all entities) (xxx)
Repayment of long-term borrowings (all entities) (xxx)
Net cash from/(used in) financing activities
xxx

Financing activities are activities that result in changes in the size and composition of (mainly)
the equity capital and the non-current liabilities of a business entity. Cash receipts from and
cash payments to (mainly) the external providers of funds are applicable. The short-term
portion of a long-term liability as well as short-term loans (current liabilities) are regarded as
financing activities. The cash flows from financing activities can be determined by comparing
the statement of financial position of the current year with that of the preceding year and/or by
using the information given in the statement of changes in equity.

Note that transfers from the net profit for the year do not indicate cash outflows, as no cash
was paid to external parties.

The examples of financing activities give in the framework above are self explanatorily. Refer
to these examples to acquaint yourself with the kind of transaction that results in a cash flow
from financing activities.

6.6.4 Cash and cash equivalents

Once the cash flows from the operating activities, investing activities and financing activities
sections have been prepared, the net cash increase/(decrease) in cash and cash equivalents
is calculated by adding/subtracting the net cash flows of the operating, investing and financing
activities sections. The cash and cash equivalents at the beginning of the financial period are
added to this net increase/(decrease). The answer to this calculation is equal to the cash and

179
cash equivalents at the end of the financial period. This amount must be equal to the cash
and cash equivalents as disclosed in the statement of financial position for that period (so you
know your statement of cash flows has balanced).

6.6.5 Notes pertaining to a statement of cash flows

The statement of cash flows reports only those operating, investing and financing activities
that affect cash or cash equivalents. However, some non-cash investing and financing
activities may be much important for the users of financial statements because they may
have a significant impact on the current and future performance in terms of revenues, profits
and the ability of the entity to generate positive cash flows. Therefore, IFRS 7 require that,
under certain circumstances, additional information to a statement of cash flows concerning
non-cash transactions be disclosed. This will relate to all significant non-cash investing and
financing activities, which will be disclosed either at the bottom of the statement of cash
flows as a footnote or in the notes to the financial statements.

The following are some of the examples of non-cash investing and financing activities that
may be deemed to be significant for the users of financial statements:

• the issue of shares to settle a debt

• purchase of an asset on credit or by issuing shares
• conversion of debt to ordinary shares
• conversion of preference shares to ordinary shares
• payment for services rendered to the entity by issuing shares

The general approach is to disclose a schedule of non-cash investing and financing activities
at the bottom of the statement of cash flows. They can, however, also be included as a
separate schedule or in the notes to the financial statements. Both the approaches are in
practice and both are in accordance with IFRS 7.

180
6.7 Exercises and solutions
EXERCISE 6.1 – Preparation of a statement of cash flows in respect of a partnership

The following information pertains to the partnership Candyfloss:

CANDYFLOSS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.17
R
Revenue 750 900
Cost of sales (294 540)
Inventory (1 March 20.16) 150 600
Purchases 287 940
438 540
Inventory (28 February 20.17) (144 000)
Gross profit 456 360
Other income 22 200
Profit on sale of non-current asset (Land and buildings) 15 000
Rental income 7 200
478 560
Distribution, administrative and other expenses (106 800)
Administrative expenses (Salaries and wages included) 105 000
Depreciation 1 800

Profit for the year 371 760

Other comprehensive income for the year –
Total comprehensive income for the year 371 760

CANDYFLOSS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.17
Capital Current accounts
Appro- Total
C
F Floss C Candy F Floss priation equity
Candy
R R R R R R
Balances at 1 March 20.16 290 700 290 700 75 600 (600) 656 400
Capital contributions 39 300 39 300 78 600
Total comprehensive income for
the year 371 760 371 760
Interest on capital 19 800 19 800 (39 600)
Interest on current accounts 7 560 (60) (7 500)
Interest on drawings (20 160) (17 580) 37 740
Partners’ share of total
comprehensive income 181 200 181 200 (362 400)
Drawings (201 600) (175 800) (377 400)
Balances at 28 Feb 20.17 330 000 330 000 62 400 6 960 – 729 360

181
EXERCISE 6.1 (continued)

CANDYFLOSS
EXTRACTED INFORMATION FROM THE STATEMENT OF FINANCIAL POSITION AS AT
28 FEBRUARY
20.17 20.16
R R
Capital: C Candy 330 000 290 700
Capital: F Floss 330 000 290 700
Current account: C Candy 62 400 Cr 75 600 Cr
Current account: F Floss 6 960 Cr 600 Dr
Land and buildings at cost 360 000 540 000
Furniture and equipment at cost 19 200 18 000
Accumulated depreciation: Furniture and equipment 4 800 3 000
Inventory 144 000 150 600
Bank 100 860 Dr 15 000 Cr
Trade receivables control 219 900 111 000
Trade payables control 168 600 145 800
Accrued income (Rent receivable) 600 1 200
Accrued expenses (Salaries and wages) 1 800 600
Fixed deposit 60 000 –

Additional information:

1. All capital contributions were made in cash.

2. Inventory is disclosed at cost.
3. The drawings of the partners were made in cash.
4. No land and buildings were purchased during the year. Fifty percent of the selling price
of the land and buildings was received in cash, whereas the outstanding amount was
on credit.
5. No furniture or equipment was sold or scrapped during the year. All purchases were
paid for in cash.
6. All purchases of inventory were on credit. All of the other expenses, except the accrued
expenses, were paid in full.
7. There were only trade debtors at 28 February 20.16. The debtors at 28 February 20.17
pertain to trade debtors and the debtor in respect of the sale of land and buildings.
8. The fixed deposit was made on 28 February 20.17.

REQUIRED

Prepare the statement of cash flows of Candyfloss for the year ended 28 February 20.17 to
comply with the requirements of IFRS appropriate to the business of the partnership. The cash
generated from/(use in) operations must be disclosed according to the direct method.
Comparative figures are not required. Disclose only the note in respect of the non-cash
transaction pertaining to the investing activity.

182
SOLUTION 6.1

CANDYFLOSS
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 28 FEBRUARY 20.17
Note R R
Cash flows from operating activities
Cash receipts from customers  747 300
Cash paid to suppliers and employees ‚ (368 940)
Cash generated from operations 378 360
Drawings R(201 600 + 175 800) (377 400)

Net cash from operating activities 960

Cash flows from investing activities

Investments in property, plant and equipment to expand
operating capacity (1 200)
Additions to furniture and equipment R(19 200 – 18 000) (1 200)
Proceeds from the sale of land and buildings 1 97 500
Acquisition: Fixed deposit R(60 000 – 0) (60 000)

Net cash from investing activities 36 300

Cash flows from financing activities

Proceeds from capital contribution R[(330 000 – 290 700) x 2] 78 600

Net cash from financing activities 78 600

Net decrease in cash and cash equivalents 115 860
Cash and cash equivalents at beginning of year (15 000)
Cash and cash equivalents at end of year 100 860

CANDYFLOSS
NOTE FOR THE YEAR ENDED 28 FEBRUARY 20.17

1. Non-cash transaction pertaining to the investing activity

Land and buildings with a cost price of R180 000 were sold for R195 000. An amount of
R97 500 is receivable in the next financial year.

Comment
Take note of how to calculate and disclose a non-cash transaction in respect of an investing
activity.

Calculations

① Cash receipts from customers

20.16 20.17
+ Accrued - Accrued Cash received
Items in statement of profit or loss and other income – income + from
comprehensive income income Income customers
received in received in during 20.17
advance advance
R R R R
Revenue 750 900 + 111 000 - 122 400 Π= 739 500
Rental income 7 200 + 1 200 - 600 = 7 800
747 300
ΠTrade receivables (closing balance)

183
SOLUTION 6.1 (continued)

A debtor included in the amount of R219 900 does not pertain to trade receivables, but to
a debtor who purchased land and buildings from the entity (refer to additional information
7). The closing balance of this debtor’s account must be excluded from the R219 900.
The closing balance is calculated as follows:

• The selling price of the sold land and buildings:

Carrying amount + Profit on sale
R(540 000 – 360 000) + R15 000
= R195 000

• According to additional information 4,50% of R195 000 is still outstanding at the end
of 20.17:
\ R195 000 ÷ 2 = R97 500 = Closing balance
Therefore, R97 500 must be excluded from R219 900:
R(219 900 – 97 500) = R122 400 = Closing balance of trade receivables

② Cash paid to suppliers and employees

20.16 20.17 Cash to
Items in statement of profit or loss and + Accrued - Accrued suppliers and
other comprehensive income expenses – expenses + employees
Prepayments Prepayments during 20.17
R R R R
Purchases 287 940 + 145 800 - 168 600 = 265 140
Administrative expenses 105 000 + 600 - 1 800 = 103 800
368 940

184
EXERCISE 6.2 – Preparation of a statement of cash flows in respect of a close
corporation

The following information pertains to Calabash CC:

CALABASH CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20.17
R
Revenue 735 000
Cost of sales (423 750)
Inventory (1 January 20.17) 46 500
Purchases 452 250
498 750
Inventory (31 December 20.17) (75 000)

Gross profit 311 250

Other income 42 000
Dividend income: Listed investment 19 500
Fair-value adjustment: Held for trading: Listed investment 22 500

353 250
Distribution, administrative and other expenses (148 500)
Depreciation 28 500
Salaries to members 36 000
Administrative expenses 30 000
Wages 54 000
Finance costs (21 000)
Interest on long-term loan 21 000

Profit before tax 183 750

Income tax expense (54 000)
Profit for the year 129 750
Other comprehensive income for the year –
Total comprehensive income for the year 129 750

CALABASH CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.17

Members’ Retained
Total
contributions earnings
R R R
Balances at 1 January 20.17 532 500 12 000 544 500
Members’ contributions 30 000 30 000
Total comprehensive income for the year 129 750 129 750
Distribution to members (71 250) (71 250)
Balances at 31 December 20.17 562 500 70 500 633 000

185
EXERCISE 6.2 (continued)

CALABASH CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.17
Note 20.17 20.16
R R
ASSETS
Non-current assets 672 750 591 000
Property, plant and equipment 1 672 750 591 000
Current assets 226 500 154 500
Inventories 75 000 46 500
Trade receivables 52 500 45 000
Prepayments 3 000 –
Listed investment 75 000 52 500
Cash and cash equivalents 21 000 10 500

Total assets 899 250 745 500

EQUITY AND LIABILITIES
Total equity 633 000 544 500
Members' contributions 562 500 532 500
Retained earnings 70 500 12 000
Total liabilities 266 250 201 000
Non-current liabilities 150 000 105 000
Long-term borrowings 150 000 105 000
Current liabilities 116 250 96 000
Trade payables 46 500 57 000
Distribution to members payable 56 250 22 500
Current tax payable 13 500 16 500

Total equity and liabilities 899 250 745 500

CALABASH CC
ABSTRACT FROM THE NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR
ENDED 31 DECEMBER 20.17

1. Property, plant and equipment

Machinery
Land and
and Total
buildings
equipment
R R R
Carrying amount at 1 January 20.17 390 000 201 000 591 000
Cost 390 000 265 500 655 500
Accumulated depreciation – (64 500) (64 500)
Additions – 116 250 116 250
Disposals – (6 000) (6 000)
Depreciation for the year – (28 500) (28 500)
Carrying amount at 31 December 20.17 390 000 282 750 672 750
Cost 390 000 356 250 746 250
Accumulated depreciation – (73 500) (73 500)

186
EXERCISE 6.2 (continued)

Additional information:

1. During the year, machinery with a cost price of R25 500 was sold for cash at its carrying
amount and replaced with new machinery. Depreciation to the amount of R19 500 was
recorded in respect of the sold machinery as from the date of purchase to the date of
sale.
2. An additional machine was purchased for R60 000 to expand the operating capacity of
the business.
3. Machinery was purchased for cash.
4. No equipment was purchased or sold during the financial year ended
31 December 20.17.
5. Listed investment pertains to shares purchased on 31 December 20.17 from Doc
Limited. The shares are held for trading. No shares from the listed investment were sold
during the current financial year.
6. All inventories are purchased and sold on credit.
7. Inventory is recorded at cost.
8. Trade and other payables include:

20.17 20.16
R R
Trade payables control 37 500 49 500
Accrued wages 9 000 7 500
9. The close corporation will be renting additional premises as from 1 January 20.18.
10 The trade receivables control pertains to the trade debtors to whom trading inventory
was sold on credit.
11. The prepayment was in respect of a rental expense which is included in administrative
expenses.
12. The long-term borrowings pertain to a long-term loan. The interest on the loan is not
capitalised.

REQUIRED

Prepare the statement of cash flows of Calabash CC for the year ended 31 December 20.17
to comply with the requirements of IFRS appropriate to the business of the close corporation.
The cash generated from/(used in) operations must be disclosed according to the direct
method. Comparative figures and notes are not required but all calculations must be shown.

187
SOLUTION 6.2

CALABASH CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20.17
Note R R
Cash flows from operating activities
Cash receipts from customers  727 500
Cash paid to suppliers and employees ‚ (585 750)
Cash generated from operations 141 750
Dividends received ƒ 19 500
Interest paid „ (21 000)
Income tax paid (57 000)
Distributions to members paid † (37 500)

Net cash from operating activities 45 750

Cash flows from investing activities

Investments in property, plant and equipment to maintain
operating capacity (56 250)
Replacement of machinery ‡ (56 250)
Investment in property, plant and equipment to expand operating
capacity (60 000)
Addition to machinery (60 000)
Proceeds from sale of machinery ˆ 6 000

Net cash from investing activities (110 250)

Cash flows from financing activities

Proceeds from members’ contributions ‰ 30 000
Proceeds from long-term borrowings ⑩ 45 000

Net cash from financing activities 75 000

Net decrease in cash and cash equivalents 10 500
Cash and cash equivalents at beginning of year 10 500
Cash and cash equivalents at end of year 21 000

Comment
Take note of the following:
• How to disclose an investment in property, plant and equipment to maintain operating
capacity.
• How to calculate the cash receipts from the sale of machinery.
• The non-cash entry pertaining to the revaluation of the financial asset at fair value through
profit or loss: Held for trading: Listed investment. The fair-value adjustment of R22 500
R(75 000 – 52 500) pertains to a revaluation of the listed investment. The increase in the
statement of financial position is therefore a non-cash entry.

188
SOLUTION 6.2 (continued)

Calculations

① Cash receipts from customers

R
Revenue (Sales) 735 000
Add: Trade receivables control (opening balance) 45 000
Less: Trade receivables control (closing balance) (52 500)
Cash receipts from customers 727 500

② Cash paid to suppliers and employees

20.16 20.17 Cash to

+ Accrued - Accrued suppliers and
Items
expenses – expenses + employees
Prepayments Prepayments during 20.17
R R R R
Statement of profit or loss and other
comprehensive income:
Purchases (for payments made to
trade payables control) 452 250 + 49 500 - 37 500 464 250
Salaries to members 36 000 – – 36 000
Administrative expenses 30 000 – + 3 000 33 000
Wages 54 000 + 7 500 - 9 000 52 500
585 750

③ Dividends received

No dividends are indicated as receivable at the beginning or end of the financial year
under review. It can therefore be concluded that the dividend income of R19 500 for the
year ended 31 December 20.17 was received in cash.

④ Interest paid

No accrued or prepaid amounts were indicated in respect of an interest expense. It can

therefore be concluded that the interest of R21 000 in the statement of profit or loss and
other comprehensive income for the year ended 31 December 20.17 was paid in cash.

⑤ Income tax paid

R
Income tax expense 54 000
Add: Current tax payable (opening balance) 16 500
Less: Current tax payable (closing balance) (13 500)
Income tax paid 57 000

⑥ Distribution to members

R
Distribution to members 71 250
Add: Distribution to members payable (opening balance) 22 500
Less: Distribution to members payable (closing balance) (56 250)
Distribution to members paid 37 500

189
SOLUTION 6.2 (continued)

⑦ Replacement and addition to machinery

Step 1: Determine the difference between the opening and closing balances of the
machinery and equipment at cost account:

The note in respect of property, plant and equipment shows that there were additions to
the amount of R116 250. In additional information 2, it was mentioned that machinery to
the amount of R60 000 was purchased to expand the operating capacity of the business.
It can therefore be concluded that machinery to the amount of R56 250 was purchased
to replace machinery sold.

Step 2: Determine whether the additions pertain to a cash flow:

Additional information 3 states that the purchases of machinery were paid for in cash.

⑧ Proceeds from the sale of machinery

Cost – Accumulated depreciation = Carrying amount

R(25 500 – 19 500) = R6 000
Additional information 1 states that machinery was sold for cash at its carrying
amount. The selling price of the machinery is therefore R6 000.

⑨ Proceeds from members’ contributions

Step 1: Determine the difference between the opening and closing balances of the
members’ contributions account:

R
Members’ contributions (Statement of financial position as at 31 December 20.17) 562 500
Less: Members’ contributions (Statement of financial position as at
31 December 20.16) (532 500)
Increase in members’ contributions* 30 000

* Also refer to the statement of changes in net investment of members for the year ended
31 December 20.17.

Step 2: Determine whether the increase pertains to a cash flow:

No further information was given in respect of members’ contributions. It can therefore be
concluded that the increase in the members’ contributions was a cash contribution.

⑩ Proceeds from long-term borrowing

Step 1: Determine the difference between the opening and closing balances of the
long-term borrowing:

R
Long-term borrowings (Statement of financial position as at 31 December 20.17) 150 000
Less: Long-term borrowings (Statement of financial position as at
31 December 20.16) (105 000)
Increase in long-term borrowings 45 000

190
 Step 2: Determine whether the increase pertains to a cash flow:

Since there was an increase in the long-term borrowing and the interest charged on the
borrowing is not capitalised, the R45 000 must have been received in cash.

EXERCISE 6.3 Preparation of a statement of cash flows in respect of a sole

proprietorship

The following information was taken from the accounting records and financial statements of
Philander Outfitters, a sole proprietorship:
1. Balances at 30 June
20.17 20.16
R R
Land and buildings at cost .............................. 188 000 188 000
Equipment at cost ........................................... 54 000 42 000
Accumulated depreciation: Equipment............ 39 950 21 200
Capital: Philander ............................................ 306 850 230 800
Debtors control (trade debtors) ....................... 179 410 173 600
Allowance for credit losses.............................. 15 000 12 000
Bank ................................................................ 130 000 Dr 7 000 Cr
Inventory ......................................................... 20 000 25 000
Long-term borrowing ....................................... 155 000 115 000
Creditors control .............................................. 53 000 43 000
Water and electricity prepaid........................... 850 1 100
Accrued interest expense................................ 2 200 700
Accrued insurance expense ............................ 260

2. Relevant information disclosed in the statement of profit or loss and other comprehensive
income for the year ended 30 June 20.17
R
Administrative expenses ........................................................................... 20 000
Interest on long-term loan ......................................................................... 16 000
Credit losses ............................................................................................. 4 500
Insurance expense ................................................................................... 12 280
Salaries and wages .................................................................................. 45 100
Sales ......................................................................................................... 425 500
Depreciation .............................................................................................. 18 750
Water and electricity ................................................................................. 4 720
Purchases ................................................................................................. 155 000

3. Additional information:
3.1 All sales of inventory were on credit.
3.2 All purchases of inventory were on credit and R153 000 was paid to the trade creditors
during the financial year.
3.3 Mr Philander withdrew R 68 100 in cash during the year.
3.4 A deposit of R4 000 was paid on new equipment purchased on credit on 2July 20.16. The
outstanding amount of the credit purchase of equipment is included in the creditors
control account.

191
EXERCISE 6.3 (continued)

REQUIRED:

Prepare the statement of cash flows of Philander Outfitters for the year ended 30 June 20.17
to comply with the requirements of IFRS appropriate to the business of a sole proprietorship.
The cash generated from/(used in) operations must be disclosed according to the direct
method. Notes and comparative figures are not required but all calculations must be shown.

SOLUTION 6.3

PHILANDER OUTFITTERS
CASH FLOW STATEMENT FOR THE YEAR ENDED 30 JUNE 20.17
Note R R
Cash flows from operating activities
Cash receipts from customers  418 190
Cash paid to suppliers and employees ‚ (234 590)
Cash generated from operations 183 600
Interest paid ƒ (14 500)
Drawings (68 100)

Net cash from operating activities 101 000

Cash flows from investing activities

Investments in property, plant and equipment to expend
operating capacity (4 000)
Additions to equipment ④ (4 000)

Net cash used for investing activities (4 000)

Cash flows from financing activities

Proceeds from long-term borrowings R(155 000 – 115 000) 40 000

Net cash from financing activities 40 000

Net decrease in cash and cash equivalents 137 000
Cash and cash equivalents at beginning of year (7 000)
Cash and cash equivalents at end of year 130 000

Calculations

In this exercise the T-accounts of the relevant items are reconstructed to illustrate how to
determine the applicable cash amounts that affect the statement of cash flows. The aim is to
reconstruct the account when it was closed off to the statement of profit or loss and other
comprehensive income or to reconstruct a statement of financial position account from its
opening balance to its closing balance at year end. When a prepayment or accrued amount
in the statement of financial position affects an income or expense account, the relevant
expense account is used as a control account to calculate the actual cash payments/receipts
of the income or expense account.

192
SOLUTION 6.3 (continued)

① Cash receipts from customers

Dr Allowance for credit losses Cr

R R
Balance – 20.16 b/d 12 000
Balance – 20.17 c/d 15 000 Credit loss (balancing figure) 3 000
15 000 15 000
Balance – 20.17 b/d 15 000

Dr Credit losses Cr
R R
Allowance for credit loss 3 000 Statement of P/L (SoP/L) 4 500
Trade rec control (balancing figure) 1 500
4 500 4 500

The credit loss on the statement of profit or loss and other comprehensive income is disclosed
as R4 500. This amount comprises trade receivables written off during the year (which must
be calculated) and the increase in the allowance for credit losses R(15 000 – 12 000) =
R3 000. Thus the amount of trade receivables written off during the year is R(4 500 – 3 000)
= R1 500. By constructing the trade receivables control account, the amount received from
customers is calculated.

Dr Trade receivables control Cr

R R
Balance – 20.16 b/d 173 600 Credit losses 1 500
SoP/L Sales 425 500 Bank (balancing figure) 418 190
Balance – 20.17 c/d 179 410
599 100 599 100
Balance – 20.17 b/d 179 410

② Cash paid to suppliers and employees

Dr Trade payables control Cr

R R
Bank (add info 3.2) 153 000 Balance – 20.16 b/d 43 000
Balance – 20.17 c/d 53 000 Purchases SoP/L 155 000
Equipment (balancing figure) 8 000
206 000 206 000
Balance – 20.17 b/d 53 000

Dr Insurance Cr
R R
Bank (balancing figure) 12 020 Balance – 20.16 b/d -
Balance – 20.17 c/d 260 SoP/L 12 280
12 280 12 280
Balance – 20.17 b/d 260

193
SOLUTION 6.3 (continued)

In this exercise an insurance accrual of R260 was outstanding at year end. This implies that
the insurance expense in the statement of profit or loss and other comprehensive income
included an amount that was not paid in cash. Thus to calculate the cash amount paid
R(12 280 – 260) = R12 020.

Dr Water and electricity Cr

R R
Balance – 2016 b/d 1 100 SoP/L 4 720
Bank (balancing figure) 4 470 Balance – 20.17 c/d 850
5 570 5 570
Balance – 20.17 b/d 850

To calculate the cash amount of water and electricity paid, the prepayments (receivables) in
20.16 and 20.17 must be taken into account. The water and electricity expense in the SoP/L
must be increased with the amount prepaid in 20.17 and decreased with the amount prepaid
in 20.16 which is reversed in 20.17.

Administrative expenses of R20 000 and salaries and wages of R45 100 do not have any
accrued or prepaid amounts and the amount in the statement of profit or loss and other
comprehensive income will be the cash amounts paid.
Or
The payment of suppliers and employees can also be calculated as follows:

20.16 20.17 Cash to

+ Accrued - Accrued suppliers and
Items
expenses – expenses + employees
Prepayments Prepayments during 20.17
R R R R
Statement of profit or loss and
other comprehensive income:
Payments made to trade
payables control – given 153 000 153 000
Administrative expenses 20 000 – – 20 000
Insurance 12 280 – - 260 12 020
Water and electricity 4 720 -1 100 +850 4 470
Salaries and wages 45 100 – – 45 100
234 590

③ Interest paid

R
Interest expense 16 000
Add: interest payable (opening balance) 700
Less: interest payable (closing balance) (2 200)
Interest paid 14 500

194
SOLUTION 6.3 (continued)

Or

Dr Interest paid Cr
R R
Bank (balancing figure) 14 500 Balance – 20.16 b/d 700
Balance – 20.17 c/d 2 200 Interest SoP/L 16 000
16 700 16 700
Balance – 20.17 b/d 2 200

④ Equipment

Dr Equipment at cost Cr
R R
Balance – 20.16 b/d 42 000 Balance – 2017 c/d 54 000
Creditors control ② 8 000
Bank (info 3.4) 4 000
54 000 54 000
Balance – 20.17 b/d 54 000

195
 Self-assessment

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly discuss the purpose and importance of a statement of cash
flows.

Briefly explain the relationship between a statement of cash flows and

the other financial statements that were prepared on the accrual basis
of accounting and describe how this relationship impacts on the
preparation of a statement of cash flows.

Prepare a statement of cash flows and the notes regarding non-cash

transactions pertaining to investing and financing activities according
to the requirements of IAS 7 by utilising information, which is mainly
obtained from the other financial statements and any relevant notes
thereto, for each of the following business entities:
- Sole proprietor
- Partnership
- Close corporation

If you answered "yes" to all of the assessment criteria, you have completed the
learning unit on cash flows and can now move on to learning unit 9. If your answer
was "no" to any of the criteria, revise those sections concerned before commencing
with learning unit 9.

196
LEARNING UNIT

7
Branches

Learning outcomes ............................................................................................................ 198

Key concepts ..................................................................................................................... 198
7.1 Introduction ............................................................................................................... 199
7.2 Accounting for dependent branches ......................................................................... 199
7.3 Recording of transactions where inventory sent to the branch is invoiced at cost
price .......................................................................................................................... 200
7.4 Recording of transactions where inventory sent to the branch is invoiced at
selling price ............................................................................................................... 203
7.5 Exercises and solutions ............................................................................................ 206
Self-assessment ................................................................................................................ 216

197
 Learning outcomes

After studying this learning unit, you should be able to

• explain the concept of branches

• briefly explain the differences between dependent and independent branches
• identify the information to be included in the reports submitted by a dependent branch to
the head office
• record the transactions between a head office and a dependent branch in the books of
the head office, where inventory sent to the branch is invoiced at cost price
• record the transactions between a head office and a dependent branch in the books of
the head office, where inventory sent to the branch is invoiced at selling price
• record the transactions of a dependent branch pertaining to the following, where inventory
is invoiced at cost price or at selling price:
- purchases of inventory by the branch
- sales of inventory by the branch
- inventory damaged or stolen at the branch
- inventory sold by the branch at a discount
- inter-branch inventory transactions
- settlement discount granted to debtors of the branch
- donations made by the branch
- cash embezzled at the branch
- inventory in transit between the branch and the head office
• identify and record a shortage or surplus in the inventory of a branch, where inventory is
invoiced by the branch at selling price

Key concepts

• Head office
• Dependent branches
• Branch inventory
• Inventory to branch
• Branch adjustments
• Branch gross profit (or loss)
• Branch profit (or loss)
• Inventory transactions
• Other branch transactions

198
7.1 Introduction

A business entity can establish a branch (or branches) that is geographically separated from
but still form part of the main entity. One of the reasons why business entities establish
branches is to broaden their markets to increase their potential revenues in order to maximise
their profitability. Branches can be managed as dependent or independent units, each with its
own distinct accounting requirements. In this module, only dependent branches are
addressed.

7.2 Accounting for dependent branches

The concept “branches” implies that there is a mother entity called “head office”. The head
office of a dependent branch is responsible for supplying inventory to the branch and for
recording all the accounting transactions of the branch in the books of the head office. The
head office can invoice inventory to the branch at either cost or selling price. Each method of
invoicing requires a unique set of accounts and recording procedure.

Usually, the head office of a dependent branch is responsible for the payment of the major
expenses of the branch. The head office may also decide to provide the branch with petty
cash for the payment of minor expenses that are incurred by the branch. A branch may also
purchase inventory from other suppliers.

Since the activities of a dependent branch are recorded in the books of its head office, a
dependent branch is usually required to submit periodic returns – daily, weekly or monthly,
according to circumstances, on the following matters:

Ø inventory transactions
Ø wages, salaries and other payments
Ø any other transactions that the head office may deem necessary

If a branch is authorised to sell on credit, the following returns will also be required:

Ø particulars of accounts that have been paid since the previous return
Ø cash received, discounts allowed, and goods returned by clients
Ø particulars of debtors’ accounts that are doubtful or irrecoverable
Ø particulars of credit sales since the previous return
Ø a list of debtors on the date of the return

These returns enable the head office to make the necessary entries in the branch accounts
concerned. The unique circumstances of the entity will determine how the inventory
transactions between the head office and the branch are invoiced and recorded. Inventory can
be invoiced by the head office to the branch at either cost or selling price.

199
7.3 Recording of transactions where inventory sent to the branch
is invoiced at cost price
When this method of bookkeeping is followed, two accounts must be opened in the accounting
records of the head office:

(1) a branch inventory account

(2) an inventory to branch account

These accounts are specifically for the recording of transactions that pertain to the inventory
of the branch. Other types of transactions of a branch are recorded in other accounts that are
specific to the transaction, for example, a branch trade receivables control account, a branch
asset account or a branch expenses account.

When inventory is invoiced to the branch at cost price, the branch inventory account functions
as a trading account in determining the gross profit of the branch. It follows that if there is
more than one branch, a branch inventory account must be opened for every branch. Take
note that the branch inventory account requires the same entries as the ordinary trading
account that you are familiar with.

A branch profit and loss account, which can also be called branch expense account, must be
kept to determine the net profit of the branch. The gross profit is transferred from the branch
inventory account to the branch expense account. The branch expenses are also transferred
to the branch expense account and the net profit or loss of the branch for the year can then
be determined. The following are some of the branch transactions that are accounted for in
the books of the head office, where inventory is sent to branch at cost price:

Inventory sent to the branch at cost:

Dr - Branch inventory
Cr - Inventory to branch

Inventory purchases by the branch:

Dr - Branch inventory
Cr - Bank or branch trade payables control (where inventory is purchased on credit)

Inventory returned to head office:

Dr - Inventory to branch
Cr - Branch inventory

Cash/credit sale of inventory by the branch:

Dr - Bank (cash sale) or Branch trade receivables control (sale on credit)
Cr - Branch inventory

Settlement of a branch debtor’s account at a discount:

Dr - Settlement discount granted
Cr - Branch trade receivables control

200
Comment
At the end of the accounting period, the settlement discount granted is closed off to the branch
inventory account (where the sale was recorded). This ensures the similar treatment of
discounts granted in the accounting records of an entity without a branch (settlement discount
granted reduces sales).

Embezzlement of cash at the branch from either a cash or a credit sale

Cash sale:
Dr - Bank (with the actual money banked)
Dr - Branch expenses (with the embezzled amount)
Cr - Branch inventory account (with the cost of the inventory sold, which includes the money
banked and the embezzled cash)

Credit sale:
Dr - Bank (with the actual amount banked)
Dr - Branch expenses (with the embezzled amount)
Cr - Branch trade receivables control (with the total amount that the debtor paid, which
consists of the banked amount and the embezzled cash)

Inter-branch inventory transactions

Dr - Branch inventory (of the branch that receives the inventory – the receiving branch)
Cr - Branch inventory (of the branch that sells the inventory – the transferring branch)

Expenses paid for by head office and expenses paid for from petty cash

Paid by head office:

Dr - Branch expenses
Cr - Bank

Paid from petty cash:

Dr - Branch expenses
Cr - Petty cash

After all of the foregoing entries have been made, the branch accounts are balanced as
follows:

• Branch inventory account

As previously mentioned, the branch inventory account serves as a trading account of
the branch and therefore the gross profit or loss is determined in this account. A “profit”
will be a debit balancing figure and a “loss” a credit balancing figure. Profit or loss in
the branch inventory account is then transferred to the branch expense account.

• Inventory to branch account

The balance on this account is transferred to the credit side of the head office
purchases account. This process effectively reduces the purchases of the head office,
as inventory would have been transferred to the branch.

201
 • Branch expense account
The balance of the branch expense account represents a profit or loss of the branch
for the period. The profit (debit balancing figure) or loss (credit balancing figure) is
then transferred to the general (head office) profit and loss account.

If a branch is authorised to make local purchases and/or to incur certain expenses,

the branch inventory account must be debited with the cost price of the local
purchases and the branch expense account must be debited with the expenses.

If a branch makes local purchases and pretty cash payments, it must keep a certain
amount or ready cash on hand. For internal control purposes, cash received from
sales and debtors may not be utilised for this purpose.

• Inventory and cash in transit

It may happen that on the last day of the financial year, inventory and/or cash are in
transit between the head office and the branch. One party would have dispatched the
inventory or cash to the other party and recorded the transaction in the books and the
other party would have not received the inventory or cash and would therefore have
made no entry of the transaction. For example, the head office despatches inventory
to the branch shortly before the end of the financial period. Head office immediately
debits the branch inventory account and credits the inventory to branch account with
the cost price of the inventory. Assume that the branch received the inventory after the
annual inventory count has been completed. The inventory in transit must be added to
the inventory of the branch to correct the gross profit of the branch.

Activity 7.1

a) In the accounting records of the head office, when inventory is invoiced to the branch
at cost price, the branch inventory account serves the same purpose as which other
account that you have already encountered and why?
b) Explain what is meant with “the gross profit/loss of the branch”. To which account in
the accounting records of the head office will a gross profit/loss be transferred?

Feedback 7.1

a) The branch inventory account serves the same purpose as the trading account. When
balanced at the end of the accounting period, the balance on the account represents
the gross profit/loss that the branch made.
b) The gross profit/loss is the result of the difference between the price at which inventory
is received (from head office) and the price at which inventory is sold by the branch.
This profit/loss is transferred to the branch expense account.

202
7.4 Recording of transactions where inventory sent to the branch
is invoiced at selling price
When inventory is invoiced to the branch at selling price, the branch inventory account will
not reflect the gross profit of the branch (as is the case when the inventory is invoiced to
the branch at cost price). An additional account, namely a “branch adjustment account”, is
required to reflect the gross profit and to serve the function of a “trading account”. The branch
inventory account (at selling price) functions as an inventory control account.

The recording of all inventory transactions in the branch inventory account is done at selling
price. The selling price is divided into two amounts, namely the cost price and the profit mark-
up of the inventory. These two amounts are disclosed separately in the branch inventory
account (at selling price) and must add up to the selling price. The reason for this separate
disclosure in the branch inventory account is that the entries pertaining to the cost price and
the entries pertaining to the profit mark-up have different contra accounts. For example, when
inventory that is sent to the branch is recorded (assume a cost of R100 and a mark-up of
R50), the branch inventory account is debited (separately) with the cost price (R100) and the
profit mark-up thereof (R50) against different contra accounts: the inventory to branch account
(R100) and the branch adjustment account (R50) respectively. The inventory to branch
account is credited with the cost price (R100) and the branch adjustment account is credited
with the profit mark-up (R50).

Activity 7.2

a) D Pelser CC trades in watercoolers. Each cooler is sold at a price which equals to cost
plus 50% profit mark-up. Calculate the profit that D Pelser CC must add to send two
watercoolers with a total cost of R6 000 to its branch.

b) D Pelser CC invoices inventory to its branch at cost plus 50%. Inventory with a cost
price of R50 000 will have a selling price of …

c) Damaged inventory with a selling price of R12 000 was returned by the branch to
D Pelser CC. What is the cost of the inventory returned?

d) D Pelser CC sells inventory to its customers at an additional 20% mark-up on the

selling price to its branch. How much will a customer pay for a watercooler with a cost
of R2 500 bought from D Pelser CC?

Feedback 7.2

a) %
Cost assumed to be 100
Profit 50
Selling price 150

R6 000 x 50/100 = R3 000

203
b) R50 000 x 150/100 = R75 000

c) R12 000 x 100/150 = R8 000

d) R2 500 x 180/100 = R4 500

%
Cost assumed to be 100
Profit 50
Selling price to branch 150
Additional profit 20% x 150% 30
Selling price to customers 180

The following are some of the branch transactions that are accounted for in the books of the
head office, where inventory is sent to the branch at selling price:

Inventory sent to the branch at selling price:

Dr - Branch inventory (with the cost)
Cr - Inventory to branch (with the cost)
Dr - Branch inventory (with the profit mark-up)
Cr - Branch adjustment account (with the profit mark-up)

Inventory purchases by the branch from other suppliers:

Dr - Branch inventory (with the cost)
Cr - Bank or branch trade payables control (where inventory is purchased on credit). In both
instances, the credit entry is at purchase price of the inventory.
Dr - Branch inventory (with the profit mark-up)
Cr - Branch adjustment account (with the profit mark-up)

Inventory returned to head office:

Dr - Inventory to branch (with the cost)
Cr - Branch inventory (with the cost)
Dr - Branch adjustment account (with the profit mark-up)
Cr - Branch inventory (with the profit mark-up)

Cash/credit sale of inventory by the branch:

Dr - Bank (cash sale) at selling price or Branch trade receivables control (sale on credit) at
selling price
Cr - Branch inventory (at selling price)

Settlement of a branch debtor’s account at a discount:

Dr - Settlement discount granted
Cr - Branch trade receivables control

Comment:

At the end of the accounting period, the settlement discount granted is closed off to the branch
adjustment account.

204
Mark-down on inventory sold (below the normal selling price):
Dr - Bank (cash sale) with proceeds on sale or Branch trade receivables control (sale on
credit) with proceeds on sale at selling price
Dr - Branch adjustment (with mark-down of normal selling price)
Cr - Branch inventory (proceeds on sale)
Cr - Branch inventory (with mark-down of normal selling price)

Embezzlement of cash at the branch from either a cash or a credit sale:

Cash sale:
Dr - Bank (with the actual money banked)
Dr - Branch expenses (with the embezzled amount)
Cr - Branch inventory account (with the price of the inventory sold, which includes the money
banked and the embezzled cash)

Credit sale:
Dr - Bank (with the actual amount banked)
Dr - Branch expenses (with the embezzled amount)
Cr - Branch trade receivables control (with the total amount that the debtor paid, which
consists of the banked amount and the embezzled cash)

Inter-branch inventory transactions:

Receiving branch:
Dr - Branch inventory (with the cost of inventory transferred)
Dr - Branch inventory (with the mark-up of inventory transferred)
Cr - Branch adjustment account (with the mark-up of inventory transferred)
Transferring branch:
Dr - Branch adjustment account (with the mark-up of inventory transferred)
Cr - Branch inventory (with the cost of inventory transferred)
Cr - Branch inventory (with the mark-up of inventory transferred)

205
7.5 Exercises and solutions

EXERCISE 7.1 – Inventory is invoiced to the branch at cost price

The following information pertains to the head office and branch of Boom CC for the year
ended 31 December 20.15:
R
Inventory sent to branch 4 800
Inventory returned to head office by the branch 80
Sales by branch for the year: Cash 2 000
Credit 3 290
Cash received from branch debtors and paid into the head office bank 2 890
account
Sundry expenses paid by head office 600

Additional information:

1. The branch began trading on 2 January 20.15 and inventory is invoiced to the branch at
cost price.
2. An amount of R50 must be written off as a credit loss.
3. Discount on selling prices for cash sales granted to customers amounted to R30.
4. Inventory at 31 December 20.15 amounted to R480.

REQUIRED

Prepare the following accounts properly balanced/closed off, in the general ledger of the head
office for the year ended 31 December 20.15:
a) Branch inventory account
b) Inventory to branch account
c) Branch trade receivables control account
d) Branch expenses account
e) Bank account (partly)

206
SOLUTION 7.1

BOOM CC (HEAD OFFICE)

GENERAL LEDGER

a) Dr Branch inventory (at cost price) Cr

20.15 R 20.15 R
Dec 31 Inventory to branch 4 800 Dec 31 Inventory to branch 80
(Delivery at cost) (Returns at cost)
Branch expenses 1 050 Bank (Cash sales) 2 000
(Branch gross profit for Branch trade receivables
year)* control (Credit sales) 3 290
Balance c/d 480
(Closing inventory)
5 850 5 850
20.16
Jan 1 Balance b/d 480

* Balancing figure

b) Dr Inventory to branch (at cost price) Cr

20.15 R 20.15 R
Dec 31 Branch inventory 80 Dec 31 Branch inventory 4 800
(Returns at cost) (Deliveries at cost)
Head office: Trading
account* 4 720
4 800 4 800

* Balancing figure

c) Dr Branch trade receivables control Cr

20.15 R 20.15 R
Dec 31 Branch inventory 3 290 Dec 31 Bank (Collections de- 2 890
(Credit sales) posited by branch)
Branch expenses 50
(Credit losses)
Balance c/d 350
3 290 3 290
20.16
Jan 1 Balance b/d 350

d) Dr Branch expenses Cr
20.15 R 20.15 R
Dec 31 Bank (Sundry expenses) 600 Dec 31 Branch inventory 1 050
Branch trade receivables ( (Branch gross profit for
control (Credit losses) 50 the year)
Head office: Profit or loss 400
(Branch profit for the year)*
1 050 1 050

* Balancing figure

207
SOLUTION 7.1 (continued)

e) Dr Bank (extract) Cr

20.15 R 20.15 R
Dec 31 Branch trade receivables Dec 31 Branch expenses 600
control 2 890
(Collections deposited by
branch)
Branch inventory 2 000
(Cash sales)

Comments
• The cash discount on sales of R30 will not be recorded because the cash sales of
R2 000 already exclude this amount.
• Only cash transactions with the branch are shown in the bank account. In practice, the
bank account will contain the cash transactions of the branch as well as those of the
head office.
• In the above solution, we see that the branch inventory is brought down as a balance in
the branch inventory account at the end of the financial period. The balances of the
branch trade receivables control and the branch asset accounts are added to the head
office balances and disclosed as a total amount in the statement of financial position.

EXERCISE 7.2 – Inventory is invoiced to the branch at selling price

The following information pertains to the head office and the branch of Pama CC for the year
ended 31 December 20.15:
R
Inventory sent to branch (selling price) 18 750
Cash sales (deposited in bank) 17 918
Returns to head office (selling price) 186
Sundry expenses paid by head office 4 760

Additional information:

1. All purchases are made by head office and all goods required by the branch are supplied
by head office at selling price, which is cost price plus 50%.
2. A burglary took place during the year and R55 in cash (cash sales) and inventory to the
value of R36 (selling price) were stolen. No entries have been made in the records yet.
3. The net proceeds of the annual sales amounted to R360. Inventory was sold at selling
price less 10% and no entries were made in the records concerning this price reduction.
4. Inventory invoiced to the branch at R75 (included in the amount of R18 750 above) was
still in transit at 31 December 20.15 and was therefore not included in the branch’s
inventory at 31 December 20.15.
5. Inventory at selling price:
31 December 20.14 R1 500
31 December 20.15 R1 950

208
REQUIRED

Prepare the following accounts, properly balanced/closed-off, in the general ledger of the head
office for the year ended 31 December 20.15:
a) Branch inventory account
b) Inventory to branch account
c) Branch adjustment account
d) Branch expenses account

SOLUTION 7.2

PAMA CC (HEAD OFFICE)

GENERAL LEDGER

a) Dr Branch inventory (at selling price) Cr

20.15 R 20.15 R
Jan 1 Balance b/d 1 500 Dec 31 Bank (Sales) 17 918
Inventory to branch  12 500 Inventory to branch ƒ 124
(Deliveries at cost) (Returns at cost)
Branch adjustment ‚ 6 250 Branch adjustment 62
(Mark-up on deliveries) (Mark-up on returns)
Branch adjustment 10 Branch expenses 55
(Inventory surplus)* (Cash stolen)
Branch expenses „ 24
(Inventory stolen at cost)
Branch adjustment 12
(Mark-up on inventory
stolen)
Branch adjustment † 40
(Discount on sales)
Balance c/d 75
(Inventory in transit)
Balance c/d 1 950
(Closing inventory)
20 260 20 260
20.16
Jan 1 Balance b/d 75
(Inventory in transit)
Balance b/d 1 950
(Opening inventory)

* Balancing figure

b) Dr Inventory to branch (at cost price) Cr

20.15 R 20.15 R
Dec 31 Branch inventory 124 Dec 31 Branch inventory 12 500
(Returns at cost) (Deliveries at cost)
Head office: Trading
account* 12 376
12 500 12 500

* Balancing figure

209
SOLUTION 7.2 (continued)

c) Dr Branch adjustment (mark-up at 50% on cost) Cr

20.15 R 20.15 R
Dec 31 Branch inventory 62 Jan 1 Balance ‡ b/d 500
(Mark-up on returns) (Mark-up on opening
Branch inventory 12 inventory)
(Mark-up on inventory Branch inventory 6 250
stolen) (Mark-up on deliveries)
Branch inventory 40 Branch inventory 10
(Discount on sales) (Inventory surplus)
Balance ➇ c/d 25
(Mark-up on inventory in
transit)
Balance ‰ c/d
(Mark-up on closing 650
inventory)
Branch expenses 5 971
(Branch gross profit for
the year)*
6 760 6 760
20.16
Jan 1 Balance b/d 25
(Mark-up on inventory in
transit)
Balance b/d 650
(Mark-up on opening
inventory)

* Balancing figure

d) Dr Branch expenses Cr
20.15 R 20.15 R
Dec 31 Bank (Sundry expenses) 4 760 Dec 31 Branch adjustment 5 971
Branch inventory 55 (Branch gross profit for
(Cash stolen) the year)
Branch inventory 24
(Inventory stolen)
Head office: Profit or loss 1 132
(Branch profit for the
year)*
5 971 5 971

* Balancing figure

Calculations

 Cost of inventory sent to branch

%
Cost 100
Profit mark-up 50
Selling price 150

Inventory sent to branch at cost = R18 750 x 100/150 = R12 500

210
SOLUTION 7.2 (continued)

‚ Profit mark-up on deliveries

R18 750 x 50/150 = R6 250

ƒ Cost of returns to head office

R186 x 100/150 = R124

„ Cost of inventory stolen

R36 x 100/150 = R24

Profit mark-up on inventory stolen

R36 x 50/150 = R12

† Discount on sale
R360 = 90% of original selling price
Original selling price = R360 ÷ 90%
= R400
.˙. Discount = R(400 – 360) = R40
or
%
Cost 100
Profit mark-up 50
Original selling price 1 50
Markdown (10% x 150) (15)
Sold at 135

Original selling price

R360 x 150/135 = R400
Markdown on the original selling price
R(400 – 360) = R40
or
R400 x 15/150 = R40

‡ Profit mark-up on opening inventory

R1 500 x 50/150 = R 500

➇ Profit mark-up on closing inventory in transit

R75 x 50/150 = R25

‰ Profit mark-up on closing inventory

R1 950 x 50/150 = R650

211
EXERCISE 7.3 – Inventory is invoiced to the branch at selling price

The following information pertains to the head office and branch of Sucro Confectionary CC
for the year ended 28 February 20.15:
R
Inventory to branch at selling price 64 500
Inventory returned to head office at selling price 1 800
Cash sales of branch embezzled by cashier 375
Administrative expenses of branch paid by head office 5 000
Discount granted to branch debtors for early settlement 150
Cash sales by branch (after deducting local purchases) – cost 41 500
price R500
Credit sales of branch 20 000
Rent expense of branch paid by head office 1 800
Inventory damaged – selling price 300
Credit losses of branch written off 50

Additional information:

1. Inventory was supplied to the branch by head office at selling price, that is, cost plus
50%.
2. Inventory at selling price at:
28 February 20.14 R4 500
28 February 20.15 R4 800
3. It is estimated that theft of inventory amounting to R360 (selling price) occurred during
the year. This amount must be taken into account during inventory reconciliations.
4. During the year, the branch donated inventory (cost R60) towards a local charity fund-
raising campaign.
5. Inventory purchased locally was also sold at cost price plus 50%.

REQUIRED

Prepare the following accounts, properly balanced/closed-off, in the general ledger of the head
office for the year ended 28 February 20.15:
a) Branch inventory account
b) Branch adjustment account
c) Branch expenses account

212
SOLUTION 7.3

SUCRO CONFECTIONERY CC (HEAD OFFICE)

GENERAL LEDGER

a) Dr Branch inventory (at selling price) Cr

20.14 R 20.15 R
Mar 1 Balance b/d 4 500 Feb 28 Inventory to branch „ 1 200
Inventory to branch  43 000 (Returns at cost)
(Deliveries at cost) Branch adjustment 600
Branch adjustment ‚ 21 500 (Mark-up on returns)
(Mark-up on deliveries) Branch expenses 375
Bank (Local purchases) 500 (Cash embezzled)
Branch adjustment ƒ 167 Bank (Cash sales) † 42 000
(Mark-up on local Branch trade receivables
purchases) control (Credit sales) 20 000
Branch expenses ‡ 200
(Cost of inventory
damaged)
Branch adjustment ˆ 100
(Mark-up on inventory
damaged)
Branch expenses ‰ 240
(Cost of inventory
stolen)
Branch adjustment Š 120
(Mark-up on inventory
stolen)
Branch expenses 60
(Cost of inventory
donated)
Branch adjustment 20
(Mark-up on inventory
donated)
Branch adjustment 25
(Inventory shortage)*
Balance c/d 4 727
(Closing inventory)
69 667 69 667
20.15
Mar 1 Balance b/d 4 727
(Opening inventory)

* Balancing figure

213
SOLUTION 7.3 (continued)

b) Dr Branch adjustment (mark-up at 50% on cost) Cr

20.15 R 20.14 R
Feb 28 Branch inventory 600 Mar 1 Balance ⑫ b/d 1 500
(Mark-up on returns) (Mark-up on opening
Branch inventory 100 inventory)
(Mark-up on inventory Branch inventory ‚ 21 500
damaged) (Mark-up on deliveries)
Branch inventory 120 Branch inventory 167
(Mark-up on inventory (Mark-up on local
stolen) purchases)
Branch inventory ⑪ 20
(Mark-up on inventory
donated)
Branch inventory 25
(Inventory shortage)
Balance ⑬ c/d 1 600
(Mark-up on closing
inventory)
Branch expenses 20 702
(Branch gross profit for
the year)*
23 167 23 167
20.15
Mar 1 Balance b/d 1 600
(Mark-up on opening
inventory)
* Balancing figure

c) Dr Branch expenses Cr
20.15 R 20.15 R
Feb 28 Branch inventory 375 Feb 28 Branch adjustment 20 702
(Cash embezzled) (Branch gross profit for
Bank (Admin expenses) 5 000 the year)
Bank (Rent expenses) 1 800
Branch inventory 200
(Inventory damaged)
Branch debtors’ control 50
(Credit losses)
Branch inventory 240
(Inventory stolen)
Branch inventory 60
(Inventory donated)
Head office: Profit or loss 12 977
(Branch profit for the
year)*
20 702 20 702

* Balancing figure

214
SOLUTION 7.3 (continued)

Calculations

① Cost of inventory sent to branch

%
Cost 100
Profit mark-up 50
Selling price 150
Inventory sent to branch at cost = R64 500 x 100/150 = R43 000

② Profit mark-up on inventory sent to branch

R64 500 x 50/150 = R21 500

③ Profit mark-up on local purchases

R500 x 50/150 = R167

④ Cost of returns to head office

R1 800 x 100/150 = R1 200

⑤ Profit mark-up on returns to head office

R1 800 x 50/150 = R600

⑥ Bank (Cash sales)

R
Cash sales (after deduction of R500) 41 500
Cash used for local purchases 500
Total cash sales 42 000

⑦ Cost of inventory damaged

R300 x 100/150 = R200

⑧ Profit mark-up on inventory damaged

R300 x 50/150 = R100

⑨ Cost of inventory stolen

R360 x 100/150 = R240

⑩ Profit mark-up on inventory stolen

R360 x 50/150 = R120

⑪ Profit mark-up on inventory donated

R60 x 50/150 = R20

⑫ Profit mark-up on opening inventory

R4 500 x 50/150 = R1 500

⑬ Profit mark-up on closing inventory

R4 800 x 50/150 = R1 600

215
 Self-assessment

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly discuss the concept of branches.

Briefly explain the difference between dependent and independent

branches.

Briefly discuss the information to be included in the reports submitted by a

dependent branch to a head office.

Record the transactions between a head office and a dependent branch in

the books of the head office, where inventory sent to the branch is invoiced
at cost price.
Record the transactions between a head office and a dependent branch in
the books of the head office, where inventory sent to the branch is invoiced
at selling price.

Record the transactions of a dependent branch pertaining to the following,

where inventory is invoiced at cost price or at selling price:
- Purchases of inventory by the branch
- Sales of inventory by the branch
- Inventory sold by the branch at a discount
- Inventory damaged or stolen at the branch
- Inter-branch inventory transactions
- Settlement discount granted to debtors of the branch
- Donations made by the branch
- Cash embezzled at the branch
- Inventory in transit from the branch to the head office and from the
head office to the branch

Identify and record a shortage or surplus in the inventory of a branch where

inventory is invoiced by the head office at selling price.

If you answered "yes" to all of the above assessment criteria, you have completed your
studies on branches and can now focus on revision of the study material for the exams.

216