CHAPTER 5 SUGGESTED SOLUTIONSSOLUTION TO MULTIPLE CHOICE QUESTIONS
5.1 (a) 5.6 (d) 5.11 (b)
5.2 (d) 5.7 (b) 5.12 (c)
5.3 (e) 5.8 (c) 5.13 (b)
5.4 (b) 5.9 (b) 5.14 (d)
5.5 (c) 5.10 (e) 5.15 (e)
END OF CHAPTER QUESTIONS
5.1An Act of Parliament called the Companies Act, which was introduced in 1973, governs reporting by management to the shareholders. One of its major objectives is to ensure that company directors do not withhold information which shareholders are entitled to know. The first reference in this Act to generally accepted accounting practice is made when it states that ‘the annual financial statements of a company shall, in conformity with generally accepted accounting practice, fairly present the state of affairs of the company and its business as at the end of the financial year concerned and the profit or loss of the company for that financial year’.
When this legislation was tabled in Parliament, accountants in South Africa were faced with the question: ‘What is generally accepted accounting practice?’ As there was no easy answer to the question, the South African Institute of Chartered Accountants (SAICA) started working on defining the term ‘generally accepted accounting practice’. The result is that a number of ‘statements of generally accepted accounting practice’ have been published, which assist accountants when preparing financial statements of companies. The SAICA will continue to produce more statements as new problems in financial reporting are identified. Examples of the topics that have required attention, include how to report on Non Current assets, how to report sales of inventory and how to report on investments. Each has resulted in a statement of generally accepted accounting practice, usually referred to as a GAAP statement.
When the need for a specific standard relating to financial reporting is identified by the APC (Accounting Practices Committee, which is a committee of the South African Institute of Chartered Accountants), an exposure draft or discussion paper is circulated to all interested partners for comment. When consensus is reached, the proposed standard is submitted to the APB (Accounting Practices Board) for acceptance. The APB is a board with representation from the Public Accountants' and Auditors' Board, the JSE, Die Afrikaanse Handelsinstituut, the Chamber of Mines, the Association of Chambers of Commerce, the Federated Chambers of Industries and the Steel and Industry Federation. Its basic objective is to establish and procure recognition and acceptance of what the Board considers is or should be generally accepted accounting practice. Once the APB has accepted the proposed standard, it attains the status of generally accepted accounting practice.
5.2The auditors of financial statements are required to state that it their opinion, financial statements “fairly present” the financial performance and the financial position of the company in accordance with generally accepted accounting practice. The auditors are thus passing an opinion on the profit (performance) for the year and the assets and liabilities (position) at a moment in time (the reporting date). In order to establish what is “fair”, a benchmark is needed, because reporting is not a totally objective activity. The benchmark is generally accepted accounting practice, that is, the practices of financial accountants that are commonly used and accepted. Most of these have been codified in GAAP statements, which must therefore be observed.
When comparing “generally accepted accounting practice” to “true” values, especially as they relate to the valuation of assets, the values will be different. Another way of looking at this is that accountants do not purport to report on true values. The values offered by accountants in financial statements are based on a set of principles. Investors, or other users of financial statements need to understand the GAAP principles, and use the data base presented in financial statements to estimate “true” value.
Financial statements measure and report the results of operations of specific entities which are separate and distinct from the owners of the entity. By understanding and applying this concept, the personal transactions of the owners will not be recorded or mixed up with the transactions of the business itself.
2. The historic cost concept
The original price paid for an asset is called its ‘historic cost’. From the date of purchase, the asset is used and depreciation is deducted from the historic cost. The purpose of the depreciation is to record an amount which reflects the usage of the asset. The asset is reported in the balance sheet at its historic cost less the depreciation which has been deducted since the date it was purchased..
3. The going concern concept
Because financial statements are presented periodically during the life of a business, the financial results and position of that business has to be established on a particular day, the accounting date. The financial position of a business would have to be reported differently if it was expected that the business intends to cease its operations. However, most businesses operate as if they intend to continue operations indefinitely, and in preparing the financial statements it may therefore be assumed that this is the intention, unless specifically stated to the contrary.
4. The matching concept
If goods are sold during one accounting period, but payment is only received in the next accounting period, in which period should that amount be treated as profit? If expenses, such as telephone, electricity or rent are incurred in one accounting period, but only paid in the next period, in which period should the amount be treated as an expense? This and similar questions are resolved by applying the matching concept. The matching concept states that revenues and costs are recognised in the period in which they are earned or incurred, and not in the period in which the money is received or paid
5. The prudence concept
The word prudence implies being careful, cautious or wise. It is not considered good business practice to anticipate income if there is a strong likelihood that it will not be received. The prudence concept states that income should only be recognised when received in the form of cash or if it exists in the form of other assets, which the business is reasonably certain will eventually become cash and when provision has been made for all known expenses and losses.
6. The materiality concept
The materiality concept therefore states that financial statements should disclose all items which are substantial enough to affect evaluations and decisions.
5.4At the time of purchase, an estimate must be made of the period over which the vehicle will be used and of the amount which will be received on disposal of the vehicle at the end of its useful life to the business. The depreciation policy of the business will then be applied to the depreciable amount. Using the example of a vehicle purchased for R200 000, the following could be the facts after three years.
Estimated useful life 5 years [Assume]Estimated disposal value R50 000 [Assume]Depreciation policy 20% p.a. straight line [Assume]Therefore depreciable amount R150 000 (R200 000 – R50 000)Amount to be written off each year R30 000 (20% of R150 000)Amount written off over three years R90 000 (3 x R30 000)Value (historic cost) reported in Balance Sheet R110 000 (R200 000 – R90 000)
5.5Once an entrepreneur, or anyone else, starts a business, the capital investment (R100 000) in this case, is treated as if it belongs to a different person (the business). The owner however still has a claim against the business for the amount. It is similar to a loan to the business, except that it bears more risk (if the business fails, it may not be able to repay the entrepreneur, who will suffer the loss of his/her capital investment). The business is thus an entity on its own and all exchanges of money or value between it and the owner must be treated as if a separate person (entity) exists. Examples of these are drawing of cash in the form of dividends or capital repayments. Thus no owner of a business should ever mix private and personal transactions with those of the business. Only if this principle is observed, is it possible to correctly determine the profit of the business, as an entity, over a period.
5.6 Historic Cost: The machine was purchased at an earlier date for an amount greater than R400
000, and has been depreciated since the date of purchase. GAAP permits the reporting of the asset at Cost less Accumulated Depreciation. The fact that it could be sold for R450 000 is not relevant to the historic cost principle.
Going concern concept: The business is expected to continue its operations and each year the machine will continue to be depreciated. The effect of this is that each year a portion of the cost of the machine will be written off against income, to reflect the part of the cost matched to that year. If the business was not expected to continue its existence, then the asset should be revalued to reflect the value which could be realised on liquidation of the machine, namely R450 000
Prudence concept: The financial reports, if they must reflect estimates, will rather reflect a conservative figure, than report optimistic figures. The effect of this is that depreciation estimates might be conservative (writing off a higher amount each year, and thus reporting the book value at a lower value). Another (obvious) reason why the selling (realisable) value of the machine will be higher is because of inflation, over a period of years.
5.7The Administrative Expenses account will record all payments made for this account, as well as any credit transactions. For the financial year, the matching concept requires that all accruals (amount expended for this account, but not yet recorded) and all prepayments (amounts recorded, but which will only be “used” in the following financial period). The amount reflected in the Income Statement for Administrative Expenses for the period, will be the amount which was incurred for the period in order to generate the Revenue which was realised. [Expensed incurred are matched against Revenue earned during the financial period– NOT Expenses recorded against Revenue received]
5.8The amount of R5 400 owing (a credit in Telephone Expense account) at the beginning of the financial year, was expensed (written off using the matching concept) during the previous year. The payment of R98 000 during the year (a debit in the Telephone Expense account), includes paying, during the current year, R5 400 for a previous year expense. The net effect of these two entries is an amount of R92 600 for current year telephone expenses incurred.
As the business has incurred a further expense of R8 500, (which has not yet been paid), it requires a further debit to the Telephone Expense account , giving a new balance of R101 100, which is the expense incurred during the year to be matched against the Revenue earned. The amount of R101 100 will therefore be reported in the Income Statement as the expense for the year, and the amount of R8 500 will be reported in the Balance Sheet as a creditor, who, at that moment in time, is owed R8 500. This amount will be paid early in the new financial year.
5.9 Historic Cost concept: Under the historic cost principles, the Investment will be recorded at its cost
of R700 000. In addition to reporting the Investment at its cost, it is customary, to indicate in a note what the value is on Balance Sheet date. This is important information for the users of the financial statements.
Prudence concept: This would dictate that the amount reported should not be re-valued to the higher value of R900 000. However, if the value was lower than cost of R700 000, prudence would require the investment to be shown at the lower value.
5.10This error in the financial reports is so small at R90, that the materiality concept would permit the error to remain unchanged in the report. It will be of no consequence to any of the users of financial statements or affect any decision, which may be made on the basis of the information. It should be noted that from a financial recording perspective, the error may well be corrected for the purpose of ensuring that all internal records are accurate.
5.11The following are all possible types of shares which may be issued: Ordinary shares (par value or no par value)
Ordinary shareholders are the effective owners of the company and their shares confer the following rights: to attend the shareholders' meeting of the company; to elect a board of directors; to share in the company's profits by way of dividends, and to share in any surplus assets on liquidation of the company.
Preference shares (par value or no par value) Preference shares may, in exactly the same way as ordinary shares, be shares with a par value or shares of no par value. Preference shareholders have preferential rights over ordinary shareholders with regard to the receipt of a dividend, as dividends on preference shares must be paid before dividends on ordinary shares can be paid. Preference shares are characterized by a Non Current dividend rate. Preference shareholders do not normally, in terms of the articles of association, have a right to vote at shareholders' meetings. They may have preference with regard to the repayment of capital on liquidation before ordinary shareholders are paid out. There are a number of classes of preference shares, the most common of which are the following: cumulative preference shares participating preference shares convertible preference shares redeemable preference shares.
5.12Par value shares: These are shares which have a nominal value, for example R1.00, stated on the face of the share certificate.
No par value shares: Such shares do not have a nominal value and are issued at a price which is considered appropriate by the directors of the company.
Once the ordinary shares have been issued, the factor of par value or no par value becomes of little or no interest to shareholders. The shares will trade at a market value and dividends are paid per share, and are not based on a consideration of any par value.
5.13 Cumulative preference shares: The dividend accumulates in the event of a period during which
dividends are not paid. No dividend may be paid to ordinary shareholders until the accumulated dividend has been paid to the preference shareholders
Participating preference shares: These shares, apart from being entitled to a fixed dividend, will also carry a clause indicating some share of profits granted to ordinary shareholders. Preference shareholders thus benefit in receiving a fixed dividend, but also sharing in the fortunes of the company.
Convertible preference shares: These shares may be converted into ordinary shares at some fixed future date, at a price agreed at the date of issue. The shareholder usually has the option to convert, that is they may choose not to convert (in the event of the ordinary shares not doing well, they may decide not to convert)
Redeemable preference shares: This is the only form of share which allows for the capital to be returned to the shareholder at a future date. It is thus similar to a loan.
5.14A company usually has growth as one of its objectives. In order to grow, it required additional capital from investors. Investors have different needs and objectives. Some are seeking investments with a high degree of certainty (low risk), while others may be prepared to take on more risk in the hope of achieving a higher return. Financial managers, wanting to raise capital design different financial instruments (types of shares), in order to appeal to a wider sector of the investment community, and thus attract more capital, albeit in various forms.
5.15The term 'distributable reserve' in defined in statute, as any amount which has been carried to reserves and which may, in accordance with generally accepted accounting practice and legal principles, be taken to the credit of the income statement and distributed by way of dividend, and does not include any amount retained by way of providing for any known liability. The paragraph does not define non-distributable reserves, but merely states that non-distributable reserves shall be construed in accordance with the definition of distributable reserves.
The disclosure of an item as a non-distributable reserve in the balance sheet provides an indication to shareholders and lenders that the company may not, and does not intend to, distribute the funds thus classified. This means that they may never be paid out in the form of dividends to the shareholders. Amounts listed under distributable reserves may, however, be paid out in the form of dividends.
5.16A reserve is often considered to be an amount of money set aside somewhere. It is not. A reserve is simply profits that have been made by a company (as a result of operations, or as a result of holding assets which increase in value), and which have not be distributed (hand back to) to the investors. As these assets are reported in the Balance Sheet, the amounts must also be shown as belonging to the shareholders (otherwise the Balance Sheet would not “balance”). Reserves thus indicate value belonging to the shareholders, but it is not necessarily in the form of cash. Most usually it is invested in all the assets of the business.
5.17A company may decide to take out long term loans or to issue Debentures.
5.18A debenture is a long-term loan from the public raised in small amounts such as R10 or R100, usually at a fixed rate of interest and with specified repayment terms. It is issued as a form of debt in order to raise funds for the long-term financing of the business operations of a company. Debentures may be issued at a discount or at a premium because they are usually registered at a particular interest rate, while the interest rate in the market fluctuates from time to time. In order to ensure that the debentures remain attractive, the debentures must offer the lender a return equivalent to that which can be obtained from similar financial instruments in the market place at that time. In order to achieve this return, debentures are often offered at a discount or at a premium.
Debenture-holders who hold secured debentures have the assurance that in the event of the company experiencing financial hardship, the amount which the debenture-holder has lent to the company is secured by an asset such as land and buildings. This is not the case if debentures are unsecured.
5.19Depreciation expense account is a nominal account. It represents the portion of the depreciable amount of an asset which is allocated to depreciation during a financial year. It thus represents the cost incurred by the business during the year for the use of an asset in earning income. As it is a nominal account, it is written off at the end of each financial year to the profit and loss account and the balance in the account at the beginning of each financial year will thus be nil.
Accumulated depreciation account is a real account which is credited whenever depreciation expense is debited. As it is a real account, the balance in the accumulated depreciation account is not written off annually to the profit and loss account - rather, the annual depreciation change is "accumulated" in the accumulated depreciation account. Consequently, as an asset becomes older and more depreciation is written off, the balance in the accumulated depreciation account becomes larger. The net book value of the asset therefore becomes smaller, as book value is represented by the original cost less accumulated depreciation at the point in time when the financial position of the business is being reported.
5.20As with all predictions, an estimate of future events is essential. The estimate that is required in this case is the rand amount of debtors who are unlikely to be able to settle their debts. When making predictions, the most common method is to use historical data in order to estimate the future. The assumption underlying this approach is that all other things remaining equal, the past will be repeated in the future. In addition to this, however, expected economic conditions should also be taken into account. For example, during a recession or before an expected recession it is likely that bad debts will increase rather than decrease.
The data most frequently used to predict bad debts is a list of debtors, usually in the form of an age analysis, in which debtors are analysed by period and amount outstanding. Varying percentages for estimated doubtful debts can then be applied to the different categories of debtors. Alternative methods include the application of a single percentage to total debtors or to credit sales for the financial year.
5.21The accrual basis of accounting recognises revenue as income when the criteria of performance, measurability and collectibility have been met. For most business operations, the delivery of the goods or provision of the services and the invoicing take place virtually simultaneously. As both parties are acting in good faith, the revenue is recognised as having been earned at that point. All recorded sales, both cash and credit, are therefore reflected in the income statement at the end of a period.
Despite the recognition of all credit sales as revenue, it is widely known that, given the vagaries of business and the fact that no credit control system is infallible, certain of the revenue recognised will not ultimately be received in cash, that is, some debtors will default.
At the end of a financial period, the risk of default is dependent upon the amount owed by debtors at that time. Some proportion of the debtors' amount - based on previous experience, knowledge of the debtors and predicted economic circumstances - must be set aside, in accordance with the concept of prudence, for the eventuality of non-payment by some debtors. Such a provision for doubtful debts also accords with the matching concept, as the amount, which may not be collected in the subsequent accounting period, is, in reality, a loss, which relates to the financial period in which the sale took place. For these reasons, a provision for doubtful debts must be created at each reporting date.
5.22
Robson Ltd
a) Original Plant and Machinery
Calculation of depreciation for the year ended 30 June 20.1Cost on 1 Jan 20.1 R120 000Residual value R10 000Depreciable amount R110 000Amount written of each full financial year R110 000/10
R11 000
Additional plant and machinery:
Cost on 1 Dec 20.4 R66 000Residual value R3 000Depreciable amount R63 000Depreciation 7 Months (63000/6) x (7/12) R6 125
New plant manufactured:
Cost (15 000 + 38 000) R53 000Depreciation 2 months R53 000 x 0,25 x 2/12 R2 208
Total Depreciation for the year ended 30 June 20.4
R11 000 + R6 125 + R2208 R19 333
b) Income statement of Robson Ltd for the year ended 30 June 20.1
Note to the balance sheetPlant and machinery is depreciated on a straight-line basis to reduce the assets to their estimated residual values, as follows:Acquired before 30 June 20.1 10 % p.a.Acquired during the current year 162/3% p.a.Manufactured 25% p.a.
a) General journal of Fedoc Distributors Ltd 20.0Jul 1 Motor vehicles 30000
Bank 30000Purchase of new vehicleDec 1 Equipment 18000Creditors' control (Quip Ltd) 18000 Purchase of equipment on credit
b)20.1Jun 30 Depreciation 55 450Accumulated deprec. on buildings 4000Accumulated deprec. on motor veh. 18 000Accumulated deprec. on equipment 33 450Depreciation for the year as per accounting policies
c)20.1Jun 30 Profit and loss 55 450.Depreciation 55 450Closing transfer of depreciation
d) Balance sheet at 30 June 20.1Non Current assets Note 1 758 550
Notes:1. Non Current assets
COST ACCUMULATED DEPRECIATION
BOOK VALUE
Land and Buildings 390,000 25,000 365,000Motor Vehicles 150,000 65,000 85,000
Debit CreditOrdinary share capital 110,000Long-term loan 20,000Investments 127,500Office equipment 15,000Acc dep: Equipment 3,000Bank 22,870Services rendered 303,450Commission earned 89,309Dividends received 9,600Salaries 204,685Rent 6,800Wages 25,750Electricity 8,099Consumable stores 113,115Interest on loan 3,600Consumable stores on hand 8,540Depreciation 3,000Accrued expenses 3,600
538,959 538,959
Post adjustment trial balance at 28 February 20.1
20.1Feb 1 Balance b/d 7,457
7 Bank 6428,099
20.1 20.1Feb 1 Balance b/d 120,220 Feb 28 Consumable stores
15 Bank 1,435 onhand 8,540113,115
20.1Feb 28 Accrued expenses 3,600
20.1Feb 28 Cons stores 8,540
20.1Feb 28 Acc Dep. 3,000
[Off Equip]
20.1Feb 28 Interest on loan 3,600
Depreciation
Accrued expenses
Consumable stores on hand
Electricity
Consumable stores
Interest on loan
d)
e) Return on equity = 37 310/100000 = 37,3%OR = 37 310 / 167 310 = 22,3%Note that conceptually, ROE should be calculated on the amount invested at the beginning of the period. If additional capital is injected, the weighted average of the capital investment over the period should be used. As the additional amount of R10 000 was invested very close to the end of the year, the first calculation of around 37% is quite accurate. In practice, analysts tend to use the second calculation (the equity at the end of the period). While this is not conceptually appealing, the most significant issue is that the formula chosen be used consistently over the years for comparison.
Income 402,359Services rendered 303,450Commission earned 89,309Dividends received 9,600
Less: Expenses 365,049Salaries 204,685Rent 6,800Wages 25,750Electricity 8,099Consumable stores 113,115Interest on loan 3,600Depreciation 3,000Net income 37,310
Equity and LiabilitiesShareholders' equity 147,310Share capital 110,000Retained income 37,310
Long term loan 20,000167,310
AssetsNon Current assets 1 12,000
Investments 127,500
Net current assets 27,810
Current assets 31,410Stock 8,540Bank 22,870Less Current liabilities 3,600Accrued expenses 3,600
167,310
NOTE 1 Cost Accumulated Bookdepreciation value
Office equipment 15,000 3,000 12,000
Income statement for the year ended 28 February 20.1
Balance sheet at 28 February 20.1
f) The market value of the company's investments may have changed There may have been a change in key personnel The economic climate may have changed Competitors may have entered the company's market Demand for the services of the company may have changed These factors will affect the value of the business and its future prospects.
g) The level of income earned by the company is adequate to cover the interest expense, without incurring a loss. The company is, furthermore, sufficiently liquid to pay the interest due. No guarantee exists, however, that the company will still be liquid enough to repay the loan on 30 April 20.4.
ASSETSNon Current Assets 134,200 At cost 236,000 Accumulated Deprec -101,800Investment in Associate 165,000Net Current Assets 803,890Current Assets 1,092,650
Inventory 542,900 Debtors 548,000 Expenses Prepaid 1,750Current Liabilities 288,760 Bank Overdraft -35,770 Creditors 267,830 Expenses Accrued (Interest) 4,800 Receiver for Tax 51,900 Shareholder for Dividends
REAL ACCOUNTSShare capital 80,000Vehicles 84,600Accumulated depreciation on vehicles 20,000Furniture 30,000Accumulated depreciation on furniture 600Equipment 21,000Accumulated depreciation on equipment 6,200Stock of consumable stores 3,450Non Current deposit: Santambank 10,000Debtors 740Cash at bank 8,397Long-term loan from Standard Bank 5,000Creditors 3,740Accrued expenses 2,460NOMINAL ACCOUNTSElectricity and water 1,341Salaries and wages 17,927Advertising 2,349Interest on loan 550Rent paid 12,370Stationery 491Telephone 609Fee income 92,886Repairs 1,906Depreciation 12,390Bank charges 876Consumable stores 1,890
210,886 210,886
Trial balance of Unisex Stylists Limited at 31 March 20.1
Fee income 92,886Expenses 52,699Electricity and water 1,341Salaries and wages 17,927Advertising 2,349Interest on loan 550Rent paid 12,370Stationery 491Telephone 609Repairs 1,906Depreciation 12,390Bank charges 876Consumable stores 1,890Net Profit 40,187
EQUITY AND LIABILITIESShareholders' equity 120,187 Share capital 80,000 Retained income 40,187Long-term liability 5,000Current liabilities 6,200Creditors 3,740Accrued expenses 2,460
131,387ASSETSNon Current assets Note 1 108,800InvestmentsFixed deposit: Santambank 10,000Current assets 12,587Stock of consumable stores 3,450Debtors 740Cash at bank 8,397
Share capital 112,000Long-term loan @ 18% 50,000Office equipment 15,000Accumulated depreciation:Equipment 3,000Investments 257,000Consumable stores on hand 5,250Debtors 8,500Accrued income 2,885Bank 37,811Creditors 12,800Accrued expenses 9,796Shareholders for dividends 5,000Taxation owing 18,350Fee revenue 527,270Investment revenue 10,245Rent revenue 2,400Rent expense 6,000Wages 33,650Salaries 308,985Utilities expense 9,195Consumable stores 25,035Interest on loan 9,000Depreciation 3,000Tax paid 24,550Dividends 5,000
750,861 750,861
Taurus Finanical Brokers LimitedPost-adjustment trial balance at 28 February 20.1
28 Fee revenue 527,270Rent revenue 2,400Investment revenue 10,245Profit and loss 539,915Closing entry i.r.o. of income accounts Profit and loss 419,415Rent expense 6,000Wages 33,650Salaries 308,985Utilities expense 9,195Consumable stores 25,035Interest on loan 9,000Depreciation 3,000Tax paid 24,550Closing entry in respect of expenseaccounts Profit and loss 120,500Retained income 120,500Closing of profit and loss to retainedincome Retained income 5,000Dividends 5,000Closing of dividends to retained income
Closing transfers of Taurus Financial Brokers Limited for February 20.1
NET INCOME BEFORE TAXATION 145,050TAXATION 24,550NET PROFIT TO SHAREHOLDERS 120,500ORDINARY DIVIDENDS 5,000RETAINED INCOME AT END OF YEAR 115,500
Income statement for the year ended 28 February 20.1
Taurus Financial Brokers Limited
f)
g) The return on equity earned by the shareholders amounts to
120 500 / 227 500 = 53%
This would appear to be a very favourable return for shareholders, considering that it is the first year of operation. The company has paid out a dividend of R5 000; thus indicating the intention to retain most of its profits in the business for future growth.
The return on the investment which the company has made amounts to 10 245 / 257 000 = 4,0% which is lower than the interest of 18% payable on the long-term loan. It is not clear, however, whether there has been any capital growth in the value of the investments; if there has been no capital growth, the investment could be utilized better by redeeming the long-term loan.
Current liabilities 45,946 Creditors 12,800 Accrued expenses 9,796 Shareholders for dividends 5,000 Taxation owing 18,350
323,446
ASSETSNon Current assets 12,000Office equipment 12,000Cost 15,000Less Accumulated Depreciation 3,000
Investments 257,000
Current assets 54,446 Consumable stores on hand 5,250 Debtors 8,500 Bank 37,811 Accrued income 2,885
323,446
Taurus Financial Brokers Limited
Balance sheet at 28 February 20.1
h) Alternative method 1Treat the "Consumable stores" account as an asset account.
i) (1) Investments - these are stated at cost and there is no indication of the market value. It is, therefore, difficult to assess whether the amount reflected in the balance sheet is over- or under-valued. The prudence concept requires the amount to be written down if the market value is lower than the cost. (The same reasoning applies in the case of consumable stores.)
(2) Office equipment - this is stated at net book value and is unlikely to reflect its actual value. It is difficult to assess whether it is over- or under-valued because of the lack of information.
30 Consumable stores expense 112 3,165Stock of consumable stores 4 3,165Accrued income 9 2,750Service income 104 2,750Prepaid expenses 10 1,428
Insurance 106 1,428Stationery on hand 11 439Stationery 107 439Stationery 107 235Salaries and wages 103 235Electricity and water 108 345Telephone 109 208Accrued expenses 12 553Depreciation 113 22,625Accumulated depreciation onequipment XX 10,000Accumulated depreciation on motor vehicles (5685 + 6940) XX 12,625Deferred expenditure 15 42,533
Research and development 111 42,533Taxation 114 26,450Receiver of Revenue 16 26,450Dividends 115 17,600Shareholders for dividends 17 17,600
Wetwell (Pty) Limited
General journal of Wetwell (Pty) Ltd for April 20.1
b) General ledger of Wetwell (Pty) Ltd
Note: The closing journal entries from part (d) have also been entered in the ledger accounts which follow.
Note: The general journal folio numbers have not been inserted in the above accounts. This should be done as soon as each amount is posted from the general journal to a general ledger account.
20.1 20.1Apr 30 Rental 31,500 Apr 30 Service income 358,000
Advertising 17,983Salaries and wages 82,142Directors' fees 40,000Insurance 13,422Stationery 1,344Electricity & water 12,125Telephone 1,798Motor vehicleexpenses 7,420Research and development 22,667Consumable storesexpense 3,165Depreciation 22,625Taxation 26,450Retained income 75,359
358,000 358,000
Profit and loss
Fol Debit CreditReal accountsShare capital 1 110,000Bank 2 31,257Equipment, at cost 3 50,000Stock of consumable stores 4 360Motor vehicles, at cost 5 64,380Creditors 6 28,690Debtors 7 46,830Provisional tax payments 8 23,700Accrued income 9 2,750Prepaid expenses 10 1,428Stationery on hand 11 439Accrued expenses 12 553Accumulated depreciation on equipment 13 10,000Accumulated depreciation on motor vehicles 14 12,625Deferred expenditure 15 42,533Receiver of Revenue 16 26,450Shareholders for dividends 17 17,600Nominal accountsRental 101 31,500Advertising 102 17,983Salaries and wages 103 82,142Service income 104 358,000Directors' fees 105 40,000Insurance 106 13,422Stationery 107 1,344Electricity and water 108 12,125Telephone 109 1,798Motor vehicle expenses 110 7,420Research and development 111 22,667Consumable stores expense 112 3,165Depreciation 113 22,625Taxation 114 26,450Dividends 115 17,600
563,918 563,918
Wetwell (Pty) Ltd Post-adjustment trial balance at 30 April 20.1
d)
Once the amounts above and in part (a) have been posted to the ledger accounts, the folio numbers of the accounts should be inserted in the general journal.
Rental 31,500Advertising 17,983Salaries and wages 82,142Directors' fees 40,000Insurance 13,422Stationery 1,344Electricity and water 12,125Telephone 1,798Motor vehicle expenses 7,420Research and development 22,667Consumable stores expense 3,165Depreciation 22,625Taxation 26,450
30 Service income 358,000
Profit and loss 358,000
Retained income 17,600Dividends 17,600
Receiver of Revenue 23,700Provisional tax payments 23,700
Profit and loss 75,359
Retained income 75,359
General Journal of Wetwell (Pty) Ltd for April 20.1
Service income 358,000Less: Expenses 256,191 Rental 31,500 Advertising 17,983 Salaries and wages 82,142 Directors' fees 40,000 Insurance 13,422 Stationery 1,344 Electricity and water 12,125 Telephone 1,798 Motor vehicle expenses 7,420 Research and development 22,667 Depreciation 22,625 Consumable stores expense 3,165Net income before taxation 101,809Taxation 26,450Net profit after taxation 75,359Dividends 17,600Retained income for the year 57,759
Income statement of Wetwell (Pty) Ltd for the year ended 30 April 20.1
f)
g)The company's results reflect a positive start for the business. The net profit percentage (after tax) of 21.1% (75 359/358 000) should be compared to percentages achieved by other companies in the same business in order to assess the results more objectively. The treatment of the research and development expenditure has a material impact on the results (see (h) for further comments).
h)
In determining the expense for the year for research and development, the amount of R21 200, which was in respect of research done, has been written off during the year. This is in line with the prudence concept as it is difficult to estimate accurately any future income which will arise from the research alone. Andries has estimated future income from implementing the new method and, consequently, the expenditure on developing the method (R44 000) will be split over the periods during which income is expected to be earned.
Expected income from Development20.1 R20 00020.2 R350 00020.3 R230 000Total R600 000
Amount spent or Research to be written off each year. This year = R21 200Amount spent on Development to be matched to expected benefit. This year = R44 000Research write off = 20 000/600 000 x R44 000 = R1 467Deferred write off = R44 000 – R1 467 = R42 533
EQUITY AND LIABILITIESShareholders' equity 167,759Share capital 110,000Retained income 57,759Current liabilities 49,593Creditors 28,690Accrued expenses 553Receiver of Revenue 2,750Shareholders for dividends 17,600
Balance sheet of Wetwell (Pty) Limited at 30 April 20.1
i) Points that should be considered, which will affect the usefulness of the financial statements: inflation (use of historic costs) estimates judgements first year of operating makes comparisons difficult.
j) Depreciation - estimating the useful lives of assets. Research and development - estimating future income which will arise from the new
technique. Accrued expenses - estimating the amount of expenses incurred at year-end. Non Current assets - estimating their residual value (if any). Taxation - although the accountant has established the tax liability precisely, this is unusual
because in practice, this is normally an estimated amount. The final assessment by the Receiver of Revenue is normally made a considerable time after the year-end.
k)Net income represents the amount which has been earned by the company over the financial period. This is used to measure the performance of the company. The net income after tax is the amount that the directors have available to distribute to shareholders. Net income thus represents the return by the company on its activities.
Dividends represent the return to the shareholders on their investment. The amount of dividends distributed may be the same as net income, but this is unlikely. Normally, a portion of the company's earnings is retained for future growth of the company.
l)Book value of a share = Net asset value / Number of shares
= 167 759 / 220 000= 76c per share
The market value of the share will depend on the perception by the public of the future of the company. Depending on this perception, the market value may differ from the book value.
