CIMA - C2 Fundamentals of Financial Accounting
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250 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
STEPHEN CHEE
TRIAL BALANCE AS AT 31 MAY 20X1
Dr
Cr
$
$
Property, at cost
120,000
Equipment, at cost
80,000
Provisions for depreciation (as at 1 June 20X0)
– on property
20,000
– on equipment
38,000
Purchases
250,000
Sales
402,200
Stock, as at 1 June 20X0
50,000
Discounts allowed
18,000
Discounts received
4,800
Returns out
15,000
Wages and salaries
58,800
Bad debts
4,600
Loan interest
5,100
Other operating expenses
17,700
Trade payables
36,000
Trade receivables
38,000
Cash in hand
300
Bank
1,300
Drawings
24,000
Allowance for receivables
500
17% long term loan
30,000
Capital, as at 1 June 20X0
121,300
667,800
667,800
The following additional information as at 31 May 20X1 is available.
(a) Inventory as at the close of business has been valued at cost at $42,000.
(b) Wages and salaries need to be accrued by $800.
(c) Other operating expenses are prepaid by $300.
(d) The allowance for receivables is to be adjusted so that it is 2% of trade receivables.
(e) Depreciation for the year ended 31 May 20X1 has still to be provided for as follows.
Property: 1.5% per annum using the straight line method; and
Equipment: 25% per annum using the reducing balance method.
Required
Prepare Stephen Chee's income statement for the year ended 31 May 20X1 and his statement of financial position as at
that date.
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Part C Final accounts and audit ⏐ 17: Preparation of sole trader's accounts 251
Solution
STEPHEN CHEE
INCOME STATEMENT
FOR THE YEAR ENDED 31 MAY 20X1
$
$
Sales
402,200
Cost of sales
Opening inventory
50,000
Purchases
250,000
Purchases returns
(15,000
)
285,000
Closing inventory
42,000
243,000
Gross profit
159,200
Other income – discounts received
4,800
164,000
Expenses
Operating expenses
Wages and salaries ($58,800 + $800)
59,600
Discounts allowed
18,000
Bad debts (W1)
4,860
Loan interest
5,100
Depreciation (W2)
12,300
Other operating expenses ($17,700 – $300)
17,400
117,260
Net profit for the year
46,740
STEPHEN CHEE
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X0
Accumulated
Net book
Cost
depn.
value
$
$
$
Non-current assets
Property
120,000
21,800
98,200
Equipment
80,000
48,500
31,500
200,000
70,300
129,700
Current assets
Stock
42,000
Trade receivables net of allowance for receivables ($38,000 – 760 (W1))
37,240
Prepayments
300
Bank
1,300
Cash in hand
300
81,140
210,840
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252 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
$ $
Capital
Balance at 1 June 20X0
121,300
Net profit for the year
46,740
168,040
Drawings
24,000
144,040
Non-current liabilities
17% loan
30,000
Current liabilities
Trade payables
36,000
Accruals
800
36,800
210,840
Workings
1
Bad debts
$
Previous allowance
500
New allowance (2% × 38,000)
760
Increase
260
Per trial balance
4,600
Income statement
4,860
2
Depreciation
Property
Opening provision
20,000
Provision for the year (1.5% × 120,000)
1,800
Closing provision
21,800
Equipment
Opening provision
38,000
Provision for the year (25% × 42,000)
10,500
Closing provision
48,500
Total charge in I/S
12,300
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Part C Final accounts and audit ⏐ 17: Preparation of sole trader's accounts 253
Question
Final accounts
Donald Brown, a sole trader, extracted the following trial balance on 31 December 20X0.
TRIAL BALANCE AS AT 31 DECEMBER 20X0
Debit
Credit
$
$
Capital at 1 January 20X0
26,094
Receivables
42,737
Cash in hand
1,411
Payables
35,404
Fixtures and fittings at cost
42,200
Discounts allowed
1,304
Discounts received
1,175
Inventory at 1 January 20X0
18,460
Sales
491,620
Purchases
387,936
Motor vehicles at cost
45,730
Lighting and heating
6,184
Motor expenses
2,862
Rent
8,841
General expenses
7,413
Bank overdraft
19,861
Provision for depreciation
Fixtures and fittings
2,200
Motor vehicles
15,292
Drawings
26,568
591,646
591,646
The following information as at 31 December is also available.
(a) $218 is owing for motor expenses.
(b) $680 has been prepaid for rent.
(c) Depreciation is to be provided of the year as follows.
Motor vehicles: 20% on cost
Fixtures and fittings: 10% reducing balance method
(d) Inventory at the close of business was valued at $19,926.
Required
Prepare Donald Brown's income statement for the year ended 31 December 20X0 and his statement of financial position
at that date.
Answer
Tutorial note. You should note these points.
(a) Discounts allowed are an expense of the business and should be shown as a deduction from gross profit.
Similarly, discounts received is a revenue item and should be added to gross profit.
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254 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
(b) The figure for depreciation in the trial balance represents accumulated depreciation up to and including 20W9.
You have to calculate the charge for the year 20X0 for the income statement and add this to the trial balance
figure to arrive at the accumulated depreciation figure to be included in the statement of financial position.
DONALD BROWN
INCOME STATEMENT
FOR THE YEAR ENDED 31 DECEMBER 20X0
$
$
Sales
491,620
Less cost of sales
Opening inventory
18,460
Purchases
387,936
406,396
Closing inventory
19,926
386,470
Gross profit
105,150
Discounts received
1,175
106,325
Less expenses:
discounts allowed
1,304
lighting and heating
6,184
motor expenses (2,862 + 218)
3,080
rent (8,841 – 680)
8,161
general expenses
7,413
depreciation (W)
13,146
39,288
Net profit
67,037
Working: depreciation charge
Motor vehicles: $45,730 × 20% = $9,146
Fixtures and fittings: 10% × $(42,200 – 2,200) = $4,000
Total: $4,000 + $9,146 = $13,146.
DONALD BROWN
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X0
Cost
Depreciation
Net
$
$
$
Non-current assets
Fixtures and fittings
42,200
6,200
36,000
Motor vehicles
45,730
24,438
21,292
87,930
30,638
57,292
Current assets
Inventory
19,926
Receivables
42,737
Prepayments
680
Cash in hand
1,411
64,754
122,046
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Part C Final accounts and audit ⏐ 17: Preparation of sole trader's accounts 255
Cost
Depreciation
Net
$
$
$
Capital
Balance b/f
26,094
Net profit for year
67,037
93,131
Less drawings
26,568
66,563
Current liabilities
Payables
35,404
Accruals
218
Bank overdraft
19,861
55,483
122,046
Chapter roundup
• You should now be able to prepare a set of final accounts for a sole trader from a trial balance after incorporating period
end adjustments for depreciation, inventory, prepayments, accruals, bad debts, and allowances for receivables.
Quick quiz
1 Which of the following is the correct formula for cost of sales?
A Opening inventory – purchases + closing inventory.
B Purchases – closing inventory + sales.
C Opening inventory – closing inventory + purchases.
D Opening inventory + closing inventory – purchases.
2 The trial balance is the final phase prior to preparation of the accounts. True or false?
3 Which is the correct order of current assets in the statement of financial position?
A Bank, prepayments, receivables, inventory
B Inventory, receivables, prepayments, bank
C Inventory, prepayments, receivables, bank
D Inventory, bank, receivables, prepayments
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256 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
Answers to quick quiz
1 C Correct, this is a version of the more normal formula: opening inventory + purchases – closing inventory.
A Incorrect.
B Incorrect. Sales should never form part of cost of sales.
C Incorrect.
2 False. The trial balance checks that the double entry has been done correctly. After the trial balance has been struck,
there are usually adjustments (eg for accruals, prepayments, depreciation) before the financial statements are
prepared.
3 B Remember that current assets are listed in order of increasing liquidity (inventory being the least easy to turn into
cash).
Now try the questions below from the Question Bank
Question numbers Page
75–76 405
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257
Topic list Syllabus references
1 Limited liability companies A (6), D (6)
2 Share capital and reserves D (6)
3 Bonus and rights issues D (6)
4 The final accounts of limited liability companies A (6), D (6)
5 Loan stock D (6)
6 Statement of changes in equity D (6)
7 Taxation D (6)
8 The ledger accounts of limited liability companies D (6)
Limited liability
companies
Introduction
In this chapter we study the accounts of limited liability companies. The accounting rules
and conventions for recording the business transactions of limited liability companies and
then preparing their final accounts, are much the same as for sole traders. For example,
companies will have a cash book, sales day book, purchase day book, journal, sales ledger,
purchase ledger and nominal ledger etc. They also prepare an income statement annually,
and a statement of financial position at the end of the accounting year.
We shall see that, in the statement of financial position, the treatment of assets and liabilities
is basically the same but the particular nature of limited liability companies calls for changes
in the owners' equity section. Similarly, in the income statement, the principal differences are
found in the statement of other comprehensive income. There is also a statement of changes
in equity, which shows how the profit or loss for the period has been divided.
One important difference is the legal requirement that limited liability companies must
publish their accounts. The relevant legislation specifies certain information which must be
included in the published financial statements of a limited liability company.
It should be stressed that, while you do not have to learn the published accounts formats by
heart at this stage, it is important for you to have an overall awareness of the form of
company accounts. In Chapter 25 you will learn about interpretation of accounts and this will
include items in company accounts formats.
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258 18: Limited liability companies ⏐ Part C Final accounts and audit
1 Limited liability companies
Company accounts preparation in the UK is governed by the Companies Act.
Companies issue shares to shareholders who enjoy limited liability.
There are two classes of limited liability company in the UK.
(a) Private companies. These have the word 'limited' at the end of their name. Being private, they cannot invite
members of the public to invest in their equity (shares).
(b) Public companies. These are much fewer in number than private companies, but are generally much larger in size.
They have the words 'public limited company' – shortened to PLC or plc (or the Welsh language equivalent) at the
end of their name. Public limited companies can invite members of the general public to invest in their equity, and
the 'shares' of these companies are traded on a Stock Exchange.
Under IFRS, public companies are usually 'Inc' and private companies 'Co'.
1.1 Limited liability
Limited liability companies offer limited liability to their owners. This means that the liability of an owner is limited to
any amounts not yet paid up for shares bought from the company. So, unlike sole traders, the owners (shareholders) of
a company do not have to use their own, private, finances to pay payables if there are insufficient funds in the business.
2 Share capital and reserves
2.1 Share capital
The proprietors' capital in a limited liability company consists of share capital. A company issues shares, which are paid
for by investors, who then become shareholders of the company.
When a company is set up with a share capital of, say, $100,000, it may be decided to issue
• 100,000 shares of $1 each nominal value
• 200,000 shares of 50c each
• 400,000 shares of 25c each
• 250,000 shares of 40c each
$1, 50c, 25c or 40c is the nominal value of the share. The nominal value is not the same as the market value, which is
the price someone is prepared to pay for the share.
The authorised share capital is the maximum amount of share capital that the company is empowered to issue. Issued
share capital is the nominal amount of share capital that has been issued to shareholders. This cannot exceed the
authorised share capital. Called up share capital is the total amount of issued share capital for which the shareholders
are required to pay. Paid up share capital is the amount of share capital paid by the shareholders.
Key terms
Key term
Key term
FA
S
T F
O
RWAR
D
FA
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T F
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RWAR
D
Assessment
focus point
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Part C Final accounts and audit ⏐ 18: Limited liability companies 259
2.2 Dividends
Profits paid out to shareholders are called dividends.
• An interim dividend is a dividend paid part-way through the year
• At the end of the year, the company might pay a further final dividend.
The total dividend for the year is the sum of the interim and final dividends. (Not all companies pay an interim dividend.
Interim dividends are commonly paid by public limited companies.)
Usually, at the end of an accounting year, a company's directors will propose a final dividend payment, but this will not
yet have been paid. This means that the final dividend will be shown as a note to the financial statements. It is not a
liability until the dividend is approved at the AGM.
2.3 The terminology of dividend
The terminology of dividend payments can be confusing, since they may be expressed either in the form, as 'x cents per
share
' or as 'y per cent'. In the latter case, the meaning is always 'y per cent of the nominal value of the shares in issue'.
For example, suppose a company
's issued share capital consists of 100,000 50c ordinary shares. The company's
statement of financial position would include the following.
Called up share capital: 100,000 50c ordinary shares $50,000
If the directors wish to pay a dividend of $5,000, they may propose any of the following.
• A dividend of 5c per share (100,000 × 5c = $5,000)
• A dividend of 10% (10% × $50,000 = $5,000)
• A dividend of 10c in the pound ($50,000 × 10c = $5,000)
Any profits not paid out as dividends are put in reserves (see below).
2.4 Ordinary shares and preference shares
The two types of shares most often encountered are preference shares and ordinary shares.
Preference shares carry the right to a fixed dividend which is expressed as a percentage of their nominal value: eg a 6%
$1 preference share carries a right to an annual dividend of 6c.
Preference dividends have priority over ordinary dividends. If the directors of a company wish to pay a dividend (which
they are not obliged to do) they must pay any preference dividend first. Otherwise, no ordinary dividend may be paid.
Ordinary shares are by far the most common. They carry no right to a fixed dividend but are entitled to all profits left
after payment of any preference dividend. In most companies only ordinary shares carry voting rights.
Should the company be wound up, any surplus is shared between the ordinary shareholders.
Question
Dividends 1
At the year-end, the trial balance for KT shows a debit balance of $20,000 in respect of dividends. The Share Capital
account of $1m comprises 200,000 5% preference shares of $1 with the balance made up of 50c ordinary shares. The
dividends account represents a half-year's preference dividend and an interim ordinary dividend. A final dividend of 5c
per ordinary share was proposed before the trial balance was prepared.
Calculate the interim and final dividends for each category of share.
Key terms
FA
S
T F
O
RWAR
D
FA
S
T F
O
RWAR
D
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