CIMA CO2 Official Learning System - Fundamentals of Financial Accounting

STUDY MATERIAL C2

200

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

Statement of ﬁ nancial position of XYZ as at 31 December 20X3

Assets

Non-current assets Cost ($) Acc. Depreciation ($) Carrying amount ($)

Premises at cost 100,000 (27,000) 73,000

Plant at cost 18,000 (4,100) 13,900

118,000 (31,100) 86,900

Current assets

Inventories 12,500

Receivables 27,500

Less : allowance (550)

26,950

Prepayments 300

39,750

126,650

Capital and liabilities

Capital at start of year 80,000

Add : net proﬁ t 3,000

83,000

Less : drawings (25,000)

Capital at end of year 58,000

Non-current liabilities

Bank loan 30,000

Current liabilities

Payables 16,000

Accruals 3,700

Bank overdraft 18,950

38,650

126,650

Exercise 7.2

J W Ltd had, among others, the following balances in the books at 30 June 20X9

Debit ($) Credit ($)

Motor vehiclesatcost 200

Motor vehicles acc. depreciation at 1 July 20X8 70

Fixturesatcost 60

Fixtures acc. depreciationat1July 20X8 20

Ofﬁ ce equipmentatcost 125

Ofﬁ ce equipment – acc. depreciation at 1 July 20X8 45

Trade receivables 580

Allowance for receivablesat1July 20X8 10

Insurance 90

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FUNDAMENTALS OF FINANCIAL ACCOUNTING

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

The following adjustments have not yet been made in the books:

(i) Motor vehicles are depreciated over 4 years on the straight-line basis. On 31 March

20X9, a motor vehicle that had cost $20,000 on 1 July 20X6 was disposed of for

$8,000. It is the company’s policy to charge a full year’s depreciation in the year of

purchase, and hence none in the year of disposal. No entries have been made for the

disposal.

(ii) Fixtures are depreciated on the straight-line basis over 10 years, on an actual time basis

(i.e. from the date of acquisition). On 1 October 20X8, ﬁ xtures were purchased for

$40,000, which have not been entered in the books.

(iii) Ofﬁ ce equipment is depreciated at 20 per cent per annum on the reducing-balance

basis.

(iv) On 30 June 20X9, it was decided to write off a bad debt of $80,000 and to make an

allowance for receivables of 3 per cent of the remaining receivables.

(v) The insurance ﬁ gure above covers the period 1 July 20X8 to 30 September 20X9.

(vi) Sales representatives are paid commission, which amounts to 5 per cent of the previ-

ous month’s sales. The commission is due for payment on the 15th of the following

month. During June 20X9, sales amounted to $120,000.

Requirements

(a) Prepare ledger accounts for all the above items, showing clearly all calculations,

t ransfers to the income statement for the year ending 30 June 20X9, and balance to be

carried down at 30 June 20X9.

(2 marks)

(b) Show the ‘ expenses ’ section of the income statement for the year ending 30 June 20X9,

to include all the items above.

(2 marks)

(c) Show the extracts from the non-current assets, current assets and current liabilities

sections of the balance sheet at 30 June 20X9, which includes balances for the above

items.

(2 marks)

(d) Explain brieﬂ y why depreciation is charged in the income statement, but does not

affect cash balances.

(4 marks)

(Total marks  20)

Solution

This solution does not utilise a ‘ depreciation expense ’ account or a ‘ bad debts expense ’

account. Although many businesses do maintain such accounts, it is often considered

unnecessary and time-consuming to produce them in the computer-based assessment.

Instead of transferring the depreciation to such an expense account, the amount is trans-

ferred directly to the income statement.

STUDY MATERIAL C2

202

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

(a)

Motor vehicles at cost

$ $

1 Jul. X8 Balance b/fwd 200 31 Mar.X9 Disposals a/c 20

30 Jun. X9 Balance c/fwd 180

200 200

Motor Vehicles – accumulated depreciation

$ $

31 Mar. X9 Disposals (W1) 10 1 Jul.98 Balance bfwd 70

30 Jun. X9 Balance c/fwd 105

30 Jun. X9 Income statement (W2) 45

115 115

Disposal of non-current assets

$ $

31 Mar. X9 Motor vehicles at cost 20 31 Mar. X9 Motor vehicle accumulated

depreciation

10

Cash 8

Loss on disposal (IS) 2

2 0 2 0

Fixtures at cost

$ $

1 Jul. X8 Balance b/fwd 60 30 Jun. X9 Balance c/fwd 100

1 Sep. X8 Purchase (bank) 40

100 100

Fixtures – accumulated depreciation

$ $

30 Jun. X9 alance c/fwd 29 1 Jul. X8 Balance b/fwd 20

30 Jun. X9 Income statement (W3) 9

2 9 2 9

Ofﬁ ce equipment at cost

$ $

1 Jul. X8 Balance b/fwd 125 30 Jun. X9 Balance c/fwd 125

125 125

Ofﬁ ce equipment – accumulated depreciation

$ $

30 Jun. X9 Balance c/d 61 1 Jul. X8 Balance b/fwd 45

30 Jun. X9 Income statement (W4) 16

6 1 6 1

Bad debts written off

$ $

30 Jun. X9 Receivables 80 30 Jun. X9 80

8 0 8 0

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FUNDAMENTALS OF FINANCIAL ACCOUNTING

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

Trade receivables

$ $

30 Jun. X9 Balance c/fwd 580 30 Jun. X9 Bad debts (IS) 80

Balance c/fwd 500

580 580

Allowance for receivables

$ $

30 Jun. X9 Balance c/fwd 15 1 Jul. X8 Balance b/fwd 10

Income statement (W5) 5

1 5 1 5

Insurance

$ $

1 Jul. X8 Bank 90 30 Jun. X9 Prepaid c/fwd (W6) 18

Income statement 72

9 0 9 0

Sales commission payable

$ $

30 Jun. X9 Bank (during year) 40 30 Jun. X9 Income statement 46

Accrued c/fwd (W7 ) 6

4 6 4 6

Workings

(W1) Motor Vehicles – depreciation on disposed vehicle

$’000

Cost on 1 July 20X6 20

Depreciation y/e 30 June 20X7: 20  4 5

Depreciation y/e 30 June 20X8: 20  4 5

Total depreciation to be removed 10

(W2) Motor vehicles – depreciation

Motor vehicles – cost at 30 June 20X9 180

Depreciation  180  4 years  45

Note : The depreciation rate could also be expressed as 25% on cost.

(W3) Fixtures – depreciation on existing items

$’000 $’000

Cost at 1 July 20X8 60

Depreciation  6 0  10 6

Depreciation on new items:

Cost at 1 September 20X8 40

Depreciation  4 0  10  9 / 12 3

STUDY MATERIAL C2

204

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

(W4) Ofﬁ ce equipment – depreciation

$’000

Cost b/fwd 125

Depreciation b/fwd (45)

Carrying amount b/fwd 80

(W5) Allowance for receivables

$’000

Receivables (prior to bad debts) 580

Bad debts written off (80)

Revised receivables 500

Allowance for receivables 3%  500  15

Less : existing allowance for receivables (10)

5

(W6) Insurance Prepaid

$’000

Insurance paid for 15 months 90

Prepaid  3 / 15  90 (18)

Income statement charge 72

(W7) Sales commission accrued

$’000

Sales commission paid 40

Accrued  5 %  120 6

Income statement charge 46

(b) Income statement for the year ended 30 June 20X9 (extract)

Expenses $’000

Depreciation

Motor vehicles 45

Fixtures 9

O f ﬁ ce equipment 16

Loss on disposal of non-current assets 2

Bad debts written off 80

Allowance for receivables 5

Insurance 72

Sales commission 46

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FUNDAMENTALS OF FINANCIAL ACCOUNTING

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

(c) Statement of ﬁ nancial position at 30 June 20X9 (extract)

Cost Acc. Dep’n Carrying amount

($’000) ($’000) ($’000)

Non-current assets

Motor vehicles 180 (105) 75

Fixtures 100 (29) 71

Ofﬁ ce equipment 125 (61) 6 4

405 (195) 210

Current assets

Receivables 500

Less: allowance for receivables (15)

485

Prepaid insurance 18

Current liabilities

Accrued commission 6

(d) Depreciation is a means of spreading the cost of non-current assets (less any expected

sale proceeds) over their expected useful life, so as to charge the income statement with

a portion of their cost to reﬂ ect the usage of assets in earning revenue.

If depreciation were not charged then the proﬁ ts would be overstated. There is a

danger that these proﬁ ts would be paid out as dividends (or as drawings in the case

of a sole trader), thereby depleting the cash balances and the capital employed in the

business. When the asset was disposed of, the whole of the decrease in value since pur-

chase would appear as a charge in that period’s income statement, thereby distorting

the proﬁ ts.

Cash is paid out when a non-current asset is paid for, not when depreciated. Cash

comes in when the asset is disposed of. Accounting for depreciation does not involve

any movement of cash and does not provide a means of replacing non-current assets at

the end of their lives, unless cash is set aside as a separate transaction.

7.7 Summary

This chapter has shown how:

●

a transaction can be traced from a ledger account to a trial balance, and from there to

the ﬁ nancial statements – income statement or statement of ﬁ nancial position;

●

ﬁ nancial statements are prepared from a trial balance and a list of adjustments, which

need to be made to ﬁ nalise the ﬁ nancial statements.

The whole of this chapter should be regarded as a ‘ must know ’ topic you are to be success-

ful in passing the examination. This chapter has brought together much of what has been

learnt in Chapters 2–6 inclusive. It is a good point to consolidate your studies before mov-

ing on to Chapter 8 and the remaining chapters in this learning system.

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207

Revision Questions

Question 1 Multiple choice

1.1 The following is an extract from the trial balance of ABC Ltd at 31 December 20X4:

Debit ($) Credit ($)

Sales 73,716

Returns 5,863 3,492

Discounts 871 1,267

The ﬁ gure to be shown in the trading account for net sales is:

(A) $66,586

(B) $66,982

(C) $67,853

(D) $70,224

1.2 A company’s working capital was $43,200. Subsequently, the following transactions

occurred:

●

payables were paid; 3,000 by cheque;

●

a bad debt of $250 was written off;

●

inventories valued at $100 were sold for $230 on credit.

Working capital is now:

$ … … … … … .

1.3 Working capital will reduce by $500 if:

(A) goods costing $3,000 are sold for $3,500 on credit.

(B) goods costing $3,000 are sold for $3,500 cash.

(C) non-current assets costing $500 are purchased on credit.

(D) non-current assets with a carrying amount of $750 are sold for $250 cash.

1.4 A business has opening inventories of $12,000 and closing inventories of $18,000.

Purchase returns were $5,000. The cost of goods sold was $111,000. Purchases were:

$ … … … … …

7

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

REVISION QUESTIONS C2

208

1.5 At the beginning of the year, the balance on the allowance for receivables account

was $6,000, representing 4 per cent of receivables. At the end of the year, receivables

amounted to $150,000, but it was decided that the allowance should be increased to

5 per cent of receivables. Which of the following is correct?

Account entry Income statement Net receivables

on statement of

ﬁ nancial position

Allowance for

receivables account

A $1,500 credit $142,500 $7,500 credit

B $1,500 debit $148,500 $1,500 debit

C $1,500 debit $142,500 $7,500 credit

D $7,500 debit $142,500 $13,500 credit

1.6 The following is an extract from the trial balance of a business for its most recent year.

Debit ($) Credit ($)

Opening Inventories 28,000

Sales 310,000

Purchases 225,000

Returns 22,000 26,000

Carriage inwards 7,000

Carriage outwards 8,000

You are also told that closing inventories were $23,000.

Using some or all of the ﬁ gures above, the correct gross proﬁ t is:

$ … … … … …

1.7 The following is an extract from the trial balance of a business for its most recent year:

Debit ($) Credit ($)

Heat and light 22,000

Rent and local business tax 27,000

Non-current assets 80,000

Acc. depreciation on non-current assets 20,000

Gross proﬁ t has already been calculated as being $85,000. Depreciation is to be cal-

culated at 25 per cent on the reducing balance. At the end of the year, heat and light

accrued is $4,000, and rent and local business tax prepaid is $2,500.

The correct net proﬁ t is:

$ … … … … …

PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS

209

FUNDAMENTALS OF FINANCIAL ACCOUNTING

Question 2

GBA is a sole trader, supplying building materials to local builders. He prepares his ﬁ nan-

cial statements to 30 June each year. At 30 June 20X5, his trial balance was as follows:

Debit ($) Credit ($)

Capital at July 20X4 55,550

Purchases & Sales 324,500 625,000

Returns 2,300 1,700

Discounts 1,500 2,500

Inventory of building materials at 1 July 20X4 98,200

Packing materials purchased 12,900

Distribution costs 17,000

Rent and insurance 5,100

Telephone 3,200

Car expenses 2,400

Wages 71,700

Allowance for receivables at 1 July 20X4 1,000

Heat and light 1,850

Sundry expenses 6,700

Delivery vehicles cost 112,500

Delivery vehicles acc. depreciation at July 20X4 35,000

Equipment cost 15,000

Equipment acc. depreciation at July 20X4 5,000

Receivables and payables 95,000 82,000

Loan 10,000

Loan repayments 6,400

Bank deposit account 15,000

Bank current account

26,500

817,750 817,750

The following additional information at 30 June 20X5 is available:

1. Closing inventories:

$

Building materials 75,300

Packing materials 700

There was also an unpaid invoice of $200 for packing materials received and consumed

during the year.

2. Prepayments:

$

Rent and insurance 450

3. Accrued expenses:

$

Heat and light 400

Telephone 500

CIMA CO2 Official Learning System - Fundamentals of Financial Accounting

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