SCHOLAR Study Guide CfE Higher Accounting Unit 1 ... CONTENTS 4.3 Preparation of the Manufacturing...

SCHOLAR Study Guide

CfE Higher AccountingUnit 1: Preparing FinancialAccounting Information

Authored by:Joe Millar (Previously Trinity High School)

Claire Robertson (Culloden Academy)

Reviewed by:Anita Weir (Inverurie Academy)

Previously authored by:Brian M Bennie

Joe Millar

John Murray

Anita Weir

Heriot-Watt University

Edinburgh EH14 4AS, United Kingdom.

First published 2001 by Heriot-Watt University.

This edition published in 2016 by Heriot-Watt University SCHOLAR.

Copyright © 2016 SCHOLAR Forum.

Members of the SCHOLAR Forum may reproduce this publication in whole or in part foreducational purposes within their establishment providing that no profit accrues at any stage,Any other use of the materials is governed by the general copyright statement that follows.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval systemor transmitted in any form or by any means, without written permission from the publisher.

Heriot-Watt University accepts no responsibility or liability whatsoever with regard to theinformation contained in this study guide.

Distributed by the SCHOLAR Forum.

SCHOLAR Study Guide CfE Higher Accounting Unit 1: Preparing Financial AccountingInformation

1. CfE Higher Accounting Course Code: C700 76

ISBN 978-1-909633-57-5

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AcknowledgementsThanks are due to the members of Heriot-Watt University’s SCHOLAR team who planned andcreated these materials, and to the many colleagues who reviewed the content.

We would like to acknowledge the assistance of the education authorities, colleges, teachersand students who contributed to the SCHOLAR programme and who evaluated these materials.

Grateful acknowledgement is made for permission to use the following material in theSCHOLAR programme:

The Scottish Qualifications Authority for permission to use Past Papers assessments.

The Scottish Government for financial support.

The content of this Study Guide is aligned to the Scottish Qualifications Authority (SQA)curriculum.

All brand names, product names, logos and related devices are used for identification purposesonly and are trademarks, registered trademarks or service marks of their respective holders.

i

Contents

1 The role of Financial Accounting 11.1 What is Financial Accounting . . . . . . . . . . . . . . . . . . . . . . . 21.2 The Financial Accountant - functions and limitations . . . . . . . . . . . 31.3 Users of Financial Information . . . . . . . . . . . . . . . . . . . . . . . 51.4 Learning points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71.5 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

2 Partnership 92.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112.2 Reasons for forming a Partnership . . . . . . . . . . . . . . . . . . . . 112.3 Types of Partners and the Limited Liability Partnership Act 2000 . . . . 122.4 The Partnership agreement . . . . . . . . . . . . . . . . . . . . . . . . 132.5 The accounts of a Partnership - The Final section of the Income

Statement (Appropriation Account) . . . . . . . . . . . . . . . . . . . . 152.6 The Current Accounts of Partners . . . . . . . . . . . . . . . . . . . . . 182.7 Final section of the Income Statement (Appropriation Account) and

Statement of Financial Position (Balance Sheet) extract . . . . . . . . . 202.8 A full set of Partnership accounts . . . . . . . . . . . . . . . . . . . . . 232.9 Current Accounts and reversed Final section of the Income Statements

(Appropriation Accounts) . . . . . . . . . . . . . . . . . . . . . . . . . . 242.10 Admission of Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252.11 The effect of admitting a new Partner . . . . . . . . . . . . . . . . . . . 262.12 Learning points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 322.13 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

3 Public Limited Companies 373.1 The Theory of Public Limited Companies - Introduction and set-up . . 383.2 The Equity (Capital) of a Public Limited Company . . . . . . . . . . . . 393.3 The Accounts of a Public Limited Company . . . . . . . . . . . . . . . 403.4 The Final section of the Income Statement (Appropriation Account) . . 433.5 The Accounts of a Public Limited Company - The Statement of Financial

Position (Balance Sheet) . . . . . . . . . . . . . . . . . . . . . . . . . . 453.6 Full Financial Statements exercises (Full Final Accounts exercises) . . 493.7 Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . . 623.8 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

4 Manufacturing concerns 814.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 824.2 Types of Cost in a Manufacturing Account . . . . . . . . . . . . . . . . 82

ii CONTENTS

4.3 Preparation of the Manufacturing Account . . . . . . . . . . . . . . . . 844.4 Transferring Manufacturing Cost to the Income Statement (Trading

Account) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 894.5 The Income Statement (Profit and Loss Account) . . . . . . . . . . . . 914.6 Apportionment of Overheads . . . . . . . . . . . . . . . . . . . . . . . . 954.7 Profit or Loss on Manufacture . . . . . . . . . . . . . . . . . . . . . . . 974.8 Manufacturing Cost per unit . . . . . . . . . . . . . . . . . . . . . . . . 994.9 Summative Tasks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1034.10 Revision of the Financial Statements (Final Accounts) of Public Limited

Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1114.11 The Financial Statements (Final Accounts) of a Manufacturing Public

Limited Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1184.12 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

5 End of Unit 1 test 125

Glossary 136

Answers to questions and activities 1421 The role of Financial Accounting . . . . . . . . . . . . . . . . . . . . . 1422 Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1433 Public Limited Companies . . . . . . . . . . . . . . . . . . . . . . . . . 1604 Manufacturing concerns . . . . . . . . . . . . . . . . . . . . . . . . . . 1745 End of Unit 1 test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192

© HERIOT-WATT UNIVERSITY

1

Topic 1

The role of Financial Accounting

Contents

1.1 What is Financial Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

1.2 The Financial Accountant - functions and limitations . . . . . . . . . . . . . . . 3

1.3 Users of Financial Information . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1.4 Learning points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

1.5 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Learning objectives

By the end of this topic you should know:

• there are 2 types of Accounting - Financial and Management;

• the purpose of Financial Accounting;

• the limitations of Financial Accounting;

• the stakeholders who have a particular interest in Financial Accountinginformation.

2 TOPIC 1. THE ROLE OF FINANCIAL ACCOUNTING

This short theory topic covers the purpose and functions of Financial Accounting. It willalso cover the role of the Financial Accountant and inform you of those stakeholderswho have a particular interest in Financial Accounting information.

1.1 What is Financial Accounting

In this new CFE Higher course there are 2 main areas of accounting to study: FinancialAccounting, and Management Accounting.

Financial accounting is concerned mainly with double-entry book-keeping and thepresentation of a range of financial statements or final accounts for a range ofbusiness organisations within the United Kingdom - sole trader, partnership and limitedcompanies.

Basic double-entry book-keeping (debits and credits) lies at the heart of the recordingstage of accounting. It is concerned with ensuring that records of individual transactionsare accurate, up-to-date and comprehensive.

It ensures that the rest of the accounting process has all of the information that it requiresand a reliable foundation on which to build. Basic double-entry book-keeping lets thebusiness know how much it has bought and sold, how much is owing to it by customersand by it to suppliers, and various other pieces of information such as current bankbalance.

At the end of a financial period a trial balance will be drawn up to check the accuracy ofthe book-keeping. From this trial balance final accounts can be drawn up - dependenton the type of business organisation concerned.

Financial Accounting uses the information provided by book-keeping to classify andcommunicate information through the presentation of financial statements - whichprovide essential information on the company’s profitability and worth.

Management Accounting is sometimes known as Cost Accounting. It deals withplanning, policy making and decision-making

Key point

Higher Accounting covers two areas:

1. Financial Accounting

2. Management Accounting

Although the new CFE Higher Accounting course is split into 3 units -(Preparing Financial Accounting Information, Preparing Management AccountingInformation, Analysing Accounting Information) - it covers both types ofAccounting - Financial Accounting and Management Accounting - Unit 1 is basedon Financial Accounting, Unit 2 is based on Management Accounting and Unit 3is a combination of both.


TOPIC 1. THE ROLE OF FINANCIAL ACCOUNTING 3

1.2 The Financial Accountant - functions and limitations

The role or functions of the Financial Accountant

As previously stated, Financial Accounting is concerned mainly with book-keeping andthe preparation of final accounts for a range of business enterprise within the UnitedKingdom.

When presenting financial statements or preparing final accounts for external orinternal use, Financial Accountants must deal with legal requirements - for examplecomplying with legislation such as the Companies’ Acts - and working within the rulesof the accounting profession through Financial Reporting Standards produced by theAccounting Standards Board - and adhering to conventional concepts and conventions.

All businesses must account for stewardship - this means that the business has toaccount to its owners for any activity carried out in their name - for example PublicLimited Companies must account to their shareholders who have invested in thecompany. There are plenty of interested parties who would show an interest in abusiness’s financial performance.

The main functions of a Financial Accountant can be wide and varied - dependent onthe type of business organisation - below is listed the main functions:

• The responsibility of maintaining correct and comprehensive financial records

• The responsibility for accurate financial record-keeping relating to assets, liabilitiesand the flow of income and expenditure

• The stewardship duty of providing accounting information required for internal andexternal use

• To prepare financial accounting statements to fulfil the stewardship function -trading and profit and loss accounts, balance sheet and cash flow statements

• To determine a system of book-keeping and a checking procedure in order tomaintain accuracy and reduce the possibility of fraud

• To ensure that all information presented is consistent with Government Legislation- for example the Companies’ Acts

• To ensure all information is within the rules of the accounting profession - FinancialReporting Standards, concepts and conventions

• To ensure that financial transactions comply with taxation regulations

• To be responsible for submitting the first draft of published accounts to auditors

To sum up the objectives of a Financial Accountant are:

• to present a historical financial record of the business affairs

• to show stewardship of the business and accountability to its owners

• to ensure all legal requirements are complied with (PLC)

• to publish finished accounting statements for internal and external use



• to comply with Financial Reporting Standards and traditional concepts andconventions

The limitations of the Financial Accountant

The information given by the Financial Accountant is extremely useful in determining theperformance of the business . . . but it has its limitations.

Financial Accounting is based on historical cost. That is, it records what has happenedin the past - not the future. Any financial statement or final account produced by theFinancial Accountant refers to what has happened in the past so the information haslimited scope. The Management Accountant deals with what may happen in the futureso they would be more responsible for planning and decision making.

Financial Accounting deals with total accounting. It does not analyse in detail, as is donein management accounting. It only gives us final figures - it does not break informationdown into the performance of certain products or certain departments as would be thecase in management accounting. Financial Accounting is concerned with the wholefirm - a firm may produce and sell 5 distinct products which yield an annual profit of£200,000, but this does not detail whether all 5 products are profit-making or which ofany of the products are making a loss.

Financial Accounting gives us figures in monetary terms. Of course, this information isextremely useful in determining the profitability and liquidity of any business enterprisebut does not give any additional information, for example, employee views, workingconditions etc.

It is quite certain that the role of the Financial Accountant is crucial to an organisationbut the role of the management accountant is equally as important.

Key point

Financial Accounting looks to the past whereas Management Accounting looksto the future.

Quiz: The Financial Accountant

Go online

For the following six questions please answer True or False:

Q1: The Financial Accountant has a more important role to play than the ManagementAccountant.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q2: Financial Accounting is based on historical cost.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q3: The Financial Accountant must produce accounts in compliance with theCompanies Acts.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q4: Financial Reporting Standards should be ignored by the Financial Accountant.

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Q5: Basic double entry book-keeping lies at the root of Financial Accounting.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q6: Financial Accounting looks to the future whereas Management Accounting dealswith the past.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3 Users of Financial Information

There is a variety of stakeholders who would be interested in viewing the financialrecords of a business organisation. Different groups will be interested in different typesof information for different reasons which are relevant to them.

Listed below are some of the main groups who would show an interest in this informationand examples of what they might want to know.



Stakeholders What they might be interested in?

Banks (for loans)

Business profit trends; liquidity position; purpose and lengthof proposed loan; is business creditworthy, will we be paidback? What is the bank’s position if the company goesbankrupt?

Existing shareholders Proposed dividends; profitability; etc.

Potential shareholders

Profit/sales trends; dividends paid; ease with whichdividends are paid; future plans; expansion forecasts;management policies; dividends and yields on investmentscompared with similar businesses or alternative forms ofinvestment.

Debenture holdersCompany’s ability to pay interest and to repay the loan;security of your investment if the company goes intoliquidation.

Trade payables(Creditors) / Suppliers

The ability to repay debts; the firm’s liquidity position - docurrent assets cover current liabilities; priority of claims onassets if the company goes bankrupt; management policies.

Managers / Owners

How much does the business own; how much does thebusiness owe; profitability - is the business selling enoughto cover costs to make a profit; how is the business doingcompared with previous years and competitors; the effecton profit of new decisions taken during the year.

Government

Inland Revenue interested in accounts for tax purposes(Income Tax and Corporation Tax) as well as the Customsand Excise Department (VAT); are businesses followinggovernment legislation?

Employees / Tradeunions

Profitability in terms of wage claims and job security;employee profit-sharing schemes; employee wagescompared to management and director salaries.

Competitors / Potentialtakeover bidders

Liquidity and profitability situation of the business; real valueof the business assets; dividend policies of the business;market and nominal value of existing shares; utilisation ofresources.

Key point

A Stakeholder is an someone or a business who has a vested interest in thefinancial performance of a business.



1.4 Learning points

Summary

You should now know:

• there are 2 types of Accounting - Financial and Management;

• the purpose of Financial Accounting;

• the limitations of Financial Accounting;

• the stakeholders who have a particular interest in Financial Accountinginformation.

1.5 End of topic test

End of topic test

Go online

For the first six questions, state which of the following statements (True or False) are theresponsibility of the Financial Accountant:

Q7: Dealing with VAT returns.

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Q8: Preparing Final Accounts.

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Q9: Planning and Budgeting.

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Q10: Financial Reporting Standards.

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Q11: Producing a Trial Balance.

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Q12: What is a Stakeholder?

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Q13: Name four groups who would be interested in seeing the financial performance ofa business.

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9

Topic 2

Partnership

Contents

2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

2.2 Reasons for forming a Partnership . . . . . . . . . . . . . . . . . . . . . . . . 11

2.3 Types of Partners and the Limited Liability Partnership Act 2000 . . . . . . . . 12

2.4 The Partnership agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

2.5 The accounts of a Partnership - The Final section of the Income Statement(Appropriation Account) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

2.6 The Current Accounts of Partners . . . . . . . . . . . . . . . . . . . . . . . . . 18

2.7 Final section of the Income Statement (Appropriation Account) and Statement ofFinancial Position (Balance Sheet) extract . . . . . . . . . . . . . . . . . . . . 20

2.8 A full set of Partnership accounts . . . . . . . . . . . . . . . . . . . . . . . . . 23

2.9 Current Accounts and reversed Final section of the Income Statements(Appropriation Accounts) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

2.10 Admission of Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

2.11 The effect of admitting a new Partner . . . . . . . . . . . . . . . . . . . . . . . 26

2.12 Learning points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

2.13 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Prerequisite knowledge

You should already have knowledge of:

• the theory of other types of firm e.g. sole trader and plc;

• the theory of partnerships;

• the Financial Statements (Final Accounts) of other types of firm e.g. sole traderand plc.

Learning objectives

By the end of this topic you will know:

• the reasons for forming a Partnership;

• the advantages and disadvantages of Partnership;

• the different types of partner;

10 TOPIC 2. PARTNERSHIP

• the Limited Liability Partnership Act 2000;

• the main components of a Partnership Agreement;

• the different accounts which must be drawn up for a Partnership;

• the steps to be taken when introducing a new partner;

• the accounts to be prepared when admitting a new partner.


TOPIC 2. PARTNERSHIP 11

2.1 Introduction

A Partnership is a type of business organisation where a minimum of two and amaximum of 20 people come together to form a business. Although firms of solicitors,accountants etc can have more than 20 partners.

A partnership can be formed from scratch by two or more people deciding to go intobusiness together or by a sole trader deciding that there is a need for more money orexpertise or experience.

Activity: Sole trader

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Q1: Why would a sole trader want to form a partnership? Decide, for each statementgiven, whether it is an advantage or a disadvantage of being a sole trader.

A) I get all the profits!

B) How do I take a holiday?

C) I’m the boss!

D) What if I lose everything?

E) This is easy!

F) How do I get more money?

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2 Reasons for forming a Partnership

The Partnership is the next logical development of the firm after the Sole Trader. ThePartnership Act of 1890 and the Limited Partnership Act of 1907 set out the law ofPartnership.

The Partnership Act of 1890 defines a partnership as:

’Two or more persons carrying out business in common with a view to profit’.

Two or more persons means that more than one person must be involved in theenterprise otherwise it is the business of a sole trader. Most businesses are restrictedto 20 partners but there is no maximum for professional firms such as accountant andsolicitors.

Carrying on a business with a view to profit means that the partners must be workingtogether for the purpose of the business with profit as the prime objective.

The main reasons for forming a partnership are:

1. To expand the existing business.

2. To bring in new Equity (Capital) and finance.

3. To bring in new ideas and initiatives.

4. To allow a degree of specialisation.



5. To allow responsibility of control of the business to be shared.

6. To allow greater continuity of the existence of the business.

7. To survive the economic climate.

Advantages Disadvantages

Easy to formThere are more people to share in theprofits of the business

Partners can specialise in particularareas

Unlimited liability (unless you are alimited partner)

Increased Equity (Capital) for thebusiness

Incompatibility of partners can causedisagreements

Shared responsibilities, workload anddecision making

Decisions made by one partner arebinding on all

Helps survive difficult economic climatePartnership has to be reformed if apartner leaves or dies

Losses can be shared

Activity: Advantages and disadvantages of forming a partnership

Go online

Q2: Decide, for each statement given, whether it is an advantage or a disadvantage offorming a partnership.

A) I can take advantage of new skills.

B) What if they leave?

C) What if we have arguments?

D) What if we lose everything?

E) I can take a holiday at last!

F) There’s more money.

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2.3 Types of Partners and the Limited Liability PartnershipAct 2000

Each partner has to pay a share of the firm’s debts in the event of its liquidation. Ifnecessary, each partner can be forced to sell off personal assets (e.g. house) to do so.This is known as unlimited liability and is the same as a sole trader.

Partners can decide to limit their liability for the firm’s debts to the amount of Equity(Capital) they have invested. This is called a limited partnership and is similar to a plcwhere the liability of the shareholders is limited. Partners with limited liability cannot beasked to contribute more money to pay the debts but, in return, for this they cannot takepart in the management of the firm.



There must be at least one partner with unlimited liability.

Limited partners must not withdraw or take back any part of the Equity (Capital) thatthey have invested in the business during the life of the partnership. They take no partin the management of the partnership nor can they make contracts on behalf of thepartnership.

The Limited Liability Partnership Act 2000

Any partnership formed under this Act has to register with the Registrar of Companiesin Edinburgh. This type of partnership is very similar to a public limited company wheremembers have the advantage of limited liability. It has a more flexible structure ofmanagement than the traditional partnership. This type of partnership is a separatelegal entity and can make contracts. Like a public limited company it must lodge itsaudited accounts with the Registrar of Companies.

This type of partnership can have an unlimited membership but requires a minimum of2 members to sign the incorporation documentation.

2.4 The Partnership agreement

Although not necessary, it is advisable that the partners draw up a written partnershipagreement with a lawyer to avoid possible disputes.

The following clauses should be included in a partnership agreement:

1. Name of firm

2. Duration of partnership

3. Amount of Equity (Capital) of each partner

4. Ratio in which profits/losses are to be shared

5. Rate of interest, if any, to be allowed on Equity (Capital)

6. The amount of personal drawings to be taken by each partner

7. Rate of interest, if any, to be charged on drawings

8. Amount of partnership salary, if any Equity (Capital)

9. Procedure for settling any disputes

10. Accounting procedures

11. Procedure for admission of new partner

12. Arrangements for the retiral or death of a partner

If no agreement is formally drawn up, the Partnership Act of 1890 will be applied tosettle any dispute in an unlimited partnership or the Limited Partnership Act of 1907in a limited partnership.



Quiz: Partnerships 1

Go online

Q3: The maximum number of people in a partnership is 20:

a) Trueb) False

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q4: .

a) trueb) false

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Q5: Which of the following is a reason for forming a partnership?

a) Longer holidays for each partnerb) Less work for each partnerc) More profit available for each partner

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Q6: A limited partner has the following:

a) Liability for a share in the firm’s debtsb) Limited amount of Equity (Capital)c) No say in the management of the firm

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Q7: The minimum number of unlimited partners in a partnership is:

a) oneb) twoc) three

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Q8: An agreement should be made verbally by the partners before setting up apartnership.

a) trueb) false



. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q9: Which of the following would not appear in a partnership agreement?

A) Name of the firm

B) Name of each partner

C) The amount of Equity (Capital) of each partner

D) The amount of wages of each partner

E) The Finance Costs (Interest Payable) on overdrafts

F) The Finance Costs (Interest Payable) on drawings

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Q10: Which of the following Partnership Acts applies to an unlimited partnership?

a) 1890b) 1907

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2.5 The accounts of a Partnership - The Final section of theIncome Statement (Appropriation Account)

The Final section of the Income Statement (Appropriation Account)

The Income Statement (Trading and Profit and Loss Account) of the Partnership has thesame layout as that for the Sole Trader.

The Final section of the Income Statement (Appropriation Account) of a Partnershipserves the same purpose as the one for a Plc, it shows how the available profits areshared amongst the owners of the firm.

Key point

The Final section of the Income Statement (Appropriation Account) records howthe profit is shared amongst the partners.

There are three items that are exclusive to partnerships - interest on Equity (Capital),interest on drawings and partnership salary:

1. Interest on Equity (Capital) is a share of the Profit for the Year (Net Profit) thatis paid to partners to compensate them for investing their Equity (Capital) in thepartnership. This is normally when the amount of Equity (Capital) contributedby each partner is different. They are proportionately rewarded for their differingcapitals (equities).

2. Interest on drawings is a charge against individual partners to discourage themfrom taking too much out of the partnership in drawings. It has the effect ofincreasing the profits available.



3. A partnership salary is where one partner is rewarded with an extra share ofprofit for carrying out a specific job for the partnership like keeping the books. Itincreases that partner’s share of the profits.

Activity: Green and Brown Final section of the Income Statement for yearending 31 December (Appropriation Account)

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Q11: Green and Brown are in partnership sharing profits and losses equally. At 1January their accounts had the following balances:

Green BrownEquity (Capital) Account £15,000 Cr £10,000 CrCurrent Account £300 Cr £250 Cr

The two partners have agreed that:

1. interest on Equity (Capital) is payable annually at 10 %;

2. interest on drawings is charged at 5 % on the total amount withdrawn;

3. a partnership salary of £2„000 is payable to Brown;

4. their drawings for that year were £4,000 and £2,000 for Green and Brownrespectively.

The Profit for the Year (Net Profit) for the year ended 31 December was £6200

Show the Final section of the Income Statement (Appropriation Account).

Profit for the Year (NetProfit)Add Interest on drawings Brown (5% × 2,000)

Green (5% × 4,000)

Less Interest on Equity(Capital)

Brown (10% × 10,000)

Green (10% × 15,000)

Less Partnership salary Brown(Residual profit)share of profit Brown (1/2 × 2,000)

Green (1/2 × 2,000)

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Notice that the interest on drawings has the effect of increasing the profit available toshare between the partners. It is as though the partners have paid the interest into thepartnership although no actual funds changes hands.Also that the two appropriations for interest on Equity (Capital) and drawings are sharedfirst before the profit is finally shared between them.Notice also that there is no entry for actual drawings in the Final section of the IncomeStatement (Appropriation Account), this will appear later in the current accounts.



Key point

Drawings does not appear in the Final section of the Income Statement(Appropriation Account) only interest on drawings appears.

Activity: Fry and Laurie Partnership

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Q12:

Fry Laurie

Equity (Capital) Account £50,000 Cr £25,000 CrCurrent Account £1,600 Cr £400 Cr


1. interest on Equity (Capital) is payable annually at 8 %;

2. interest on drawings is charged at 10 % on the total amount withdrawn;

3. a partnership salary of £8,000 is payable to Laurie;

4. they will share profits in the ratio of their Equity (Capital) balances.

The Profit for the Year (Net Profit) for the year ended 31 December was £40,000 andtheir drawings for that year were £16,000 and £6,000 for Fry and Laurie respectively.

Show the Final section of the Income Statement (Appropriation Account).

Profit for the Year (NetProfit)Add Interest on drawings Fry (10% × 16,000)

Laurie (10% × 6,000)


Fry (8% × 50,000)

Laurie (8% × 25,000)

LESS Partnership salary LaurieResidual Profitshare of Profit Fry(2/3 × 28200)

Laurie (1/3 × 28200)

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2.6 The Current Accounts of Partners

The recording of the Equity (Capital) position for a partnership is different to that of a soletrader. There are normally two accounts for each partner - a Equity (Capital) Account,recording the initial and any subsequent donations of Equity (Capital) to the firm anda Current Account, recording share of profits earned, any interest on Equity (Capital)received, any salary received and any drawings made during the year or any interest ondrawings charged. If any partner had given the partnership a loan - any interest on theloan would also appear in the current account - not in the Final section of the IncomeStatement (Appropriation Account) - this would already have been charged in the profitand loss account.

Both accounts will normally have credit balances as they are both liabilities owed to theowners of the firm.

Any sum of money received would be entered on the credit side of the current accountand any money withdrawn would be entered on the debit side of the current account.

Key point

The Current Account records the share of profits received, the drawings andother receipts and charges made by each partner.

Activity: Green and White Current Account

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Q13: Green and White are in partnership sharing profits and losses equally. At 31December their accounts had the following balances after the Final section of the IncomeStatement (Appropriation Account) was made up:

Green White

Equity (Capital) Account £15,000 Cr £10,000 CrCurrent Account £300 Cr £250 Cr

The drawings for Green and White for that year were £4,000 and £2,000 respectively.



Partnership Final section of the Income Statement (Appropriation Account)

Profit for the Year (NetProfit) £6200

Add Interest on drawings White (5% x 2,000) £100Green (5% x 4,000) £200 £300

£6,500Less Interest on Equity(Capital)

White (10% x 10,000) £1,000

Green (10% x 15,000) £1,500 £2,500£4,000

Less Partnership salary White £2,000(Residual Profit) £2,000share of profit White(1/2 x 2,000) £1,000

Green (1/2 x 2,000) £1,000 £2,000

Prepare the current account of each partner.

Current A/C - White

DR (-) CR (+) BALOpening balanceInterest on Equity (Capital)Partnership salaryDrawingsInterest on drawingsShare of profit

Current A/C - Green

DR (-) CR (+) BALOpening balanceInterest on Equity (Capital)Partnership salaryDrawingsInterest on drawingsShare of profit

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Notice how the figures in the Final section of the Income Statement (AppropriationAccount) are repeated in the current accounts with addition of the drawings figure inthe current accounts.

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Activity: Gray and Gold Partnership

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Q14: Gray and Gold are in partnership sharing profits and losses in the ratio 2:1. At31 December their accounts had the following balances after the Final section of theIncome Statement (Appropriation Account) was made up:

Green White

Equity (Capital) Account £50,000 Cr £50,000 CrCurrent Account £5,900 Cr £500 Cr

The drawings for Gray and Gold for that year were £22,000 and £18,000 respectively.

The Profit for the Year (Net Profit) for the year ended 31 December was £23,500.

Gray and Gold will share Profit for the Year (Net Profit) in the ratio 2:1


Profit for the Year (Net Profit) £23,500Add Interest on drawings Gray £2,200

Gold £1,800 £4,000£27,500


Gray £4,000

Gold £4,000 £8,000£19,500

Less Partnership salary Gold £9,000(Residual Profit) £10,500share of profit Gray £7,000

Gold £3,500 £10,500

Prepare the current account of each partner.

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2.7 Final section of the Income Statement (AppropriationAccount) and Statement of Financial Position (BalanceSheet) extract

Once the Current Account balances have been calculated the final balance for eachpartner is transferred to the Financed section of the Statement of Financial Position(Balance Sheet) and this section now should look like this as an example:

Financed by:

Partner A Partner B

Equity (Capital)Accounts

28,000 25,000 53,000

Current Accounts 6,000 4,200 10,200

63,200



Activity: White and Black Partnership 1

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Q15: White and Black are in partnership sharing Profit for the Year (Net Profit) andlosses in the ratio of 3:2. At 1 January their accounts had the following balances:

White Black

Equity (Capital)Account

£30,000 Cr £20,000 Cr

Current Account £600 Cr £500 Cr


1. interest on Equity (Capital) is payable annually at 10%;

2. interest on drawings is charged at 5% on the total amount withdrawn;

3. a partnership salary of £4,000 is payable to Black.

The Profit for the Year (Net Profit) for the year ended 31 December was £12,400 andtheir drawings for that year were £8,000 and £4,000 respectively.

A) Show the Final section of the Income Statement (Appropriation Account).

B) Prepare the current account of each partner.

C) Represented by extract from Statement of Financial Position (Balance Sheet).

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Activity: White and Black Partnership 2

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Q16: The figures for Black and White for the next year are shown. The partnershipagreement is as follows:

1. interest on Equity (Capital) is payable annually at 10%;

2. interest on drawings is charged at 5% on the total amount withdrawn;

3. a partnership salary of £4,000 is payable to Black.

4. profits are to be shared by Black and White in the ratio 2 : 3

Their current accounts have been adjusted with their Equity (Capital) accounts asfollows:

White Black

Equity (Capital) Account £28,000 Cr £23,000 CrCurrent Account £500 Dr £1,000 CrDrawings Account £5,000 Dr £7,000 Dr

Profit for the Year (Net Profit) for the year is £20,000.

Prepare the Final section of the Income Statement (Appropriation Account), currentaccounts and Statement of Financial Position (Balance Sheet) extract.

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Activity: Blue and White Partnership

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Q17: The figures for the year for Blue and White are as follows:

White Blue

Equity (Capital) Account £31,000 Cr £29,000 CrCurrent Account £950 Cr £850 CrDrawings Account £8,000 Dr £9,000 Dr

Profit for the Year (Net Profit) for the year is £25,000.

The partnership agreement is that the two partners have agreed that:

1. interest on Equity (Capital) is payable annually at 10%

2. interest on drawings is charged at 5% on the total amount drawn

3. a partnership salary of £4,000 is payable to Blue

4. Blue and White will share profits in the ratio 2 : 3

Prepare the Final section of the Income Statement (Appropriation Account), currentaccounts and Statement of Financial Position (Balance Sheet) extract by entering theappropriate figures or calculations in the interactive accounts.

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2.8 A full set of Partnership accounts

The final part is the preparation of the full Financial Statements (Final Accounts) andStatement of Financial Position (Balance Sheet).

Activity: Red and White Partnership

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Q18:

The following is the Trial Balance for Red and White as at 31 December.

£000 £000Sales Revenue (Sales) 200Purchases 80Inventory (Stock) at 1 January 10Selling Expenses 20Office Expenses 16Equity (Capital) - Black 30Equity (Capital) - White 40Current - Black 1Current - White 3Fittings (at cost) 50Vehicles (at cost) 30Provisions for depreciation1 January:Fittings 4Vehicles 5Provision for doubtful debts 2Trade Receivables (Debtors) 60Trade Payables (Creditors) 40VAT (net) 8Drawings - Black 20Drawings - White 20Cash and Cash Equivalents (Bank) 27

333 333

Notes: The following are to be taken into account at 31 December:

1. The Inventory (Stock) at 31 December is valued at £15,000.

2. Office and administration Expenses accrued - £3000.

3. Selling and advertising Expenses prepaid - £4000.

4. Provide for depreciation for the year as follows:• Fittings - 10% on cost• Vehicles - 20% on reduced balance.

5. The provision for doubtful debts is to be adjusted to 5% of Trade Receivables(Debtors).


1. interest on Equity (Capital) is payable annually at 10%



2. interest on drawings is charged at 5% on the total amount withdrawn

3. a partnership salary of £14,000 is payable to Red

4. profits and losses are to be shared between the partners as follows: Red 2/5 andWhite 3/5.

Prepare the following accounts:

• The Income Statement (Profit and Loss account)• Current Accounts• Statement of Financial Position (Balance Sheet)

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2.9 Current Accounts and reversed Final section of theIncome Statements (Appropriation Accounts)

Sometimes SQA examination questions ask you to work backwards and calculate theProfit for the Year (Net Profit) after giving all the other relevant figures.

Activity: Grey and Pink Partnership

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Q19: Here are the figures of Grey and Pink for the year.

Pink Grey

Equity (Capital) Account £60,000 Cr £40,000 CrOpening current account balance £1,000 Cr £2,000 CrClosing current account balance £5,200 Cr £8,800 CrDrawings Account £18,000 Dr £12,000 Dr

The partnership agreement is as follows:

1. Interest on Equity (Capital) is payable annually at 10%.

2. Interest on drawings is charged at 5% on the total amount withdrawn.

3. A partnership salary of £4,000 is payable to Grey.

4. Profits and losses to be shared Pink to Grey in ratio of 3:2.

Complete the Current Accounts.

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Now that the shares of profit of £11,400 for Grey and £17,100 for Pink have been found,the Profit for the Year (Net Profit) for the partnership can be found by working the Finalsection of the Income Statement (Appropriation Account) in reverse.

Q20: Prepare the Final section of the Income Statement (Appropriation Account).

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Notice that the partnership salary, interest on Equity (Capital) and share of profit areadded together and interest on drawings subtracted to find the Profit for the Year (NetProfit), the opposite of what happens in the Final section of the Income Statement(Appropriation Account).

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Activity: X and Y Partnership

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At this stage there is an online activity. If however you do not have access to the internetyou may try the question which follows.

Q21: X and Y are in partnership with Equity (Capital) of £15,000 and £10,000respectively. The partnership agreement states that:

1. Interest on Equity (Capital) is payable annually at 10%

2. Drawings will be X: £4,000 and Y: £2,000

3. Interest on drawings is charged at 5%

4. Partnership salaries of £2,000 and £1,500 are payable to X and Y respectively

5. Residual profits/losses are to be shared in the ratio of Equity (Capital) invested

On 1 Jan the Current Account balances were:

• X: £800 debit• Y: £7,000 credit

On 31 December after the partnership agreement had been taken into account theCurrent Account balances were:

• X: £7,500 credit• Y: £7,000 credit

Complete the Current Accounts and the Final section of the Income Statement(Appropriation Account).

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2.10 Admission of Partner

A new partner may be admitted to an existing partnership to obtain additional Equity(Capital)/skills or to replace a partner who has retired or died.

The new partner will receive a share in the profits but is also entitled to share in anyIntangible Assets (Goodwill) which the firm may have. Intangible Assets (Goodwill) isan intangible asset which a firm may have based on the following factors:

• the average level of profits made annually

• the number of customers it has



• its reputation for being reliable

• its location in a prime site.

Intangible Assets (Goodwill) is only realisable on the sale of the firm as a goingconcern and is valued at the selling price less the value of the assets being taken overby the new owner. For example: selling price £100,000, value of assets being takenover £80,000 = Intangible Assets (Goodwill) of £20,000 payable by the new owner whobenefits by obtaining an existing firm which is already profitable.

The new partner will normally receive a share in the firm’s Intangible Assets (Goodwill)by paying the existing partners a premium to compensate them for their loss in givingup part of their share of the Intangible Assets (Goodwill). Such a premium may beretained in the firm - in which case the Equity (Capital) of the existing partners will beincreased - or it may be withdrawn by the existing partners for personal use.

As an alternative to paying a premium for Intangible Assets (Goodwill) the Equity(Capital) accounts of the partners, including the new partner, may be adjusted to reflectthe amount of Intangible Assets (Goodwill) being shared which is usually based on theprofit sharing ratio.

Prior to the admission of a new partner, the assets of the firm will normally be revaluedto reflect their current value. A revaluation account is used to show the increase(credit) or decrease (debit) in values. Any surplus/deficit on revaluation will be sharedby the existing partners in their profit sharing ratio. The Equity (Capital) (or current)accounts of the existing partners will be credited with any surplus or debited with anydeficit.

With the introduction of a new partner a new Deed of Partnership or PartnershipAgreement will have to be drawn up.

The accounting procedure for introducing a new partner normally follows three steps:

1. Revaluing the assets of the existing partnership.

2. Calculating any Intangible Assets (Goodwill) that may exist and deciding whetherthe new partner should pay anything for this.

3. Calculating the new profit sharing ratio of the new partnership.

2.11 The effect of admitting a new Partner

You can now put it all together to see the overall effect of admitting a new partner intoan existing partnership.

Bruce, Wallace and Stuart

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Q22: Using the information given complete the Equity (Capital) accounts and profitsharing table.



At the start of the year Bruce and Wallace decide to admit Stuart as a new partner onthe following terms:

1. Before the admission, the assets of Bruce and Wallace are to be revalued asfollows:

Old value New value

Property (Premises) £60,000 £90,000Vehicles £30,000 £25,000Inventory (Stock) £20,000 £18,000Trade Receivables (Debtors) £6,000 £5,000

Any surplus/deficit on revaluation is transferred to the existing partners’ Equity(Capital) accounts on the profit sharing ratio of 3:2.

2. Stuart is to invest £65,000 of which £40,000 is her Equity (Capital) and theremainder a premium to share in the Intangible Assets (Goodwill) of the firm.

3. This premium is to be shared by Bruce and Wallace in the profit sharing ratio andis to be retained by them in the business.

4. Stuart is to receive a 1/6 share of future profits, with Bruce and Wallace continuingto share as before (3:2).

The Equity (Capital) accounts of Bruce and Wallace prior to Stuart’s admission are£60,000 and £40,000 respectively.

Asset Old value New valueDifference

(+ or -)

Property (Premises)VehiclesInventory (Stock)Trade Receivables (Debtors)

£Share of surplus/(deficit) to Equity (Capital) Bruce

to Equity (Capital) Wallace

Share of Premium to Equity (Capital) Bruceto Equity (Capital) Wallace



Equity (Capital) A/C - Bruce

DR (-) CR (+) BALOriginal balanceShare of revaluationShare of premium

Equity (Capital) A/C - Wallace

DR (-) CR (+) BALOriginal balanceShare of revaluationShare of premium

New profit sharing

StuartBruceWallace

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Notice the effect of Stuart’s admission is an increase in the existing partner’s Equity(Capital) and a reduction in their profit sharing ratio to allow for Stuart’s share.Had the revaluation of assets produced a deficit, their Equity (Capital) would be reducedaccordingly.Having paid a premium for Intangible Assets (Goodwill), Stuart will be entitled to a 1/6share of the value of future Intangible Assets (Goodwill) with Bruce and Wallace havinga 1/3 and 1/2 share respectively.Had Stuart not paid this premium, she would not be entitled to any share in the valueof future Intangible Assets (Goodwill). Bruce and Wallace would share the value in theoriginal profit sharing ratio of 2/5 and 3/5 respectively.

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Smith and Jones Partnership

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Q23: Smith and Jones are in partnership, sharing profits and losses in proportion toEquity (Capital) invested.

At 1 January their accounts are:

Equity (Capital) Account Smith £80,000 cr and Jones £40,000 cr.

Smith and Jones now decide to admit Adams as a new partner on the terms described.

1. Adams is to invest £36000 of which £30,000 is her Equity (Capital) contribution andthe remainder a premium for Intangible Assets (Goodwill).

2. This premium is to be shared by Smith and Jones in relation to their existing capitals(equities) and retained in the business.

3. Adams is to receive a 1/5 share of future profits, with Smith and Jones continuingto share as before.



Prior to Adam’s admission, the assets of the firm are revalued as follows:

Old value New valueProperty (Premises) 50,000 60,000Vehicles 25,000 16,000Inventory (Stock) 15,000 12,000Trade Receivables (Debtors) 8,000 7,300

Any surplus or deficit is shared by existing partners in their profit sharing ratio.

Complete the share of surplus table and the Equity (Capital) accounts.


(+ or -)


Share of deficit £to Equity (Capital) Smithto Equity (Capital) Jones

Share of premium £to Equity (Capital) Smithto Equity (Capital) Jones

Equity (Capital) A/C: Smith

dr (-) cr (+) Bal £Original balanceShare of revaluationShare of premium

Equity (Capital) A/C: Jones


New profit sharing ratio

Adams £SmithJones

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Ash and Oak Partnership

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Q24: Ash and Oak are in partnership, sharing profits and losses in proportion to Equity(Capital) invested.


Equity (Capital) Account Ash £60,000 cr and Oak £40,000 cr

Ash and Oak now decide to admit Fir as a new partner on the following terms:

1. Fir is to invest £40,000 of which £30,000 is her Equity (Capital) contribution and theremainder as a premium for Intangible Assets (Goodwill).

2. This premium is to be shared by Ash and Oak in relation to their existing capitals(equities) and retained in the business.

3. Fir is to receive a 1/4 share of future profits, with Ash and Oak continuing to shareas before.

Prior to Fir’s admission, the assets of the firm are revalued as follows:



Work out the share of surplus/deficit and the new profit sharing. Complete the Equity(Capital) accounts.


(+ or -)


Share of surplus £to Equity (Capital) Ashto Equity (Capital) Oak

Share of premium £to Equity (Capital) Ashto Equity (Capital) Oak

Equity (Capital) A/C: Ash




Equity (Capital) A/C: Oak



Fir £AshOak

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Quiz: Theory exercise

Go online10 min

Q25: The admission of a new partner can only take place on the retiral or death of anexisting partner.

a) trueb) false

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Q26: Replace the gaps with the most appropriate word from the word list.

Word list: assets: customers: going concern: Intangible Assets (Goodwill): intangible:location: realisable: reputation: selling: value

Intangible Assets (Goodwill) is an �� asset whose ��

will depend on the level of profit and the numbers of �� together withthe firm’s �� for reliability and ��. Intangible Assets(Goodwill) is �� on the sale of the firm as a ��. Tocalculate the value of �� you subtract the value of ��

being sold from the �� price.

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Q27: The premium paid for Intangible Assets (Goodwill) will have what effect on theEquity (Capital) amounts of the existing partners if the money is withdrawn by them?

a) Increaseb) Decreasec) No change

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Q28: On which of the following is each partner’s share of the Intangible Assets(Goodwill) based?

a) profit sharing ratiob) amount of drawingsc) amount of Equity (Capital)

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Q29: Replace the gaps with the most appropriate word from the word list.

Word list: surplus: credit: exceeds: admission: current: debited: deficit: debit: assets:Equity (Capital): revaluation: existing: profit sharing ratio

Before the �� of a new partner, the �� will berevalued using a �� account. An increase in value is shown onthe �� side and a decrease in value on the �� sideof the revaluation account. If value of increases �� the value ofdecreases there is a �� which the �� partners shareusing ��. Either the �� account or the ��

account will be credited if there is a surplus or �� if there is a��.

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2.12 Learning points

Summary

You should now know the:

• Reasons for forming a Partnership.

• Advantages and disadvantages of Partnership.

• Different types of partner.

• Limited Liability Partnership Act 2000.

• Main components of a Partnership Agreement.

• Different accounts which must be drawn up for a Partnership.

• Steps to be taken when introducing a new partner.

• Accounts to be prepared when admitting a new partner.




End of topic test

Go online10 min

Q30:

Bogart and Bacall are in partnership sharing profit and losses in the ratio of 2:1. Theirpartnership agreement states:(1) Interest on Equity (Capital) is payable at 10%(2) Interest on drawings is charged at 20%(3) A partnership salary of £15,000 is payable to Bacall

Trial Balance as at 31 December£000 £000

Sales Revenue (Sales) 280Purchases 140Inventory (Stock) at 1 January 20Selling Expenses 26Office Expenses 22Bad debts 4Discounts (net) 3Equity (Capital): Bogart 140Equity (Capital): Bacall 70Current: Bogart 34Current: Bacall 15Property (Premises) 200Fittings (at cost) 50Vehicles (at cost) 59Provision for depreciation 1 JanFittings 14Vehicles 19Provision for doubtful debts 2Trade Receivables (Debtors) 60Trade Payables (Creditors) 49VAT (net) 7Drawings: Bogart 15Drawings: Bacall 20Cash and Cash Equivalents (Bank) 11

630 630

Notes

1. The Inventory (Stock) at 31 December is valued at £25,000

2. Office and administration Expenses accrued are £3,000

3. Selling and advertising Expenses prepaid are £4,000

4. Depreciation is calculated as:• Fittings: 10% on cost• Vehicles: 20% on reduced balance

5. The provision for doubtful debts is to be adjusted to 5% of Trade Receivables(debtors).



For the year ended 31 December prepare:

• the Income Statement (Profit and Loss account)

• Current Accounts

• Statement of Financial Position (Balance Sheet)

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Q31: Smith and Jones are in partnership with Equity (Capital) of £30,000 and £20,000respectively.

The partnership agreement states:

1. Interest on Equity (Capital) is payable annually at 10%

2. Drawings (to be taken) Smith: £20,000 and Jones: £12,000

3. Interest on drawings is charged at 20%

4. Partnership salaries of £6,000 and £3,000 are payable to Smith and Jonesrespectively.

5. Residual profits/losses are to be shared in the ratio of Equity (Capital) invested.

On 1 Jan the current account balances were: Smith: £1600 debit and Jones: £1200credit.

On 31 December after the partnership agreement had been taken into account, thecurrent account balances were: Smith: £1400 credit and Jones: £3800 credit.

Prepare the current accounts and the reverse Final section of the Income Statement(Appropriation Account).



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Q32: Laurel and Hardy are in partnership, sharing profits and losses in proportion toEquity (Capital) invested.


Equity (Capital) Account Laurel £40,000 cr and Hardy £20,000 cr.

They decide to admit Chaplain as a new partner on the following terms:

1. Chaplain is to invest 39000 of which 30,000 is his Equity (Capital) contribution andthe remainder a premium for Intangible Assets (Goodwill).

2. This premium is to be shared by Laurel and Hardy in relation to their existingcapitals (equities) and retained in the business.

3. Chaplain is to receive a 1/4 share of future profits, with Laurel and Hardy continuingto share as before.

Prior to Chaplain’s admission, the assets of the firm are revalued as follows:



Work out the share of surplus/deficit and the new profit sharing. Complete the Equity(Capital) accounts.


(+ or -)


Share of surplus £to Equity (Capital) Laurelto Equity (Capital) Hardy

Share of premium to Equity (Capital) Laurelto Equity (Capital) Hardy

Equity (Capital) Account: Laurel

DR (-) CR (+) BAL £Original BalanceShare of revaluationShare of premium



Equity (Capital) Account: Hardy

DR (-) CR (+) BAL £Original BalanceShare of revaluationShare of premium

New Profit Sharing Ratio

Chaplain £LaurelHardy

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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37

Topic 3

Public Limited Companies

Contents

3.1 The Theory of Public Limited Companies - Introduction and set-up . . . . . . 38

3.2 The Equity (Capital) of a Public Limited Company . . . . . . . . . . . . . . . . 39

3.3 The Accounts of a Public Limited Company . . . . . . . . . . . . . . . . . . . 40

3.4 The Final section of the Income Statement (Appropriation Account) . . . . . . 43

3.5 The Accounts of a Public Limited Company - The Statement of Financial Position(Balance Sheet) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

3.5.1 A full Statement of Financial Position (Balance Sheet) of a Public LimitedCompany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

3.6 Full Financial Statements exercises (Full Final Accounts exercises) . . . . . . 49

3.7 Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

3.7.1 Development of Accounting Standards . . . . . . . . . . . . . . . . . . . 64

3.7.2 Statement of Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

3.7.3 The Urgent Issues Task Force (UITF) . . . . . . . . . . . . . . . . . . . 66

3.7.4 The International Accounting Standards Board (IASB) . . . . . . . . . . 66

3.7.5 Statement of Principles for financial reporting . . . . . . . . . . . . . . . 67

3.7.6 Examples of Accounting Standards and current practice . . . . . . . . . 70

3.8 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Learning objectives

By the end of this topic you will know:

• how a public limited company is set up;

• the documents required to set up a public limited company;

• the difference between Ordinary Shares, Preference Shares and Debentures;

• the layout of the Income Statement for a plc (Profit and Loss Appropriation Accountfor a plc);

• the layout of the Statement of Financial Position (Balance Sheet of a plc);

• the purpose of the ASB and the IASB;

• current Financial Reporting Standards.

38 TOPIC 3. PUBLIC LIMITED COMPANIES

3.1 The Theory of Public Limited Companies - Introductionand set-up

A PLC is a form of business organisation which raises the equity (capital) required tostart by sub-dividing it into shares which are offered for sale to the public.

The number and value of the shares can be of any amount and the person who buysthem becomes a member of the plc or a shareholder with limited liability.

This means that, in the event of the plc becoming bankrupt and losing all its assets, theshareholders will only lose the value of their shares. They cannot be asked to pay forany debts of the plc from their personal assets.

To set up (or float) a plc the following conditions have to be met:

• Minimum number of shareholders is 2 (no maximum).

• Minimum authorised equity (capital) is £50,000.

• Must be registered as a public limited company and have those words/initials afterits name (PLC).

Memorandum of Association

This document states the conditions which govern the intended company’s relationshipwith the outside world.

It contains five clauses:

• Name of the company - to include the term PLC if appropriate.

• Address of the UK where its registered office is to be situated.

• Statement that the liability of its members is limited.

• Details of the intended amount of share equity (capital) and types of shares.

• Statement of its objects.

The objects clause is important as it defines the future powers of the company, i.e. it willbe illegal or ultra vires (beyond power) for the company to do anything not permitted bythe objects clause.

The objects clause is therefore made wide-ranging to cover any possible activity whichin the future might be considered to be in the best interests of the company.

Articles of Association

This deals with internal regulations for the management of the proposed company.

It is subordinate to, and is controlled by, the Memorandum of Association.

They state the way in which the company is to be administered with particular referenceto:

• Matters relating to the raising of equity (capital), e.g. borrowing powers or shareallotment.


TOPIC 3. PUBLIC LIMITED COMPANIES 39

• Directors’ remuneration and powers.

• Dividends and reserves.

• Holding of meetings.

• The rights of shareholders.

If the Registrar of Companies is satisfied with the above documentation, a Certificateof Incorporation is issued which makes the plc a legal entity - able to sue and be suedin place of the shareholders.

This Certificate also enables the plc to issue its prospectus to invite potential investorsto buy its shares.

If the issue of shares is successful each shareholder will receive share certificates asproof of ownership and the plc will receive a Certificate of Trading enabling it to startoperating.

3.2 The Equity (Capital) of a Public Limited Company

There are two main types of shares which a plc may issue to raise the required amountof equity (capital):

• Preference Shares whose owners are the first to receive a share of the profit byway of a dividend the percentage of which is fixed in advance. The dividend maybe cumulative - if not paid in one year it is carried over to the next. Preferenceshareholders are also first to have their investment returned if the plc is wound up.

• Ordinary Shares whose owners may be given a dividend if the level of profitis sufficient. The percentage of dividend is variable with no upper or lowerlimit. Ordinary shareholders are the last to have their investment returned onliquidation which, along with no guaranteed dividend, makes Ordinary sharesa more risky investment.

In addition to the above shares a plc may also raise equity (capital) through a loan byissuing what are known as debenture certificates. Debenture holders will receive afixed rate of interest on their loan regardless of any profit or loss being made and, asthey are trade payables (creditors), will be repaid before the preference or ordinaryshareholders.

Debentures can be classed as redeemable - repayable by a certain date - orirredeemable - repayable when the plc is officially terminated. To make the debenturesa more attractive or safer form of investment, they may be secured against a specificnon-current asset (fixed asset), which would be sold to repay the loan if necessary.

Shareholders have no say in the day-to-day decision-making or running of a plc. Controlis kept by the Board of Directors who will own the majority (equity (capital)) of shares.

An Annual Report with a Income Statement (Trading and Profit and Loss account)and Statement of Financial Position (Balance Sheet) are prepared for the AnnualGeneral Meeting (AGM) of shareholders at which they have the right to vote.



3.3 The Accounts of a Public Limited Company

The Income Statement (Trading and Profit and Loss accounts) of a plc are preparedin the same way as any firm - sole trader/partnership - to show Gross Profit (Gross)and Profit for the Year (Net Profit). Included in the Income Statement (Profit and Lossaccount) are such items as directors’ remuneration (fees) and Debenture FinanceCost (Debenture Interest) which are expenses only associated with a plc.

As with a partnership, once the Net Profit of a plc is calculated, there is a section underthe Income Statement (Profit and Loss account) to show how the Profit for the Year(Net Profit) is to be appropriated or used. In the final part of the Income Statement(Appropriation Account) the following items might appear:

• Profit for the Year (Net Profit) for the current year.

• Corporation Tax as a percentage of Profit for the Year (Net Profit).

• Unappropriated (retained) Profit from the previous year.

• Reduction of Intangible Asset (Goodwill).

• Preliminary Expenses - if written off from Profit for the Year - (e.g. legal fees)spent in setting up a plc.

• Interim Dividends paid during the year.

• Balance being carried to next year (unappropriated profit this year).

The final Ordinary Dividend will only be decided by the Board of Directors at the AGMafter the accounts have been drawn up.

As with the final accounts of a plc, the Statement of Financial Position (Balance Sheet)is similar to that of any firm but more detailed given that a plc has a wider range of assetsand liabilities than a sole trader/partnership.

The layout of a plc Statement of Financial Position (Balance Sheet) is important sothat information is readily available as to the value of non-current assets (fixed assets),net current assets, net total assets, shareholders’ interest, and bank loans (loans) duelonger than one year.

Companies have to keep and produce the same set of accounts as any other businesslike a sole trader or a partnership. They have to produce an audited set of accountsat the end of the financial year for presentation to their shareholders and to the InlandRevenue for tax purposes. Unlike sole traders or partnerships, these accounts have tobe published and are in the public domain meaning that any member of the public canhave access to them.

These accounts are the same Income Statement (Trading and Profit and Loss account)and Statement of Financial Position (Balance Sheet). The main differences betweenthese accounts and those of a sole trader or partnership is the greater number of itemscontained in them and the usually larger values of assets and liabilities.

The other main difference is the fact that the Income Statement (Profit and Loss account)has an extra section called the Final section of the Income Statement (AppropriationAccount) which shows how the profits earned in a year are going to be distributed



amongst the various interested parties: Corporation Tax to the Inland Revenue,interim dividends to the owners or shareholders or retained profits to help the companyexpand.

You will look at each part in turn building up to creating a full set of final accounts for aplc.

Quiz: Theory of Public Limited Companies

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Q1: The number of shares in a plc is:

a) limited to 25000b) limited to 50000c) limited to 100000d) unlimited

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Q2: Limited liability means each shareholder is responsible for paying a share of thefirm’s debts on liquidation on the following basis:

a) the amount of shares heldb) the value of shares heldc) the number of shareholdersd) has no responsibility

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Q3: Which of the following would not appear in the Memorandum of Association?

a) Name and address of the firmb) Number and type of sharesc) Share allotmentd) Objects

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Q4: Which of the following would not appear in the Articles of Association?

a) Rights of shareholdersb) Limited liability of shareholdersc) Holding of meetingsd) Directors’ remuneration



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Q5: Which of the following documents makes a plc a legal ’entity’?

a) Certificate of tradingb) Certificate of incorporationc) Share certificated) Prospectus

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Q6: Which of the following statements is true?

a) Ordinary shares are a safer investmentb) Preference dividends must be paidc) Ordinary dividends have no upper limitd) Ordinary shareholders are first to have their investment returned

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Q7: Which of the following statements is false?

a) Debenture holders are trade payables (creditors) to a plcb) Debentures are only redeemable on the liquidation of a plcc) Debenture Finance Cost (Debenture Interest) must be paidd) Debenture can be secured against the non-current assets (fixed assets) of a plc

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Q8: Which of the following would not appear in the Income Statement (Profit and Lossa/c) of a plc?

a) Debenture Finance Cost (Debenture Interest)b) Corporation taxc) Preliminary Expenses written downd) Reduction in the value of non-current assets (fixed assets)

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Q9: Which of the following would not appear in the final part of the Income Statementafter Profit for the Year (Appropriation a/c of a plc)?

a) Unappropriated Profitb) Directors’ remunerationsc) Reduction in the value of Intangible Asset (Goodwill)d) Interim Dividends

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Q10: Shareholders control a plc by their votes at the AGM.

a) trueb) false

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3.4 The Final section of the Income Statement(Appropriation Account)

As previously indicated the Profit for the Year (Net Profit) of a plc is found in the sameway as a sole trader or partnership type of firm.

Once calculated, the Profit for the Year (Net Profit) is appropriated or distributedaccording to the proposals of the Board of Directors. The shareholders may not bein agreement with these proposals and may voice their objections at the AGM where thedirectors will have the final say, as they have the majority of the votes.

The following is an example of an Income Statement (Appropriation Account) with thedirectors proposals not taken into account until the AGM (with the directors’ proposalstaken into account.)

Income Statement (Appropriation Account) for year ending 31 December

£000 £000Profit for the Year (Net Profit) 40

Less: Corporation Tax (25% × 40) 1030

Add: Unappropriated Profit b/f 5(Profit for Year (after Tax))

35Less: Intangible Asset (Goodwill) w/d 10

Interim Ordinary Dividend paid 15Interim Preference Dividend 8 33Unappropriated Profit c/f 2

Notice that of the total profit available for distribution of £35000, the shareholders onlyreceive a total of £23,000 (15,000 + 8000) with the remaining £12000 (10000 + 2000)being retained in the firm - the Directors will decide the final Ordinary Dividend and finalPreference Dividend at the AGM.

Notice that Debenture Finance Cost (Debenture Interest) due does NOT appear in theFinal section of the Income Statement (Appropriation Account) as it has already beendeducted in the Income Statement (Profit and Loss account) in the calculation of theProfit for the Year (Net Profit) of £40000.

Key point

Key points

The Final section of the Income Statement (Appropriation Account) of a plcshows the distribution of available profits amongst interested parties.

Debenture Finance Cost (Debenture Interest) does not appear in the Finalsection of the Income Statement (Appropriation Account) as it is an expense nota distribution of profit.



Activity: Final section of the Income Statement (Appropriation Account)

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Q11: Prepare the Final section of the Income Statement (Appropriation Account) fromthe information given

Information1 Profit for the Year (Net Profit) - £80,000

2 Corporation Tax is to be calculated at 25% of Profit for the Year (Net Profit)

3 Unappropriated Profit b/f - £8,000

4 100,000 10% Preference Shares, £1 each, fully paid

60,000 Ordinary Shares, £1 each, fully paid

5 An Interim Dividend of 20% has been paid on the Ordinary Shares

6 An Interim Dividend of £5,000 is to be paid on the Preference Shares

£ £Profit for the Year (Net Profit)Less Corporation Tax

Add Unappropriated Profit b/f

LessInterim Ordinary DividendInterim Preference DividendUnappropriated Profit c/f

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3.5 The Accounts of a Public Limited Company - TheStatement of Financial Position (Balance Sheet)

The Statement of Financial Position (Balance Sheet) of a plc is more detailed that othertypes of firms due to its equity (capital) structure - types of shares issued, reservescreated, bank loans (loans) borrowed.

Using the information from the previous activity, the current liabilities and representedby sections of the Statement of Financial Position (Balance Sheet) of this firm wouldappear as follows.

Extract from Statement of Financial Position (Balance Sheet) as at 31 December

Current Liabilities:

£000 £000Trade Payables 5

Corporation Tax due 20 25

Represented by:

Issued Equity (Capital): £000 £00050,000 8% Preference Shares at £1 each 5060,000 Ordinary Shares at £1 each 60 110Reserves 37

Unappropriated Profit 31 31141

Taxes are shown as a liability because this year’s tax won’t fall due to be paid until partway through the next financial year.

Key point

Key points

The Statement of Financial Position (Balance Sheet) of a plc has many moreitems, particularly the Current Liabilities and Represented by sections.

Debenture holders are not owners of the plc just long term lenders.Any Non-current liabilities (long term liabilities) should now be deducted in thefirst half of the Statement of Financial Position (Balance Sheet) and not the lastitem to appear as was previously.



3.5.1 A full Statement of Financial Position (Balance Sheet) of a PublicLimited Company

The following is an example of a full Statement of Financial Position (Balance Sheet) ofa plc.

Statement of Financial Position (Balance Sheet) as at 31 December Year 2:

£000 £000 £000Non-Current Assets (Fixed Assets) Cost DEP NBVProperty (Premises) 120 120Fittings 31 13 18Vehicles 60 20 40

211 33 178Current AssetsInventory (Stock) 23Trade Receivables (Debtors) 40less Provision for doubtful debts 2 38Cash and Cash Equivalents (Bank) 4Other Receivables (Prepaid Expenses) 6 71less Current LiabilitiesVAT 4Corporation tax 8Trade Payables (Creditors) 25Other Payables (Accrued Expenses) 2Debenture Finance Cost payable (DebentureInterest) due 4 43

Working Equity (Capital) 28206

less Non-Current LiabilitiesLess Debentures 40Total Net Assets 166Represented by:Issued Equity (Capital)Ordinary Shares of £1 each, fully paid 808% Preference shares of £1 each, fully paid 50 130Reserve Equity (Capital)Share Premium 24Unappropriated Profit 12 36(Shareholders’ interest) 166

Notice that the non-current assets (fixed assets) and current assets sections are verysimilar to those of a sole trader/partnership.

The main difference is the represented by section which reflects the equity (capital)structure of the plc. In the above example the firm has issued both types of shares -ordinary and preference - and debentures.

It also has three reserves including share premium which is the result of issuing sharesat a price above their face value e.g. 50000 ordinary shares at £1 each being issued at



£1.20 each = a premium of 50000 x 20p = £10000.

This situation can occur if the current market value of issued shares has risen on thestock market, where shares in a plc are bought and sold, as a result of the firm makinggood profits. Any new issue of shares would be sold at the higher market value.

Key point

Key point

The Statement of Financial Position (Balance Sheet) of a plc is very similar to asole trader but with more items.

Activity: Sections of the Statement of Financial Position (Balance Sheet)

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Q12: Prepare an Final section of the Income Statement (Appropriation Account),current liabilities, and represented by section of the Statement of Financial Position(Balance Sheet) from the information given

Information£000

1 Profit for the Year (Net Profit) for the Year 602 Corporation Tax - 25% of Profit for the Year (Net Profit)3 Unappropriated Profit b/f 124 100,000 8% Preference Shares, £1 each, fully paid 1005 80,000 £1 Ordinary Shares, fully paid 806 10% Debentures 50

An Interim Dividend of 15% has been paid to Ordinary Shareholders.

NB Debenture Finance Cost (Debenture Interest) has yet to be paid.

Final section of the Income Statement (Appropriation Account)

£000 £000Profit for the Year (Net Profit) (before Tax)

less Corporation Tax

add Unappropriated Profit b/f

less Interim Ordinary DividendUnappropriated Profit c/f



Sections of the Statement of Financial Position (Balance Sheet)

£000 £000Current Liabilities

Debenture Finance Cost payable (Debenture Interest) dueCorporation Tax

Represented byIssued Equity (Capital)100,000 8% Preference Shares £1 fully paid80000 Ordinary shares at £1 each

Reserves:Unappropriated Profit c/fShareholders Interest

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3.6 Full Financial Statements exercises (Full Final Accountsexercises)

The following is an example of a full set of final accounts of a plc.

Income Statement (Trading and Profit and Loss Account) for year ending 31December

£000 £000 £000Sales Revenue (Sales) 500

Less: Sales Revenue (Sales) returns (In) 7493

Less: Cost of SalesInventory (Stock) at start (Opening) 24

Add: Purchases 350Less: Purchases returns (Out) 12 338Add: Carriage inwards 6

Warehouse wages 20388

Less: Inventory (Stock) at end (Closing) 23 365Gross Profit 128

Less: ExpensesOffice expenses (30 + 2) 32Selling expenses (46 - 6) 40Carriage outward 8Debenture finance cost (debenture interest) 4Depreciation of vehicles 20% cost 12Depreciation of fittings 25% NBV 6 102

26Add: Income

Discount received 5Decrease in Provision for Doubtful Debts 1

Profit for the Year (Net Profit) 32

Less: Corporation Tax (25% × 32) 8Profit for Year (after Tax) 24

Add: Unappropriated last year 2(Available Profits) 26

Less:Interim Ordinary Dividend 12Unappropriated Profit c/f 14

Notice that, with the exception of Debenture Finance Cost (Debenture Interest), thefinal accounts are very similar to those of a sole trader/partnership.The appropriation section appears at the bottom of the Income Statement (Profit andLoss a/c) and shows what tax is due on this year’s profit and what the directorspropose to do with the available profits.



Company AB: Income Statement (Profit and Loss account)

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Q13: Complete the Income Statement (Profit and Loss account) from the Trial Balanceand notes given.

Notes:At 31 December the following had to be taken into account:

• Inventory (Stock) £30,000

• Office expenses payable £3,000

• Selling expenses receivable £4,000

• A year’s Debenture Finance Cost (Debenture Interest) is due

• Depreciation: vehicles: 20% on cost

• Depreciation: fittings: 25% reduced balance

• Provision for Doubtful Debts is to be 5% of Trade Receivables (Debtors)

• Corporation Tax is to be charged at 25% of Profit for the Year (Net Profit).



Trial Balance£000 £000

Sales Revenue (Sales) 680Sales Revenue (Sales) returns 4Purchases 470Purchases returns 20Carriage in 7Warehouse wages 29Inventory (Stock) at 1 January 23Discount allowed 6Office expenses 35Selling expenses 52Carriage out 10Property (Premises) 160Vehicles 60Fittings 37Trade Receivables (Debtors) 60Interim Ordinary Dividend 12Provision for Depreciation: vehicles 24Provision for Depreciation: fittings 13Provision for Doubtful Debts 2Trade Payables (Creditors) 28Cash and Cash Equivalents (Bank Overdraft) 2Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 24Unappropriated Profit 2

965 965



Income Statement (Profit and Loss account)

£000 £000 £000Sales Revenue (Sales)

less Sales Revenue (Sales) returns

less Cost of SalesInventory (Stock) at start (opening)

add Purchasesless Purchases returns (out)add Carriage inwards

Warehouse wages

less Inventory (Stock) at end (closing)Gross Profit

less ExpensesOffice expensesSelling expensesCarriage outwardDebenture Finance cost (Debenture interest)Depreciation: vehicles (20% cost)Depreciation: fittings (25% NBV)Discount allowedIncrease in prov. for d. debtProfit for the Year (Net Profit)

less Corporation Tax

add Unappropriated last year

less Ordinary Dividend 15%Unappropriated Profit c/f

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Company AB: Statement of Financial Position (Balance Sheet)

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Q14: Prepare the Statement of Financial Position (Balance Sheet) for company AB fromthe information given.

Note the question uses the Corporation Tax (18) and Unappropriated Profit (10) figuresalready calculated in the previous activity.

Notes

At 31 December the following had to be taken into account:


• Office Expenses Payable £3,000



• Selling Expenses receivable £4,000





• Corporation Tax is to be charged at 25% of Profit for the Year (Net Profit)


Sales Revenue (Sales) 680Sales Revenue (Sales) returns 4Purchases 470Purchases returns 20Carriage in 7Warehouse wages 29Inventory (Stock) at 1 January 23Discount allowed 6Office expenses 35Selling expenses 52Carriage out 10Property (Premises) 160Vehicles 60Fittings 37Trade Receivables (Debtors) 60Interim Ordinary Dividend 12Provision for Depreciation: vehicles 24Provision for Depreciation: fittings 13Provision for Doubtful Debts 2Trade Payables (Creditors) 28Cash and Cash Equivalents (Bank Overdraft) 2Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 24Unappropriated Profit 2

965 965



Statement of Financial Position (Balance Sheet): Company AB as at 31 December

£000 £000 £000Non-Current Assets (Fixed Assets) Cost DEP NBVProperty (Premises)FittingsVehicles

Current AssetsInventory (Stock)Trade Receivables (Debtors)Less Provision for Doubtful DebtsOther Receivables (Prepaid Expenses)

Current LiabilitiesCorporation TaxCash and Cash Equivalents (Bank Overdraft)Debenture Finance costOther Payables (Accrued Expenses)Trade Payables (Creditors)Equity Capital (Working Capital)

less Non-Current LiabilitiesDebenturesTotal Net Assets

Represented by:Issued Equity (Capital)80,000 £1 Ordinary Shares, fully paid50,000 8% Preference Shares £1, fully paid

ReservesUnappropriated Profit c/fShare PremiumShareholders Interest

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Company BC: Income Statement (Profit and Loss account)

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Q15: Prepare the Income Statement (Profit and Loss account) for year ending 31December for company BC from the information given.

Notes



• Office Expenses Payable £4,000

• Selling Expenses receivable £4,000




• Provision for doubtful debts is to be 5% of Trade Receivables (Debtors)

• Corporation tax is to be charged at 25% of Profit for the Year (Net Profit).


Sales Revenue (Sales) 788Sales Revenue (Sales) returns 7Purchases 585Purchases returns 16Carriage in 10Warehouse wages 30Inventory (Stock) at 1 January 30Discount (net) 4Office expenses 38Selling expenses 55Carriage out 12Property (Premises) 148Vehicles 75Fittings 37Trade Receivables (Debtors) 80Interim Ordinary Dividend 16Provision for Depreciation: vehicles 24Provision for Depreciation: fittings 13Provision for Doubtful Debts 3Trade Payables (Creditors) 37Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 50Unappropriated Profit 18

1123 1123





Less Sales Revenue (Sales) returns

Less Cost of SalesInventory (Stock) at start (opening)

Add PurchasesLess Purchases returns (out)Add Carriage inwards

Warehouse wages

Less Inventory (Stock) at end (closing)Gross Profit

Less ExpensesOffice expensesSelling expensesCarriage outwardDebenture finance cost (debenture interest)Depreciation: vehiclesDepreciation: fittingsIncrease in provision for d. debt

Add IncomeDiscount receivedProfit for the Year (Net Profit)

Less Corporation TaxProfit for the year (after Tax)

Add Unappropriated last year

Less Interim Ordinary DividendUnappropriated Profit c/f

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Company BC: Statement of Financial Position (Balance Sheet)

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Q16: Prepare the Statement of Financial Position (Balance Sheet) for company BC fromthe information given.

Note: This activity uses the Corporation Tax (12) and Unappropriated Profit (34) figuresalready calculated in the previous activity.



Notes


• Inventory (Stock) £33000

• Office Expenses Payable £4000

• Selling Expenses receivable £4000




• Provision for doubtful debts is to be 5% of Trade Receivables (Debtors)

• Corporation tax is to be charged at 25% of Profit for the Year (Net Profit).


Sales Revenue (Sales) 788Sales Revenue (Sales) returns 7Purchases 585Purchases returns 16Carriage in 10Warehouse wages 30Inventory (Stock) at 1 January 30Discount (net) 4Office expenses 38Selling expenses 55Carriage out 12Property (Premises) 148Vehicles 75Fittings 37Trade Receivables (Debtors) 80Interim Ordinary Dividend 16Provision for Depreciation: vehicles 24Provision for Depreciation: fittings 13Provision for Doubtful Debts 3Trade Payables (Creditors) 37Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 50Unappropriated Profit 18

1123 1123



Statement of Financial Position (Balance Sheet) Company BC as at 31 December


Current AssetsInventory (Stock)Trade Receivables (Debtors)less Provision for doubtful debtsOther Receivables (Prepaid Expenses)Current LiabilitiesDebenture Finance Cost payable (DebentureInterest) dueCorporation TaxOther Payables (Accrued Expenses)Trade Payables (Creditors)Working Equity (Capital)

less Non-Current LiabilitiesDebenturesTotal Net AssetsRepresented by:Issued Equity (Capital)50,000 8% Preference Shares £1, fully paid80,000 £1 Ordinary Shares, fully paidReservesUnappropriated Profit c/fShare PremiumShareholders Interest

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Company CD: Income Statement (Profit and Loss account)

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Q17: Prepare the Income Statement (Profit and Loss account) at the end of the year forCompany CD from the information given.

Notes


• Inventory (Stock) £40000• Office Expenses Payable £3000• Selling Expenses receivable £4000• A year’s Debenture Finance Cost (Debenture Interest) is due• Depreciation: vehicles: 20% on cost• Depreciation: fittings: 25% reduced balance






Sales Revenue (Sales) 850Sales Revenue (Sales) returns 10Purchases 670Purchases returns 18Carriage in 12Warehouse wages 36Inventory (Stock) at 1 January 33Discount (net) 5Office expenses 40Selling expenses 58Carriage out 15Property (Premises) 160Vehicles 75Fittings 40Cash and Cash Equivalents (Bank) 8Trade Receivables (Debtors) 60Interim Ordinary Dividend 4Provision for Depreciation: vehicles 47Provision for Depreciation: fittings 24Provision for Doubtful Debts 4Trade Payables (Creditors) 61Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 44Unappropriated Profit 8

1226 1226








Warehouse wages


Less ExpensesOffice expensesSelling expensesCarriage outwardDebenture finance cost (debenture interest)Depreciation: vehicles 20% costDepreciation: fittings 25% NBVDiscount allowed

Add IncomeDecrease in Provision for bad debtProfit for the Year (Net Profit)

Less Corporation TaxProfit for Year (after Tax)

Add unappropriated last year

Less Interim Ordinary DividendUnappropriated Profit c/funappropriated profit this year c/f

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Company CD: Statement of Financial Position (Balance Sheet)

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Q18: Prepare the Statement of Financial Position (Balance Sheet) for Company CDfrom the information given.

Note: This activity uses the Corporation Tax (2) and Unappropriated Profit (10) figuresalready calculated in the previous activity.

Notes






• Selling Expenses receivable £4000







Sales Revenue (Sales) 850Sales Revenue (Sales) returns 10Purchases 670Purchases returns 18Carriage in 12Warehouse wages 36Inventory (Stock) at 1 January 33Discount (net) 5Office expenses 40Selling expenses 58Carriage out 15Property (Premises) 160Vehicles 75Fittings 40Cash and Cash Equivalents (Bank) 8Trade Receivables (Debtors) 60Interim Ordinary Dividend 4Provision for Depreciation: vehicles 47Provision for Depreciation: fittings 24Provision for Doubtful Debts 4Trade Payables (Creditors) 61Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 44Unappropriated Profit 8

1226 1226



Statement of Financial Position (Balance Sheet) Company CD as at 31 December


Current AssetsInventory (Stock)Trade Receivables (Debtors)Less: Provision for Doubtful DebtsCash and Cash Equivalents (Bank)Other Receivables (Prepaid Expenses)Current LiabilitiesDebenture Finance Cost payable (DebentureInterest) dueCorporation TaxOther Payables (Accrued Expenses)Trade Payables (Creditors)Working Equity (Capital)

less Non-Current Liabilitiesless DebenturesTotal Net AssetsRepresented by:Issued Equity (Capital)50,000 8% Preference Shares, £1, fully paid80,000 £1 Ordinary Shares, fully paidReservesUnappropriated Profit c/fShare PremiumShareholders Interest

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3.7 Financial Reporting Standards

Introduction: The role of the ASC and ASB

Any financial statement produced by business organisations should always give a trueand fair view of the financial position of the business. To achieve this objective,accountants within the United Kingdom are required to follow guidelines which arereferred to as principles, standards, concepts or conventions.

Accounting standards are authoritative statements of how particular types oftransaction and other events should be reflected in the financial statements of business



organisations. Accordingly, compliance with Accounting Standards will normally benecessary for financial statements to give a true and fair view of final accounting.

These Accounting Standards have been developed over a long period of time.

The Accounting Standards Committee (ASC) was set up over 40 years ago andpublished a number of Statements of Standard Accounting Practice (SSAPS) whichwere guidelines which the accounting profession should follow in the presentation oftheir final accounting statements.

Accounting Standards are now produced by the Accounting Standards Board (ASB) -this is an independent body which replaced the ASC in 1990. The ASB has the powerto issue its own standards, without the approval of any other body, to increase thequality of accounting standards and increase the speed with which they are issued inresponse to new problems encountered in accounting. The ASB is autonomous in itsrole in issuing standards and the standards issued by it are called Financial ReportingStandards (FRS).

The ASB does not need the approval of any other body for the production of thesestatements and these new FRS statements will gradually replace the ’old’ Statementsof Standard Accounting Practice (SSAPS).

Accounting standards are authoritative statements detailing how particular types oftransaction should be reported in financial statements and accordingly compliance withaccounting standards will normally be necessary for financial statements to give a trueand fair view. They apply to all companies that prepare accounts.

There is no general law compelling accountants to use these standards, however,compliance is ensured through the accounting professional bodies using their owndisciplinary procedures on their members.

The aims of the ASB are to establish and improve standards of financial accounting andreporting for everyone involved in the preparation or auditing of accounting statements.

To achieve all of their aims and objectives the ASB will establish accounting standards,issue new standards, update or amend existing standards in the light of newdevelopments or any deficiencies identified in current accounting practice and providea framework to allow others to make judgements in resolving accounting issues.

The purpose of an accounting standard is to:

• Give a true and fair view of the financial position of a company i.e. - ensure thesame accounting base is used in the preparation of the accounts from year to year- for example using the same method of depreciation.

• Clarify the concepts which underlie the preparation and presentation of financialstatements.



• Reduce the range of options open to accountants when dealing with difficult areas.

When carrying out its duties the ASB has certain guidelines to follow:

1. It must ensure regular communication takes place and also that any standardsprepared takes notice of any international regulations or developments. The ASBmust ensure that total consistency exists between accounting standards, andaccounting standards and company law.

2. It should be objective - any information produced from the application ofaccounting standards should be neutral and bias-free as this may influence certaindecision making.

3. Full research should be carried out by the ASB in determining which aspectsshould be included in any accounting standards.

4. It should only issue standards when the expected benefits of the introduction isgreater than the cost of implementing any standard.

Key point

Key Point

ASC: Accounting standards committee was replaced by the ASB (Accountingstandards board) in 1990.

Quiz: The role of the ASC and ASB

Go onlineQ19: What does ASC stand for?

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Q20: What does ASB stand for?

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Q21: What does FRS stand for?

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Q22: What does SSAP stand for?

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Q23: Must accountants by law use financial reporting standards?

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3.7.1 Development of Accounting Standards

The ASB identifies topics that become the subjects of FRSs, either from its own researchor from an external source.

The ASB will commission its staff to undertake a programme of research andconsultation - this will include the consideration of procedures and practice in the UK,



Republic of Ireland and overseas, as well as the economic, legal and practicalimplications of the introduction of particular requirements.

Once the issues have been identified and debated, the ASB will issue a discussiondraft which will be circulated to interested parties who should make comment on itsappropriateness and its feasibility.

Thereafter an exposure draft of an accounting standard (a financial reportingexposure draft or FRED) is published to allow an opportunity for all interested parties tocomment on the proposals and possibly suggest amendments.

Any feedback can be used to refine the exposure draft - all the relevant information isavailable on the ASB’s website and interested parties can make comments onproposals by e-mail.

After this consultation process is completed, a new financial accounting standard isissued. This issue will be monitored and reviewed as necessary and the standard maybe modified or revised in light of new developments.

Key point

Key Point

Before an accounting standard is produced an exposure draft is produced.

Preparation of an Accounting standard

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Q24: Place the following Accounting Standards steps in the correct order:

• Exposure draft is refined and modified• Topic for discussion is identified• Discussion draft is issued to interested parties• Financial reporting standard is issued• Exposure draft is issued

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3.7.2 Statement of Principles

The ASB published its Statement of Principles for financial reporting in December1999.

The statement is based on the International Accounting Standards Committee’sFramework for the preparation and presentation of financial statements and statementstherefore typically described the standard-setters view on:



• How information should be presented in financial statements

• The attributes that information needs to have if it is to be included in financialstatements

• The activities that should be reported on in financial statements

• The aspects of those activities that should be highlighted

The main purpose of the statement is to provide a theoretical framework for theconsistent and logical formulation of accounting standards. This should provide aframework under which the ASB will develop new or refine existing standards.

The Statement of Principles is, in itself, not an accounting standard and does not givedetails on how a business should prepare financial statements. It only sets out theprinciples which underlie how financial statements should be presented.

3.7.3 The Urgent Issues Task Force (UITF)

The ASB has a sub-committee called the Urgent Issues Task Force. The main role ofthe UITF is to assist the ASB where unsatisfactory or conflicting interpretations havedeveloped (or seem likely to develop) about a requirement of an accounting standard orthe Companies Act. The UITF tries to arrive at a consensus on the accounting treatmentthat should be adopted, in such cases, in the context of the ASB’s declared aim of relyingon principles rather than detailed prescription.

The UITF also tackles urgent matters not covered by existing standards, and forwhich, given the urgency, the normal, lengthy standard setting process would not bepracticable.

UITF pronouncements, which are called ‘abstracts’, are intended to come into effectquickly. They therefore tend to become effective within approximately one month ofpublication date. The UITF has so far issued around 50 abstracts, some of which beensuperseded by new FRSs.

All pronouncements by the UITF have the full backing of the ASB and compliance withthe abstracts is necessary to show a true and fair view. Any non-compliance must befully justified and explained in the accounts.

Some of the abstracts have been triggered by accounts of individual companies,whereas others reflect concern which has arisen over a period of time. There is nodoubt that the quick responses of the UITF have closed many loopholes as soon asthey have become apparent.

3.7.4 The International Accounting Standards Board (IASB)

Most companies in the UK still prepare financial statements by following the accountingstandards issued by the ASB. However, companies listed on the London StockExchange are required to prepare their consolidated financial statements usinginternational accounting standards.

The IASB is the body that develops, issues and withdraws accounting standards. It isan independent, privately funded body, based in London. There are 14 Board members,who come from nine countries, and who have a variety of backgrounds.



The standards that are issued by the IASB are called International Financial ReportingStandards (IFRSs). The standards issued by its predecessor standard setting body areknown as International Accounting Standards (IASs), and where these have not beensuperceded by IFRSs, they have been adopted by the IASB. International standardsapply to all companies and other kinds of entities which prepare accounts intended toprovide a true and fair view.

The IASB collaborates with national accounting standard-setters in many countriesin order to ensure that its standards are developed with due regard to internationaland national developments. The IASB has no authority to require compliance with itsaccounting standards. However, as in the UK, many countries require the financialstatements of publicly traded enterprises to be prepared in accordance with IFRSs, and(where necessary) to give particulars of any material departure from those standardsand the reasons for it. International accounting standards have helped both to improveand harmonise financial reporting around the world.

3.7.5 Statement of Principles for financial reporting

The ASB has issued a Statement of Principles for Financial Reporting. The Statementsets out the concepts that underlie the preparation and presentation of financialstatements for external users, and is also used as a basis for the development andreview of accounting standards. The Statement is not itself an accounting standard nordoes it contain any requirements on how financial statements are to be prepared. Itsprimary purpose is to provide a frame of reference to help the ASB itself in developingnew accounting standards and reviewing existing ones. Its main impact on accountingpractice is therefore through its influence on the standard-setting process. It mayalso influence practice by helping preparers and auditors faced with new or emergingaccounting issues to carry out an initial analysis of the issues involved.

The Statement of Principles therefore plays a very important role in the standard-settingprocess, although it is only one of the factors that the ASB takes into account whensetting standards. Other factors include legal requirements, cost-benefit considerations,industry-specific issues, and the desirability of evolutionary change and implementationissues.

The Statement is based on the International Accounting Standards Committee’s‘Framework for the Preparation and Presentation of Financial Statements’ and thereare few differences of significance between the two documents. The Statement is alsolargely consistent with the framework statements issued in Australia, Canada, NewZealand, the USA and elsewhere. This reflects the ASB’s view that it will be easierto achieve harmonisation of accounting practice if standard-setters work with a commonset of principles.

The ASB believes there is a need for accounting practice around the world to convergetowards a set of globally accepted standards. It also believes, however, that, unlessa common set of principles is adopted by all the standard-setters involved, suchconvergence will be difficult to achieve. That is because it is only through using thelanguage created by shared principles that a consistent approach can be adopted inanalysing accounting problems and resolving differences.

The Statement was published in 1999, and the ASB does not expect the Statement tobe its final word on the subject. Accounting thought is continually evolving and it is only



to be expected that the Statement will need to be revised from time to time to reflectsuch developments.

The scope of the Statement includes:

• The objective of financial statements

• The qualitative characteristics of financial information

• The definition, recognition, measurement and presentation of the elements fromwhich financial statements are constructed.

3.7.5.1 The objective of Financial Statements

The stated objective in the Statement of Principles is "to provide information about thefinancial position performance and financial adaptability of an enterprise that is usefulto a wide range of users for assessing the stewardship of management and for makingeconomic decisions".

In particular, the Statement points out that users of accounts will be interested inthe financial performance, financial position, generation and use of cash and financialadaptability of a business.

Q25: The information to be provided is to be useful to a wide range of users. In whatways will the following users of accounts be interested in financial statements?

• Existing and potential investors• Employees• Lenders and suppliers• Customers• Government• General public

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3.7.5.2 Qualitative characteristics of Financial statements

The Statement identifies four qualities of financial information that make it useful. Forinformation to be useful it must be:

Relevant

The information must be relevant to the decision-making needs of the user. Informationis useful when it influences the economic decisions of users by helping them evaluatepast, present or future events, or confirming or correcting their past evaluations.

The relevance of the information is affected by its nature and materiality. Materiality is athreshold quality which provides the cut-off point as to what makes information useful.An item is material if its misstatement or omission might reasonably be expected toinfluence the economic decisions of its users.



Reliable

Q26: To be useful, information must also be reliable. What should be the characteristicsof financial information which make it reliable?

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3.7.5.3 The elements of Financial Statements

Seven elements are identified as the elements to be included in financial statements.These are, along with their definitions:

• Assets - "are rights or other access to future economic benefits controlled by anentity as a result of past transactions or events". For example, having a debtorgives the right to future cash (an economic benefit) as a result of a sale (a pasttransaction).

• Liabilities - "are an entity’s obligations to transfer economic benefits as a resultof past transactions or events". For example, having a creditor means having anobligation to pay cash in the future as a result of a past transaction.

• Ownership interest is "calculated as total assets less total liabilities".

• Gains - "are increases in ownership interest, other than those relating tocontributions from owners".

• Losses - "are decreases in ownership interest, other than those relating todistributions to owners".

• Contributions from owners - "are increases in ownership interest resulting frominvestments made by owners in their capacity as owners".

• Distribution to owners - "are decreases in ownership interest resulting fromtransfers made to owners in their capacity as owners".

Each of these elements should be recognised and included in the financial statementsonly if it is probable that any future economic benefit associated with the item will flowto or from the company, and the item has a cost or value which can be measured withreliability.

Q27: One item not recognised in a company’s financial statements is its workforce. Whyshould a company not include this as an asset in the Statement of Financial Position(Balance Sheet)?

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If an element of financial statements does meet the recognition criteria, the next stepis to decide how to measure it. There are a number of bases which can be usedmeasure a particular asset or liability. Traditionally, accountants use historic cost asthe measurement base. However, the Statement points out that alternative approachescould be used where appropriate, including current cost or value, realisable value and



present value. The decision as to which base to use is up to the individual preparing thefinancial statements, but they must comply with legislation and accounting standards.For example, Inventory (Stock) will always be valued at the lower of cost and netrealisable value, but pension liabilities are carried at present value.

3.7.6 Examples of Accounting Standards and current practice

This section will examine five different examples of accounting standards and currentpractice.

3.7.6.1 FRS 1 (Revised) Cash Flow Statements

FRS 1 (Revised 1996) requires companies to prepare a cash flow statement in themanner set out in the FRS. (Some companies are exempt from this requirement, suchas small companies, life assurance companies and pension funds).

Cash flows are increases or decreases in amounts of cash, and cash is cash in handand deposits repayable on demand at any qualifying institution less overdrafts from anyqualifying institution repayable on demand.

A company’s cash flow statement should list its cash flows for the period classified underthe following standard headings:

• Operating activities

• Returns on investments and servicing of finance

• Taxation

• Equity (Capital) expenditure and financial investment

• Acquisitions and disposals

• Equity dividends paid

• Management of liquid resources

• Financing

Cash Flow Statement requirement

Write 150 - 200 words to explain why does the ASB require companies to produce acash flow statement in addition to the Income Statement (Profit and Loss account) andStatement of Financial Position (Balance Sheet)?

Show your answer to your teacher or tutor after comparing it with the answer given.

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3.7.6.2 FRS 3 Reporting Financial Performance

FRS 3 was issued in 1992, and has changed the way in which performance is reported.Its objective is to require companies to highlight a range of important components of



financial performance to aid users in understanding the performance achieved by thecompany in a period and to assist them in forming a basis for their assessment of futureresults and cash flows.

The standard requires a layered format for the Income Statement (Profit and Lossaccount) to highlight a number of important components of financial performance:

• results of continuing operations (including acquisitions);

• results of discontinued operations;

• profits and losses on the sale or termination of an operation, costs of afundamental reorganisation or restructuring and profits or losses on the disposalof non-current assets (fixed assets); and

• extraordinary items.

The effect of the standard has been effectively to outlaw extraordinary items.Extraordinary items are ‘material items possessing a high degree of abnormality whicharise from events or transactions that fall outside the ordinary activities of the reportingentity and which are not expected to occur’. Prior to FRS 3, many companies includedall manner of items as ‘extraordinary’ when, in reality, they were part of normal business.This allowed companies to report ‘extraordinary losses’, which were actually fairlynormal losses.

The standard also requires a statement of total recognised gains and losses to beshown. This is a primary financial statement that includes the profit or loss for theperiod together with all movements in reserves reflecting recognised gains and lossesattributable to shareholders.

A note of historical profits, which is a memorandum item, is also required. The purposeof this note is to present the profits or losses of companies that have revalued assets ona more comparable basis with those of companies that have not.

3.7.6.3 FRS 10 Intangible Asset (Goodwill) and Tangible Assets

The objective of FRS 10 is to ensure that:

• capitalised Intangible Asset (Goodwill) and intangible assets are charged in theIncome Statement (Profit and Loss account) in the periods in which they aredepleted; and

• sufficient information is disclosed in the financial statements to enable users todetermine the impact of Intangible Asset (Goodwill) and intangible assets on thefinancial position and performance of the reporting entity.

The standard takes the view that Intangible Asset (Goodwill) arising on an acquisition (iethe cost of acquisition less the aggregate of the fair value of the purchased company’sassets and liabilities) is neither an asset like other assets nor an immediate loss in value.Rather, it forms a bridge between the cost of an investment shown as an asset in the



acquirer’s own financial statements and the values attributed to the acquired assets andliabilities in the consolidated financial statements. Although purchased Intangible Asset(Goodwill) is not in itself an asset, its inclusion amongst the assets of the reportingcompany, rather than as a deduction from shareholders’ equity (capital), recognisesthat Intangible Asset (Goodwill) is part of a larger asset, the investment, for whichmanagement remains accountable.

An intangible item may meet the definition of an asset when access to the futureeconomic benefits that it represents is controlled by the reporting company, whetherthrough custody or legal protection. However, intangible assets fall into a spectrumranging from those that can readily be identified and measured separately fromIntangible Asset (Goodwill) to those that are essentially very similar to Intangible Asset(Goodwill). The basic principles set out in the standard for accounting for intangibleassets that are similar in nature to Intangible Asset (Goodwill) are therefore closelyaligned with those set out for Intangible Asset (Goodwill).

The standard requires purchased Intangible Asset (Goodwill) and certain intangibleassets to be capitalised and, in most circumstances, to be amortised systematicallythrough the Income Statement (Profit and Loss account) (usually over 20 years or less).Impairment reviews must be undertaken, particularly if the Intangible Asset (Goodwill)or intangible asset is regarded as having an infinite life and is therefore not beingamortised. Internally generated Intangible Asset (Goodwill) should not be capitalisedand internally developed intangible assets should be capitalised only where they have areadily ascertainable market value.

Intangible Asset (Goodwill)

Intangible Asset (Goodwill) as a term was originally used to reflect the fact that anongoing business had some ‘intrinsic value’ beyond its assets, such as the reputationthe firm enjoyed with its clients. FRS 10 does not allow internally generated good will tobe recognised as an asset and shown on the Statement of Financial Position (BalanceSheet). Why do you think this is banned?

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3.7.6.4 FRS 15 Tangible Non-Current Assets (Fixed Assets)

FRS 15 sets out the principles of accounting for tangible non-current assets (fixedassets), with the exception of investment properties, which are dealt with in SSAP19 ’Accounting for investment properties’. The objective of FRS 15 is to achieveconsistency in the initial measurement, valuation, depreciation and disclosure of tangiblenon-current assets (fixed assets).

Consistently with previous practice (as reflected, for example, in the Companies Act)the FRS permits a choice as to whether tangible non-current assets (fixed assets) arestated at cost or at revalued amount. However, where a company chooses to adopt apolicy of revaluing some assets, all assets of the same class (that is, those with a similarnature, function or use) must be revalued.

The FRS also contains requirements that ensure that the valuations are kept up todate. The FRS acknowledges that in a limited number of cases, no depreciation charge



may be made on the grounds that it is immaterial. Where this is the case, or wheredepreciation is calculated on a basis that assumes that the useful economic life of anasset is longer than fifty years, the standard requires annual impairment reviews to beperformed, to ensure that the carrying amount of the asset is not overstated.

3.7.6.5 FRS 18 Accounting Policies

FRS 18 deals primarily with the selection, application and disclosure of accountingpolicies. Its objective is to ensure that for all material items:

• an entity adopts the accounting policies most appropriate to its particularcircumstances for the purpose of giving a true and fair view;

• the accounting policies adopted are reviewed regularly to ensure that they remainappropriate, and are changed when a new policy becomes more appropriate tothe entity’s particular circumstances; and

• sufficient information is disclosed in the financial statements to enable users tounderstand the accounting policies adopted and how they have been implemented

FRS 18 states that entities should adopt accounting policies that enable the financialstatements to give a true and fair view. Accounting policies should be consistent withthe requirements of accounting standards and companies legislation. The objectivesagainst which accounting policy selection should be judged are outlined in the Statementof Principles as being desirable characteristics of useful financial information: relevance,reliability, comparability, understandability.

In selecting accounting policies, entities need to balance the costs of following aparticular policy against the benefits that are likely to flow to the user. However FRS 18makes it clear that cost/benefits considerations do not on their own justify the selectionof an accounting policy that is at odds with that laid down in accounting standards.

FRS 18 requires entities to review their accounting policies on a regular basis andchange them where appropriate. However, any decision to change a particularaccounting policy must be taken in the light of the key object of comparability. Frequentchanges to accounting policies are not desirable because they make comparison moredifficult. However, consistency is not an end in itself and it does not impede theintroduction of improved accounting practices that result in improved information forusers.

FRS 18 requires entities to make the following key disclosures:

1. The accounting policies selected.

2. The key estimation techniques used (for example depreciation methods).

3. Details of any changes to accounting policies.

4. Information relevant to the assessment of an organisation as a going concern, ifthe going concern basis is under question.

5. Details of any departure from the requirements of any accounting standard orcompanies legislation in the interest of showing a true and fair view.



3.7.6.6 Revision

Are the following statements true or false?

Q28: The ASB is a sub-committee of the IASB.

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Q29: Accounting standards apply only to limited companies.

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Q30: During the development of an accounting standard, a Discussion Paper is issued,followed by an exposure draft (FRED) and finally the FRS.

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Q31: The UITF can issue accounting standards more quickly than the ASB.

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Q32: The Statement of Principles is used as a basis for the development and review ofaccounting standards.

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Q33: Companies should always use historic cost as the measurement base for financialreporting.

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Q34: FRS 1 (Revised) requires that all companies include a Cash Flow Statement aspart of their financial statements.

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Q35: FRS 3 requires companies to include a statement of total recognised gains andlosses in the financial statements.

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Q36: FRS 10 defines Intangible Asset (Goodwill) as the cost of acquisition less theaggregate of the book value of the purchased company’s assets and liabilities.

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Q37: FRS 15 allows no depreciation charge to be made on non-current assets (fixedassets) where it is immaterial.

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Q38: FRS 18 allows companies to depart from the requirements of an accountingstandard if required to show a true and fair view.

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End of topic test

Go online10 min

Q39: Complete the Income Statement (Profit and Loss account) then a Statement ofFinancial Position (Balance Sheet) from the Trial Balance and notes given.

Notes: At 31 December the following had to be taken into account:



• Selling Expenses receivable 5000









Sales Revenue (Sales) 900Sales Revenue (Sales) returns 12Purchases 700Purchases returns 20Carriage in 15Warehouse wages 38Inventory (Stock) at 1 January 40Discount (net) 4Office expenses 44Selling expenses 60Carriage out 18Property (Premises) 190Vehicles 80Fittings 40Cash and Cash Equivalents (Bank) 9Trade Receivables (Debtors) 40Interim Dividend - Ordinary Shares 4Provision for Depreciation: vehicles 62Provision for Depreciation: fittings 28Provision for Doubtful Debts 3Trade Payables (Creditors) 37Ordinary Shares of £1 each 808% Preference Shares of £1 each 5010% Debentures 40Share Premium 71Unappropriated Profit 3

1294 1294








Warehouse wages


Less ExpensesOffice expensesSelling expensesCarriage outwardDebenture finance cost (debenture interest)Depreciation: vehicles 20% costDepreciation: fittings 25% NBVDiscount allowed

Add IncomeDecrease in Provision for bad debtProfit for Year (Net Profit)

Less Corporation TaxProfit for Year (after Tax)

Add Unappropriated last year

Less Interim Ordinary DividendUnappropriated Profit c/f



Now prepare the Statement of Financial Position (Balance Sheet).


Current AssetsInventory (Stock)Cash and Cash Equivalents (Bank)Trade Receivables (Debtors)Less: Provision for Doubtful DebtsOther Receivables (Prepaid Expenses)Current Liabilities

Debenture Finance Cost payable (DebentureInterest) dueCorporation TaxOther Payables (Accrued Expenses)Trade Payables (Creditors)Working Equity (Capital)

less Non-Current Liabilitiesless DebenturesTotal Net AssetsRepresented by:Issued Equity (Capital)50,000 8% Preference Shares, £1, fully paid80,000 Ordinary shares, £1, fully paid

Reserve:Unappropriated Profit c/fShare PremiumShareholders Interest

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Q40: Which of the following is a Current Asset?

a) Other Payables (Accrued expenses).b) Tax due.c) Other Receivables (Prepaid expenses).d) Trade Payables (Dividend due).

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Q41: Which item below should appear in the first half of the Income Statement (Profitand Loss account) before Profit for the year?

a) Debenture Finance Cost (Debenture Interest).b) Ordinary Dividend.c) VAT.d) Preference Dividend.

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a) Debenture holders are owners.b) Debenture holders are lenders.c) Preference Shareholders are lenders as they receive a fixed rate dividend.d) Ordinary Shareholders receive all the profits.

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a) Provision for bad debts is charged to the Income Statement (Profit and Lossaccount).

b) Only the change in provision for bad debts is charged to the Income Statements(Profit and Loss accounts).

c) Provision for bad debts only appears in the Income Statement (Profit and Lossaccount).

d) The Trade Receivables (Debtors) figure in the Statement of Financial Position(Balance Sheet) is adjusted for the change in the provision.

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Q44: A company has the following Equity (Capital) structure: Ordinary Shares £100000;Preference Shares £50000; Debentures £20000; Reserves £20000; UnappropriatedProfit £5000.Which of the following is correct figure for Shareholders Interest?

a) £150000b) £175000c) £170000d) It is impossible to work out the Shareholders Interest.

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Q45: Give the meaning of the following abbreviations.

1. SSAP

2. FRS

3. ASB

4. ASC

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Q46: State whether the following statements are true or false.

1. The ASC replaced the ASB in 1990.

2. The Statement of Principles was published in 1999.

3. Financial Reporting Standards are legally binding.

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81

Topic 4

Manufacturing concerns

Contents

4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

4.2 Types of Cost in a Manufacturing Account . . . . . . . . . . . . . . . . . . . . 82

4.3 Preparation of the Manufacturing Account . . . . . . . . . . . . . . . . . . . . 84

4.4 Transferring Manufacturing Cost to the Income Statement (Trading Account) . 89

4.5 The Income Statement (Profit and Loss Account) . . . . . . . . . . . . . . . . 91

4.6 Apportionment of Overheads . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

4.7 Profit or Loss on Manufacture . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

4.8 Manufacturing Cost per unit . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

4.9 Summative Tasks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

4.10 Revision of the Financial Statements (Final Accounts) of Public LimitedCompanies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

4.11 The Financial Statements (Final Accounts) of a Manufacturing Public LimitedCompany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

4.12 End of topic test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Learning objectives

By the end of this topic you will be able to:

• know the purpose of preparing a Manufacturing Account;

• know the layout of a Manufacturing Account;

• be able to differentiate between the types of Cost used in preparing the Account;

• be able to transfer the Manufacturing Account to an Income Statement (Tradingand Profit and Loss Account);

• calculate whether the business has made a Manufacturing Profit or Loss;

• be able to place this Profit or Loss correctly in the Income Statement (Trading andProfit and Loss Account);

• be able to calculate Manufacturing Account per unit;

• be able to complete a full set of Financial Statements (Final Accounts) for aManufacturing Public Limited Company.

82 TOPIC 4. MANUFACTURING CONCERNS

4.1 Introduction

Manufacturing firms are actually businesses which make their own products rather thanbuy products for re-sale. Any business producing their own goods should prepare amanufacturing account:

• to ascertain the cost of production for goods manufactured,

• to calculate the profit or loss on the manufacturing process.

4.2 Types of Cost in a Manufacturing Account

A manufacturing organisation will deal with two types of cost: Direct Costs andIndirect Costs.

Direct Costs

These are costs which can be traced directly to the item being produced: e.g. the clothin a shirt or the wages of a sewing machinist.

1. Direct Materials

These are the natural or man-made resources which are actually used in themanufacturing of any product such as wool for a coat, cloth in a shirt or gold for awatch.

2. Direct Labour (Wages)

These are the wages of the workers actually engaged in the manufacturingprocess - for example: wages of a machinist, baker.

3. Direct Expenses

These are any other costs which vary directly with the output being produced andcan be attributable to the goods being manufactured. Examples are Royalties onlicensed production or hire of specific machinery for the manufacturing process,and direct power used in the production process. Direct Costs are referred to asVariable Costs - costs which vary directly with the level of output: for example if ittakes 3 metres of cloth to make one table cover then it will take 30 metres to maketen.

Key point

Key Point

The total of all Direct Costs equals Prime Cost


TOPIC 4. MANUFACTURING CONCERNS 83

Indirect Costs

Indirect Costs or Overheads are costs which cannot be directly identified with anyparticular product. They are not linked to the manufacturing process but are necessaryto enable the production process to be carried out. These expenses are referred to asoverheads. For example - electricity, rent, insurance, supervisors’ wages. These costsare sometimes referred to as Fixed Costs as they remain more or less the sameirrespective of changes in the volume of production and will have to be paid even ifproduction is not taking place.

Key point

Key Point

Indirect Costs are sometimes called Overheads or Fixed Costs.

Suit production

Go online5 min

Q1: Categorise the following as either a Direct Cost or an Indirect Cost.

A) supervisor’s salary

B) cloth

C) rent

D) machinists’ wages

E) insurance

F) royalties

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Quiz: Types of cost in a manufacturing Account

Go online

Q2: Prime Cost is the total of all Direct Costs of production.

a) trueb) false

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Q3: Another name for Direct Costs is Fixed Costs.

a) trueb) false

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Q4: Variable Costs do not vary with output.

a) trueb) false

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Q5: Overheads are sometimes referred to as Indirect Costs.

a) trueb) false

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Q6: Depreciation is an example of a Direct Cost.

a) trueb) false

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4.3 Preparation of the Manufacturing Account

There are three sections in the Manufacturing Account:

1. Prime Cost

2. Factory Overheads

3. Work in Progress

These three sections must be completed before the Cost of Manufacture can becalculated.

Prime CostIn this section of the account all Direct Costs will be totalled and the final figure willdetermine the Prime Cost. All Direct Materials, Direct Labour and any other DirectExpenses will be added. Raw Materials can be one of the most important componentsof overall Prime Cost, particularly for high-value materials. Changes in the costs ofRaw Materials can have a significant impact on the overall profitability of a product. Aclose check will also have to be kept on Labour Costs which will have to be controlled.It is also essential to account for all the Direct Costs incurred in the manufacturingprocess. Once the individual components of Raw Materials, Direct Labour and DirectExpenses have been calculated these figures should be entered in the Prime Costelement of the Manufacturing Account - the layout is as follows:



Name of BusinessManufacturing Account for year ended 31 December Year 1

£ £ £Raw MaterialsOpening Inventory (Stock) 10,000Purchases 24,000add Carriage Inwards 1,000

25,000less Purchases Returns 2,000 23,000

33,000Less Closing Inventory (Stock) 1,500Cost of Raw Materials consumed 31,500

Add Direct Labour 25,000Add Direct Expenses (e.g.Royalties, Direct Power etc)

5,000 30,000

Prime Cost 61,500

ABC Ltd Prime Costs

Go online5 min

Q7: Using the information given, complete the table of Prime Costs.

Costs £Purchases 30,000Purchases Returns 1,000Closing Inventory (Stock) 4,000Direct Labour 15,000Carriage Inwards 400Opening Inventory (Stock) 9,000Direct Expenses 4,000

Prime Costs of ABC Ltd

£ £ £Raw MaterialsOpening Inventory (Stock)Purchasesadd Carriage Inwards

less Purchases Returns

less Closing Inventory (Stock)Cost of Raw Materials consumedadd Direct Labouradd Direct Expenses (Royalties, DirectPower)Prime Cost

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Factory Overheads

These, as already stated, are costs which cannot be directly identified in the productionprocess - they are ancillary to manufacturing. These costs are incurred by the Factoryeg Rent, Insurance, Depreciation of Factory Machinery etc. These overheads areentered, totalled and added onto Prime Cost. It should also be noted that as with allother financial accounting cost/profit statements that Other Payables (AccruedExpenses) and Other Receivables (Prepaid Expenses) should be taken intoaccount. Any expenses accruing or owing at the end of the financial period should beadded on to the relevant expense figure and any expenses prepaid for the nextfinancial period should be deducted from the relevant expense figure.

These overheads should be added to Prime Cost as shown:

£ £Prime Cost 61,500Add Factory Overheads

Rent and Rates 3,000Insurance (2,000 + 500)* 2,500Factory Maintenance 1,000Indirect Wages 2,500Depreciation of Factory Machinery 1,500 10,500

72,000

*Factory insurance owing £500 - if this had been prepaid it would have been deductedfrom £2,000.

Note: a common error in examinations is to deduct Factory Overheads fromPrime Cost. This can result in a deductin from your final mark.

Key point

Key Points

Add Factory Overheads to Prime Cost.Accrued Expensed are added onto the original Expense figure, whereas OtherReceivables (Prepaid Expenses) are deducted.



ABC Ltd Factory Overheads

Go online5 min

Q8: Using the information given, add the Factory Overheads to the Prime Cost of£53400 which you previously calculated.

Costs £Rent and Rates 3,000Light and Heat 1,700Depreciation of Machinery 3,000Factory Insurance 2,500Indirect Wages 10,000Maintenance 2,000

Factory Overheads of ABC Ltd

£ £ £Prime Cost 53,400(Add Factory Overheads)

Rent and RatesFactory InsuranceLight and HeatIndirect WagesDepreciation of MachineryMaintenance

Factory or Manufacturing Cost ofProduction

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Work in Progress

The Work in Progress section is the third section of the Manufacturing Account. Theend of a firm’s financial year is just another working day - there is no obligation to haveall of the work completed or all of the goods sold to simplify the accounting procedure.At the end of the year or at the beginning of the year Raw Materials will have beenstarted in the production line and some work carried out on these - but the goods willstill be in an incomplete state. All of this Inventory (Stock) must be valued at thebeginning or end of the financial period - this is known as Work in Progress. We are notinterested in giving this Inventory (Stock) a valuation which is related to its state ofcompletion, but its value will include a portion of the Materials, Labour and Overheadsused. Closing Work in Progress from one year becomes Opening Work in Progress forthe following year. Work in Progress figures are shown as an adjustment at the end ofthe Manufacturing Account.

72,000Work in Progress (1 January) 5,000less Work in Progress (31 December) 3,000 2,000Factory/Manufacturing Cost of Production 74,000



Key point

Key PointPrime Cost + Factory Overheads + Work in Progress= Manufacturing Cost of Production

ABC Ltd Work in Progress

Go online5 min

Q9: Using the figures given for Work in Progress, complete the Manufacturing Accountof ABC Ltd for the year ending 31 December. The total Prime Cost value from theprevious exercise is used (75600)

Costs £Work in Progress 1 January 4,000Work in Progress 31 December 2,000

Total Prime Cost 75,600Work in Progress (1 January)less Work in Progress (31 December)Factory/Manufacturing Cost of Production

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Sinclair Ltd

Go online10 min

Q10: Using the information given, complete the Manufacturing Account for Sinclair Ltd.

List of Balances £000Opening Inventory (Stock): Raw Materials 4,000Closing Inventory (Stock): Raw Materials 2,000Purchases: Raw Materials 30,000Carriage Inwards 400Direct Labour 12,500Royalties 3,000Factory Rent 1,800Supervisor’s Wages 12,000Indirect Wages 8,000Factory Insurance 2,000Factory Expenses 6,000Depreciation: Factory Machinery 2,500Opening Inventory (Stock): Work inProgress

1,500

Closing Inventory (Stock): Work inProgress 500

Note:£500 is owing for Factory InsuranceFactory Expenses prepaid £200




less Closing Inventory (Stock)Cost of Materials consumedadd Direct LabourRoyaltiesPrime Cost(add Factory Overheads)

Factory RentFactory InsuranceFactory WagesIndirect WagesDepreciation of Factory MachinerySupervisor’s Wages

add Work in Progress (1 January)less Work in Progress (31 December)Factory/Manufacturing Cost of Production

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4.4 Transferring Manufacturing Cost to the IncomeStatement (Trading Account)

Once the Manufacturing Account is completed the Cost of Manufacture (the final figurein the Manufacturing Account) is transferred to the Income Statement (TradingAccount). The Finished Goods produced in the manufacturing process will betransferred to Inventory (Stock) or to the Warehouse. This account will follow thenormal layout for a Income Statement (Trading Account) (as used in sole trader,partnership or limited company) but will also include any expenses incurred in thestorage of finished goods prior to sale - these are known as Warehouse Expenses.Other costs may be allocated to the Income Statement (Trading Account) as part ofWarehouse Expenses for example - Insurance, Indirect Wages etc.



An example is given below:

Name of BusinessIncome Statement (Trading and Profit and Loss Account) for year ended 31December Year 1

£ £ £Sales Revenue (Sales): Finished Goods 190,000Less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 12,000add Purchases: Finished Goods 5,000add Manufacturing Cost of Production 74,000

91,000less: Closing Inventory (Stock): FinishedGoods

11,000

80,000add Warehouse Wages 12,000 92,000

Gross Profit 98,000

Key point

Key PointThe final figure in the Manufacturing Account (Manufacturing Cost of Production)is transferred to the Income Statement (Trading Account).

ABC Ltd Income Statement (Trading Account)

Go online5 min

Q11: Complete the Income Statement (Trading Account) of ABC Ltd for the year ending31 December. The activity uses the Manufacturing Cost of Production found in the ABCLtd Work in Progress activity (77600)

Costs £Sales Revenue (Sales): FinishedGoods

175,000

Purchases: Finished Goods 8,000Warehouse Wages 6,000Opening Inventory (Stock): FinishedGoods

10,000

Closing Inventory (Stock): FinishedGoods

6,000



£ £ £Sales Revenue (Sales): FinishedGoodsless Cost of Sales Revenue (Sales)Opening Inventory (Stock): FinishedGoodsadd Purchases: Finished Goodsadd Manufacturing Cost ofProduction

77,600

less Closing Inventory (Stock):Finished Goods

add Warehouse WagesGross Profit

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4.5 The Income Statement (Profit and Loss Account)

The Income Statement (Profit and Loss) section is a similar layout to that of the soletrader, partnership or limited company - but this account should contain no expensesincurred by the Factory or the production or manufacturing process - only the Office.Once these expenses are deducted from Gross Profit a figure called Profit for the Year(Net Profit) will be calculated.

Key point

Key PointOnly Office Expenses or Administration or Distribution Expenses should beentered in the Income Statement (Profit and Loss) section.

ABC Ltd Income Statement (Profit and Loss)

Go online5 min

Q12: Complete the Profit Statement for the year ending 31 December. The activity usesthe previously calculated Gross Profit figure of 79,400.

Costs £Selling Expenses 2,300Bad Debts 1,000Rent 2,500Office Salaries 31,000General Expenses 3,000Depreciation: Office Equipment 3,000



£ £ £Gross Profit 79,400(Less Expenses)

Selling ExpensesOffice SalariesBad DebtsGeneral ExpensesRentDepreciation: Office Equipment

Profit for the Year (Net Profit)

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Manufacturing or Income Statement? (Trading or Profit and Loss)

Go online5 min

Q13: For each item, choose the Account to which it belongs: Manufacturing or IncomeStatement (Trading or Profit and Loss). Note Profit on Manufacture has two places.

1. Depreciation: Factory Machinery

2. Direct Labour

3. Factory Repairs

4. Purchase of Raw Materials

5. Royalties

6. Sales Revenue (Sales)

7. Purchase of Finished Goods

8. Warehouse Wages

9. Depreciation Office Equipment

10. Profit on Manufacture

11. Selling Expenses

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Accounts for Ford Ltd.

Go online15 min

Q14: From the following list of balances prepare the Manufacturing and IncomeStatement (Trading and Profit and Loss Accounts) of Ford Ltd for the year ending 31December Year 1.List of balances £000Opening Inventory (Stock): Raw Materials 134Closing Inventory (Stock): Raw Materials 94Purchases: Raw Materials 1,240Purchases Returns: Raw Materials 40Light and Heat (Factory) 12Indirect Wages 34Opening Inventory (Stock): Work in Progress 7Sales Revenue (Sales) 3,940Opening Inventory (Stock): Finished Goods 70Warehouse Wages 12Office Rent 16Selling Expenses 14Depreciation: Office Equipment 5Direct Production Wages 240Direct Power 120Factory Maintenance 14Depreciation: Factory Machinery 12Factory Rates 15Factory Insurance 10Closing Inventory (Stock): Work in Progress 6Purchases: Finished Goods 50Office Salaries 40General Office Expenses 15Administration Expenses 16

Note: Direct Production Wages owing: £30,000Office Salaries prepaid: £1,000



Manufacturing Account for Ford Ltd as at 31 December Year 1

£ £ £Raw MaterialsOpening Inventory (Stock)PurchasesAdd Carriage Inwards

Less Purchases Returns

Less Closing Inventory (Stock)Cost of Raw Materials consumedAdd Direct LabourDirect PowerPrime CostAdd Factory Overheads

Light and HeatFactory RatesFactory MaintenanceIndirect WagesDepreciation of Factory MachineryFactory Insurance

Add Work in Progress (1 January)Less Work in Progress (31 December)Factory/Manufacturing Cost ofProduction



Income Statement (Trading and Profit and Loss Account) for Ford Ltd as at 31December Year 1

£ £ £Sales Revenue (Sales): Finished GoodsLess Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished GoodsAdd Purchases: Finished GoodsAdd Manufacturing Cost of Production

Less Closing Inventory (Stock): Finished Goods

Add Warehouse WagesGross ProfitLess ExpensesSelling ExpensesOffice SalariesAdministration ExpensesGeneral Office ExpensesOffice RentDepreciation: Office EquipmentProfit for the Year (Net Profit)

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4.6 Apportionment of Overheads

Overheads should be split between the 3 main accounts as follows:

• Any Factory Cost - Manufacturing Account

• Any Warehouse Expense - first half of Income Statement (Trading Account)

• Any Office or Administrative/Selling Expense - Income Statement (Profit and LossAccount)

Some times only one figure will be given for an expense and you may be asked to splitthis between the Factory, Warehouse and the Office.

For example:

The rates bill for the year is £10,000. This is to be apportioned between the Factory,Warehouse and the Office in the ratio 5:4:1 (add up the ratio elements and they add upto 10 i.e. 5 + 4 + 1).

Therefore the Factory will be charged with 5/10 (1/2) of the rates bill; the Warehouse willbe charged with 4/10 (2/5) of the rates bill; and the Office will be charged with 1/10 of therates bill.



Therefore:

• Factory Rates (in Overheads) - £5,000

• Warehouse Rates (Income Statement (Trading Account)) - £4,000

• Office Rates second half of Income Statement (Profit and Loss Account) - £1,000

NOTE: Watch for any accrued or prepaid expense also at the end of the year as thiswill also have to be taken into account before splitting any expenses for the yearbetween the Factory, Office and the Warehouse.

In most SQA Past Paper Higher Accounting questions on this topic you are usuallygiven overheads to apportion.



Key point

Key Point

Expenses may have to be apportioned between different sections of theaccounts - this is usually done on a ratio basis.

Apportioning Expenses

Go online10 min

Q15: Complete the table for apportioning expenses.

Expense Factory Warehouse OfficeRent £2000 50% 40% 10%Amount to be apportioned (£)Insurance £12000 1/4 1/3 5/12Amount to be apportioned (£)Heat and Light £16000 50% 20% 30%Amount to be apportioned (£)Indirect Wages £40000 1/4 1/8 5/8Amount to be apportioned (£)

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Q16: ABC Ltd has incurred an Indirect Wage Expense of £150,000.

It has been decided to split this expense based on the number of employees employedin specific areas of the organisation which are:

Factory - 30 workersWarehouse - 10 workersOffice - 20 workers

Calculate the amount of Indirect Wages to be apportioned to each area.

Indirect wages £150,000Amount to be charged:FactoryWarehouseOffice

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4.7 Profit or Loss on Manufacture

Sometimes an organisation will want to find out if it is better to buy in products ratherthan produce them themselves. They may wish to compare the Cost of Manufacturewith the Market Value of Goods Manufactured . From this they can decide whether itis more or less profitable to manufacture or maybe better to purchase instead.



To calculate the Profit on Manufacture (or Loss on Manufacture)we take the marketor wholesale value of the output and deduct the Manufacturing / Factory Cost ofOutput from it.

For example, in the first example - Manufacturing Cost of output is £74,000. TheWholesale or Market Value of output is £100,000.

Therefore £100,000 - £74,000 = £26,000 and this is our Profit on Manufacture.

In the accounts this is dealt with as follows:

1. The Profit on Manufacture is shown between the Manufacturing Cost of Productionand the Market Value of Production.

2. The Cost of Manufacture is transferred to the Income Statement (Trading Account)at Market Value.

3. The Profit on Manufacture is added onto the Gross Profit in the Income Statement(Trading Account).

The Manufacturing Account would end like this:

72,000Work in Progress (1 January) 5,000Less Work in Progress (31 December) 3,000 2,000Factory/Manufacturing Cost of Production 74,000Profit on Manufacture 26,000

Market Value of Production 100,000

The Income Statement (Trading Account) would now look like this:

Name of BusinessIncome Statement (Trading and Profit and Loss Account) for year ended 31December Year 1

£ £Sales Revenue (Sales) 190,000less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 12,000add Purchases: Finished Goods 5,000add Manufacturing Cost of Production (Market Value) 100,000

117,000less: Closing Inventory (Stock): Finished Goods 11,000

106,000add Warehouse Wages 12,000 118,000Gross Profit 72,000plus Profit on Manufacture 26,000

98,000



NOTE: When a Loss on Manufacture has been made the loss is deducted from theGross Profit figure in the Income Statement (Trading Account).

Q17: From the following information calculate whether the businesses have made aProfit or Loss on Manufacture.

BusinessManufacturing

Cost of ProductionMarket Value of

ProductionProfit/Loss onManufacture

Smith plc £120,000 £150,000 £Jones Ltd £135,000 £130,000 £Green Ltd £175,000 £146,000 £Brown plc £150,000 £165,000 £

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4.8 Manufacturing Cost per unit

From the information entered in the manufacturing account it is possible to calculatemanufacturing cost per unit. This will enable firms to compare performance with rivalfirms or from previous years. Obviously, corrective action may be taken if this cost hasrisen or is too high.

To calculate the manufacturing cost per unit the formula is:

Manufacturing cost of productionNumber of units of output produced

Example

Problem:

A business produces 60000 lamps in one year at a total cost of £360,000.

The manufacturing cost of each lamp would be £360,000/6,000 = £6 per lamp.

Solution:

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Key point

Key Point

Manufacturing cost per unit =Manufacturing cost of production

Units produced

Q18: Complete the following table to calculate manufacturing cost per unit for eachbusiness.

ABC Ltd DEF plc PQR Ltd XYZ plcManufacturing Cost of Production £150,000 £90,000 £180,000 £36,000Units produced 25,000 30,000 40,000 9,000Manufacturing Cost per Unit

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Quiz: Manufacturing Cost per unit

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Q19: Which of the following is a Factory Overhead?

a) Production Wagesb) Selling Expensesc) Indirect Wagesd) Royalties

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Q20: Rent of £60,000 is to be split between the Factory, Warehouse and Office in theratio 3:2:1 - how much will be apportioned to the Factory?

a) £30,000b) £20,000c) £40,000d) £10,000

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Q21: Which one of the following statements is TRUE?

a) Prime Cost is another term for Direct Labour.b) Warehouse Expenses always appear in the Cost of Sales in the Income Statement

(Trading Account).c) Indirect Costs are sometimes referred to as Variable Costs.d) Profit on Manufacture is added onto Profit for the Year (Net Profit).

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Q22: Which one of the following statements is TRUE?

a) Fixed Costs vary with output.b) Fixed Costs are Direct Costs.c) Fixed Costs do not vary with output.d) Fixed Costs are sometimes referred to as Prime Cost.

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Q23: Which expense below should ONLY appear in the Income Statement (Profit andLoss Account)?

a) Selling Expensesb) Royaltiesc) Depreciation of Factory Machineryd) Warehouse Expenses

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Q24: The Manufacturing Cost of output totals £600,000. The Market value of productionis £640,000 - which of the following is correct?

a) No Profit or Loss has been made on Manufacture.b) A Profit on Manufacture of £40,000 has been made.c) A Loss on Manufacture of £40,000 has been made.d) It is impossible to work out any Profit on Manufacture.

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Summary so far

The main points which should be remembered are:

A The Manufacturing Account

• The first section of the Manufacturing Account dealt with all the Direct Costsincurred by the organisation - namely Direct Materials, Direct Wages and any otherDirect Expenses.

• The actual Cost of Raw Materials used in production was referred to as Cost ofRaw Materials consumed.

• To this figure was added any other Direct Costs incurred - namely Direct orManufacturing Wages or any other Direct Expenses - for example Royalties.

• The total figure for Direct Costs was referred to as Prime Cost.

• To this Prime Cost figure was added any Indirect Costs or Overheads - forexample Factory Rent and Rates, Depreciation of machinery, Factory insurance,Factory salaries etc. - these overheads must be directly attributable to the Factory(figures should also be adjusted for accruals or Other receivables (Prepayments)).

• Any Work in Progress was then accounted for and the net figure for this alsoadded.



• The final figure in the Manufacturing Account was Factory or Manufacturing Costof Production or (Cost of Goods Manufactured or any other similar term).

• If the goods were being transferred to the Warehouse at current market valuea Profit or Loss on Manufacture had to be calculated before concluding thisaccount.

B The Income Statement (Trading and Profit and Loss Account)

• The layout of the Income Statement (Trading Account) was similar to that for anybusiness organisation but the following should be noted:

• Cost of Goods Manufactured (at market value) should be transferred to theIncome Statement (Trading Account) and replace or be added to the purchases ofFinished Goods.

• Any Expenses of the Warehouse should be added to the Cost of Sales in thisaccount - for example Warehouse Wages.

• Once the Gross Profit is calculated any Profit on Manufacture should be addedto it or Loss on Manufacture deducted from it.

• The Income Statement (Profit and Loss) section of this account has a similarlayout to that of any business organisation - but the account should contain noExpenses incurred by the Factory or the Manufacturing process - only the office.

• Any Expenses will be deducted from the Gross Profit figure to arrive at the Profitfor the Year (Net Profit) for the business.

• It is common practice to be asked to split certain Expenses between theFactory, Warehouse and Office based on a ratio (e.g. 3:2:1) or even onthe number of employees in each area.

• To calculate the Manufacturing Cost per unit you should divide theactual Manufacturing Cost of Production by the number of unitsproduced.



4.9 Summative Tasks

Task 1: J Brown Plc

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Q25: From the following balances extracted from the accounts of J Brown plc at 31December Year 2, and the notes which follow prepare:

a) the Manufacturing account of the business at 31 December Year 2

b) the Income Statement (Trading and Profit and Loss Account) of the business at 31December Year 2

List of balances at 31 Dec Year 2 £000Opening Inventory (Stocks) (1 Jan)Raw Materials 30Work in Progress 8Finished Goods 15Purchases: Raw Materials 450Carriage Inwards: Raw Materials 4Purchases returns: Raw Materials 3Production (Direct) Wages 45Royalties 3Indirect Wages 15Rent 20Insurance 10Repairs to Factory Machinery 5General Factory Expenses 8Factory Machinery (at Cost) 100Sales Revenue (Sales) 800Purchases: Finished Goods 20Selling Expenses 10General Administration Expenses 12Warehouse Expenses 3

Notes:

The following should also be taken into account:

Inventory (Stock)s at 31 December Year 2

Raw Materials 40Work in Progress 6Finished Goods 8Direct Wages owing 6

Rent is to be split between Factory and the office in the ratio 3:1 and insurance is to besplit in the ratio 3:2

Factory machinery is to be depreciated by 10% on Cost

Selling Expenses prepaid 1General Factory Expenses owing 2Wholesale on Market Value of completed Production 600



Manufacturing Account for J Brown as at 31 December Year 2


less Purchases returns

less Closing Inventory (Stock)Cost of Raw Materials consumedadd Direct LabourRoyaltiesPrime Costadd Factory Overheads

RentInsuranceGeneral ExpensesRepairs to Factory MachineryDepreciation of Factory MachineryIndirect Wages

add Work in Progress (1 January)less Work in Progress (31 December)Factory/Manufacturing Cost ofProductionProfit on ManufactureMarket value of Production



Income Statement (Profit and Loss Account) for J Brown

£ £Sales Revenue (Sales)Less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goodsadd Purchases: Finished Goodsadd Manufacturing Cost of Production

less Closing Inventory (Stock): Finished Goods

add Warehouse WagesGross Profitplus Profit on Manufacture

less ExpensesRentInsuranceSelling ExpensesGeneral Administration ExpensesProfit for the Year (Net Profit)

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Q26: On completion of the accounts, calculate the Manufacturing Cost per unit if thebusiness produces 50,000 units in the year.

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Task 2: K Smith Accounts

Go onlineQ27: Use the following balances extracted from the accounts of K Smith at 31December, and the notes to prepare the Manufacturing and Income Statement (Tradingand Profit and Loss) accounts.

£000Opening Inventory (Stock)s at 1 JanuaryRaw Materials 45Work in Progress 10Finished Goods 20Purchases of Raw Materials 560Carriage Inwards: Raw Materials 2Purchases returns: Raw Materials 3Production (Direct) Wages 124Royalties 7Indirect Wages 34Rent 40Insurance 9Repairs to Factory Machinery 4General Factory Expenses 12Factory Machinery (at Cost) 160Sales Revenue (Sales) 950Purchases: Finished Goods 10Selling and Distribution Expenses 16General Administration Expenses 18Warehouse Wages 6Office Equipment (at Cost) 60

Notes:

Rent is to be split between Factory and office in the ratio 4:1.Insurance is to be split in the ratio 2:1.

Factory Machinery is to be depreciated by 10% on Cost.Office equipment is to be depreciated by 20% on Cost.

£000Inventory (Stock)s at 31 December

Raw Materials 30Work in Progress 5Finished Goods 5

Direct Wages owing 10Selling and Distribution Expenses prepaid 3Warehouse Wages owing 2Wholesale or Market Value of completed Production 850

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Q28: Calculate the Manufacturing Cost per unit if the business produces 60,000 unitsin the year.

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Task 3: Revision of Manufacturing Accounts

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Are the following statements True or False?

Q29: Prime Cost is the total of all Direct Costs.

a) Trueb) False

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Q30: Factory Overheads are deducted from Prime Cost.

a) Trueb) False

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Q31: Warehouse Expenses are a Factory Overhead.

a) Trueb) False

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Q32: Royalties are a Direct Expense.

a) Trueb) False

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Q33: A Loss on Manufacture is added to Gross Profit.

a) Trueb) False

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Q34: Cost of Goods Manufactured is transferred to the Income Statement (TradingAccount) at Market Value.

a) Trueb) False

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Q35: Expenses of the office appear in the Income Statement (Profit and Loss Account).

a) Trueb) False

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Q36: Work in Progress appears in the Manufacturing Account.

a) Trueb) False

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Task 4: L Brown Plc Accounts

Go onlineQ37: Using the notes and Trial Balance provided for L Brown Plc at 31 December Year3 prepare the:

• Manufacturing Account of the business at 31 December Year 3

• Income Statement (Trading and Profit and Loss Account) of the business at 31December Year 3.

Notes:

The following notes should also be taken into account:

Inventory (Stock) at 31 December Year 3Raw Materials 40Work in Progress 8Finished Goods 10Direct Wages owing 10Selling and Distribution Expenses prepaid 3Warehouse Wages owing 4Wholesale or Market Value of completedProduction

800

Rent is to be split between the Factory and the office in the ratio 4:1 and insurance is tobe split in the ratio 2:1Factory machinery is to be depreciated by 10% on Cost and office Equipment by 20%on Cost.



Account balances at 31 December Year 3

£000Raw Materials 50Work in progress 12Finished Goods 20Purchases of Raw Materials 500Carriage Inwards: Raw Materials 5Purchases Returns: Raw Materials 4Production (Direct) Wages 118Royalties 5Indirect Wages 38Rent 60Insurance 9Repairs to Factory Machinery 8General Factory Expenses 20Factory Machinery (at Cost) 150Sales Revenue (Sales) 920Purchases: Finished Goods 10Selling and Distribution Expenses 20General Administration Expenses 16Warehouse Wages 6Office Equipment (at Cost) 80



Manufacturing Account

£000 £000 £000Raw MaterialsOpening Inventory (Stock)PurchasesAdd Carriage Inwards

Less Purchase Returns

Less Closing Inventory (Stock)Cost of Raw Materials consumedDirect WagesRoyaltiesPrime CostAdd Factory OverheadsRentInsuranceGeneral ExpensesRepairs to Factory MachineryDepreciation of Factory MachineryIndirect Wages

Add Work in Progress (1 Jan)Less Work in Progress (31 Dec)Factory/Manufacturing Cost of ProductionProfit on ManufactureMarket Value of Production



Income Statement (Profit and Loss Account)

£000 £000 £000Sales Revenue (Sales): Finished GoodsLess Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished GoodsAdd Purchases: Finished GoodsAdd Market Value of Production

Less: Closing Inventory (Stock): FinishedGoods

Add Warehouse WagesGross ProfitPlus Manufacturing Profit

Less ExpensesRentInsuranceSelling and Distribution ExpensesGeneral Administration ExpensesDepreciation: Office EquipmentProfit for the Year (Net Profit)

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4.10 Revision of the Financial Statements (Final Accounts)of Public Limited Companies

The main points which should be remembered from Unit 3 are:

A The Income Statement (Trading and Profit and Loss and Appropriation Account)

• The layout for the Income Statement (Trading Account) is exactly the same as thatfor a sole trader and a partnership.

• After arriving at a Gross Profit figure any income received is added on - this mayinclude discount received or rent received etc; as well as any income generatedfrom investments which the public limited company has made eg dividendsreceived. A reduction in the provision for bad debts may also be included here.

• All expenses are then deducted in this account. Expenses which will be uniqueto the public limited company will include Debenture Finance cost (DebentureInterest) - the fixed return on debentures which must be paid regardless if thecompany makes a profit or not.

• The total of all of the expenses will then be deducted and the figure arrived at willbe called Profit for the Year (Net Profit) (before tax).

• Any appropriations from profit decided by the board of directors will then be



deducted from this figure - this will include any interim dividends already paid.Also include here any Intangible Assets (Goodwill) written down.

• The total of the appropriations will be deducted from the Profit for the Year (NetProfit) (after tax) figure and will give unappropriated profit (retained profit) forthe year. To this figure will be added any retained profits from previous years togive unappropriated profit (carried forward) - this will be the last figure in theaccount and will be transferred to the Reserves in the Statement of FinancialPosition (Statement of Financial Position (Balance Sheet)).

•

B The Statement of Financial Position (Balance Sheet)

• Non-current Assets (Fixed Assets) will be presented in the usual way - showingcost, aggregate depreciation and net book value of each fixed asset. Where therehas been a positive revaluation, the amount of the revaluation should be shown inbrackets (this represents appreciation).

• Intangible Assets will include investments, patents and trademarks andIntangible Assets (Goodwill). If there is a current market value for investmentsthis should be shown as a note.

• Current Assets will then be listed. Any dividends due from investments is acurrent asset as it is owed to the public limited company.

• Under Current Liabilities should be listed corporation tax and VAT due; anyDebenture Finance cost (Debenture Interest) outstanding as well as TradePayables (Creditors), Other Payables (accruals) etc.

• The final figure in the first half of the Statement of Financial Position (BalanceSheet) is Total Net Assets.

• Working Equity should then be calculated and added to the total of Non-FixedAssets. Debentures should then be deducted from this figure to give Total NetAssets.

• In the financed section of the Statement of Financial Position (Balance Sheet),Share Equity (Capital) should be listed firstly - the number and value of the sharesshould be shown. Reserves should follow - any share premium, revaluationreserves, and unappropriated profits.

• If your accounting has been carried out correctly the two halves should balance.



Quiz: Revision of PLCs’ Accounts

Go onlineAre the following True or False?

Q38: Debenture Finance cost (Debenture Interest) must be paid whether the PLCmakes a profit or not.

a) Trueb) False

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Q39: An Interim Dividend is a current liability.

a) Trueb) False

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Q40: Preference Shareholders are paid before Ordinary Shareholders.

a) Trueb) False

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Q41: Share Premium is placed in the appropriation section of the Income Statement(Profit and Loss Account)

a) Trueb) False

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Q42: Goodwill is an Intangible Asset.

a) Trueb) False

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Q43: Corporation Tax appears in both the Income Statement (Appropriation Account)and the Statement of Financial Position (Balance Sheet) under Current Assets.

a) Trueb) False

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Q44: Debentures are Non - current liabilities (Long Term Liabilities).

a) Trueb) False

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Q45: Appreciation of a Fixed Asset means it has decreased in value.

a) Trueb) False

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Q46: The final figure in the Income Statement (Appropriation Account) - UnappropriatedProfit is placed under Reserves in the Statement of Financial Position (Balance Sheet).

a) Trueb) False

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Q47: If discounts are placed on the Debit side of the Trial Balance then they should belisted under Expenses in the Income Statement (Profit and Loss Account).

a) Trueb) False

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Q48: Bad Debts are an Expense and should appear in the Income Statement (Profitand Loss Account) only.

a) Trueb) False

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M White

Go onlineQ49: Prepare the following Accounts for M White:

• The Income Statement (Trading and Profit and Loss Account) (including theAppropriation of available Profits) for the year ended 31 March

• A Statement of Financial Position (Balance Sheet) as at that date

Trial Balance at 31 March

£000 £000Sales Revenue (Sales) 2,156Purchases 1,260Property (Buildings) (at Cost) 867Fittings (at Cost) 130Motor Vehicles (at Cost) 181700000 Ordinary Shares of £1 each 700200000 8% Preference Shares of £1 each 2008% Debentures (2010 - 2015) 200Investments (Market Value £65000) 60Intangible Assets (Goodwill) 20Provision for Depreciation (at 1 April)Fittings and Equipments 28Motor Vehicles 56Unappropriated Profit (at 1 April) 62Cash and Cash Equivalents (Bank) 5Trade receivables (Debtors) 100Trade Payables (Creditors) 90Inventory (Stock) (at 1 April) 192Carriage Inwards 40Bad Debts 4Discounts (Net) 23Selling and Distribution Expenses 145Rates 137Wages and Salaries 318Insurance 95Dividends on Quoted Investments 6VAT 57Provision for Doubtful Debts (at 1 April) 5Debenture Finance cost (Debenture Interest) Paid (halfyear) 8

Share Premium 253,585 3,585

The following notes should also be taken into account:

1. Inventory (Stock) at 31 March was valued at £204,000

2. £2,000 was owing from Dividends on Quoted Investments

3. Provide for Depreciation for the year as follows:



• Motor vehicles: 20% Diminishing Balance method• Fittings: 10% on Cost

4. The provision for Doubtful Debts is to be adjusted to 3% of Trade receivables(Debtors) at 31 March

5. £5,000 was due for Wages and Salaries at 31 March

6. Selling and Distribution Expenses were prepaid at 31 March by £3,000

7. Provide for Corporation Tax at a rate of 25%

8. Property (Buildings) were professionally valued at £900,000 with the surplus beingtransferred directly to a Equity (Capital) Reserve Account.

It is acceptable to show a reduction in the Provision for Bad Debts as a negative Expense(i.e. (2) under Expenses)

When a Net Discount figure is given - if it appears on the Debit side of the Trial Balanceit should appear as an Expense - if shown on the Credit side it is added on to GrossProfit under Income

£000 £000 £000Sales Revenue (Sales)Opening Inventory (Stock)PurchasesPlus Carriage Inwards

Less: Closing Inventory (Stock)Cost of Sales Revenue (Sales)Gross ProfitPlus IncomeDividends on Quoted InvestmentsReduction in Provision for Bad DebtsLess ExpensesBad DebtsDiscountsSelling and Distribution ExpensesRatesWages and SalariesInsuranceDebenture Finance cost (Debenture Interest)Provision for DepreciationMotor VehiclesFittingsProfit for the Year (Net Profit) (before Tax)Less Corporation TaxProfit for the Year (Net Profit) (after Tax)Add Unappropriated Profit b/fUnappropriated Profit c/f



Statement of Financial Position (Balance Sheet): M White as at 31 March

£000 £000 £000Non-current Assets (Fixed Assets) Cost Deprn NBVProperty (Buildings)FittingsMotor Vehicles

£000 £000 £000Intangible AssetsInvestmentsIntangible Assets (Goodwill)

Current AssetsInventory (Stock)Trade receivables (Debtors)Dividends dueSelling/Distribution Expenses prepaidCash and Cash Equivalents (Bank)Less Current LiabilitiesTrade Payables (Creditors)VATCorporation Tax dueOrdinary Dividend owingDebenture Finance cost (Debenture Interest) owingWages owingWorking Equity (Capital)less DebenturesTotal Net Assets

Financed by £000 £000 £000Issued Share Equity (Capital)700000 £1 Ordinary Shares200000 £1 Preference SharesReservesShare PremiumUnappropriated Profit c/fEquity (Capital) Reserve

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4.11 The Financial Statements (Final Accounts) of aManufacturing Public Limited Company

Now that you are familiar with the layouts you should be able to cope with the preparationof the Financial Statements (Final Accounts) of a Public Limited Company whichmanufactures its own products.

This is a common question in the SQA Higher examination.

Points to Note:

1. The layouts of the accounts is basically joining the Manufacturing, IncomeStatement (Trading and Profit and Loss Account)s and Statement of FinancialPosition (Balance Sheet) together.

2. When calculating the closing Inventory (Stock) figure in the Statement ofFinancial Position (Balance Sheet) we must add the final Inventory (Stock)s ofFinished Goods, Raw Materials and Work in Progress together.

Otherwise, it is just a matter of joining the layouts together.



Apollo Plc

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Q50: Prepare the following for Apollo Plc from the Trial Balance and notes.

1. Manufacturing Account

2. Income Statement (Profit and Loss Account)

3. Statement of Financial Position (Balance Sheet)

Trial Balance at 31 December Year 3

£000 £000Factory Property (Buildings) (at Cost) 770Factory Machinery (at Cost) 140Motor Vehicles (at Cost) 204Inventory (Stock)s (at 1 January Year 3)Raw Materials 148Work in Progress 111Finished Goods 245Trade receivables (Debtors) 550Trade Payables (Creditors) 137Cash and Cash Equivalents (Bank Overdraft) 120Purchases of Raw Materials 2,048Production Wages 780Sales Revenue (Sales) 3,820750000 Ordinary Shares £1 each 750500000 7% Preference Shares £1 each 500General Administration Expenses 252Provision for Bad Debts 13Selling and Distribution Expenses 84Rates 168VAT 45Debenture Finance cost (Debenture Interest) 5Factory Expenses 148Interim Dividend: Ordinary Shares 20Income Statement (Profit and Loss Account) Balance (1Apr) 58

10% Debentures 50

Provision for Depreciation (1 January Year 3)Factory Machinery 30Motor Vehicles 60

5,673 5,673

The following should also be taken into account at 31 December Year 3:

1. Closing Inventory (Stock)s at 31 December Year 3 were:

• Raw Materials: £183,000• Work in Progress: £106,000• Finished Goods: £232,000



2. Production Wages owing: £13,000

3. General Administration Expenses prepaid: £7,000

4. Rates are to be split between the Factory and the office in the ratio 3:1.

5. Completed Production is to be transferred to the Income Statement (Trading) at acurrent Market Value of £3.4 million.

6. The Provision for Bad Debts is to be adjusted to 2% of the Trade receivables(Debtors) figure.

7. Depreciation is to be provided for the year as follows:

• Factory Property at cost.• Motor Vehicles: 12.5% reducing Balance method.

8. Corporation Tax is to be provided on profits at a rate of 25%.


£000 £000 £000Raw MaterialsOpening Inventory (Stock)Purchases

Less Closing Inventory (Stock)Cost of Raw MaterialsProduction WagesPrime CostAdd Factory OverheadsFactory ExpensesRatesDepreciation of Factory Machinery

Add Work in Progress (1 Apr)Less Work in Progress (31 Mar)Manufacturing Cost of ProductionProfit on ManufactureMarket Value of Production



Income Statement (Profit and Loss Account) at 31 December Year 3

£000 £000 £000Sales Revenue (Sales): finished Goodsless Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished GoodsAdd Market Value of Production

Less: Closing Inventory (Stock): FinishedGoodsGross ProfitPlus Profit on Manufacture

less ExpensesGeneral Administration ExpensesSelling and Distribution ExpensesRatesDebenture Finance cost (Debenture Interest)Provision for Depreciation: Motor vehiclesProvision for Bad DebtsProfit for the Year (Net Profit) (before Tax)Less Corporation TaxProfit for the Year (Net Profit) (after Tax)Interim Ordinary Dividend

Add Unappropriated Profit b/fUnappropriated Profit c/f



Statement of Financial Position (Balance Sheet): as at 31 December Year 3

£000 £000 £000Non-current Assets (Fixed Assets) Cost Deprn NBVFactory Property (at cost)Factory MachineryMotor Vehicles

£000 £000 £000Current AssetsInventory (Stock)Trade receivables (Debtors)General admin. Other receivables (Expensesprepaid)Less Current LiabilitiesTrade Payables (Creditors)VATCorporation Tax dueOrdinary Dividend owingProduction Wages owingCash and Cash Equivalents (Bank Overdraft)Working Equity (Capital)

less DebenturesTotal Net Assets

Financed by £000 £000 £000

750000 £1 Preference Shares500000 £1 Ordinary SharesReservesUnappropriated Profit c/f

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End of topic test

Go online

Q51: The following transactions have to be entered in the Financial Statements (FinalAccounts) of a Manufacturing Plc twice.

State in which part of the accounts they should be entered from the list below:

1. Manufacturing Account

2. Income Statement (Trading Account)

3. First half of Income Statement Profit for year (Profit and Loss Account)

4. Income Statement (Appropriation Account)

5. Statement of Financial Position (Balance Sheet) - Non-current Assets (FixedAssets) or Intangible Assets

6. Statement of Financial Position (Balance Sheet) - Current Assets

7. Statement of Financial Position (Balance Sheet) - Current Liabilities

8. Statement of Financial Position (Balance Sheet) - Financed by section

List of transactions:

A) Loss on Manufacture - £10000:

B) Closing Inventory (Stock): Finished Goods - £32,000:

C) Warehouse Wages owing - £2,000:

D) Cost of Goods Manufactured - £200,000:

E) Intangible Assets (Goodwill) written down by 50%:

F) Provision for Bad Debts created - £,000:

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Q52: State which of the following statements are true or false:

1. Royalties should be included in Prime Cost calculation.

2. Warehouse Wages should appear in the Income Statement before Gross profit iscalculated (Trading Account).

3. Interim Dividend is a current Asset in the Statement of Financial Position (BalanceSheet).

4. Debenture Finance cost (Debenture Interest) is a Fixed Interest payment.

5. A Profit on Manufacture should be added to Gross Profit.

6. Proposed Corporation Tax appears in both the Income Statement (Profit and LossAccount) and Statement of Financial Position (Balance Sheet).

7. If a Non-current Asset (Fixed Asset) appreciates in Value it is normal practice totransfer the surplus to a Equity (Capital) Reserve.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



Q53: From the following figures calculate the Profit or Loss on Manufacture by replacingletters A to E with the correct entries.

Prime Cost 3,400Factory OverheadsRates 40Insurance 20Fuel and Power 60Repairs to Machinery 36 A

BWork in Progress (1 April year start) 34Work in Progress (31 March year end) 31 CFactory / Manufacturing Cost of Production DProfit on Manufacture EMarket Value of Production 3,700

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q54: Complete the appropriation section of the Income Statement (Profit and LossAccount) by replacing the letters A to G with the correct entries:

Profit for the Year (Net Profit) (before Tax) 300Less Corporation Tax (25%) AProfit for the Year (Net Profit) (after Tax) BLess AppropriationsInterim Preference Dividend (10% of 100) CIntangible Assets (Goodwill) (50% of 80%) DInterim Ordinary Dividend 10 E

FAdd Unappropriated Profit b/f 16Unappropriated Profit c/f G

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


125

Topic 5

End of Unit 1 test

126 TOPIC 5. END OF UNIT 1 TEST

End of Unit 1 test

Go online10 min

Q1: Which of the following are the responsibility of the Financial Accountant?

a) Preparing a Trial Balanceb) Constructing a Break-Even Analysisc) Preparing a Cash Budgetd) Preparing a Statement of Financial position (Balance Sheet)e) Preparing a Ratio Analysis report

f)Ensuring Financial Statement (Final Accounts) conform to the requirements of theCompanies Act

g) Preparing an Overhead Analysis Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q2: Name four stakeholders with an interest in the financial performance of a PublicLimited Company.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


TOPIC 5. END OF UNIT 1 TEST 127

Q3: The following balances were extracted from the books of Carrick plc after theTrading Account had been prepared (first part of the Income Statement was completed):

£000 £000Gross Profit 310Inventory (Stock) at 31 December Year 5 24General Expenses 36Warehouse Expenses Payable 3Selling Expenses 50Discounts (net) 3Wages 98VAT 11Provision for Doubtful Debts at 1 January Year 5 6Trade Receivables (Debtors) 80Trade Payables (Creditors) 63Investment Property (Quoted Investments) 75Cash and Cash Equivalents (Bank) 5Interim Dividend - Ordinary Shares 12Intangible Assets (Goodwill) 30100,000 7% Preference Shares of £1 each 100200,000 Ordinary Shares of 50p each 10010% Debentures (Year 12) 60Property (Premises) (at cost) 140Equipment (at cost) 80Vehicles (at cost) 60Provisions for Depreciation at 1 January Year 5:Equipment 20Vehicles 10Share Premium 34Intangible Assets (Preliminary Expenses) 30Unappropriated Profit (Profit and Loss Account balance) at 1January Year 5 12

£726 £726



Notes at 31 December Year 5:1 The market value of Closing Inventory (Stock) was £30,000

2 General Expenses receivable (General Expenses prepaid) - £4,000

3The Provision for Doubtful Debts is to be adjusted to 10% of Closing TradeReceivables (Debtors)

4Intangible Assets (Preliminary Expenses) are to be written down by transferfrom the Share Premium Account

5 Non-Current Assets (Fixed Assets) are to be depreciated as follows:

Equipment - 10% of the reduced balance

Vehicles - 20% on cost

6 Property (Premises) were professionally revalued at £160,000

7Dividends of £5,000 were owing on the Investment Property (QuotedInvestments)

8 Intangible Assets (Goodwill) is to be written down by £20,000

You are required to prepare, for internal use, from the Trial Balance and Notes:

Income Statement (Profit and Loss Account) (including the appropriation of availableprofits) for the year ended 31 December Year 5 and a Statement of Financial Position(Balance Sheet) as at that date.



Carrick plc Income Statement (Profit and Loss) And Appropriation Account for yearended 31 December Year 5:

Income Statement £000 £000 £000Gross ProfitLess ExpensesGeneral ExpensesSelling ExpensesWagesIncrease in Provision for Doubtful DebtsDebenture Finance Cost (Debenture Interest) dueProvision for Depreciation: EquipmentProvision for Depreciation: Vehicles

add Income:Dividends on Investment Property (QuotedInvestments)DiscountsProfit for year (Net profit) BEFORE TAXLESS Corporation Tax (25%)Profit for year (Net profit) AFTER TAXADD Unappropriated Profit

less AppropriationsIntangible Assets (Goodwill) written downInterim Ordinary DividendUNAPPROPRIATED PROFIT C/F



Statement of Financial position (Balance Sheet) as at 31 December Year 5:

£000 £000 £000Non-Current Assets (Fixed Assets)Property (Premises)EquipmentVehicles

Investment Property (Investments)Intangible Assets (Goodwill)

Current AssetsInventory (Stock) (market value £30,000)Trade Receivables (Debtors)General Expenses receivable (General Expensesprepaid)Dividends owingVATless Current LiabilitiesTrade Payables (Creditors)Debenture Finance Cost payable (Debenture Interestdue)Corporation Tax dueWarehouse Expenses payable (Warehouse Expensesowing)Cash and Cash Equivalents (Bank overdraft)Equity (Working Capital)less DebenturesTOTAL NET ASSETSFINANCED BY100,000 7% Preference Shares of £1 each200,000 Ordinary Shares of 50p eachRESERVESEquity (Capital) ReserveShare PremiumUnappropriated Profit

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Q4:

The following information was extracted from the books of Burnside Manufacturing plcfor the year ended 31 December Year 2:

£000Inventories (Stocks) - 1 January Year 2:

Raw Materials 32Work-In-Progress 27Finished Goods 16

Purchases:Raw Materials 155Finished Goods 60

Purchases Returns - Raw Materials 15Carriage In on Finished Goods 2Wages 120Direct Factory Power 20Royalties 62Advertising 8Factory Repairs 12Factory Rates 8Salaries:Factory 33Office 11General Expenses: 12Lighting and Heating 25Insurance 17Factory Machinery (at cost) 100Vehicles (at cost) 50Provision for Depreciation:

Factory Machinery 20Vehicles 10Trade Receivables (Debtors) 40Bad Debts 5Sales Revenue (Sales) of Finished Goods 680Sales Returns of Finished Goods 18Selling Expenses 4

Inventories (Stocks) - 31 December Year 2:

Raw Materials 20Work-In-Progress 22Finished Goods 19



NOTES at 31 December Year 2:1 Wages payable - £5,000.

2A breakdown of the Wages paid, based on the number of workers in each areaof the firm shows the following:

Direct Factory - 80%

Warehouse - 20%

3Lighting and Heating and Insurance are to be apportioned between the Factoryand the Office in the ratio of 4:1 after taking into account prepaid Insurance of£2,000.

4The Factory is to be charged with 75% of the General Expenses with theremainder being charged to the Warehouse.

5 Depreciation per annum is to be provided for as follows:

Factory Machinery - 20% diminishing balance.

Vehicles - 10% on cost. The vehicles are used 80% for distribution and 20% inthe factory.

6 The Factory Profit for the year is £30,000.



You are required to:

a) Prepare the Manufacturing Account for the year ended 31 December Year 2.Burnside Manufacturing plc: Manufacturing Account for year ending 31December Year 2:

£000 £000

Opening Inventory (Stock) of Raw MaterialsAdd Purchases of Raw MaterialsLess Purchases Returns Raw Materials

Less Closing Inventory (Stock) of Raw MaterialsCost Of Raw Materials Consumed

Add Direct CostsDirect Factory PowerWagesRoyaltiesPrime Cost of Production

Add Factory OverheadsFactory RepairsFactory RatesSalariesGeneral ExpensesLighting and HeatingInsuranceDepreciation:Factory MachineryMotor Vehicles

Add Work-In-Progress 1 April, Year 1

Less Work-In-Progress 31 March, Year 2Factory Cost of ProductionMarket Price of Finished GoodsFactory Profit



b) Prepare the Trading Account of for the year ended 31 December Year 2.Burnside Manufacturing plc Trading Account for year ending 31 December Year2:


Less Sales Returns

LessCost of Sales Revenue (Cost ofSales)Opening Inventory (Stock) of FinishedGoods

Add Market Price of Finished GoodsAdd Purchases of Finished GoodsAdd Carriage In On Finished Goods

LessClosing Inventory (Stock) of FinishedGoods

Warehouse ExpensesAdd Wages

General ExpensesCost of Sales Revenue (Cost of Sales)Gross Profit

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q5:

Brown and Green are in partnership with Equities (capitals) of £30,000 and £20,000respectively.

Residual profits/losses are shared in the ratio of Equity (Capital) invested.

On 1 January Year 3, they decide to admit a new partner - Grey - who will invest £15,000into the business of which £10,000 is his Equity (Capital) contribution and the remaindera premium for Goodwill.

Before the admission of Grey the assets of the business were revalued as follows:

Old Value New ValueProperty (Premises) £60,000 £90,000

Motor Vehicles £25,000 £20,000

Inventory (Stock) £13,000 £10,000

Trade Receivables (Debtors) £8,000 £6,000

Grey is to receive a 1/6 share of future profits, with Brown and Green continuing to shareas before.



Calculate:

a) The profit or loss on revaluation:

£Property (Premises)VehiclesInventory (Stock)Trade Receivables (Debtors)

OverallProfit

Split:Brown (3/5)Green (2/5)

b) The new Equity (Capital) balances of Brown and Green:

Brown Green£ £

Original BalanceProfit On RevaluationIntangible Assets (Goodwill)(3:2)New Balance

c) The new profit sharing ratio of the partnership:Grey

Brown (3/5 x ?)

Green (2/5 x ?)

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Q6: What do the following acronyms stand for?

a) ASCb) ASBc) FRSd) SSAP

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136 GLOSSARY

Glossary

Articles of Association

a document required in the set up of a plc - it deals with internal regulations of theplc.

Bonus Shares

free shares given to existing shareholders usually as a percentage of their currentshareholding. They are financed from Share Premium.

Book-keeping

the process of recording and classifying business financial transactions. In plainlanguage,-maintaining the records of a firm’s or an individual’s financial activities.

Carriage Inwards

Cost of transporting materials to your warehouse

Corporation Tax

a tax levied on the profits of a plc by the Inland Revenue.

Current Account

is the account where the partners’ dealings with the Partnership are kept. It canhave a debit or credit balance.

Current Market Value

the value that a share will get when sold on the stock market. Will be higher orlower than the face value depending on how successful the company is.

Debentures

a long term loan to a plc with a fixed rate of interest. They are trade payables(creditors) of the business.

Direct Costs

costs directly attributable to the production process.

Direct Expenses

other costs besides Direct Materials and Direct Labour directly attributable to theproduction process e.g. Royalties; Direct Power.

Direct Labour (Wages)

Wages of workers or operatives directly involved in the productive process.

Direct Materials

resources used in the actual production process.

Dividend

annual return shareholder receives on their shareholding.


GLOSSARY 137

Drawings

is the amount of money or goods which a partner has withdrawn from the businessfor his own use. There may be a maximum figure for Drawings which may bedetailed in the Partnership Agreement.

Equity (Capital) Account

is the account where the amount of money invested by each partner is listed.

Face value

the value of a share as printed on the share itself. Most shares are worth more orless than this depending on how successful the company is.

Factory Overheads

Indirect Costs or Fixed Costs - not directly related to production.

Final section of the Income Statement (Appropriation Account)

is an account which is drawn up after the Profit for the Year (Net Profit) has beenarrived at. Adjustments are necessary for Interest on Equity (Capital), Interest onDrawings and Salary before the Residual profit or Loss is divided.

Fixed Costs

costs which do not vary with output e.g. Rent/Rates - sometimes referred to asOverheads, Indirect Costs - ancillary to production.

Indirect Costs

cost ancillary to production process - indirect costs.

Inland Revenue

the government department responsible for collecting taxes from individuals andbusinesses.

Intangible asset

an asset not represented by a physical item like property, vehicles, etc. Mostcommonly Intangible Assets (Goodwill).

Intangible Asset (Goodwill)

where a business is worth more than the value of its physical assets.

Intangible Assets

an asset not represented by a physical item like property. The most commonexample is Intangible Asset (Goodwill).

Intangible Assets (Goodwill)

is where a business may be worth more than the value of its physical assets dueto the average level of profits made annually, the number of customers it has, itsreputation, its location etc. It is usual for a new partner to pay for the IntangibleAssets (Goodwill) which a business has built up.

Interest on drawings

is a charge against individual partners to discourage them from taking drawingsfrom the business.


138 GLOSSARY

Interest on Equity (Capital)

is a share of the Profit for the Year (Net Profit) which partners are paid for investingtheir Equity (Capital) in the business. It is usually paid in proportion to Equity(Capital) invested eg 10%.

Interim Dividend

dividend issued to shareholders during the financial year - usually if business isdoing well.

Limited Liability

Shareholders’ liability is limited to the extent of their shareholding.

Limited Liability Partnership Act

is a government act introduced in 2000 governing the laws on partnerships.

Limited Partnership

This type of partner has limited liability ie they will only lose their initial investmentshould the business go bankrupt. They take no part in the running of the business.A Partnership must have at least one general or unlimited partner.

Limited Partnership Act of 1907

a government act governing the laws on limited partnerships.

Loss on Manufacture

When Market value of production is actually less than manufacturing cost of output- is deducted from Gross Profit in the Income Statement (Trading Account)

Manufacturing/Factory Cost of Output

Total or final figure in the Manufacturing Account


Account which calculates Manufacturing cost of Output

Manufacturing Cost per unit

Manufacturing Cost of Production/Units produced

Market Value of Goods Manufactured

Wholesale value of current production or output

Memorandum of Association

a document required in the set up of a plc - deals with the external regulations ofthe plc.

Ordinary Shares

the most common type of share - carries most risk - variable dividend - last to bepaid back if business becomes bankrupt.


GLOSSARY 139

Other Payables (Accrued Expenses)

Expenses unpaid or owing - which should have been paid during the presentfinancial period - add amount owing to original expense - also a Current Liabilityin the Statement of Financial Position (Statement of Financial Position (BalanceSheet)).

Other Receivables (Prepaid Expenses)

Expenses paid in advance for the next financial period - amount prepaid isdeducted from expenses figure - also appears as a Current Asset in the Statementof Financial Position (Statement of Financial Position (Balance Sheet)).

Overheads

Indirect Costs or Fixed Costs - not directly related to production.

Partnership

a business set up by two or more persons.

Partnership Act of 1890

a government act governing the laws on partnerships.

Partnership agreement

a legal document drawn up by a lawyer governing the way a partnerships works.Can help to resolve disputes between partners.

Partnership salary

is where a partner is rewarded for carrying out a specific duty for the partnershipeg book-keeping

Preference Shares

less risky type of share - fixed dividend - first to be paid if business goes bankrupt.

Preliminary Expenses

the legal and set up cost for forming a plc. They are written down as soon aspossible usually from Share Premium. They are classified as an Intangible Asset.

Premium

is the surplus paid when buying into a business to compensate the existingpartners forgiving up part of their share of Intangible Assets (Goodwill).

Prime Cost

total of all Direct Costs

Profit on Manufacture

When Manufacturing Cost of Production is less than Market or wholesale value ofproduction - is added onto Gross Profit in the Income Statement (Trading Account)

Purchases Returns

Goods returned to supplier - might be unsatisfactory, damaged etc.


140 GLOSSARY

Realisable

an asset that can be converted into cash.

Represented by

the part of a company Statement of Financial Position (Balance Sheet) detailingthe equity (capital) structure, retained profits and long term finance.

Reserves

retained profits kept within a firm to reinvest in the future.

Residual Profit or Loss

the amount to be divided between partners after Interest on Equity (Capital),Interest on Drawings and any Salary have been accounted for.

Revaluation

is when the assets of a business a revalued to reflect their current value. Thisusually happens when admitting a new partner - the profit or loss on revaluation isshared between existing partners.

Revaluation Reserve

when the assets of a business are revalued and any appreciation is transferred toa Revaluation Reserve.

Royalties

Payments made to the inventor or developer of a product based on the amount ofthe product sold.

Share Premium

when shares are sold for more than their face value. Any value accruing from sharepremium is treated as a reserve in the Statement of Financial Position (BalanceSheet).

Sole Trader

a business set up by one person only.

Statement of Financial Position (Balance Sheet)

a statement of the plc assets and liabilities.

Stock Market

the set of institutions that make possible the exchange of stocks and sharesbetween buyers and sellers.

Taxation

a payment to government.

Unappropriated Profit

profit retained in the business - not used for distribution.


GLOSSARY 141

Unlimited liability

if a business goes bankrupt the partner can lose more than their initial investmentto meet the debts of the partnership eg their house or car may be sold or any otherpersonal possessions.

Variable Costs

costs which vary directly with production - sometimes called Direct Costs.

VAT

tax levied on sales and purchases - payable to the Customs and ExciseDepartment.

Warehouse Expenses

Cost of storage or Inventory (Stock) or warehouse - placed in the IncomeStatement (Trading Account).

Work in progress

Goods which are in an incomplete state - must be valued as material and labouralready spent on them.


142 ANSWERS: TOPIC 1

Answers to questions and activities

1 The role of Financial Accounting

Quiz: The Financial Accountant (page 4)

Q1: False - both are equally important.

Q2: True - Financial Accounting is based on what has happened in the past whereasManagement Accounting looks to the future.

Q3: True - this is a necessary requirement for PLCs.

Q4: False - FrS must be adhered to in the presentation of final Accounts by PLCs.

Q5: True - Yes this is true - Final Accounts cannot be produced if book-keeping is notaccurate.

Q6: False - yes Financial Accounting is based on what has happened in the pastwhereas Management Accounting looks to the future.

End of topic test (page 7)

Q7: True - Vat returns is the responsibility of the Financial Accountant as it his job todeal with invoices etc.

Q8: True - Preparing Final Accounts ie Income Statement and Statement of FinancialPosition is completed by Financial Accountant.

Q9: False - Planning and Budgeting is Forecasting and the responsibility of theManagement Accountant.

Q10: True - It is the responsibility of the Financial Accountant to ensure Final Accountsadhere to Financial Reporting Standards requirements.

Q11: True - It is the responsibility of the Financial Accountant to prepare a Trial Balanceto ensure book-keeping has been carried out correctly before Final Accounts are drawnup.

Q12: A stakeholder is a person or organisation who has an interest in the performanceof a particular business enterprise.

Q13: Any four from: Banks; Competitors/Potential takeover bidders; Tradepayables (Creditors)/Suppliers; Debenture holders; Employees/Trade unions; Existingshareholders; Government; Managers/owners; Potential shareholders


ANSWERS: TOPIC 2 143

2 Partnership

Activity: Sole trader (page 11)

Q1: Advantages are: A, C and E

Disadvantages are: B, D and F

Activity: Advantages and disadvantages of forming a partnership (page 12)

Q2: Advantages are: A, E and F

Disadvantages are: B, C and D

Quiz: Partnerships 1 (page 14)

Q3: a) usually true but Accountants and Solicitors can have more than 20 members ina Limited Partnership.

Q4: a) true

Q5: b) Less work for each partner

Q6: c) No say in the management of the firm

Q7: b) two

Q8: b) false

Q9: B, D and E would not appear.

Q10: a) 1890

Activity: Green and Brown Final section of the Income Statement for year ending31 December (Appropriation Account) (page 16)

Q11:




Profit for the Year (NetProfit)

£6,200

Add Interest on drawings Brown (5% × 2,000) £100Green (5% × 4,000) £200 £300


Brown (10% × 10,000) £1,000

Green (10% × 15,000) £1,500 £2,500£4,000

Less Partnership salary Brown £2,000(Residual profit) £2,000share of profit Brown (1/2 × 2,000) £1,000

Green (1/2 × 2,000) £1,000 £2,000

Activity: Fry and Laurie Partnership (page 17)

Q12:

Profit for the Year (NetProfit)

£40,000

Add Interest on drawings Fry (10% × 16,000) £1,600Laurie (10% × 6,000) £600 £2,200


Fry (8% × 50,000) £4,000

Laurie (8% × 25,000) £2,000 £6,000£36,200

LESS Partnership salary Laurie £8,000Residual Profit £28200share of Profit Fry(2/3 × 28200) £18800

Laurie (1/3 × 28200) £9400 £28200

Activity: Green and White Current Account (page 18)

Q13:

Current A/C - White

DR (-) CR (+) BALOpening balance £250Interest on Equity (Capital) £1,000 £1,250Partnership salary £2,000 £3,250Drawings £2,000 £1,250Interest on drawings £100 £1,150Share of profit £1,000 £2,150



Current A/C - Green

DR (-) CR (+) BALOpening balance £300Interest on Equity (Capital) £1,500 £1,800Partnership salary £0 £1,800Drawings £4,000 -£2,200Interest on drawings £200 -£2,400Share of profit £1,000 -£1,400

Activity: Gray and Gold Partnership (page 20)

Q14:

Current A/C - Gray

DR (-) CR (+) BALOpening balance £5,900Interest on Equity (Capital) £4,000 £9,900Partnership salary £9,900Drawings £22,000 -£12,100Interest on drawings £2,200 -£14,300Share of profit £7,000 -£7,300

Current A/C - Gold

DR (-) CR (+) BALOpening balance £500Interest on Equity (Capital) £4,000 £4,500Partnership salary £9,000 £13,500Drawings £18,000 -£4,500Interest on drawings £1,800 -£6,300Share of profit £3,500 -£2,800

Activity: White and Black Partnership 1 (page 21)

Q15:

Partnership Final section of the Income Statement for year ending 31 December(Appropriation Account)



Profit for the Year (Net Profit) £12,400Add Interest on drawings Black £200

White £400 £600£13,000

Less Interest on Equity(Capital) Black £2,000

White £3,000 £5,000£8,000

Less Partnership salary Black £4,000(Residual Profit) £4,000Share of profit Black(2/5) £1,600

White(3/5) £2,400 £4,000

Current A/C - Black

DR (-) CR (+) BALOpening balance £500Interest on Equity (Capital) £2,000 £2,500Partnership salary £4,000 £6,500Drawings £4,000 £2,500Interest on drawings £200 £2300Share of profit £1600 £3900

Current A/C - White

DR (-) CR (+) BALOpening balance £600Interest on Equity (Capital) £3,000 £3,600Partnership salary £0 £3,600Drawings £8,000 -£4,400Interest on drawings £400 -£4,800Share of profit £2,400 -£2,400

represented by:Black White TOTALS

Equity (Capital) at start £20,000 £30,000ADD NEW current A/C balances £3,900 -£2,400

£23,900 £27,600 £51,500



Activity: White and Black Partnership 2 (page 21)

Q16:


Profit for the Year (Net Profit) £20,000ADD Interest on drawings Black £350

White £250 £600£20,600

LESS Interest on Equity(Capital) Black £2,300

White £2,800 £5,100£15,500

LESS Partnership salary Black £4,000(Residual Profit) £11,500Share of profit Black(2/5) £4,600

White(3/5) £6,900 £11,500

Current A/C - Black

DR (-) CR (+) BALOpening balance £1,000Interest on Equity (Capital) £2,300 £3,300Partnership salary £4,000 £7,300Drawings £7,000 £300Interest on drawings £350 - £50Share of profit £4,600 £4,550

Current A/C - White

DR (-) CR (+) BALOpening balance - £500Interest on Equity (Capital) £2,800 £2,300Partnership salary £0 £2,300Drawings £5,000 - £2,700Interest on drawings £250 - £2,950Share of profit £6,900 - £3,950

represented by:Black White TOTALS

Equity (Capital) at start £23,000 £28,000ADD NEW current A/C balances £4,550 £3,950

£27,550 £31,950 £59,500



Activity: Blue and White Partnership (page 22)

Q17:


Profit for the Year (Net Profit) £25,000ADD Interest on drawings Blue £450

White £400 £850£25,850

LESS Interest on Equity(Capital) Blue £2,900

White £3,100 £6,000£19,850

LESS Partnership salary Blue £4,000 £4,000(Residual Profit) £15,850Share of profit Blue(2/5) £6,340

White(3/5) £9,510 £15,850

Current A/C - Blue

DR (-) CR (+) BALOpening balance £850Interest on Equity (Capital) £2,900 £3,750Partnership salary £4,000 £7,750Drawings £9,000 -£1,250Interest on drawings £450 -£1,700Share of profit £6,340 £4,640

Current A/C - White

DR (-) CR (+) BALOpening balance £950Interest on Equity (Capital) £3,100 £4,050Partnership salary £0 £4,050Drawings £8,000 -£3,950Interest on drawings £400 -£4,350Share of profit £9,510 £5,160

represented by:Blue White TOTALS

Equity (Capital) at start £29,000 £31,000ADD NEW current A/C balances £4,640 -£5,160

£33,640 £36,160 £69,800



Activity: Red and White Partnership (page 23)

Q18:

Income Statement (Profit and Loss) Account for the year ended 31 December

£000 £000Sales Revenue (Sales) 200Less cost of Sales Revenue (Sales)Opening Inventory (Stock) 10Add Purchases 80

90Less closing Inventory (Stock) 15 75Gross profit 125Less ExpensesSelling Expenses 16Office Expenses 19Increase in provision for bad debt 1Depreciation: vehicles 5Depreciation: fittings 5 46Profit for the Year (Net Profit) 79

Add interest on drawings Red 1White 1 2

81Less Interest on Equity(Capital) Red 3

White 4 774

Less Partnership salary Red 14(Residual Profit) 60Share of profit Red 24

White 36 60

Current A/C - Red

DR (-) CR (+) BALOpening balance £1,000Interest on Equity (Capital) £3,000 £4,000Partnership salary £14,000 £18,000Drawings £20,000 -£2,000Interest on drawings £1,000 -£3,000Share of profit £24,000 £21,000



Current A/C - White

DR (-) CR (+) BALOpening balance £3,000Interest on Equity (Capital) £4,000 £7,000Partnership salary £0 £7,000Drawings £20,000 -£13,000Interest on drawings £1,000 -£14,000Share of profit £36,000 £22,000

Statement of Financial Position (Balance Sheet) as at 31 December

Cost Depr NBV£000 £000 £000

Non-current Assets (Fixed Assets)Fittings 50 9 41Vehicles 30 10 20

61

£000 £000 £000Current assetsInventory (Stock) at end 15Trade Receivables (Debtors) 60Less provision for doubtful debt 3 57Cash and Cash Equivalents (Bank) 27Other receivables (Prepaid Expenses) 4

103Current liabilitiesTrade Payables (Creditors) 40VAT 8Unpaid Expenses (Other payables) 3 51 52Net assets 113Represented by

Red WhiteEquity (Capital) at start 30 40New current account balances 21 22

51 62 113113



Activity: Grey and Pink Partnership (page 24)

Q19:

Current Account: Grey

Debit Credit BalanceOpening balance £2,000Interest on Equity (Capital) £4,000 £6,000Partnership salary £4,000 £10,000Drawings £12,000 (£2,000)Interest on drawings £600 (£2,600)Share of profit £11,400 £8,800

Notice that, before inserting Grey’s share of profit, the balance on the account is £2600(debit) so in order to achieve a closing balance of £8800 (credit) the share of profit mustbe £11400.

Current Account: Pink

Debit Credit BalanceOpening balance £1,000Interest on Equity (Capital) £6,000 £7,000Partnership salary £0 £7,000Drawings £18,000 (£11,000)Interest on drawings £900 (£11,900)Share of profit £17,100 £5,200

Q20:

Reversed Appropriation a/c for year ended 31 December

Working Total

Shares of profit(11,400 +

17,100)£28,500

+ Partnership salary £4,000£32,500

+ Interest on Equity (Capital) (4,000 + 6,000) £10,000£42,500

- Interest on drawings (600 + 900) £1,500Profit for the Year (Net Profit) £41,000



Activity: X and Y Partnership (page 25)

Q21:

Current Account: X

Debit Credit BalanceOpening balance -£800Interest on Equity (Capital) £1,500 £700Partnership salary £2,000 £2,700Drawings £4,000 -£1,300Interest on drawings £200 -£1,500Share of profit £9,000 £7,500

Current Account: Y

Debit Credit BalanceOpening balance £600Interest on Equity (Capital) £1,000 £1,600Partnership salary £1,500 £3,100Drawings £2,000 £1,100Interest on drawings £100 £1,000Share of profit £6,000 £7,000

Reverse Final section of the Income Statement (Appropriation Account)

Working TotalShares of profit (9,000 + 6,000) £15,000+ Partnership salary (2,000 + 1,500) £3,500

£18,500+ Interest on Equity(Capital)

(1,500 + 1,000) £2,500

£21,000- Interest on drawings (200 + 100) £300Profit for the Year (NetProfit)

£20,700

Bruce, Wallace and Stuart (page 26)

Q22:


(+ or -)

Property (Premises) £60,000 £90,000 £30,000Vehicles £30,000 £25,000 (£5,000)Inventory (Stock) £20,000 £18,000 (£2,000)Trade Receivables (Debtors) £6,000 £5,000 (£1,000)

£22,000



Share of surplus/(deficit) £(3/5 × 22,000) to Equity (Capital) Bruce £13,200(2/5 × 22,000) to Equity (Capital) Wallace £8,800Share of Premium(3/5 × 25,000) to Equity (Capital) Bruce £15,000(2/5 × 25,000) to Equity (Capital) Wallace £10,000

Equity (Capital) A/C - Bruce

DR (-) CR (+) BALOriginal balance £60,000Share of revaluation £13,200 £73,200Share of premium £15,000 £88,200

Equity (Capital) A/C - Wallace

DR (-) CR (+) BALOriginal balance £40,000Share of revaluation £8,800 £48,800Share of premium £10,000 £58,800


Stuart 1/6 16.67%Bruce 2/5 x 5/6 = 1/3 33.33%Wallace 3/5x5/6 = 1/2 50%

Smith and Jones Partnership (page 28)

Q23:


(+ or -)

Property (Premises) 50,000 60,000 10,000Vehicles 25,000 16,000 -9,000Inventory (Stock) 15,000 12,000 -3,000Trade Receivables (Debtors) 8,000 7,300 -700

-2,700

Share of deficit £to Equity (Capital) Smith -1,800to Equity (Capital) Jones -900

Share of premium £to Equity (Capital) Smith 4,000to Equity (Capital) Jones 2,000

Equity (Capital) A/C: Smith



dr (-) cr (+) Bal £Original balance 80,000Share of revaluation 1,800 78,200Share of premium 4,000 82,200

Equity (Capital) A/C: Jones

dr (-) cr (+) Bal £Original balance 40,000Share of revaluation 900 39,100Share of premium 2,000 41,100


Adams 1/5 20%Smith 2/3 x 4/5 = 8/15 53.34%Jones 1/3x4/5 = 4/15 26.66%

Ash and Oak Partnership (page 29)

Q24:


(+ or -)


12400

Share of surplus £to Equity (Capital) Ash 7,440to Equity (Capital) Oak 4,960

Share of premium £to Equity (Capital) Ash 6,000to Equity (Capital) Oak 4,000

Equity (Capital) A/C: Ash


Equity (Capital) A/C: Oak





Fir 1/4 25%Ash 3/5 x 3/4 = 9/20 45%Oak 2/5 x 3/4 = 3/10 30%

Quiz: Theory exercise (page 31)

Q25: b) false

Q26:

Intangible Assets (Goodwill) is an intangible asset whose value will depend on the levelof profit and the numbers of customers together with the firm’s reputation for reliabilityand location. Intangible Assets (Goodwill) is realisable on the sale of the firm as a goingconcern. To calculate the value of Intangible Assets (Goodwill) you subtract the value ofassets being sold from the selling price.

Q27: c) No change

Q28: a) profit sharing ratio

Q29:

Before the admission of a new partner, the assets will be revalued using a revaluationaccount. An increase in value is shown on the credit side and a decrease in value onthe debit side of the revaluation account. If value of increases exceeds the value ofdecreases there is a surplus which the existing partners share using profit sharing ratio.Either the current account or the Equity (Capital) account will be credited if there is asurplus or debited if there is a deficit.




Q30:

Trading and the Income Statement (Profit and Loss) at 31 December

£000 £000Sales Revenue (Sales) 280Less Cost of Sales Revenue (Sales)Opening Inventory (Stock) 20Add Purchases 140

160Less closing Inventory (Stock) 25 135Gross Profit 145Less ExpensesSelling Expenses 22Office Expenses 25Actual bad debt 4Provision for doubtful debt 1Discount allowed 3Depreciation: vehicles 8Depreciation: fittings 5 68Profit for the Year (Net Profit) 77

Add Interest on Drawings Bogart 3Bacall 4 7

84LESS Interest on Equity(Capital)

Bogart 14

Bacall 7 2163

LESS Salary Bacall 15Residual Profit 48Share of Profit Bogart (2/3) 32

Bacall (1/3) 16 48

Current Account: Bogart

Debit Credit BalanceOpening Balance £34,000Interest on Equity (Capital) £14,000 £48,000Partnership Salary £0 £48,000Drawings £15,000 £33,000Interest on Drawings £3,000 £30,000Share of Profit £32,000 £62,000

Current Account: Bacall



Debit Credit BalanceOpening Balance £15,000Interest on Equity (Capital) £7,000 £22,000Partnership Salary £15,000 £37,000Drawings £20,000 £17,000Interest on Drawings £4,000 £13,000Share of Profit £16,000 £29,000

Statement of Financial Position (Balance Sheet) as at 31 December

Cost Depr NBV£000 £000 £000

Non-current Assets (Fixed Assets)Property (Premises) 200 200Fittings 50 9 31Vehicles 59 27 32

263

£000 £000 £000Current AssetsInventory (Stock) at end 25Trade Receivables (Debtors) 60Less provision for doubtful debt 3 57Cash and Cash Equivalents (Bank) 11Other receivables (Prepaid Expenses) 4

97Less Current LiabilitiesTrade Payables (Creditors) 49VAT 7Other Payables (Expenses owing) 3 59 38

301Financed by:

Bogart BacallEquity (Capital) at start 140 70Current Account 62 29

202 99 301

Q31:

Current Account: SmithDebit Credit Balance

Opening Balance £1,600Interest on Equity (Capital) £3,000 £1,400Partnership Salary £6,000 £7,400Drawings £20,000 -£12,600Interest on Drawings £4,000 -£16,600Share of Profit £18,000 £1,400

Current Account: Jones



Debit Credit BalanceOpening Balance £1,200Interest on Equity (Capital) £2,000 £3,200Partnership Salary £3,000 £6,200Drawings £12,000 -£5,800Interest on Drawings £2,400 -£8,200Share of Profit £12,000 £3,800

Reverse Final section of the Income Statement (Appropriation Account)

Working TotalShares of Profit (18,000 + 12,000) £30,000+ Partnership Salary (6,000 + 3,000) £9,000

£39,000+ Interest on Equity(Capital)

(3,000 + 2,000) £5,000

£44,000- Interest on Drawings (4,000 + 2,400) £6,400Profit for the Year (NetProfit)

£37,600

Q32:


(+ or -)


22200

Share of surplus £to Equity (Capital) Laurel 14,800to Equity (Capital) Hardy 7,400

Share of premium to Equity (Capital) Laurel 6,000to Equity (Capital) Hardy 3,000

Equity (Capital) Account: Laurel

DR (-) CR (+) BAL £Original Balance 40,000Share of revaluation 14,800 54,800Share of premium 6,000 60,800

Equity (Capital) Account: Hardy

DR (-) CR (+) BAL £Original Balance 20,000Share of revaluation 7,400 27,400Share of premium 3,000 30,400



New Profit Sharing ratio

Chaplain 1/4 25%Laurel 2/3 x 3/4 = 1/2 50%Hardy 1/3x3/4 = 1/4 25%



3 Public Limited Companies

Quiz: Theory of Public Limited Companies (page 41)

Q1: d) unlimited

Q2: d) has no responsibility

Q3: c) Share allotment

Q4: b) Limited liability of shareholders

Q5: b) Certificate of incorporation

Q6: c) Ordinary dividends have no upper limit

Q7: b) Debentures are only redeemable on the liquidation of a plc

Q8: b) Corporation tax

Q9: b) Directors’ remunerations

Q10: b) false

Activity: Final section of the Income Statement (Appropriation Account) (page44)

Q11:

£ £Profit for the Year (Net Profit) 80,000Less Corporation Tax 20,000

60,000Add Unappropriated Profit b/f 8,000

68,000Less

Interim Ordinary Dividend 12,000Interim Preference Dividend 5,000 17,000Unappropriated Profit c/f 51,000



Activity: Sections of the Statement of Financial Position (Balance Sheet) (page47)

Q12:

£000 £000Profit for the Year (Net Profit) (before Tax) 60

less Corporation Tax 1545

add Unappropriated Profit b/f 1257

less Interim Ordinary Dividend 12Unappropriated Profit c/f 45

£000 £000Current liabilities

Debenture Finance Cost payable (Debenture Interest) due 12Corporation Tax 15 27

Represented byIssued Equity (Capital)100,000 8% Preference Shares £1 fully paid 10080000 Ordinary shares at £1 each 80 180

Reserves:Unappropriated Profit c/f 45Shareholders Interest 225



Company AB: Income Statement (Profit and Loss account) (page 50)

Q13:


less Sales Revenue (Sales) returns 4676

less Cost of SalesInventory (Stock) at start (opening) 23

add Purchases 470less Purchases returns (out) 20 450add Carriage inwards 7


less Inventory (Stock) at end (closing) 30 479Gross Profit 197

less ExpensesOffice expenses 38Selling expenses 48Carriage outward 10Debenture Finance cost (Debenture interest) 4Depreciation: vehicles 12Depreciation: fittings 6Discount allowed 6Increase in prov. for d. debt 1 125Profit for the Year (Net Profit) 72

less Corporation Tax 1854

add Unappropriated last year 256

less Interim Ordinary Dividend 15% 12Unappropriated Profit c/f 44



Company AB: Statement of Financial Position (Balance Sheet) (page 52)

Q14:


202Current AssetsInventory (Stock) 30Trade Receivables (Debtors) 60Less Provision for Doubtful Debts 3 57Other Receivables (Prepaid Expenses) 4

91Current LiabilitiesCorporation Tax 18Cash and Cash Equivalents (Bank Overdraft) 2Debenture Finance cost 4Other Payables (Accrued Expenses) 3Trade Payables (Creditors) 28 55Working Equity (Capital) 36

238less Non-Current LiabilitiesDebentures 40Total Net Assets 198Represented by:Issued Equity (Capital)80,000 £1 Ordinary Shares, fully paid 80 13050,000 8% Preference Shares £1, fully paid 50

ReservesUnappropriated Profit c/f 44Share Premium 24 68Shareholders Interest 198



Company BC: Income Statement (Profit and Loss account) (page 55)

Q15:


Less Sales Revenue (Sales) returns 7781

Less Cost of SalesInventory (Stock) at start (opening) 30

Add Purchases 585Less Purchases returns (out) 16 569Add Carriage inwards 10


Less Inventory (Stock) at end (closing) 33 606Gross Profit 175

Less ExpensesOffice expenses 42Selling expenses 51Carriage outward 12Debenture finance cost (debenture interest) 4Depreciation: vehicles 15Depreciation: fittings 6Increase in provision for d. debt 1 131

44Add Income

Discount received 4Profit for the Year (Net Profit) 48

Less Corporation Tax 12Profit for the year (after Tax) 36

Add Unappropriated last year 1854

Less Interim Ordinary Dividend 16Unappropriated Profit c/f 38



Company BC: Statement of Financial Position (Balance Sheet) (page 56)

Q16:


202Current AssetsInventory (Stock) 33Trade Receivables (Debtors) 80less Provision for doubtful debts 4 76Other Receivables (Prepaid Expenses) 4 113Current LiabilitiesDebenture Finance Cost payable (DebentureInterest) due 4

Corporation Tax 12Other Payables (Accrued Expenses) 4Trade Payables (Creditors) 37 57Working Equity (Capital) 56

258less Non-Current LiabilitiesDebentures 40Total Net Assets 218Represented by:Issued Equity (Capital)50,000 8% Preference Shares £1, fully paid 5080,000 £1 Ordinary Shares, fully paid 80ReservesUnappropriated Profit c/f 38Share Premium 50Shareholders Interest 218



Company CD: Income Statement (Profit and Loss account) (page 58)

Q17:







Less ExpensesOffice expenses 43Selling expenses 54Carriage outward 15Debenture finance cost (debenture interest) 4Depreciation: vehicles 20% cost 15Depreciation: fittings 25% NBV 4Discount allowed 5 140

Add IncomeDecrease in Provision for bad debt 1Profit for the Year (Net Profit) 8

147Less Corporation Tax 2

Profit for Year (after Tax) 6Add unappropriated last year 8

14Less Interim Ordinary Dividend 4

Unappropriated Profit c/f 10



Company CD: Statement of Financial Position (Balance Sheet) (page 60)

Q18:


185Current AssetsInventory (Stock) 40Trade Receivables (Debtors) 60Less: Provision for Doubtful Debts 3 57Cash and Cash Equivalents (Bank) 8Other Receivables (Prepaid Expenses) 4 109Current LiabilitiesDebenture Finance Cost payable (DebentureInterest) due 4


224less Non-Current LiabilitiesDebentures 40Total Net Assets 184Represented by:Issued Equity (Capital)50,000 8% Preference Shares, £1, fully paid 5080,000 £1 Ordinary Shares, fully paid 80 130ReservesUnappropriated Profit c/f 10Share Premium 44 50Shareholders Interest 184

Quiz: The role of the ASC and ASB (page 64)

Q19: ASC - Accounting Standards Committee

Q20: ASB - Accounting Standards Board

Q21: FRS - Financial Reporting Standard

Q22: SSAP - Statement of Standard Accounting Practice

Q23: NO - but the accounting professional bodies may discipline those who do notfollow standards.



Preparation of an Accounting standard (page 65)

Q24:

• Topic for discussion is identified

• Discussion draft is issued to interested parties

• Exposure draft is issued

• Exposure draft is refined and modified

• Financial reporting standard is issued

Answers from page 68.

Q25:

Existing andpotential investors

Will they get an adequate return on their investment, either in theform of dividends or equity (capital) growth to compensate themfor the risk of investing their money?

Employees Are their jobs secure?

Lenders andsuppliers

Will they receive back the money they are due from thebusiness, and will it be on time? Is the business at risk with aview to considering how safe the source of demand is?

CustomersAre profits excessive - is there scope to negotiate a discount? Isthe business at risk with a view to considering how safe thesource of supply is?

GovernmentWhat are the profits made, as a basis for calculating the taxesdue?

General public What are the environmental impacts of the company, and howethical are its actions?

While recognising that there is a wide range of users with different needs, the Statementconcludes that the objective of financial statements can usually be met by focusing onthe needs of present and future investors, the ‘defining class’ of users. It is assumedthat meeting the needs of this user group will meet the needs of the others.


Q26: The Statement of Principles says that information is reliable if:

• It can be depended upon by users to represent faithfully either what it purports torepresent, or could reasonably be expected to represent;

• It is free from deliberate or systematic bias (ie it is neutral);

• It is free from material error;

• It is complete within the bounds of materiality; and

• In its preparation under conditions of uncertainty, a degree of caution (ie prudence)has been applied in exercising judgement and making the necessary estimates.



There may be a conflict between the relevance and reliability of information. A pieceof relevant information may be so unreliable that its recognition may be potentiallymisleading. An example would be where the future result of a legal claim against acompany is so uncertain that it cannot be quantified.

Comparable

The Statement recognises that users need to be able to compare a company’s financialinformation over time in order to identify trends in its financial position and performance.In addition, financial information should be comparable between companies. Financialinformation should therefore be consistent from period to period, and there should befull disclosure of accounting policies.

Understandable

Information included in financial statements should be readily understandable by users.It is expected that users do have a knowledge of business, economics and accounting,and a willingness to study carefully the information presented.


Q27: In order for an item to be recognised in the financial statements, an appropriatemonetary amount must be ascribed to it. It would be impossible to come up with auniversally acceptable system to assign a monetary value to a company’s workforce.

Cash Flow Statement requirement (page 70)

Expected answer

A company needs to hold enough cash to pay its creditors and to meet its day today running costs. It should not hold too much cash, as it would not then be makingthe best use of its resources. A clear statement of a company’s cash flow positionallows investors to check whether the company is being run efficiently (i.e. not holdingtoo much cash) as well as checking on solvency (i.e. holding too little cash). Cashand Cash Equivalents (Cash) is often more important than accounting profitability indetermining whether a firm can survive in the short run. It is much more difficult todistort or misinterpret movements of cash than some other accounting entries.

Cash flow statements have increasingly come to be recognised as a useful additionto the Statement of Financial Position (Balance Sheet) and Income Statement (Profitand Loss account) in their portrayal of financial position, performance and financialadaptability (in particular in indicating the relationship between profitability and cash-generating ability) and thus of the quality of the profit earned.

Intangible Asset (Goodwill) (page 72)

Expected answer

Internally generated Intangible Asset (Goodwill) is not recognised as an asset becauseit is not an identifiable resource controlled by the company that can be measured reliablyat cost. Differences between the market value of a company and the carrying amount of



its identifiable net assets at any point in time may be due to a range of factors that affectthe value of the company. However, such differences cannot be considered to representthe cost of intangible assets controlled by the company.


Q28: False - they are entirely separate standard setting bodies. The ASB is part of theFRC.

Q29: False - accounting standards apply to all entities which prepare accounts intendedto show a true and fair view.

Q30: True - that is the correct order of publication.

Q31: False - the UITF does not issue standards, it issues ‘abstracts’.

Q32: True - it provides the conceptual framework.

Q33: False - alternative measurement bases such as current cost should be used whereappropriate.

Q34: False - some companies are exempt, including small companies.

Q35: True - this shows all movements in reserves as well as the profit or loss for theperiod.

Q36: False - it is the fair value, not the book value, which should be taken into account.

Q37: True - although in this case regular impairment reviews need to be carried out.

Q38: True - the true and fair view requirement overrides other requirements, but detailsof the departure must be disclosed in a note to the accounts.


Q39:










Less ExpensesOffice expenses 48Selling expenses 55Carriage outward 18Debenture finance cost (debenture interest) 4Depreciation: vehicles 20% cost 16Depreciation: fittings 25% NBV 3Discount allowed 4 148

11Add Income

Decrease in Provision for bad debt 1Profit for Year (Net Profit) 12

Less Corporation Tax 3Profit for Year (after Tax) 9

Add Unappropriated last year 312

Less Interim Ordinary Dividend 4Unappropriated Profit c/f 8



Statement of Financial Position (Balance Sheet)


201Current AssetsInventory (Stock) 44Cash and Cash Equivalents (Bank) 9Trade Receivables (Debtors) 40Less: Provision for Doubtful Debts 2 38Other Receivables (Prepaid Expenses) 5 96Current Liabilities

Debenture Finance Cost payable (DebentureInterest) due 4


249less Non-Current Liabilitiesless Debentures 40Total Net Assets 209Represented by:Issued Equity (Capital)50,000 8% Preference Shares, £1, fully paid 5080,000 Ordinary shares, £1, fully paid 80 130

Reserve:Unappropriated Profit c/f 8Share Premium 71 79Shareholders Interest 209

Q40: c) Other Receivables (Prepaid expenses).

Q41: a) Debenture Finance Cost (Debenture Interest).

Q42: b) Debenture holders are lenders.

Q43: b) Only the change in provision for bad debts is charged to the Income Statements(Profit and Loss accounts).

Q44: b) £175000

Q45:

1. Statement of Standard Accounting Practice



2. Financial Reporting Standard

3. Accounting Standards Board

4. Accounting Standards Committee

Q46:

1. false

2. true

3. false



4 Manufacturing concerns

Suit production (page 83)

Q1:

A) Indirect Cost

B) Direct Cost

C) Indirect Cost

D) Direct Cost

E) Indirect Cost

F) Direct Cost

Quiz: Types of cost in a manufacturing Account (page 83)

Q2: a) true

Q3: b) false

Q4: b) false

Q5: a) true

Q6: b) false

ABC Ltd Prime Costs (page 85)

Q7:

£ £ £Raw MaterialsOpening Inventory (Stock) 9,000Purchases 30,000add Carriage Inwards 400

30,400less Purchases Returns 1,000 29,400

38,400less Closing Inventory (Stock) 4,000Cost of Raw Materials consumed 34,400add Direct Labour 15,000add Direct Expenses (Royalties, DirectPower)

4,000 19,000

Prime Cost 53,400



ABC Ltd Factory Overheads (page 87)

Q8:

£ £ £Prime Cost 53,400(Add Factory Overheads)

Rent and Rates 3,000Factory Insurance 2,500Light and Heat 1,700Indirect Wages 10,000Depreciation of Machinery 3,000Maintenance 2,000 22,200

Factory or Manufacturing Cost ofProduction

75,600

ABC Ltd Work in Progress (page 88)

Q9:

Total Prime Cost 75,600Work in Progress (1 January) 4,000less Work in Progress (31 December) 2,000 2,000Factory/Manufacturing Cost of Production 77,600



Sinclair Ltd (page 88)

Q10:

£ £ £Raw MaterialsOpening Inventory (Stock) 4,000Purchases 30,000add Carriage Inwards 400 30,400

34,400less Closing Inventory (Stock) 2,000Cost of Materials consumed 32,400add Direct Labour 12,500Royalties 3,000 15,500Prime Cost 47,900(add Factory Overheads)

Factory Rent 1,800Factory Insurance 2,500Factory Wages 5,800Indirect Wages 8,000Depreciation of Factory Machinery 2,500Supervisor’s Wages 12,000 32,600

80,500add Work in Progress (1 January) 1,500less Work in Progress (31 December) 500 1,000Factory/Manufacturing Cost of Production 81,500

ABC Ltd Income Statement (Trading Account) (page 90)

Q11:

£ £ £Sales Revenue (Sales): FinishedGoods

175,000

less Cost of Sales Revenue (Sales)Opening Inventory (Stock): FinishedGoods

10,000

add Purchases: Finished Goods 8,000add Manufacturing Cost ofProduction

77,600

95,600less Closing Inventory (Stock):Finished Goods

6,000

89,600add Warehouse Wages 6,000 95,600Gross Profit 79,400



ABC Ltd Income Statement (Profit and Loss) (page 91)

Q12:

£ £ £Gross Profit 79,400(Less Expenses)

Selling Expenses 2,300Office Salaries 31,000Bad Debts 1,000General Expenses 3,000Rent 2,500Depreciation: Office Equipment 3,000 42,800

Profit for the Year (Net Profit) 36,600

Manufacturing or Income Statement? (Trading or Profit and Loss) (page 92)

Q13:

1. Manufacturing

2. Manufacturing

3. Manufacturing

4. Manufacturing

5. Manufacturing

6. Income Statement (Trading)



9. Income Statement (Profit and Loss)

10. Manufacturing and Income Statement (Trading)

11. Income Statement (Profit and Loss)



Accounts for Ford Ltd. (page 93)

Q14:

£ £ £Raw MaterialsOpening Inventory (Stock) 134Purchases 1,240Add Carriage Inwards 0

1,240Less Purchases Returns 40 1,200

1,334Less Closing Inventory (Stock) 94Cost of Raw Materials consumed 1,240Add Direct Labour 270Direct Power 120 390Prime Cost 1,630Add Factory Overheads

Light and Heat 12Factory Rates 15Factory Maintenance 14Indirect Wages 34Depreciation of Factory Machinery 12Factory Insurance 10 97

1,727Add Work in Progress (1 January) 7Less Work in Progress (31 December) 6 1Factory/Manufacturing Cost ofProduction

1,728



£ £ £Sales Revenue (Sales): Finished Goods 3,940Less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 70Add Purchases: Finished Goods 40Add Manufacturing Cost of Production 1,728

1,838Less Closing Inventory (Stock): Finished Goods 50

1,788Add Warehouse Wages 12 1,800Gross Profit 2,140Less ExpensesSelling Expenses 14Office Salaries 39Administration Expenses 16General Office Expenses 15Office Rent 16Depreciation: Office Equipment 5 105Profit for the Year (Net Profit) 2,035

Apportioning Expenses (page 97)

Q15:

Expense Factory Warehouse OfficeRent £2000 50% 40% 10%Amount to be apportioned (£) 10,000 8,000 2,000Insurance £12000 1/4 1/3 5/12Amount to be apportioned (£) 3,000 4,000 5,000Heat and Light £16000 50% 20% 30%Amount to be apportioned (£) 8,000 3,200 4,800Indirect Wages £40000 1/4 1/8 5/8Amount to be apportioned (£) 10,000 5,000 25,000


Q16:

Indirect Wages £150,000Amount to be charged:Factory £ 75,000Warehouse £25,000Office £ 50,000




Q17:

BusinessManufacturing

Cost ofProduction

Market Valueof Production

Profit/Loss onManufacture

Smith plc £120,000 £150,000 £30,000 ProfitJones Ltd £135,000 £130,000 £5,000 LossGreen Ltd £175,000 £146,000 £29,000 LossBrown plc £150,000 £165,000 £15,000 Profit


Q18:

ABC Ltd DEF plc PQR Ltd XYZ plcManufacturing Cost of Production £150,000 £90,000 £180,000 £36,000Units produced 25,000 30,000 40,000 9,000Manufacturing Cost per Unit £6.00 £3.00 £4.50 £4.00

Quiz: Manufacturing Cost per unit (page 100)

Q19: c) Indirect Wages.

Production Wages and Royalties are Direct Expenses in the Manufacturing Account -Selling Expenses appear in the Profit and Loss Section of the Income Statement

Q20: a) £30,000

Q21: b) Warehouse Expenses always appear in the Cost of Sales in the IncomeStatement (Trading Account).

Q22: c) Fixed Costs do not vary with output.

Q23: a) Selling Expenses.

Royalties and Factory Depreciation appear in Manufacturing Account -WarehouseExpenses in Trading Account (first part of Income Statement)

Q24: b) A Profit on Manufacture of £40,000 has been made.

Task 1: J Brown Plc (page 103)

Q25:

Manufacturing Account for J Brown as at 31 December Year 2



£ £ £Raw MaterialsOpening Inventory (Stock) 30Purchases 450add Carriage Inwards 4

454less Purchases returns 3 451

481less Closing Inventory (Stock) 40Cost of Raw Materials consumed 441add Direct Labour 51Royalties 3 54Prime Cost 495add Factory Overheads

Rent 15Insurance 6General Expenses 10Repairs to Factory Machinery 5Depreciation of Factory Machinery 10Indirect Wages 15 61

556add Work in Progress (1 January) 8less Work in Progress (31 December) 6 2Factory/Manufacturing Cost ofProduction

558

Profit on Manufacture 42Market Value of Production 600

Income Statement (Profit and Loss Account) for J Brown



£ £Sales Revenue (Sales) 800Less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 15Add Purchases: Finished Goods 20Add Manufacturing Cost of Production 600

635Less: Closing Inventory (Stock): Finished Goods 8

627Add Warehouse Wages 3 630Gross Profit 170Plus Profit on Manufacture 42

212less ExpensesRent 5Insurance 4Selling Expenses 9General Administration Expenses 12 30Profit for the Year (Net Profit) 182

Q26: £600,000/£50,000 = £12 per unit

Task 2: K Smith Accounts (page 106)

Q27:

K Smith Manufacturing Account for year ended 31 December



£000 £000 £000Raw MaterialsOpening Inventory (Stock) 45Purchases 560add Carriage Inwards 2

562less Purchases returns 3 559less Closing Inventory (Stock) 30

Cost of Raw Materials consumed 574Direct Wages (124 + 10) 134Royalties 7 141Prime Cost 715(add Factory Overheads)Rent (4/5 of 40) 32Insurance (2/3 of 9) 6General Expenses 12Repairs to Factory Machinery 4Depreciation of Factory Machinery (10% of 160) 16Indirect Wages 34 104

819add Work in Progress (1 January) 10less Work in Progress (31 December) 5 5Factory/Manufacturing Cost of Production 824Profit on Manufacture 26Market value of Production 850

£000 £000 £000Sales Revenue (Sales): Finished Goods 950(less Cost of Sales Revenue (Sales))Opening Inventory (Stock): Finished Goods 20add Purchases: Finished Goods 10add Manufacturing Cost of Production 850

880less: Closing Inventory (Stock): Finished Goods 5

875add Warehouse Wages (6 + 2) 8 883

Gross Profit 67plus Manufacturing Profit 26

93(less Expenses)Rent (1/5 of 40) 8Insurance (1/3 of 9) 3

Selling and Distribution Expenses (16 - 3) 13General Administration Expenses 18Depreciation: Office Equipment (20% of 60) 12 54Profit for the Year (Net Profit) 39



Q28: £13.73

Task 3: Revision of Manufacturing Accounts (page 107)

Q29: a) True

Q30: b) False

Q31: b) False

Q32: b) False

Q33: b) False

Q34: a) True

Q35: a) True

Q36: a) True

Task 4: L Brown Plc Accounts (page 108)

Q37:




£000 £000 £000Raw MaterialsOpening Inventory (Stock) 50Purchases 500Add Carriage Inwards 5

505Less Purchase Returns 4 501

551Less Closing Inventory (Stock) 40Cost of Raw Materials consumed 511Direct Wages 128Royalties 5 133Prime Cost 644Add Factory OverheadsRent 48Insurance 6General Expenses 20Repairs to Factory Machinery 8Depreciation of Factory Machinery 15Indirect Wages 38 135

779Add Work in Progress (1 Jan) 12Less Work in Progress (31 Dec) 8 4Factory/Manufacturing Cost of Production 783Profit on Manufacture 17Market Value of Production 800

Income Statement (Profit and Loss Account)



£000 £000 £000Sales Revenue (Sales): Finished Goods 920Less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 20Add Purchases: Finished Goods 10Add Market Value of Production 800

830Less: Closing Inventory (Stock): FinishedGoods

10

820Add Warehouse Wages 10 830Gross Profit 90Plus Manufacturing Profit 17

107Less ExpensesRent 12Insurance 3Selling and Distribution Expenses 17General Administration Expenses 16Depreciation: Office Equipment 16 64Profit for the Year (Net Profit) 43

Quiz: Revision of PLCs’ Accounts (page 113)

Q38: a) True

Q39: b) False

Q40: a) True

Q41: b) False

Q42: a) True

Q43: b) False

Q44: b) False

Q45: b) False

Q46: a) True

Q47: a) True

Q48: a) True

M White (page 115)

Q49:

Income Statement (Profit and Loss Account) at 31 March



£000 £000 £000Sales Revenue (Sales) 2,158Opening Inventory (Stock) 192Purchases 1,260Plus Carriage Inwards 40 1,300

1,492Less: Closing Inventory (Stock) 204Cost of Sales Revenue (Sales) 1,288Gross Profit 868Plus IncomeDividends on Quoted Investments 8Reduction in Provision for Bad Debts 2 10Less Expenses 878Bad Debts 4Discounts 23Selling and Distribution Expenses 142Rates 137Wages and Salaries 323Insurance 95Debenture Finance cost (Debenture Interest) 16Provision for DepreciationMotor Vehicles 25Fittings 13 778Profit for the Year (Net Profit) (before Tax) 100Less Corporation Tax 25Profit for the Year (Net Profit) (after Tax) 75Add Unappropriated Profit b/f 62Unappropriated Profit c/f 137

Statement of Financial Position (Balance Sheet): M White as at 31 March

£000 £000 £000Non-current Assets (Fixed Assets) Cost Deprn NBVProperty (Buildings) 867 33 900Fittings 130 41 89Motor Vehicles 181 81 100

1,089



£000 £000 £000Intangible AssetsInvestments 60Intangible Assets (Goodwill) 20 80

1,169Current AssetsInventory (Stock) 204Trade receivables (Debtors) 97Dividends due 2Selling/Distribution Expenses prepaid 3Cash and Cash Equivalents (Bank) 5 311Less Current LiabilitiesTrade Payables (Creditors) 90VAT 57Corporation Tax due 25Ordinary Dividend owing 63Debenture Finance cost (Debenture Interest) owing 8Wages owing 5 185Working Equity (Capital) 126less Debentures 200Total Net Assets 1,295

Financed by £000 £000 £000Issued Share Equity (Capital)700000 £1 Ordinary Shares 700200000 £1 Preference Shares 200 900ReservesShare Premium 25Unappropriated Profit c/f 137Equity (Capital) Reserve 33 195

1,0951,295

Apollo Plc (page 119)

Q50:




£000 £000 £000Raw MaterialsOpening Inventory (Stock) 148Purchases 2,048

2,196Less Closing Inventory (Stock) 183Cost of Raw Materials 2,013Production Wages 793Prime Cost 2,806Add Factory OverheadsFactory Expenses 148Rates 126Depreciation of Factory Machinery 14 288

3,094Add Work in Progress (1 Apr) 111Less Work in Progress (31 Mar) 106 5Manufacturing Cost of Production 3,099Profit on Manufacture 301Market Value of Production 3,400

Income Statement (Profit and Loss Account) at 31 December Year 3

£000 £000 £000Sales Revenue (Sales): finished Goods 3,820less Cost of Sales Revenue (Sales)Opening Inventory (Stock): Finished Goods 245Add Market Value of Production 3,400

3,645Less: Closing Inventory (Stock): FinishedGoods

232 3,413

Gross Profit 407Plus Profit on Manufacture 301

708less ExpensesGeneral Administration Expenses 245Selling and Distribution Expenses 84Rates 42Debenture Finance cost (Debenture Interest) 5Provision for Depreciation: Motor vehicles 18Provision for Bad Debts -2 392Profit for the Year (Net Profit) (before Tax) 316Less Corporation Tax 79Profit for the Year (Net Profit) (after Tax) 237Interim Ordinary Dividend 20 130

217Add Unappropriated Profit b/f 58Unappropriated Profit c/f 275

Statement of Financial Position (Balance Sheet): as at 31 December Year 3



£000 £000 £000Non-current Assets (Fixed Assets) Cost Deprn NBVFactory Property (at cost) 770 770Factory Machinery 140 44 96Motor Vehicles 204 78 126

992

£000 £000 £000Current AssetsInventory (Stock) 521Trade receivables (Debtors) 539General admin. Other receivables (Expensesprepaid) 7 1067

Less Current LiabilitiesTrade Payables (Creditors) 137VAT 45Corporation Tax due 79Ordinary Dividend owing 75Other Payables (Production Wages) owing 13Cash and Cash Equivalents (Bank Overdraft) 210 484Working Equity (Capital) 583

1,575less Debentures 50Total Net Assets 1,525

Financed by £000 £000 £000

750000 £1 Preference Shares 750500000 £1 Ordinary Shares 500 1,250ReservesUnappropriated Profit c/f 275

1,525


Q51:

1. in 1 and 2

2. in 2 and 6

3. in 3 and 6

4. in 1 and 2

5. in 4 and 5

6. in 3 and 6

Q52:

1. true



2. true

3. false

4. true

5. true

6. true

7. true

Q53:

Prime Cost 3,400Factory OverheadsRates 40Insurance 20Fuel and Power 60Repairs to Machinery 36 156

3,556Work in Progress (1 April year start) 34Work in Progress (31 March year end) 31 3Factory / Manufacturing Cost of Production 3,559Profit on Manufacture 141Market Value of Production 3,700

Q54:

Profit for the Year (Net Profit) (before Tax) 300Less Corporation Tax (25%) 75Profit for the Year (Net Profit) (after Tax) 225Less AppropriationsInterim Preference Dividend (10% of 100) 10Intangible Assets (Goodwill) (50% of 80%) 40Interim Ordinary Dividend 10 60

165Add Unappropriated Profit b/f 16Unappropriated Profit c/f 181



5 End of Unit 1 test

End of Unit 1 test (page 126)

Q1:

a) Preparing a Trial Balanced) Preparing a Statement of Financial position (Balance Sheet)e) Preparing a Ratio Analysis report

f)Ensuring Financial Statement (Final Accounts) conform to the requirements of theCompanies Act

Q2: Any four from:

• Banks;

• Government;

• Competitors/Potential Takeover Bidders;

• Trade Payables (Creditors)/Suppliers;

• Existing or Potential Shareholders;

• Debenture Holders;

• Employees/Trade Unions;

• Managers.

Q3:

Carrick plc Income Statement (Profit and Loss) And Appropriation Account for yearended 31 December Year 5:



Income Statement £000 £000 £000Gross Profit 310Less ExpensesGeneral Expenses (36-4) 32Selling Expenses 50Wages 98Increase in Provision for Doubtful Debts (10% x 80 =8-6 = 2) 2

Debenture Finance Cost (Debenture Interest) due 6Provision for Depreciation: Equipment (10% x (80-20) =6

6

Provision for Depreciation: Vehicles (20% x 60 = 12) 12 206104

add Income:Dividends on Investment Property (QuotedInvestments) 5

Discounts 3 8Profit for year (Net profit) BEFORE TAX 112LESS Corporation Tax (25%) 28Profit for year (Net profit) AFTER TAX 84ADD Unappropriated Profit 12

96less AppropriationsIntangible Assets (Goodwill) written down 20Interim Ordinary Dividend 12 32UNAPPROPRIATED PROFIT C/F 64

Statement of Financial position (Balance Sheet) as at 31 December Year 5:



£000 £000 £000Non-Current Assets (Fixed Assets)Property (Premises) 140 -20 160Equipment 80 26 54Vehicles 60 22 38

252Investment Property (Investments) 75Intangible Assets (Goodwill) 10 85

337Current AssetsInventory (Stock) (market value £30,000) 24Trade Receivables (Debtors) (80-8) 72General Expenses receivable (General Expensesprepaid) 4

Dividends owing 5VAT 11 116less Current LiabilitiesTrade Payables (Creditors) 63Debenture Finance Cost payable (Debenture Interestdue) 6

Corporation Tax due 28Warehouse Expenses payable (Warehouse Expensesowing) 3

Cash and Cash Equivalents (Bank overdraft) 5 105Equity (Working Capital) 11

348less Debentures 60TOTAL NET ASSETS 288FINANCED BY100,000 7% Preference Shares of £1 each 100200,000 Ordinary Shares of 50p each 100 200RESERVESEquity (Capital) Reserve 20Share Premium (34-30) 4Unappropriated Profit 64 88

288

Q4:

Burnside Manufacturing plc: Manufacturing Account for year ending 31 DecemberYear 2:



£000 £000

Opening Inventory (Stock) of Raw Materials 32Add Purchases of Raw Materials 155Less Purchases Returns Raw Materials 15 140

172Less Closing Inventory (Stock) of Raw Materials 20

Cost Of Raw Materials Consumed 152

Add Direct CostsDirect Factory Power 20Wages (80% x 120 + 5) = 100 100Royalties 62 182Prime Cost of Production 334

Add Factory OverheadsFactory Repairs 12Factory Rates 8Salaries 33General Expenses (75% x 12) 9Lighting and Heating (4/5 x 25 = 20) 20Insurance (4/5 x (17-2) = 12 12Depreciation:Factory Machinery (20% x (100-20)) = 16 16Motor Vehicles (10% x 50 ) = 5 x 20% = 1) 1 111

445Add Work-In-Progress 1 April, Year 1 27

472Less Work-In-Progress 31 March, Year 2 22

Factory Cost of Production 450Market Price of Finished Goods 480Factory Profit (480- 450) = 30 30

Burnside Manufacturing plc Trading Account for year ending 31 December Year 2:




Less Sales Returns 18662

Less Cost of Sales Revenue (Cost of Sales)Opening Inventory (Stock) of FinishedGoods

16

Add Market Price of Finished Goods 480Add Purchases of Finished Goods 60Add Carriage In On Finished Goods 2 542

558

LessClosing Inventory (Stock) of FinishedGoods

19

539Warehouse Expenses

Add Wages (20% x 125) = 25 25General Expenses (25% x 12) =3 3 28Cost of Sales Revenue (Cost of Sales) 567

Gross Profit 95

Q5:

Brown, Green and Grey

a) The profit or loss on revaluation:

£Property (Premises) 30,000Vehicles -5000Inventory (Stock) -3000Trade Receivables (Debtors) -2000

OverallProfit 20,000

Split:Brown (3/5 x 20,000) 12,000Green (2/5 x 20,000) 8,000

b) The new Equity (Capital) balances of Brown and Green:

Brown Green£ £

Original Balance 30,000 20,000Profit On Revaluation 12,000 8,000Intangible Assets (Goodwill)(3:2)

3,000 2,000

New Balance 45,000 30,000

c) The new profit sharing ratio of the partnership:



Grey 1/6Brown (3/5 x 5/6) 1/2Green (2/5 x 5/6) 1/3

Q6:

a) Accounting Standards Committeeb) Accounting Standards Boardc) Financial Reporting Standardsd) Standard Statement of Accounting Practice


SCHOLAR Study Guide CfE Higher Accounting Unit 1 ... CONTENTS 4.3 Preparation of the Manufacturing...

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Transcript of SCHOLAR Study Guide CfE Higher Accounting Unit 1 ... CONTENTS 4.3 Preparation of the Manufacturing...