BACHELOR OF COMMERCE HUMAN RESOURCE MANAGEMENT YEAR 1. FINANCIAL ACCOUNTING 1T Study Guide TOPICS 8 & 9

Transcription

1 BACHELO OF COMMECE HUMAN ESOUCE MANAGEMENT YEA 1 FINANCIAL ACCOUNTING 1T Study Guide TOPICS 8 & 9 Copyright 2014 MANAGEMENT COLLEGE OF SOUTHEN AFICA All rights reserved, no part of this book may be reproduced in any form or by any means, including photocopying machines, without the written permission of the publisher EF: FACCT14

2

3 MODULE CONTENTS - FINANCIAL ACCOUNTING 1T TOPIC NO. TOPIC PAGE(S) eadings 2 8 Close Corporation Companies MANCOSA BCom HM Year One 1

4 EADINGS PESCIBED There is no prescribed book for this module. This study guide will serve as your prescribed reading. ECOMMENDED Introduction to Financial Accounting Fifth edition, Dempsey, A. and Pieters. H.N. Chapters 1 to 13 and Chapter 15 MANCOSA BCom HM Year One 2

5 TOPIC 8 CLOSE COPOATIONS LEANING OUTCOME Students should be able to prepare the financial statements of a close corporation that comply with the requirements of Generally Accepted Accounting Practice. CONTENTS STUDY UNIT TITLE PAGE 1 Nature and formation of a close corporation Financial statements of a close corporation 8-42 MANCOSA BCom HM Year One 3

6 STUDY UNIT 1: NATUE AND FOMATION OF A CLOSE COPOATION SPECIFIC OUTCOMES Students should be able to: state the characteristics, advantages and disadvantages of a close corporation. explain the procedure involved in forming a close corporation. list the contents of the association agreement. explain the tax provisions relating to a close corporation. CONTENTS 1. Introduction 5 2. Characteristics, advantages and disadvantages of a close corporation 5 3. Formation of a close corporation 6 4. Management of a close corporation 6 5. Tax provisions 6 6. Self-assessment activities and solutions 7 MANCOSA BCom HM Year One 4

7 1. INTODUCTION The Close Corporations Act No 69 of 1984 made provision for incorporation of close corporations as from 1 January The primary motive of the act was to make provision for a corporate form of ownership for smaller businesses that would enjoy some status with regard to limited liability and tax benefits. Close corporations (CCs) are legal persons and fall under the control of the registrar of close corporations. They are simpler and less complicated to administer than companies. An existing company, with 10 or fewer members (all natural persons), can convert to a close corporation. 2. CHAACTEISTICS, ADVANTAGES AND DISADVANTAGES OF A CLOSE COPOATION 2.1 Characteristics of close corporations It may have a minimum of 1 but no more than 10 members who must be natural persons. It is a legal person (distinct from its members) with a limited liability and indefinite succession. Each member has an interest expressed as a percentage. Profits are distributed according to member s interest. Members are responsible for the management of the enterprise. An audit of the financial statements is not required. 2.2 Advantages of close corporations Each member may play an active role in the management of the enterprise. CCs do not have to hold any meetings of members. Liability of the members for the debts of the CC is limited to the contribution they have made to the capital of the CC. The life of a CC is indefinite despite changes to membership. The financial statements do not have to be audited. 2.3 Disadvantages of close corporations In certain instances, members may lose their benefit of limited liability. Members are agents of the CC and as such members can bind the CC through their actions. The limitation of the number of members to ten places a restriction on the amount of capital that may be raised. MANCOSA BCom HM Year One 5

8 3. FOMATION OF A CLOSE COPOATION A document, called a founding statement, must be completed and signed by the members. The founding statement must be submitted to the registrar of close corporations together with the agreement of the person who is appointed as the accounting officer and proof of payment of a prescribed fee. The founding statement contains the following details: the full name of the proposed CC the principal activity that is to be carried out by the CC the physical and postal address of the registered office of the CC the name, profession and postal address of the accounting officer the financial year end of the CC the names, addresses and identity numbers of each member the interest of each member expressed as a percentage details of the contribution of each member Upon registration, a registration number is allocated to the CC. 4. MANAGEMENT OF A CLOSE COPOATION The management of a CC is in the hands of the members. The members can draw up an agreement that regulates the internal management and relationship between the members. Such a document, called an association agreement, may contain the following details: the powers and duties of each member how a member s interest is disposed of in the event of death, retirement or insolvency procedure and voting rights at meetings remuneration for services rendered by members to the CC borrowing powers of members procedure for the distribution of profit to members 5. TAX POVISIONS In terms of the Income tax Act, a close corporation is defined as a company and is regarded as a private company for the purposes of tax. A member is regarded as a shareholder. Close corporations are taxed at the prevailing company rate. The profit distributed to members is not taxable in the hands of members. Close corporations must pay provisional tax as well as secondary tax on companies (if applicable). MANCOSA BCom HM Year One 6

9 SELF-ASSESSMENT ACTIVITIES AND SOLUTIONS Compare the characteristics of partnerships and close corporations and tabulate six differences between these two forms of ownership. 6.2 List eight details that should be included in the founding statement of a CC. 6.3 How are profits shared among members in a CC? 6.4 At what rate is the taxable profit of a CC taxed? 6.5 Are the members of a CC personally liable for tax? Explain. SOLUTIONS 6.1 PATNESHIPS CLOSE COPOATIONS Minimum 2 and maximum 20 partners Minimum 1 and maximum 10 members Is not a legal person Has legal personality Partners are jointly and severally liable for the debts of the partnership Liability of members for the debts of the CC is limited (except in certain cases) to the amount invested by members Lacks continuity It has perpetual succession Partners are taxed on the profits earned The CC is taxed as a company. Formed by oral or written agreement Formed by completing a founding statement 6.2 Formation of a close corporation. 6.3 Profits are distributed according to the members interests. 6.4 CCs are taxed at the same rate as companies. 6.5 No. Only the CC is taxed. The profits distributed to members of a CC are classified as dividends (which are not taxable). MANCOSA BCom HM Year One 7

10 STUDY UNIT 2: FINANCIAL STATEMENTS OF A CLOSE COPOATION SPECIFIC OUTCOMES Students should be able to: state the accounting records that a close corporation should maintain. name the duties of the accounting officer. prepare an Income statement, Statement of changes in equity, Balance sheet and Cash flow statement (including all notes) for a close corporation. CONTENTS 1. Introduction 9 2. Accounting records of a close corporation 9 3. The Accounting officer 9 4. Preparation of the financial statements of a close corporation Self-assessment activities and solutions MANCOSA BCom HM Year One 8

11 1. INTODUCTION The accounting records that are kept by a CC must represent the state of affairs and operations of the CC. These records are then used to draft the financial statements. 2. ACCOUNTING ECODS OF A CLOSE COPOATION The following records are required to be kept by a CC: records showing assets and liabilities, members contributions, retained earnings as well as loans to and from members a register of property, plant and equipment records showing daily entries of cash received and payments made records of all goods bought and sold on credit as well as services received and rendered on credit statements of annual inventory taking vouchers that support entries in the accounting records The financial statements of a CC should include the following: an Income statement a Balance sheet a Statement of changes in equity a Cash flow statement the accompanying notes The following must be disclosed in the financial statements: a statement of net investment of members as a note relating to the members interest on the balance sheet a description of transactions with members that were considered when determining the net profit 3. THE ACCOUNTING OFFICE The Close Corporations Act No 69 of 1984 requires that all CCs must appoint an accounting officer. The accounting officer must be a member of a recognised profession that requires its members to pass examinations in Accounting and related subjects. The accounting officer is required to: determine whether the financial statements are in agreement with the accounting records of the CC. evaluate the appropriateness of the accounting policies applied in the preparation of the financial statements. report to the members of the CC regarding the above. MANCOSA BCom HM Year One 9

12 4. PEPAATION OF THE FINANCIAL STATEMENTS OF A CLOSE COPOATION The following examples will be used to illustrate the preparation of an Income statement, Statement of changes in equity, Balance sheet and Cash flow statement of a CC. 4.1 Income statement, Statement of changes in equity and Balance sheet Example 1 The following information was taken from the accounting records of Proforma CC (with members Pro and Forma) on 30 June 20.7 (the end of the financial year). Proforma CC Trial Balance on 30 June 20.7 Balance sheet accounts section Debit () Credit () Member s contribution: Pro (66⅔%) Member s contribution: Forma (33⅓%) etained earnings Land and buildings Vehicles (cost) Equipment (cost) Accumulated depreciation on vehicles Accumulated depreciation on equipment Long-term loan: Mecer Bank (14% p.a.) Loan from Pro (12% p.a.) Loan to Forma (12% p.a.) Fixed deposit: Mecer Bank (10% p.a.) Inventory (30 June 20.6) Debtors control Provision for bad debts Bank Creditors control SAS Income tax Nominal accounts section Sales Purchases Sales returns Purchases returns Customs duty Carriage on purchases Carriage on sales Sundry expenses Salaries Motor expenses Interest on fixed deposit Interest on loan Interest on loan: Pro Interest on loan: Forma Discount allowed Commission income epairs MANCOSA BCom HM Year One 10

13 Additional information 1. The provision for bad debts must be increased by Trading inventory according to stocktaking on 30 June 20.7 amounted to A first instalment of is payable on the unsecured loan from Mecer Bank on 01 July Depreciation must be provided for as follows: on vehicles at 20% on cost on equipment at 28% on cost 5. The investment in fixed deposit was made on 01 July 20.6 and matures on 31 December Make provision for the outstanding interest. 6. An amount of is payable to Pro for special services rendered. 7. The loan to Forma is payable in full on 30 June Provide for the full year s interest on the loan. 8. Provide for the full year s interest on loan from Pro. Twenty percent of the loan is payable on 31 December The income tax for the year amounted to Provision must be made for a distribution of 75% of the net profit after tax for the year to the members. MANCOSA BCom HM Year One 11

14 Solution POFOMA CC INCOME STATEMENT FO THE YEA ENDED 30 JUNE 20.7 Note Sales ( ) Cost of sales ( ) Opening inventory Purchases ( ) Customs duty Carriage on purchases Closing inventory (96 000) Gross profit Operating expenses ( ) Carriage on sales Sundry expenses Salaries Motor expenses Discount allowed epairs Provision for bad debts adjustment Depreciation ( ) emuneration to Pro Operating profit Other income :Commission income :Interest on fixed deposit :Interest on loan to Forma Interest expense :on loan :on loan from Pro (36 960) (6 000) Profit before tax Income tax (62 400) Profit for the year MANCOSA BCom HM Year One 12

15 EMAKS The effects of the adjustments and additional information on the financial statements are as follows: Effect on Income statement Effect on Balance sheet, statement of changes in equity and notes to the financial statements 1. Provision for bad debts adjustment Provision for bad debts Closing inventory Trading inventory Long-term loan Current portion of loan Depreciation on: Vehicles ( X 20%) = Equipment ( X 28%) = Note 3 Depreciation for the year: Vehicles Equipment Interest on fixed deposit ( X 10%) = Accrued income = emuneration to Pro Accrued expenses Interest on loan to Forma: X 12% = Accrued income = Interest on loan from Pro X 12% = Accrued expenses = Loan from Pro ( 20% of ) = Current portion of loan Income tax South African evenue services = (owing) 10. Profit distribution Profit distribution payable POFOMA CC STATEMENT OF CHANGES IN EQUITY FO THE YEA ENDED 30 JUNE 20.7 Members Contributions etained earnings Total Balance at 01 July 20.6 Net profit for the year Profit distribution () () ( ) () ( ) Balance at 30 June MANCOSA BCom HM Year One 13

16 POFOMA CC BALANCE SHEET AS AT 30 JUNE 20.7 Notes ASSETS Non-current assets Property, plant and equipment Financial assets Loans to members Current assets Inventories Trade and other receivables Trade debtors Provision for bad debts ( ) Accrued income ( ) (4 400) Cash and cash equivalents Bank Total assets EQUITY AND LIABILITIES Members interest and reserves Members contributions etained earnings Non-current liabilities Long-term borrowings Loans from members ( ) Current liabilities Trade and other payables Trade creditors Accrued expenses ( ) Current portion of long-term borrowings Current portion of loans from members Profit distribution payable South African evenue Services ( ) Total equity and liabilities MANCOSA BCom HM Year One 14

17 NOTES TO THE FINANCIAL STATEMENTS 1. Accounting policy The accounting policy of Proforma CC is consistent with that of the previous year, and is as follows: 1.1 Measurement basis The financial statements are based on historical cost and comply with Generally Accepted Accounting Practice. 1.2 Property, plant and equipment Depreciation has been provided as follows: Vehicles: 20% per annum on the cost price Equipment: 28% per annum on the cost price. 1.3 Financial assets Financial assets are measured at fair value. 1.4 Inventories Inventories are measured at the lower of cost, on the FIF0 method, and net realisable value, whichever is lower. 1.5 evenue recognition Sales is recognised upon delivery of products. 2. Transactions with members emuneration Interest on loan paid to member Interest on loan received from member Pro Forma Total () () () (7 200) (7 200) (7 200) Property, plant and equipment Land and buildings Vehicles Equipment Total Carrying value at beginning of year Cost Accumulated depreciation (14 000) (28 000) (42 000) Depreciation for the year (16 000) (42 000) (58 000) Carrying value at end of year Cost Accumulated depreciation (30 000) (70 000) ( ) MANCOSA BCom HM Year One 15

18 4. Financial assets Investment in Fixed deposit at Mecer Bank at 10% p.a Loans to members Pro Forma Total () () () Balance on 01 July Advances during the year epayments during the year Balance on 30 June Inventories Inventories consist of: Merchandise Members contributions Members interest Members contributions Transactions during the yr Total Pro Forma % 66⅔% 33⅓% () () - - () Total 100 % Long term borrowings Unsecured Loan from Mecer Bank payable in instalments commencing from 01 July Interest rate is 14% p.a Less: Instalment payable within one year, transferred to current liabilities (24 000) Loans from members Pro Forma Total () () () Balance on 01 July Advances during the year epayments during the year Balance on 30 June MANCOSA BCom HM Year One 16

19 10. Members net investment statement for the year ended 30 June 20.7 Balance at the beginning of the year Movements during the year Contributions made* - Contributions repaid* - evaluations* - Net profit Distributions ( ) eserves* - Balance at the end of the year epresented by: Members contributions evaluations* - etained earnings eserves* Need not be shown if the question does not require it. 4.2 Cash flow statement The cash flow statement (or statement of cash flows), is a relatively new financial statement, that developed to fulfil the needs of the users of financial statements. This is largely due to the fact that the income statement is based on the accrual basis and does not show the cash flows from operating activities and also does not provide valuable information relating to cash flows from investing and financing activities (except for some related expenses and income). The main purpose of a cash flow statement is to provide information about the cash receipts and cash payments of an entity for a specific period. The statement provides reasons why cash and cash equivalents changed during the period by reflecting the net cash utilised or generated by operating activities, investing activities and financing activities. Having an understanding of a company s cash flows and the reasons for the cash flows are important to investors, managers, and other decision-makers. To be able to grow, a company must generate adequate cash flows to pay its bills, repay its debt, and provide an adequate return to its owners. Information obtained from a cash flow statement is used for evaluating past performance and future prospects. MANCOSA BCom HM Year One 17

20 4.2.1 Operating activities The cash flows from operating activities are derived from the main revenue-generating activities of the entity. They are cash flows that result from transactions reflected in the income statement. However, due to the determination of income and expenses according to the accrual basis, certain non-cash items are also included and they need to be excluded to determine the cash resulting from operating activities. The cash flow statement can be presented using two different formats. These formats only differ in the manner in which cash generated from operations is disclosed on the face of the statement. The remaining parts of the cash flow statement are identical for both formats. The first format called the direct method prescribes that the operating cash flows be disclosed according to the entity s major classes of gross cash receipts and gross cash payments. The following is an illustration of the disclosure on the face of the cash flow statement of cash generated from operations using this method. Direct method Cash received from customers Cash paid to suppliers and employees ( ) Cash generated from operations The second format is called the indirect method (which will be followed in this module). Using this method, the cash flows from operating activities are calculated by adjusting profit before interest in order to determine cash generated from operations. The adjustments involve the following: * items relating to investing and financing decisions e.g. loss on sale of equipment * non-cash flow adjustments e.g. depreciation * the effect of using the accrual basis (changes in working capital). The following is an illustration of the disclosure on the face of the cash flow statement of cash generated from operations using the indirect method. MANCOSA BCom HM Year One 18

21 Indirect method Profit before interest and tax Adjustments to convert to cash from operations Non-cash flow adjustments Add: Depreciation Add: Foreign exchange loss Profit before working capital changes Working capital changes ( ) Increase in inventory ( ) Increase in receivables ( ) Increase in payables Cash generated from operations Note that increases in current assets (inventory and receivables) and decreases in current liabilities (payables) are reported as operating uses of cash (and is indicated by bracketing the amount). On the other hand, decreases in current assets (inventory and receivables) and increases in current liabilities (payables) are reported as operating sources of cash Investing activities This category of the cash flow statement provides details about specific expenditures made to generate future income and outflows. It relates mainly to the purchase and sale of non-current assets. Separate disclosure of investing activities to expand operations is recommended. Examples of cash flows from investing activities include: payments to acquire non-current assets; receipts from sale of non-current assets; payments to acquire other entities and other equity or debt instruments; receipts from sale of interests in other entities, and sale of other equity or debt instruments; loans made to other parties or receipts from the repayment of such loans. MANCOSA BCom HM Year One 19

22 The following is an example of how cash flow from investing activities would appear on the face of the cash flow statement: Cash flow from investing activities Additions to plant and equipment Proceeds from sale of land and buildings (50 000) ( ) Note that any use of cash (e.g. additions to plant and equipment) is indicated by bracketing the amount Financing activities Cash flows from financing activities provide information relating to cash flows to and from providers of capital. This is useful to investors who wish to predict any future claims on the cash of the entity. Examples of cash flows from financing activities include: proceeds from the increase in members contributions (issue of shares in the case of companies); proceeds from loans and bonds (also issue of debentures in the case of companies) repayments of amounts borrowed. The following is an example of the disclosure of cash flow from financing activities on the face of the cash flow statement: Cash flow from financing activities Long-term borrowings redeemed Proceeds from increase in members contributions (50 000) Note again that any use of cash (e.g. long-term borrowings redeemed) is indicated by bracketing the amount. MANCOSA BCom HM Year One 20

23 The following example will be used to illustrate the preparation of a cash flow statement for a CC. Example 2 The following information was extracted from the accounting records of Mega CC. MEGA CC INCOME STATEMENT FO THE YEA ENDED 31 DECEMBE 20.6 Sales Cost of sales ( ) Opening inventory Purchases Closing inventory (75 000) Gross profit Operating expenses ( ) Administrative expenses (including Insurance) Wages and salaries Salaries to members Depreciation Operating profit Other income: Dividends earned Interest expense: on long-term loan (21 000) Profit before tax Income tax (69 000) Profit for the year MEGA CC STATEMENT OF CHANGES IN EQUITY FO THE YEA ENDED 31 DECEMBE 20.6 Members Contributions etained earnings Total Balance at 31 December 20.5 Net profit for the year Profit distribution Additional members contributions () () (56 250) () (56 250) Balance at 31 December MANCOSA BCom HM Year One 21

24 MEGA CC BALANCE SHEET AS AT 31 DECEMBE Note ASSETS Non-current assets Property, plant and equipment Financial assets: Investments Current assets Inventories Trade and other receivables Trade debtors Prepaid expenses (Insurance) Cash and cash equivalents Bank Cash float Total assets EQUITY AND LIABILITIES Members interest and reserves Members contributions etained earnings Non-current liabilities Long-term borrowings Current liabilities Trade and other payables Trade creditors Accrued expenses (wages) Profit distribution payable South African evenue Services (Income tax payable) Bank overdraft Total equity and liabilities MANCOSA BCom HM Year One 22

25 Note 1. Property, plant and equipment Land and buildings Equipment Total Carrying value at beginning of year Cost Accumulated depreciation (64 500) (64 500) Additions Disposals at carrying value Depreciation for the year (6 000) (28 500) (6 000) (28 500) Carrying value at end of year Cost Accumulated depreciation (73 500) (73 500) Additional information 1. Equipment that cost was sold for cash at carrying value during the year. 2. Equipment was purchased for cash during the year. equired Prepare the Cash flow statement of Mega CC for the year ended 31 December MANCOSA BCom HM Year One 23

26 Solution Mega CC Cash flow statement for the year ended 31 December 20.6 Cash flows from operating activities Profit before interest and tax (a) Adjustments to convert to cash from operations Non-cash flow adjustments Add: Depreciation (b) Profit before working capital changes Working capital changes (49 500) Increase in inventory (c) Increase in receivables (d) Decrease in payables (e) (28 500) (10 500) (10 500) Cash generated from operations Interest paid (f) (21 000) Dividends received (g) Profit distribution paid (h) (22 500) Income tax paid (i) (72 000) Cash flow from investing activities ( ) Acquisition of investments (j) (22 500) Additions to plant and equipment (k) ( ) Proceeds from sale of equipment (l) Cash flow from financing activities Proceeds from increase in members contributions (m) Proceeds from long-term borrowings (n) Net decrease in cash and cash equivalents (12 000) Cash and cash equivalents at beginning of year (o) Cash and cash equivalents at end of year (p) (1 500) MANCOSA BCom HM Year One 24

27 (a) Calculations and explanatory notes Note that all uses/outflows of cash are denoted by the use of brackets on the statement. Profit before interest and tax This amount is obtained from the Income statement (operating profit). (b) Depreciation The amount is obtained from the Income statement or the note Property, plant and equipment. (c) Increase in inventory The increase is calculated by comparing the inventory figures for both years: = (The amount is bracketed as it represents a use of cash.) (d) Increase in receivables The increase is calculated by comparing the Trade and other receivables figures for both years: = (The amount is bracketed as it represents a use of cash.) (e) (f) (g) (h) Decrease in payables The decrease is calculated by comparing the Trade and other payables figures for both years: = (The amount is bracketed as it represents a use of cash.) Interest paid The amount is obtained from the Income statement. Dividends received The amount is obtained from the Income statement. Profit distribution paid The amount paid is calculated as follows: Profit distribution due on 31 December 20.5 (22 500) Profit distribution for the year (56 250) Profit distribution due on 31 December (22 500) Note: Profit distribution due on 31 December 20.5/20.6 is obtained from the item Profit distribution payable under Current liabilities in the Balance sheet. Profit distribution for the year is obtained from the Statement of changes in equity. MANCOSA BCom HM Year One 25

28 (i) Income tax paid The amount paid is calculated as follows: Income tax due on 31 December 20.5 (16 500) Income tax for the year (69 000) Income tax due on 31 December (72 000) Note: Income tax due on 31 December 20.5/20.6 is obtained from the item South African evenue Services under Current liabilities in the Balance sheet. Income tax for the year is obtained from the Income statement. (j) Acquisition of investments The amount is calculated by comparing the Financial assets figures for both years: = (The amount is bracketed as it represents a use of cash.) (k) Additions to plant and equipment The amount is obtained from note 1 to the balance sheet viz. Property, plant and equipment and after consideration was given to the additional information. (l) Proceeds from sale of equipment The amount is also obtained from note 1 to the balance sheet viz. Property, plant and equipment and after consideration was given to the additional information. (m) Proceeds from increase in members contributions The amount may be obtained from the Statement of changes in equity or by comparing the figures for both years for Members contributions in the Balance sheet. (n) Proceeds from long-term borrowings The amount is obtained by comparing the figures for both years for Long-term borrowings (found in the Balance sheet): = MANCOSA BCom HM Year One 26

29 (o) Cash and cash equivalents at beginning of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.5: Cash and cash equivalents ( ) Bank overdraft 0 Net favourable balance (p) Cash and cash equivalents at end of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.6: Cash and cash equivalents Bank overdraft (3 000) Net unfavourable balance (1 500) Other calculations Profit before working capital changes = Cash generated from operations: = Cash flows from operating activities: = Net decrease in cash and cash equivalents This amount can be calculated by comparing the cash balances of 20.5 and 20.6 i.e. a net favourable balance of (20.5) turned into a net unfavourable balance of (20.6) resulting in a net decrease in cash and cash equivalents of The net decrease can be verified as follows: = MANCOSA BCom HM Year One 27

30 5. SELF ASSESSMENT ACTIVITIES AND SOLUTIONS 5.1 The information given below was extracted from the accounting records of egal CC, with members Charles, William and Harry, on 31 December 20.6 (the end of the financial year). Information egal CC Trial Balance on 31 December 20.6 Balance sheet accounts section Debit () Credit () Member s contribution: Charles Member s contribution: William Member s contribution: Harry etained earnings Land and buildings Vehicles (cost) Equipment (cost) Accumulated depreciation on vehicles Accumulated depreciation on equipment Mortgage bond: Gen Bank (15% p.a.) Loan from William (12% p.a.) Loan from Harry (12% p.a.) Loan to Charles (14% p.a.) Investment ( shares in IBN Ltd at market value) Inventory (31 December 20.5) Debtors control Provision for bad debts Bank Creditors control SAS Income tax Nominal accounts section Sales Purchases Import duty ailage on purchases Maintenance ates Commission on sales Delivery expenses Discount allowed Wages and salaries Stationery Bad debts 920 Sundry expenses 440 Insurance 950 Telephone Water and electricity Dividends received 900 Interest expenses on loans ent income MANCOSA BCom HM Year One 28

31 Additional information 1. Provision for bad debts must be adjusted to 5% of trade debtors. 2. Trading inventory according to stocktaking on 31 December 20.6 amounted to Depreciation must be provided for as follows: on vehicles at 25% per annum on the diminishing balance on equipment at 20% on cost 4. Interest expenses on loans include interest paid to William and Harry on the loans they made to the CC on 31 December The loans are repayable in full on 30 June will be paid on 31 May 20.7 towards the mortgage bond (that is secured by a first mortgage on land). 5. The loan to Charles was granted on 01 July Provide for outstanding interest on loan was paid to Harry for his special contribution to the management of the CC. The amount paid to him is included in wages and salaries. 7. The interest of the members in the CC is in the same ratio as their contributions. 8. The income tax for the year amounted to Provision must be made for a profit distribution of to the members. equired Prepare the following for egal CC: 1. Income statement for the year ended 31 December Statement of changes in equity for the year ended 31 December Balance sheet at 31 December The necessary notes to the financial statements The statements must comply with Generally Accepted Accounting Practice. MANCOSA BCom HM Year One 29

32 5.2 The information given below was extracted from the accounting records of Vista CC. equired Prepare the Cash flow statement for the year ended 31 December Information from the Balance sheet as at 31 December Members contributions etained earnings Mortgage bond Land and buildings at cost Equipment at cost Accumulated depreciation on equipment Investment Inventory Trade debtors Accrued income (ent) Bank (Dr) Trade creditors Accrued expenses (Interest on mortgage bond) Bank overdraft South African evenue Services (Income tax payable) Profit distribution payable Extract from the Income statement for the year ended 31 Dec 20.8 Profit before interest and tax Depreciation on equipment Dividends received on investment Loss on sale of equipment Interest on mortgage bond Income tax Extract from Statement of changes in equity for the year ended 31 December 20.8 Profit distribution Additional information 1. Equipment was sold for cash. No equipment was purchased. 2. Extensions were made to the buildings for cash. MANCOSA BCom HM Year One 30

33 Solutions 5.1 EGAL CC INCOME STATEMENT FO THE YEA ENDED 31 DECEMBE 20.6 Note Sales Cost of sales ( ) Opening inventory Purchases Import duty ailage on purchases Closing inventory ( ) Gross profit Operating expenses ( ) Maintenance ates Commission on sales Delivery expenses Discount allowed Wages and salaries ( ) Stationery Bad debts Sundry expenses Insurance Telephone Water and electricity Provision for bad debts adjustment Depreciation ( ) Salary to Harry Operating profit Other income: ent income : Interest on loan to Charles : Dividends earned Interest expense: on mortgage bond : on loans from William and Harry (15 000) (4 320) Profit before tax Income tax (19 800) Profit for the year MANCOSA BCom HM Year One 31

34 EMAKS The effects of the adjustments and additional information on the financial statements are as follows: Effect on Income statement Effect on Balance sheet, statement of changes in equity and notes to the financial statements 1. Provision for bad debts adjustment = 95 Provision for bad debts ( X 5%) = Closing inventory Trading inventory Depreciation on: Vehicles ( ) X 25% = Equipment ( X 20%) = Note 3 Depreciation for the year: Vehicles Equipment Interest on mortgage bond = Interest on loans from members Mortgage bond = Current portion of loan Interest on loan to member Accrued income X 14% X6/12 = Salary to Harry Wages and salaries atio is 8:7:5 for profit distribution 8. Income tax South African evenue Services = (owing) 9. - Profit distribution Profit distribution payable EGAL CC STATEMENT OF CHANGES IN EQUITY FO THE YEA ENDED 31 DECEMBE 20.6 Members Contributions etained earnings Total Balance at 01 January 20.6 Net profit for the year Profit distribution () () (20 000) () (20 000) Balance at 31 December MANCOSA BCom HM Year One 32

35 EGAL CC BALANCE SHEET AS AT 31 DECEMBE 20.6 Notes ASSETS Non-current assets Property, plant and equipment Financial assets Loans to members Current assets Inventories Trade and other receivables Trade debtors Provision for bad debts Accrued income (1 050) (2 005) Cash and cash equivalents Bank Total assets EQUITY AND LIABILITIES Members interest and reserves Members contributions etained earnings Non-current liabilities Long-term borrowings Loans from members Current liabilities Trade and other payables Trade creditors Current portion of long-term borrowings Profit distribution payable South African evenue Services ( ) Total equity and liabilities MANCOSA BCom HM Year One 33

36 NOTES TO THE FINANCIAL STATEMENTS 1. Accounting policy The accounting policy of egal CC is consistent with that of the previous year, and is as follows: 1.1 Measurement basis The financial statements are based on historical cost and comply with Generally Accepted Accounting Practice. 1.2 Property, plant and equipment Depreciation has been provided as follows: Vehicles: 25% per annum on the diminishing balance. Equipment: 20% per annum on the cost price. 1.3 Financial assets Financial assets are measured at fair value. Listed shares are measured at market value. 1.4 Inventories Inventories are measured at the lower of cost, on the FIF0 method, and net realisable value, whichever is lower. 1.5 evenue recognition Sales is recognised upon delivery of products. 2. Transactions with members Charles William Harry Total Salary Interest on loan paid to member Interest on loan received from member (1 050) (1 050) (1 050) Property, plant and equipment Land and buildings Vehicles Equipment Total Carrying value at beginning of year Cost Accumulated depreciation (16 800) (13 400) (30 200) Depreciation for the year (6 300) (13 200) (19 500) Carrying value at end of year Cost Accumulated depreciation (23 100) (26 600) (49 700) MANCOSA BCom HM Year One 34

37 4. Financial assets Investment in shares in IBN Ltd at market value Loans to members Charles William Harry Total Balance on 01 January 20.6 Advances during the year epayments during the year Balance on 31 December Inventories Inventories consist of: Merchandise Members contributions Members interest Members contributions Transactions during the yr Total Charles William Harry % () () () Total 100 % Long term borrowings Secured Mortgage bond from Gen Bank secured by a first mortgage on land with instalment payable from 31 May Interest rate is 15% p.a Less: Instalment payable within one year, transferred to current liabilities (20 000) Loans from members Charles William Harry Total Balance on 01 January Advances during the year epayments during the year Balance on 31 December MANCOSA BCom HM Year One 35

38 10. Members net investment statement for the year ended 31 December 20.6 Balance at the beginning of the year Movements during the year Net profit Distributions (20 000) Balance at the end of the year epresented by: Members contributions etained earnings MANCOSA BCom HM Year One 36

39 5.2 Vista CC Cash flow statement for the year ended 31 December 20.8 Cash flows from operating activities Profit before interest and tax (a) Adjustments to convert to cash from operations Non-cash flow adjustments Add: Depreciation (b) Loss on disposal of asset (c) Profit before working capital changes Working capital changes Decrease in inventory (d) Decrease in receivables (e) Decrease in payables (f) (18 000) Cash generated from operations Interest paid (g) (21 000) Dividends received (h) Profit distribution paid (i) (90 000) Income tax paid (j) (61 500) Cash flow from investing activities (50 500) Proceeds from disposal of investments (k) Additions to land and buildings (l) ( ) Proceeds from sale of equipment (m) Cash flow from financing activities Proceeds from increase in members contributions (n) Long-term borrowings redeemed (o) (45 000) Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year (p) (3 000) Cash and cash equivalents at end of year (q) MANCOSA BCom HM Year One 37

40 (a) (b) (c) (d) (e) (f) Calculations and explanatory notes Profit before interest and tax This amount is obtained from the extract of the Income statement. Depreciation The amount is obtained from the extract of the Income statement. Loss on disposal of asset The amount is obtained from the extract of the Income statement. Decrease in inventory The decrease is calculated by comparing the inventory figures for both years: = (The amount represents a source of cash.) Decrease in receivables The decrease is calculated by comparing the Trade and other receivables figures (Trade debtors and Accrued income) for both years: ( ) (45 000) = (The amount represents a source of cash.) Decrease in payables The decrease is calculated by comparing the Trade and other payables figures (Trade creditors*) for both years: = (The amount is bracketed as it represents a use of cash.) *Note: Accrued expenses are usually added to Trade creditors but because the amounts owing relate to interest on loan that is a separate item on the statement, the accrued amounts will be used to calculate the interest paid [refer to (g) below]. (g) Interest paid The amount paid is calculated as follows: Interest due on 31 December 20.7 (9 000) Interest expense for the year (19 500) Interest due on 31 December (21 000) Note: Interest due on 31 December 20.7/20.8 is obtained from the item Accrued expenses in the Balance sheet. Interest expense for the year is obtained from the extract of the Income statement. MANCOSA BCom HM Year One 38

41 (h) Dividends received The amount is obtained from the extract of the Income statement. (i) Profit distribution paid The amount paid is calculated as follows: Profit distribution due on 31 December 20.7 (56 250) Profit distribution for the year (56 250) Profit distribution due on 31 December (90 000) Note: Profit distribution due on 31 December 20.7/20.8 is obtained from the item Profit distribution payable in the Balance sheet. Profit distribution for the year is obtained from the Statement of changes in equity. (j) Income tax paid The amount paid is calculated as follows: Income tax due on 31 December 20.7 (13 500) Income tax for the year (64 500) Income tax due on 31 December (61 500) Note: Income tax due on 31 December 20.7/20.8 is obtained from the item South African evenue Services in the Balance sheet. Income tax for the year is obtained from the Income statement. (k) Proceeds from disposal of investments The amount is calculated by comparing the Investment figures for both years: = (The amount represents a source of cash.) (l) Additions to land and buildings The amount is obtained by comparing the figures for both years for Land and buildings in the Balance sheet and after consideration was given to the additional information: = MANCOSA BCom HM Year One 39

42 (m) (n) (o) (p) (q) Proceeds from sale of equipment The amount is calculated by using figures from the balance sheet (Equipment at cost; Accumulated depreciation on equipment), extract of Income statement (Loss on sale of equipment) and after consideration was given to the additional information: Carrying value of equipment on 31 December 20.7 ( ) Additions 0 Disposals at carrying value *(27 750) Depreciation (28 500) Carrying value of equipment on 31 December 20.8 ( ) *Disposals at carry value is calculated as follows: ( ) ( ) = However, the equipment was sold at a loss of 750. Therefore the proceeds from the sale of equipment is ( ). Proceeds from increase in members contributions The amount is obtained from comparing the figures for Members contributions from the Balance sheet for both years: = Long-term borrowings redeemed The amount is obtained by comparing the figures for both years for Mortgage bond in the Balance sheet: = (The amount is bracketed as it represents a use of cash.) Cash and cash equivalents at beginning of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.7: Cash and cash equivalents 0 Bank overdraft (3 000) Net unfavourable balance (3 000) Cash and cash equivalents at end of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.8: Cash and cash equivalents Bank overdraft 0 Net favourable balance MANCOSA BCom HM Year One 40

43 Other calculations Profit before working capital changes = Cash generated from operations: = Cash flows from operating activities: = Net increase in cash and cash equivalents This amount can be calculated by comparing the cash balances of 20.7 and 20.8 i.e. an unfavourable bank balance of (20.7) turned into a favourable balance of (20.8) resulting in a net increase in cash and cash equivalents of The net increase can be verified as follows: = MANCOSA BCom HM Year One 41

44 MANCOSA BCom HM Year One 42

45 TOPIC 9 COMPANIES LEANING OUTCOME Students should be able to prepare the financial statements of a company for internal use that comply with the requirements of Generally Accepted Accounting Practice. CONTENTS STUDY UNIT TITLE PAGE 1 The company as a form of entity Financial statements of a company MANCOSA BCom HM Year One 43

46 STUDY UNIT 1: THE COMPANY AS A FOM OF ENTITY SPECIFIC OUTCOMES Students should be able to: define the concept of company. describe how a company is formed. record share transactions of a company. distinguish between non-distributable and distributable reserves. explain the tax provisions relating to a companies. CONTENTS 1. Introduction Formation of a company Share capital Debentures Dividends and reserves Tax provisions Self-assessment activities and solutions MANCOSA BCom HM Year One 44

47 1. INTODUCTION A company is an association of people who work together in order to make a profit. It is a legal person and is incorporated in accordance with the Companies Act 61 of Its existence is independent of the shareholders (owners). Unlike sole proprietorships and partnerships, a company is able to: acquire more capital; exist independently of the owners (shareholders); change owners; limit the liability of shareholders to the amount that they have invested in the enterprise. A company invites the public (including the business community) to invest in it. To make it possible for many people (hundreds or even thousands) to invest in a company, it divides the capital it requires (e.g ) into small units called shares (e.g shares of 1 each or shares of 2 each). Shareholders obtain a share of the profit by receiving a dividend per share. The shares of a public company are freely transferable. Shareholders have a right to vote at meetings on matters such as the appointment of directors and determining the objectives of the company. A board of directors co-ordinate and makes policies for a company. Top management and other officials are involved in the daily management of the company. 2. FOMATION OF A COMPANY The people who start a company are called founders or promoters. A company must be established in accordance with the requirements of the Companies Act. If a company registers two important documents viz. memorandum and articles of association in accordance with the Companies Act, the company is incorporated. It comes into existence when the registrar of companies issues a certificate of incorporation. After meeting the requirements for the sale of a stated minimum number of shares, the company can then apply for a certificate to commence business. Only after this certificate is issued by the registrar may the company actually start operating. The memorandum of association includes important clauses relating to the name of the company, the purpose for which the company was established and details relating to the share capital. The articles of association, on the other hand, relates to the internal matters and management of the company. Matters covered in the articles of association include shares, meetings, directors, accounting records, dividends and reserves. MANCOSA BCom HM Year One 45