UNIVERSITY OF MAIDUGURI CENTRE FOR DISTANCE LEARNING

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1 UIVERSITY OF MAIDUGURI CETRE FOR DISTACE LEARIG ACC 201: Introduction to Financial Accounting I (2 Units) Course Facilitator: STUDY GUIDE

2 Course Code/ Title: Credit Units: Timing: Total hours of Study per each course material should be twenty Six hours (26hrs) at two hours per week within a given semester. You should plan your time table for study on the basis of two hours per course throughout the week. This will apply to all course materials you have. This implies that each course material will be studied for two hours in a week. Similarly, each study session should be timed at one hour including all the activities under it. Do not rush on your time, utilize them adequately. All activities should be timed from five minutes (5minutes) to ten minutes (10minutes). Observe the time you spent for each activity, whether you may need to add or subtract more minutes for the activity. You should also take note of your speed of completing an activity for the purpose of adjustment. Meanwhile, you should observe the one hour allocated to a study session. Find out whether this time is adequate or not. You may need to add or subtract some minutes depending on your speed. You may also need to allocate separate time for your self-assessment questions out of the remaining minutes from the one hour or the one hour which was not used out of the two hours that can be utilized for your SAQ. You must be careful in utilizing your time. Your success 2

3 depends on good utilization of the time given; because time is money, do not waste it. Reading: When you start reading the study session, you must not read it like a novel. You should start by having a pen and paper for writing the main points in the study session. You must also have dictionary for checking terms and concepts that are not properly explained in the glossary. Before writing the main points you must use pencil to underline those main points in the text. Make the underlining neat and clear so that the book is not spoiled for further usage. Similarly, you should underline any term that you do not understand its meaning and check for their meaning in the glossary. If those meanings in the glossary are not enough for you, you can use your dictionary for further explanations. When you reach the box for activity, read the question(s) twice so that you are sure of what the question ask you to do then you go back to the in-text to locate the answers to the question. You must be brief in answering those activities except when the question requires you to be detailed. In the same way you read the in-text question and in-text answer carefully, making sure you understand them and locate them in the main text. Furthermore before you attempt answering the (SAQ) be 3

4 sure of what the question wants you to do, then locate the answers in your in-text carefully before you provide the answer. Generally, the reading required you to be very careful, paying attention to what you are reading, noting the major points and terms and concepts. But when you are tired, worried and weak do not go into reading, wait until you are relaxed and strong enough before you engage in reading activities. Bold Terms: These are terms that are very important towards comprehending/understanding the in-text read by you. The terms are bolded or made darker in the sentence for you to identify them. When you come across such terms check for the meaning at the back of your book; under the heading glossary. If the meaning is not clear to you, you can use your dictionary to get more clarifications about the term/concept. Do not neglect any of the bold term in your reading because they are essential tools for your understanding of the in-text. Practice Exercises a. Activity: Activity is provided in all the study sessions. Each activity is to remind you of the immediate facts, points and major informations you read in the in-text. In every study session there is one or more activities provided for you to answer them. You must be very careful in answering these activities because they provide you with major facts of the text. You can have a separate note book for the activities which can 4

5 serve as summary of the texts. Do not forget to timed yourself for each activity you answered. b. In-text Questions and Answers: In-text questions and answers are provided for you to remind you of major points or facts. To every question, there is answer. So please note all the questions and their answers, they will help you towards remembering the major points in your reading. c. Self Assessment Question: This part is one of the most essential components of your study. It is meant to test your understanding of what you studied so you must give adequate attention in answering them. The remaining time from the two hours allocated for this study session can be used in answering the self- assessment question. Before you start writing answers to any questions under SAQ, you are expected to write down the major points related to the particular question to be answered. Check those points you have written in the in-text to ascertain that they are correct, after that you can start explaining each point as your answer to the question. When you have completed the explanation of each question, you can now check at the back of your book, compare your answer to the solutions provided by your course writer. Then try to grade your effort sincerely and honestly to see your level of performance. This procedure should be applied to all SAQ 5

6 activities. Make sure you are not in a hurry to finish but careful to do the right thing. e-tutors: The etutors are dedicated online teachers that provide services to students in all their programme of studies. They are expected to be twenty- four hours online to receive and attend to students Academic and Administrative questions which are vital to student s processes of their studies. For each programme, there will be two or more e-tutors for effective attention to student s enquiries. Therefore, you are expected as a student to always contact your e- tutors through their addresses or phone numbers which are there in your student hand book. Do not hesitate or waste time in contacting your e-tutors when in doubt about your learning. You must learn how to operate , because ing will give you opportunity for getting better explanation at no cost. In addition to your e-tutors, you can also contact your course facilitators through their phone numbers and s which are also in your handbook for use. Your course facilitators can also resolve your academic problems. Please utilize them effectively for your studies. Continuous assessment The continuous assessment exercise is limited to 30% of the total marks. The medium of conducting continuous assessment may be through online testing, Tutor Marked test or assignment. You may be required to submit your test or assignment through your . The continuous assessment may be conducted more than once. You must 6

7 make sure you participate in all C.A processes for without doing your C.A you may not pass your examination, so take note and be up to date. Examination All examinations shall be conducted at the University of Maiduguri Centre for Distance Learning. Therefore all students must come to the Centre for a period of one week for their examinations. Your preparation for examination may require you to look for course mates so that you form a group studies. The grouping or etworking studies will facilitate your better understanding of what you studied. Group studies can be formed in villages and township as long as you have partners offering the same programme. Grouping and Social etworking are better approaches to effective studies. Please find your group. You must prepare very well before the examination week. You must engage in comprehensive studies. Revising your previous studies, making brief summaries of all materials you read or from your first summary on activities, in-text questions and answers, as well as on self assessment questions that you provided solutions at first stage of studies. When the examination week commences you can also go through your brief summarizes each day for various the courses to remind you of main points. When coming to examination hall, there are certain materials that are prohibited for you to carry (i.e Bags, Cell phone, and any paper etc). You will be checked before you are 7

8 allowed to enter the hall. You must also be well behaved throughout your examination period. 8

9 Study session 1: Final Account of a Sole Trader Introduction The main objective of this Statement is the determination or calculation of the gross profit and et Profit for the period. It is also in this account that the cost of obtaining the goods, usually referred to as cost of goods sold or simply as cost of sales is calculated. Learning outcomes: At the end of this session, readers would be able to:- 1.1 Understand the steps involved in preparation of a Sole trader final accounts 1.2 Know some accounting terminologies 1.3 Prepare income Statement of a Sole Trader from trial balance 1.4 Prepared Statement of financial position 1.1 Steps involved in preparation of a Sole trader final account The first step in the preparation of the final accounts is the compilation of a Trial Balance, with a view to: (a) Proving the arithmetical accuracy of the postings, and (b) Providing in one statement a concise summary of the items, which are to be included in the Income statement (i.e. Trading, Profit and Loss account) and the Statement of financial position (i.e. Balance Sheet). Debit balances recorded in the Trial Balance normally represent either assets, or losses and expenses. The assets are entered in the Statement of financial position, while losses and expenses are debited to the Income statement. Credit balances represent liabilities, provisions, reserves, or revenues and gains. The liabilities are entered in the statement of financial position as deductions from assets of the firm, while income and gains are credited to the Income statement. The main objective of this Statement is the determination or calculation of the gross profit for the period. It is also in this account that the cost of obtaining the goods, usually referred to as cost of goods sold or simply as cost of sales is calculated. Another important function of this Statement of is that it enables the owner of a business to compare the gross and net profit of a current period with the results attained in previous periods. It is pertinent that, the component items in the Income Statement do not vary in any 9

10 material effect from previous and subsequent accounts, as this will make it impossible for any analyst to make meaningful approximate comparison. This therefore means that the Income Statement should be standardized so that the same items should appear in similar form in the successive final accounts so that an effective comparison may be made of one trading period with another. The actual items in the Income Statements of different classes of enterprises or businesses will necessarily vary depending on the nature of the nominal accounts in the respective business; for example, a retailer selling rice or maize. 1.2 Accounting Terminologies Business Organisations usually maintain four different accounts for the inventories/stocks function. The accounts involved are: i. Sales or Turnover account ii. Returns inwards account iii. Purchases account and iv. Returns outwards account The sales and the returns inwards accounts are accounts in which are recorded the respective goods sold and goods returned by customers. The purchases account and the returns outwards account contain transactions involving goods bought for resale and goods returned to suppliers respectively. The usual practice is to maintain the sales account separately and not to deduct directly any goods that have been returned by customers during the accounting period. The returns inwards account serves as a contra to the sales account by recording all sales that have been returned by customers. Being a contra account to the sales account means that it has a debit balance which when transferred to the sales account at the end of the accounting period will show the net sales or turnover of the organisation The accounting entries will be recorded as follows: Dr. Bank/Cash or Debtors/Receivables Account Cr. Sales or Turnover Account With goods sold for cash or on credit Dr. Returns inwards Account Cr. Bank/Cash or Debtors/Receivables Account With goods sold but returned by customers 10

11 Dr. Sales or Turnover Account Cr. Returns inwards Account With the balance on the return inwards account Similarly the purchases account is maintained separately by recording all goods bought for the sole purpose of resale relating to the accounting period. The returns outwards account serves as a contra to the purchases account. Into this account is recorded all purchases that were returned to suppliers. Being a contra account to the purchases account means that it has a credit balance which when transferred to the purchases account at the end of the accounting period will show the net purchases of the business organisation The accounting entries will be recorded as follows: Dr. Purchases Account Cr. Bank/Cash or Creditors/Payables Account With goods bought for cash or on credit Dr. Bank or Creditors/Payables Account Cr. Returns outwards Account With goods bought but returned to suppliers Dr. Returns outwards Account Cr. Purchases Account With the balance on the return outwards account Carriage inwards and outwards Carriage is an accounting terminology that refers to the cost of transport that a trading concern incurs in moving goods meant for resale into or out of a firm. Where the carriage is charged for delivering goods purchased, it is called carriage inwards. Carriage of goods upon sale out of a firm is called carriage outwards. Carriage inwards is a cost that is incurred in order to bring the goods into a condition that is necessary for its sale and as such should be charged to the Income Statement. This is done by adding the carriage inwards to the purchases figure in the Income Statement. This ensures that the true cost of buying goods for resale is taken into account in calculating the gross profit of a business. Carriage outwards, however, is not considered as a relevant cost the purpose of which is to put the asset into a saleable condition. It is therefore worthy to note that carriage outwards is 11

12 an Income statement item and for that reason is not included in the calculation of gross profit. This is because carriage outwards is seen as expenses on sales and as a result is debited in the Income statement Drawings of goods or cash It is common in a one man business to find the proprietor making use of the products that he is selling for his own benefit. The use of products or goods by a proprietor is usually termed inventories/stocks drawings. The accounting effect of inventories drawings is that it reduces the amount of cost of goods available for sale since the total goods bought for resale have been reduced by the inventories/stocks drawings and as such the inventories/stocks drawings account must be debited and the purchases account credited. 1.3 Preparation of income Statement of a Sole Trader from trial balance Format for preparing final accounts of a sole trader ADA SOLE TRADER Income Statement for the Year Ended 31 st December, 20XX Sales/Turnover x Returns inwards (x) et sales xx Cost of goods sold: Opening inventory/stock x Purchases x Add: Carriage inwards x Wages x Less: Return outwards (x) Drawings (x) Lost (x) x Cost of goods available for sales xx Less; closing inventory/stock (x) (xx) Gross profits xx Add other incomes: Discount received x Decrease in provision of bad and doubtful debts x Received x xx 12

13 Less Expense: Carriage outwards x Discount allowed x Bad debts written off x Increase in provision of bad and doubtful debts x Wages and salaries x Rent and Rates x Insurance x Depreciation charges on non-current assets x (xx) et profits xx 1.3 Preparation of Statement of financial position Statement of Financial Position as at 31 st December, 20XX on-current Assets: Cost Dep. BV Land properties x (x) x Fixtures x (x) x Motor Vehicles x (x) x x x (x x) xx current Assets: Inventory/stocks x Accounts receivable/debtors x Less provision for bad debts (x) Prepayments x Cash at Bank x Cash in Hand x xx Total Assets xx Equities and Liabilities: Capital x Add et profit x Less Drawings (x) Proprietor Equities xx on-current liabilities; Loans payable more one year x Current Liabilities: Accounts payable/creditors x Accruals or Outstanding s expenses x Bank Overdraft x xx Total Equities and Liabilities xxx 13

14 Illustration 1. The following trial balance was extracted from the books of AMA a Sole Trader as at 31 st December, Capital 111,000 Inventory at 1 st January, ,300 Purchases 142,400 Sales/Turnover 186,000 Account receivables 46,000 Account payables 22,000 Returns inward 5,000 Returns outward 2,000 Discounts allowed 2,500 Discounts received 2,000 Carriage inwards 2,000 Carriage outward 5,000 Drawings 2,800 Land and Building at cost 55,000 Motor vehicle at cost 20,000 Accumulated depreciation on Land properties 5,000 Accumulated depreciation on motor vehicle 1,000 Rent and Rates 6,000 Postage and Stationery 2,800 Electricity Bills 2,200 Salaries and Wages 10,000 Bad debts 2,400 Provision for bad and doubtful debt 1,000 Insurance 3,000 Cash at Bank 5,000 Cash in hand 2, , ,000 Additional information: i. Inventory as at 31 st December 2013 valued 15,500 ii. Goods worth 1,400 were consumed by the proprietor is yet to be recorded iii. Prepayment: rent and rates 2,000, salaries and wages 4,000 iv. Accrued expenses: Electricity 1, 800, postage and Stationery 500. v. Provision for bad and doubtful debts is to be reduced to 500 vi. Depreciate fixed assets on the following rate; Land properties 10% on cost, Motor vehicle 5% on cost. You are required to prepare: (a) Income Statement for the year ended 31 st December, (b) Statement of Financial Position as at that date 14

15 Solution 1 AMA Income statement for the Year ended 31 st December,2013 Sales 186,000 Lees return inwards (5,000) et sales 181,000 Less cost of goods sold: Opening inventory 15,300 Purchases 142,400 Add carriage inwards 2,000 Less; Return inwards (2,000) Drawings (1,400) 141,000 Cost of goods available for sales 156,300 Closing inventory (15,500) (140,800) Gross profit 40,200 Add other incomes: discount received 2,000 Decrease on provision of bad debts ,700 Less Expense Discount allowed 2,500 Carriage outwards 5,000 Bad debts 2,400 Insurance 3,000 Rent and Rates (6,000 2,000) 4,000 Salaries and Wages (10,000 4,000) 6,000 Postages and stationery (2, ) 3,300 Electricity bills (2, ,800) 4,000 Depreciation: land properties (10% of 55,000) 5,500 Motor Vehicles (5% of 20,000) 1,000 (36,700) et profit 6,000 15

16 Statement of Financial Position as at 31 st December, 2013 Cost Dep. BV on-current Assets Land properties 55,000 (10,500) 45,500 Motor Vehicles 20,000 (2,000) 18,000 75,000 (12,500) 62,500 Current Assets Inventory 15,500 Account receivables 46,000 Less provision (500) 45,500 Prepayment: Rent and Rates 2,000 Salaries and Wages 4,000 Cash at Bank 5,000 Cash in Hand 2,600 74,600 Total Assets 137,100 Equities and Liabilities Capital 111,000 Add et profit 6,000 Less Drawings (2, ,400) = (4,200) Equity 112,800 Current Liabilities Account payables 22,000 Accrued; Electricity bills 1,800 Postages and stationary ,300 Total Equities and liabilities 137,100 ITQ: The use of cash, products or goods by a proprietor in a business is usually called ITA: Drawings Summary In study session 1 you have learned: Steps involved in preparation of a Sole trader final account Some accounting terminologies How to Prepare income Statement of a Sole Trader from trial balance How to Prepare Statement of financial position 16

17 Self-Assessment Questions (SAQs) for study session 1 ow that you have completed this study session, you can assess how well you have achieved its learning outcomes by answering the following questions. Write your answers in your study diary and discuss them with your Tutor at the next study support meeting. SAQ1 The following trial balance was extracted from the books of PELLA ETERPRISES as at 31 st December, Capital 125,000 Inventory at 1 st January, ,500 Purchases 142,400 Sales/Turnover 232,200 Account receivables 40,000 Account payables 28,700 Returns inward 4,200 Returns outward 2,000 Discounts allowed 2,500 Discounts received 5,800 Carriage inwards 1,500 Carriage outward 2,000 Drawings 5,800 Land and Building at cost 90,000 Motor vehicle at cost 60,000 Fixtures and Fittings 18,000 Accumulated depreciation on motor vehicles 6,000 5% Loan from corporative society 20,000 Rent paid 9,800 Transportation 2,000 Sundry expenses 2,200 Salaries and Wages 10,000 Bad debts 2,400 Provision for bad and doubtful debt 1,500 Interest received 3,000 Insurance 3,000 Electricity bills 1,800 Fixed Deposit account 15,000 Cash in hand 3,100 Bank Overdraft 6, , ,200 Additional information: a) Inventory as at 31 st December 2014 valued 13,000 b) Goods worth 200 taken Monthly by proprietor is yet to be recorded in the books c) Rent paying 150 monthly in advance d) Outstanding Electricity bills 600, for three months 17

18 e) Provision for bad and doubtful debts 5% is to be adjusted on Debtors balances. f) Loan interest for the year was due but yet to be paid. g) Depreciate fixed assets on the following rate; Land and Building 25% on cost, Motor vehicle 15% on cost, fixtures and fittings 5% You are required to: i. Prepare Income Statement for the year ended 31 st December, ii. Prepare Statement of Financial Position as at that date SAQ 2 Short answer Questions 1. An accounting terminology that refers to the cost of transport that a trading concern incurs in moving goods meant for resale into or out of a firm is called 2. The use of products or goods by a proprietor is usually termed 3. In a trial balance of sole trader list Five (5) Items that would be found on Debit and Credit sides. 4. A gross profit of Ama's business is 40, 700 and the followings were incurred; provision for bad and doubtful debts is reduced by 300 Equipment s cost 23,000 depreciation charged at 10% to income statement for the year Operating expenses 25,500. Calculate the net profit of the business. 5. Ama a sole Trader provides you with the following balances in regards to the business transactions Inventory at 1st January, , 300 Purchases 142, 400 Sales 186, 000 Return outwards 2, 000 Return inwards 4, 000 Carriage inwards 600 Closing inventory at 31st December 13, 000 Calculate the gross profit of the business. References ATSWA study Pack (2009) Basic Accounting Processes and System, ABWA Publishers, igeria. Frank Wood s and Alan Sangster (2008) Business Accounting 1 Eleventh edition, prentice Hall Pearson Education Limited, London Igben, R.O.(2010). Financial Accounting made simple 2. Second edition, ROI Publishers, Lagos igeria Jennings A.R, (2005) Financial Accounting, Second Edition, Thomson Learning, Ashford Colour Press, Gosport, Hampshire, UK. 18

19 Further Reading Frank Wood s and Alan Sangster (2008) Business Accounting 2 Eleventh edition, prentice Hall Pearson Education Limited, London Igben, R.O.(2010). Financial Accounting made simple 2. Second edition, ROI Publishers, Lagos igeria Jennings A.R, (2005) Financial Accounting, Second Edition, Thomson Learning, Ashford Colour Press, Gosport, Hampshire, UK. 19

20 Study Session 2: DEPRECIATIO Introduction Capital expenditure like building, plant, fixtures and fittings do normally last for more than one year. It is obviously possible that these assets may deteriorate with the passage of time due to its usage. There is therefore the need to recognise the loss in the value of a non-current in the books of accounts of businesses. If this is not done the value of non-current assets in the statement of financial position will be overstated. Learning outcomes: At the end of this session, readers would be able to:- 2.1 Define Depreciation 2.2 Know the causes of depreciation 2.3 Learn the methods of calculating depreciation 2.4 Calculate depreciation charges for a particular period 1.1 Definition of Depreciation The process of recognising the loss in the value of non-current assets as a result of using such assets is called depreciation. The igerian SAS o. 9 states that depreciation represents an estimate of the portion of the historical cost or revalue amount of a non-current asset chargeable to operations during an accounting period. The standard also recognises the fact that depreciation for the accounting period is charged to income either directly or indirectly. This definition implies that depreciation is effectively an accrual technique, which matches the cost of a non-current asset with the benefits, which are derivable from the asset. on-current Assets produce revenue through use rather than through resale. They can be viewed as quantities of economic service potential to be consumed over time in the earning of revenues. Depreciation recognition transfers a portion of acquisition cost and capitalised post acquisition cost of non-current to an expense account called depreciation expense. The corresponding credit is the provision for depreciation, a contra non-current assets account that reduces gross assets to net book value. This expense is recorded as an adjusting entry at the end of each accounting period. Depreciation expense could be classified as a selling or administrative expense, depending on the assets function. Manufacturing firms include depreciation of plant and machinery or factory building in the cost of goods produced. When the goods are sold, depreciation becomes part of cost of goods sold. Certain types of noncurrent assets have unlimited useful economic lives, and so do not require depreciation. This is usually true of land unless the land is an agricultural land or land acquired for extractive 20

21 purposes. By contrast, buildings will normally have limited useful economic life, and therefore, will normally be subject to depreciation. You must note that the Provision for Depreciation account does not represent cash set aside for replacement of non-current; nor does depreciation recognition imply the creation of reserves for asset replacement. 1.2 Causes of Depreciation There are several factors that contribute to depreciation of non-current assets. These factors or causes can be classified as follows: Physical deterioration: This is where the fall in value of a non-current asset is due to wear and tear as a result of its constant use. atural occurrences such as erosion, rust and decay will certainly reduce the value of any non-current asset Economic factors: This is where an asset is put out of use even though it is in good working condition. This occurs where an asset becomes out of date as a result of new inventions or technological advancement. For example bakers use clay-moulded oven in baking bread. The invention of gas-moulded oven will certainly render the former out of date. This factor of depreciation is known as obsolescence. Another situation closely linked with economic factors is where a non-current asset is rendered useless as a result of the growth and changes in the size of business. A fisherman who uses canoe may have to acquire a large fishing boat when the demand for fish increases beyond the capacity that the canoe can cope with. In this situation you can clearly deduce that it would be more efficient and economical to operate a large fishing boat than the canoe, and as a result the canoe will be put out of use, though it is in good working condition. This factor of depreciation is known as inadequacy Depletion: atural resources such as mines, quarries, oil, coal and gas deposits become worthless when the deposits or resources are depleted. These assets are called wasting assets. The process of providing for the consumption of such assets is called depletion Time factor: There are certain assets that have specific period of legitimate life span. Assets such as patent, copyrights, finance leases have a legal life fixed in terms of years. As and when the years elapse, the value of these assets reduces. The cost of these assets must be spread over their legal lives. The term used in recognising the fall in value of these assets is amortisation. 1.3 Methods of calculating depreciation Depreciation is an attempt to allocate the cost of a non-current asset to each accounting period that the asset is used to generate income or earnings. Depreciation may be calculated simply by deducting the amount receivable when the asset is either sold or put out of use by the business from the cost of the non-current asset. The amount that will be received when 21

22 the asset is sold or put out of use is technically termed the salvage value or the residual value of an asset. The cost less the salvage value is called depreciable value or amount. It is this depreciable value that the accountant seeks to spread over the useful life of a non-current asset. There are several methods of calculating depreciation. These include: a. Straight Line Method b. Reducing Balance Method c. Sum-of- the-years -Digits Method d. Units-of-Output Method e. Revaluation Method f. Machine Hour Method g. Depletion of Unit Method The purpose of this manual is to explain in details only two of the methods mentioned above. The straight Line or fixed instalment method and the reducing balance or diminishing balance method will be discussed; the remaining methods will be treated in the next stage of the course. In order to calculate the depreciation charge for a period, we need to know four factors: i. The cost of (or revalue amount) of the non-current asset. ii. iii. iv. The estimated residual value of the non-current asset. The estimated useful economic life of the non-current asset. The method of depreciation that is appropriate for the business Straight Line Method The straight line method is the most widely used method of computing depreciation charge for financial statement purposes. Under this method, an equal amount of depreciation is recorded for each accounting period over the useful life of the non-current asset. The depreciation amount is computed by dividing the original cost of the non- current asset less estimated salvage value by the useful life of the asset. A mathematical formula can be deduced as follows: Annual Depreciation = Illustration 1 Original cost of Asset Salvage Value Useful Life of Asset 22

23 On January 1, 2010 OMA Limited purchased a motor vehicle for 5, 000,000. The motor vehicle has an estimated useful life of five years with a salvage value of 500, 000. You are required to calculate the depreciation charge and accumulated depreciation for each of the years and show the net book value as at the end of 2014 accounting period using the straight-line method. Solution Annual Depreciation = 5,000, ,000 5 = 900,000 Year cost of Assets Depreciation Accumulated Dep. et Book Value ,000, , ,000 4,100, ,100, ,000 1,800,000 3,200, ,200, ,000 2,700,000 2,300, ,300, ,000 3,600,000 1,400, ,400, ,000 4,500, , Reducing Balance Method Under this method of depreciation, the book value of a non-current asset at the beginning of the year is multiplied by a fixed percentage to determine the depreciation for the accounting year. This procedure is repeated in subsequent accounting periods so as to reduce the depreciable value of the non-current asset to zero (i.e. reduce its cost to its residual value). Illustration 1 On January 1, 2010 HAPS Limited purchased plant and machinery for 5, 000,000. It is the policy of the company to charge depreciation on non-current assets at 15%. You are required to calculate the net book value as at the end of 2014 accounting period using the reducing balance method. Solution to Illustration 1 Year cost of Assets Dep. rate Depreciation Accumulated Dep. et Book Value 23

24 2010 5,000,000 15% 750, ,000 4,250, ,250,000 15% 637,000 1,387,000 3,612, ,612,500 15% 541,875 1,928,875 3,070, ,070,625 15% 460, ,389, ,610, ,610, % 391, ,780, ,219, When a non-current asset is purchased during the year, depreciation is calculated to the nearest month. In some organisations a full year s depreciation charge is provided on noncurrent assets acquired during the year irrespective of the period in which they were purchased. Where this is the case any asset sold in the year will also not attract depreciation in the year of sale irrespective of the time of sale within the accounting period Double entry records for depreciation After calculating the depreciation charge for the accounting year you must record the amount in the books of account. It is important for you to remember that the process of providing for depreciation is recording for the use of non-current assets during the accounting period. This therefore means that depreciation is revenue expenditure and as such must be recorded in the same manner that accountants record normal business expenses. The modern practice of recording depreciation treats depreciation as a contra to the noncurrent asset account. The non-current asset account is maintained at its original cost. A ledger account called Accumulated Provision for Depreciation account is opened and all depreciation calculations are credited to that account, the corresponding entry being passed into the Depreciation charge Account as a debit. The double entry is as follows: Dr. Depreciation charge Account Cr. Accumulated Provision for Depreciation Account ITQ: The process of recognising the loss in the value of non-current assets as a result of using such assets is called ITA: Depreciation Summary In study session 2 you have learned: 24

25 Definition of Depreciation, Causes of depreciation, Methods of calculating depreciation Calculation depreciation charges for a particular period Self-Assessment Questions (SAQs) for study session 2 ow that you have completed this study session, you can assess how well you have achieved its learning outcomes by answering the following questions. Write your answers in your study diary and discuss them with your Tutor at the next study support meeting. SAQ1 On 1 st June, 2011 KAKA PLC Bought plant and Machinery at the cost of 4, 000,000. The on-current asset in the company has an estimate of four years with a salvage value of 800, 000. You are required to calculate the depreciation charge and accumulated depreciation for each of the years and show the et Book Value as at the end of the accounting period using the straight-line method. SAQ2 On January 1, 2011 HAPS Limited purchased plant and machinery for 4, 000,000. It is the policy of the company to charge depreciation on non-current assets at 10%. You are required to calculate the net book value as at the end of 2015 accounting period using the reducing balance method. SAQ3. Enumerate four (4) factors that contribute to depreciation of non-current assets. Reference ATSWA study Pack (2009) Basic Accounting Processes and System, ABWA Publishers, igeria. Frank Wood s and Alan Sangster (2008) Business Accounting 1 Eleventh edition, prentice Hall Pearson Education Limited, London Igben, R.O.(2010). Financial Accounting made simple 2. Second edition, ROI Publishers, Lagos igeria Jennings A.R, (2005) Financial Accounting, Second Edition, Thomson Learning, Ashford Colour Press, Gosport, Hampshire, UK 25

26 Study Session 3: PARTERSHIP ACCOUT Introduction: Partnership is widely accepted as the relationship which exists between persons carrying on a business in common with the objective of making a profit and sharing in agreed terms. Here we are basically concerned with the statements of account keeping by the partnership business. Learning outcomes: At the end of this session, readers would be able to:- 3.1 Define a partnership 3.2 Know types of partnership 3.3 Know Partnership agreement/deed. 3.4 Know types of accounts kept by the partnership business 3.5 Prepare Income Statement of a partnership from trial balance 3.6 Prepare statement of financial position of a partners as at the year ended 1.1 Defining a partnership Partnership is the relation which subsists between two or more persons carrying on a business in common with a view of profit making. Therefore it has been widely accepted as the relationship which exists between persons carrying on a business in common with the objective of making a profit. However, personal liability of each partner for the firm s debts is unlimited, and so an individual s personal assets may be used to meet any partnership liabilities in the event of partnership bankruptcy. 1.2 Types of partnership Limited partnership This is the type of partnership where liability of the partnership is limited to the amount of debts owed the business that is the amount of capital invested in the business which remain unpaid. Therefore in this type of a partnership, when the business becomes insolvent, the partner who has limited liability will only lose their invested capital and will not be required to contribute anything in repaying the debts of the partnership. 26

27 1.2.2 Unlimited partnership This is a type of partnership where partners are liable to all the debts of the business up to the extent of their personal assets when the partnership becomes insolvent. The partners must pay the debts even if it means selling their personal properties in order to raise money for that bankruptcy. 1.3 Partnership agreement There is no rigid principle as regards the content of agreement in the Partnership business, but for accounting purposes partners usually agree on; i. Capital to be contributed by each partner ii. iii. iv. Profit sharing ratio Rate of interest on capital Rate of interest on drawings v. Salary payable to active partners vi. vii. Admission of a new partner Procedure on death, retirement and dissolution of the Partnership. Where there is no Partnership agreement existing, the partnership Act 1890 provides the following; i. Profits/losses are to be shared equally ii. iii. iv. There is no interest allowed on capital Interest is not to be charged on drawings Salaries are not allowed v. Any amount in excess of agreed capital contributed should be entitled to 5% interest per annum. 1.3 Capital Account The capital account of the Partnership business can be represented in two ways: I. Fixed capital account: under this way of keeping capital accounts of partners, the amount of capital contributed by each partner remains fixed always in the capital account on the credit balance. 27

28 II. Fluctuating capital account:- under this method of keeping capital accounts of partners, the items affecting partners equity are adjusted on the capital account - that is items like drawings, interest on capital, salary, shares of profits or losses. 1.4 Preparation of Income Statement of a partnership from trial balance Illustration 1 Ma, Me and Mu, are in partnership sharing profits and losses in ratio of 3:2:1 respectively. The following balances were extracted from the books of the business as at 31 st December, 2013; Capital Account: Ma 20,000 Me 14,000 Mu 9,000 Current Account: Ma 1,400 Me 800 Mu 1,300 Bank Account 3,000 Stock as at 1 st January, ,000 Purchases and Sales 85, ,000 Trade Debtors and Trade Creditors 23,000 35,000 Provision for bad and doubtful debts 1,000 Discounts 1,700 2,500 Land property at cost 60,000 Furniture and Fittings at cost 20,000 Provision for depreciation: Land property 9,000 Furniture and Fittings 2,000 Rent and Rates 4,000 Salary and wages 11,000 Carriage outwards 3,000 Electricity bills 4,000 Bad debts 1,300 Drawings: Ma 5,000 Me 3,000 Mu 2, , ,000 The following additional Information s were given: (i) Stock as at 31 st December, 25,000 28

29 (ii) Prepaid rent and rate 1,000 (iii) Electricity bills outstanding 1,000 (iv) Provision for bad and doubtful debts is to be reduced at 500 (v) Depreciate fixed assets on the following rates; Land property 15% on cost. Furniture and Fittings 10% on cost. (vi) Partnership agreement as follows: Mu to be paid salary of 500 monthly Interest on capital to be 10% per annum Interest on drawings to be charged at 5% per annum Required: (a) Prepare Income Statement for the year ended 31 st December, (b) Partners current accounts in columnar form (c) Statement of financial position as at that date Solution to Illustration 1 Ma, Me and Mu Income Statement for the year ended 31 st December,2013 Sales 150,000 Cost of goods sold: Opening stock 20,000 Add purchases 85,000 Cost goods available for sales 105,000 Less closing stock (25,000) 80,000 Gross profit 70,000 Add other Incomes: Discount received 2,500 Decrease on provision for bad debts ,000 Less expenses: Discount allowed 1700 Salary and wages 11,000 Rent and Rates (4, ) 3,000 Carriage outwards 3,000 Electricity bills (4, ) 5,000 Bad debts 1,300 Depreciation: land property (15% x 60,000) 9,000 Furniture s and fittings (10% x 20,000) 2,000 (36,000) et profit 37,000 Appropriation: Add Interest on Drawings: Ma (5% x 5,000) 250 Me (5% x3,000)

30 Mu (5% x 2000) ,500 Less Interest on capital: Ma ( 10% x 20,000) 2,000 Me (!0% x 14,000) 1,400 Mu (10% x 9,000) 900 (4,300) Salary paid to Mu (500 x 12) (6,000) 27,200 Profit sharing: Ma (3/6 x 27,200) 13,600 Me (2/6 x 27,200) 9,067 Mu (1/6 x 27,200) 4,533 (27,200) Details Drawings Int.on drawings Balance c/d Ma 5, Me 3, Partners Current account Mu Details 2, Balance b/f Ints on capital Salary Profit shared Ma 1,400 2,000-13,600 Me 800 1,400-9,067 Mu 1, ,000 4,533 11,750 8,117 10,633 17,000 12,267 12,733 17,000 12,267 12,733 Balance b/d 11,750 8,117 10,633 Statement of financial position as at 31 st December, 2013 on-current Assets: Cost Dep. BV Land property 60,000 (18,000) 42,000 Furniture and Fittings 20,000 (4,000) 16,000 80,000 (22,000) 58,000 Current assets Stocks 25,000 Debtors 23,000 Less provision for doubtful debts (500) 22,500 Prepayment 1,000 Cash at bank 3,000 51,500 Total Assets 109,500 Equities and Liabilities: Equities Capital account: Ma 20,000 Me 14,000 Mu 9, Current account: Ma 11,750 Me 8,117 Mu 10,633 30,500 Current liabilities: 30

31 Trade creditors 35,000 Accrued 1,000 36,000 Total Equity and Liabilities 109,500 Illustration 2. Abu, Isa and Zaka are partners in business sharing profits and losses in the ratio of 2:3:1. The following is the trial balance extracted from the partnership s books of account as at 31 st December Inventory as at Jan 1st debtors/creditors capital as at 1st 2012: Abu Isa Zaka drawings: Isa 9000 Zaka 5100 purchase/sales Wages current accounts: Abu 8000 Isa Zaka loan: Isa Salary Land & building Cash rent and rates 4100 Insurance Furniture and fittings general expenses 9000 motor van sales/purchases returns Discount The following information was given as at year end; 1. Abu shall be entitled to an annual salary of Closing Inventory as at 31 st December 2012 stood at Insurances is paid up to March Rent and rates outstanding is Provision for bad debts is 5% of annual debtors 6. Depreciate furniture and fittings at 5% and motor van at 10% 7. Interest on capital shall be 8% per annum 8. Interest on drawing 10% 31

32 9. Drawing limits of partners shall be Interest on loan is 15% per annum You are required to prepare : Income Statement for the year ended 31 st December 2012, Appropriation account, partner s current account, partners capital accounts. Statement of Financial Position as at that date. Solution to Illustration 2 Abu, Isa and Zaka Income Statement for the year ended 31 st Dec sales 230,500 less sales return (5,742) 224,758 less cost of sales: opening inventory 40,000 add purchases 131,600 less purchases returns (5,322) 126,278 cost of goods available for sales 166,278 less inventory (35,000) 131,278 Wages 10,500 cost of sales (141,778) gross profit 82,980 discount received 2,200 85,180 less expenses: Salary 20,000 rent and rates 5,100 Insurance 8,400 discount allowed 3,600 provision for bad debt 3,310 general expenses 9,000 depreciation on furniture and fittings 2,550 depreciation on motor van 5,000 (56,960) net profit 28,220 Appropriation salaries: net profit 28,220 32

33 Abu 5,000 interest on drawings: interest on capital: Isa (9,000 of 10%) 900 Abu (50,000 of 8%) 4,000 Zaka (5,100 of 10%) 510 1,410 Isa (80,000 of 8%) 6,400 Zaka (40,000 of 8%) 3,200 13,600 interest on loan: Isa (20,000 of 15%) 3,000 share of profit: Abu ( 2 / 6 of 14,030) 4,677 Isa ( 3 / 6 of 14,030) 7,015 Zaka ( 1 / 6 of 14,,030) 2,338 14,030 32,630 32,630 Partners current account Abu Isa Zika Abu Isa Zika interest on drawings balance b/d 8,000 16,000 10,300 interest on loan 3,000 Salaries 5,000 Drawings 9,000 5,100 interest on capital: 4,000 6,400 3,200 balance c/d 21,677 16,515 10,228 share of profit: 4,677 7,015 2,338 21,677 29,415 9,728 21,677 29,415 9,728 balance c/d 21,677 16,515 10,228 Partners capital accounts Abu Isa Zika Abu Isa Zika balance c/d 50,000 80,000 40,000 balance b/d 50,000 80,000 40,000 50,000 80,000 40,000 50,000 80,000 40,000 balance b/d 50,000 80,000 40,000 Statement of Financial position as at 31st Dec 2012 Asset: land & Building 59,000 59,000 motor van 50, ,000 furniture & fittings 51,000 2,550 48, ,000 7,550 48,450 current asset: Stock 35,000 Debtor 66,200 less provision for bad debt (3,310) 62,890 Cash 18,580 33

34 prepayment insurance 2, ,570 less current liabilities: Creditors 31,600 accruals rent & rent 1,000 (32,600) 85, ,420 financed by: capital: Abu 50,000 Isa 80,000 Zaka 40, ,000 current account: Abu 21,677 Isa 16,515 Zaka 10,228 48,420 loan: Isa 20, ,420 ITQ: A type of partnership where partners are liable to all the debts of the business up to the extent of their personal assets when the partnership becomes insolvent is known as ITA: Unlimited partnership Summary In study session 3 you have learned: a. Definition of a partnership b. Types of partnership business c. Partnership agreement/deed. d. Various types of accounts kept by the partnership business e. How to Prepare Income Statement of a partnership from trial balance f. How to Statement of financial position of a partners as at the year ended Self-Assessment Questions (SAQs) for study session 3 ow that you have completed this study session, you can assess how well you have achieved its learning outcomes by answering the following questions. Write your answers in your study diary and discuss them with your Tutor at the next study support meeting. 34

35 SAQ1. Where there is no Partnership agreement existing, the partnership Act 1890 prevailed. State five provisions by the Act guiding the partnership business that you know SAQ2 Ali, Boni and Konto are in Partnership sharing profits and losses in the ratio 4:3:2. The following is the Trial Balance of the Partnership as at 31 st December, 2014 Capital account: Ali Boni Konto Current account: Ali Boni Konto Provisions for bad debts Bank Debtors and creditors Land and building at cost Motor vehicle at cost Office expenses Purchases Rates Sales Selling expenses Stock at beginning Accumulated depreciation: Land and building Motor vehicles Drawings: Ali Boni Konto 500 2,500 23,000 60,000 20,000 4,000 85,000 4,000 14,000 20,000 4,000 3,000 3, ,000 18,000 12,000 6, ,000 35, ,000 12,000 8, ,000 Additional information i. Stocks as at 31/12/2014 was 20,000 ii. Depreciate fixed assets as follows; land & building 10% per annum on cost iii. Motor vehicle 20% per annum on cost iv. 1, 775 was owing for selling expenses v. Rates were prepaid 2,000 vi. Bad debts written off 600 vii. The bad debts provision is to be made equal to 5% of outstanding debtors balance. viii. The partnership agreement covers the following information: 35

36 Konto is to be allowed a salary of 100 weekly Interest on capital to be 10% Interest to be charged on drawing 5% Required: a. Income Statement for the year ended 30 th September b. Partners current accounts c. Statement of Financial Position as at that date SAQ3 Ali and Boni are in partnership sharing profits and losses equally. The following is their trial balance as at 31 st May, Capital accounts: Ali 90,000 Boni 90,000 Land property at cost 160,000 Furniture s and fixtures at cost 40,000 Discount received 4,500 Trade Debtors 69,600 Trade Creditors 26,590 Cash in hand 14,130 Inventory at 1/7/ ,740 Sales/Revenue 363,110 Purchases 210,800 Carriage outwards 3,410 Discount allowed 1,820 Loan interest 3,900 Sundry expenses 4,760 Salaries and wages 16,810 Bad debts 1,630 Insurance 10,000 Provision for doubtful debts 1,400 Bank loan 65,000 Drawings: Ali 21,000 Boni 20, , ,600 Additional Information: i. Inventory at 31 st May, ,200 ii. Prepaid Insurance 2,000 iii. Outstanding Salary and wages 2,000 iv. Depreciate; Land property 20% on cost, Furniture and Fixtures 10% on cost. v. Reduce provision for doubtful debts to 1,000 vi. Interest on drawings to be charge at 10% per annum. vii. Interest on capital 5% per annum Required: a. Prepare income statement for the year ended 31 st May, 2015 b. Partners capital account c. Statement of Financial position as at 31 st May,