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
MODULE CONTENTS - FINANCIAL ACCOUNTING 1T TOPIC NO. TOPIC PAGE(S) eadings 2 8 Close Corporation 3-42 9 Companies 43-88 MANCOSA BCom HM Year One 1
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, 2005. Dempsey, A. and Pieters. H.N. Chapters 1 to 13 and Chapter 15 MANCOSA BCom HM Year One 2
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 4-7 2 Financial statements of a close corporation 8-42 MANCOSA BCom HM Year One 3
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
1. INTODUCTION The Close Corporations Act No 69 of 1984 made provision for incorporation of close corporations as from 1 January 1985. 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
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
6. 6.1 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
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 10-27 5. Self-assessment activities and solutions 28-42 MANCOSA BCom HM Year One 8
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
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%) 160 000 Member s contribution: Forma (33⅓%) 80 000 etained earnings 102 000 Land and buildings 480 000 Vehicles (cost) 80 000 Equipment (cost) 150 000 Accumulated depreciation on vehicles 14 000 Accumulated depreciation on equipment 28 000 Long-term loan: Mecer Bank (14% p.a.) 264 000 Loan from Pro (12% p.a.) 50 000 Loan to Forma (12% p.a.) 60 000 Fixed deposit: Mecer Bank (10% p.a.) 48 000 Inventory (30 June 20.6) 112 000 Debtors control 128 000 Provision for bad debts 2 560 Bank 14 260 Creditors control 51 260 SAS Income tax 35 000 Nominal accounts section Sales 1 055 080 Purchases 458 000 Sales returns 10 000 Purchases returns 12 000 Customs duty 10 800 Carriage on purchases 35 000 Carriage on sales 6 000 Sundry expenses 29 740 Salaries 128 000 Motor expenses 3 600 Interest on fixed deposit 3 000 Interest on loan 36 960 Interest on loan: Pro 3 600 Interest on loan: Forma 4 000 Discount allowed 3 880 Commission income 36 100 epairs 29 160 1 862 000 1 862 000 MANCOSA BCom HM Year One 10
Additional information 1. The provision for bad debts must be increased by 1 840. 2. Trading inventory according to stocktaking on 30 June 20.7 amounted to 96 000. 3. A first instalment of 24 000 is payable on the unsecured loan from Mecer Bank on 01 July 20.7. 4. 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 20.8. Make provision for the outstanding interest. 6. An amount of 50 000 is payable to Pro for special services rendered. 7. The loan to Forma is payable in full on 30 June 20.9. 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 20.7. 9. The income tax for the year amounted to 62 400. 10. 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
Solution POFOMA CC INCOME STATEMENT FO THE YEA ENDED 30 JUNE 20.7 Note Sales (1 055 080-10 000) Cost of sales 1 045 080 (507 800) Opening inventory Purchases (458 000-12 000) Customs duty Carriage on purchases Closing inventory 112 000 446 000 10 800 35 000 (96 000) Gross profit Operating expenses 537 280 (310 220) Carriage on sales Sundry expenses Salaries Motor expenses Discount allowed epairs Provision for bad debts adjustment Depreciation (16 000+42 000) emuneration to Pro 2 6 000 29 740 128 000 3 600 3 880 29 160 1 840 58 000 50 000 Operating profit Other income :Commission income :Interest on fixed deposit :Interest on loan to Forma Interest expense :on loan :on loan from Pro 2 2 227 060 36 100 4 800 7 200 (36 960) (6 000) Profit before tax 232 200 Income tax (62 400) Profit for the year 169 800 MANCOSA BCom HM Year One 12
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 1 840 Provision for bad debts +1 840 2. Closing inventory 96 000 Trading inventory 96 000 3. Long-term loan 24 000 Current portion of loan 24 000 4. Depreciation on: Vehicles (80 000 X 20%) = 16 000 Equipment (150 000 X 28%) = 42 000 Note 3 Depreciation for the year: Vehicles 16 000 Equipment 42 000 5. Interest on fixed deposit (48 000 X 10%) = 4 800 Accrued income 4 800 3 000 = 1 800 6. emuneration to Pro 50 000 Accrued expenses 50 000 7. Interest on loan to Forma: 60 000 X 12% = 7 200 Accrued income 7 200 4 000 = 3 200 8. Interest on loan from Pro 50 000 X 12% = 6 000 Accrued expenses 6 000 3 600 = 2 400 Loan from Pro ( 20% of 50 000) 50 000 10 000 = 40 000 Current portion of loan 10 000 9. Income tax 62 400 South African evenue services 62 400 35 000 = 27 400 (owing) 10. Profit distribution 127 350 Profit distribution payable 127 350 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 () 240 000 () 102 000 169 800 (127 350) () 342 000 169 800 (127 350) Balance at 30 June 20.7 240 000 144 450 384 450 MANCOSA BCom HM Year One 13
POFOMA CC BALANCE SHEET AS AT 30 JUNE 20.7 Notes ASSETS Non-current assets 718 000 Property, plant and equipment Financial assets Loans to members 3 4 5 610 000 48 000 60 000 Current assets 238 860 Inventories 6 96 000 Trade and other receivables 128 600 Trade debtors Provision for bad debts (2 560+1840) Accrued income (1 800+3 200) 128 000 (4 400) 5 000 Cash and cash equivalents 14 260 Bank 14 260 Total assets 956 860 EQUITY AND LIABILITIES Members interest and reserves 384 450 Members contributions etained earnings 7 240 000 144 450 Non-current liabilities 280 000 Long-term borrowings Loans from members (50 000 10 000) 8 9 240 000 40 000 Current liabilities 292 410 Trade and other payables 103 660 Trade creditors Accrued expenses (50 000+2 400) 51 260 52 400 Current portion of long-term borrowings Current portion of loans from members Profit distribution payable South African evenue Services (62 400 35 000) 8 24 000 10 000 127 350 27 400 Total equity and liabilities 956 860 MANCOSA BCom HM Year One 14
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 () () () 50 000 50 000 6 000 6 000 (7 200) (7 200) 56 000 (7 200) 48 800 3. Property, plant and equipment Land and buildings Vehicles Equipment Total Carrying value at beginning of year 480 000 66 000 122 000 668 000 Cost Accumulated depreciation 480 000 80 000 (14 000) 150 000 (28 000) 710 000 (42 000) Depreciation for the year (16 000) (42 000) (58 000) Carrying value at end of year 480 000 50 000 80 000 610 000 Cost Accumulated depreciation 480 000 80 000 (30 000) 150 000 (70 000) 710 000 (100 000) MANCOSA BCom HM Year One 15
4. Financial assets Investment in Fixed deposit at Mecer Bank at 10% p.a. 48 000 5. Loans to members Pro Forma Total () () () Balance on 01 July 20.6 60 000 60 000 Advances during the year epayments during the year Balance on 30 June 20.7-60 000 60 000 6. Inventories Inventories consist of: Merchandise 96 000 7. Members contributions Members interest Members contributions Transactions during the yr Total Pro Forma % 66⅔% 33⅓% () 160 000 80 000 () - - () 160 000 80 000 Total 100 % 240 000-240 000 8. Long term borrowings Unsecured Loan from Mecer Bank payable in instalments commencing from 01 July 20.7. Interest rate is 14% p.a. 264 000 Less: Instalment payable within one year, transferred to current liabilities (24 000) 240 000 9. Loans from members Pro Forma Total () () () Balance on 01 July 20.6 50 000 50 000 Advances during the year epayments during the year Balance on 30 June 20.7 50 000 50 000 MANCOSA BCom HM Year One 16
10. Members net investment statement for the year ended 30 June 20.7 Balance at the beginning of the year 342 000 Movements during the year Contributions made* - Contributions repaid* - evaluations* - Net profit 169 800 Distributions (127 350) eserves* - Balance at the end of the year 384 450 epresented by: Members contributions 240 000 evaluations* - etained earnings 144 450 eserves* - 384 450 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
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 2 000 000 Cash paid to suppliers and employees (950 000) Cash generated from operations 1 050 000 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
Indirect method Profit before interest and tax 1 450 000 Adjustments to convert to cash from operations Non-cash flow adjustments 100 000 Add: Depreciation 60 000 Add: Foreign exchange loss 40 000 Profit before working capital changes Working capital changes (500 000) Increase in inventory (400 000) Increase in receivables (200 000) Increase in payables 100 000 Cash generated from operations 1 050 000 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 4.2.2 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
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) (200 000) 150 000 Note that any use of cash (e.g. additions to plant and equipment) is indicated by bracketing the amount. 4.2.3 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 250 000 (50 000) 300 000 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
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 735 000 Cost of sales (423 750) Opening inventory 46 500 Purchases 452 250 Closing inventory (75 000) Gross profit 311 250 Operating expenses (148 500) Administrative expenses (including Insurance) 30 000 Wages and salaries 54 000 Salaries to members 36 000 Depreciation 28 500 Operating profit 162 750 Other income: Dividends earned 19 500 Interest expense: on long-term loan (21 000) Profit before tax 161 250 Income tax (69 000) Profit for the year 92 250 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 () 532 500 30 000 () 12 000 92 250 (56 250) () 544 500 92 250 (56 250) 30 000 Balance at 31 December 20.6 562 500 48 000 610 500 MANCOSA BCom HM Year One 21
MEGA CC BALANCE SHEET AS AT 31 DECEMBE Note 20.6 20.5 ASSETS Non-current assets 747 750 643 500 Property, plant and equipment Financial assets: Investments 672 750 75 000 591 000 52 500 Current assets 132 000 102 000 Inventories 75 000 46 500 Trade and other receivables 55 500 45 000 Trade debtors Prepaid expenses (Insurance) 52 500 3 000 45 000 - Cash and cash equivalents 1 500 10 500 Bank Cash float - 1 500 9 000 1 500 Total assets 879 750 745 500 EQUITY AND LIABILITIES Members interest and reserves 610 500 544 500 Members contributions etained earnings 562 500 48 000 532 500 12 000 Non-current liabilities 150 000 105 000 Long-term borrowings 150 000 105 000 Current liabilities 119 250 96 000 Trade and other payables 46 500 57 000 Trade creditors Accrued expenses (wages) 37 500 9 000 49 500 7 500 Profit distribution payable South African evenue Services (Income tax payable) Bank overdraft 56 250 13 500 3 000 22 500 16 500 - Total equity and liabilities 879 750 745 500 MANCOSA BCom HM Year One 22
Note 1. Property, plant and equipment Land and buildings Equipment Total Carrying value at beginning of year 390 000 201 000 591 000 Cost Accumulated depreciation 390 000-265 500 (64 500) 655 500 (64 500) Additions Disposals at carrying value Depreciation for the year - - - 116 250 (6 000) (28 500) 116 250 (6 000) (28 500) Carrying value at end of year 390 000 282 750 672 750 Cost Accumulated depreciation 390 000-356 250 (73 500) 746 250 (73 500) Additional information 1. Equipment that cost 25 500 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 20.6. MANCOSA BCom HM Year One 23
Solution Mega CC Cash flow statement for the year ended 31 December 20.6 Cash flows from operating activities 45 750 Profit before interest and tax (a) 162 750 Adjustments to convert to cash from operations Non-cash flow adjustments 28 500 Add: Depreciation (b) 28 500 Profit before working capital changes Working capital changes 191 250 (49 500) Increase in inventory (c) Increase in receivables (d) Decrease in payables (e) (28 500) (10 500) (10 500) Cash generated from operations 141 750 Interest paid (f) (21 000) Dividends received (g) 19 500 Profit distribution paid (h) (22 500) Income tax paid (i) (72 000) Cash flow from investing activities (132 750) Acquisition of investments (j) (22 500) Additions to plant and equipment (k) (116 250) Proceeds from sale of equipment (l) 6 000 Cash flow from financing activities 75 000 Proceeds from increase in members contributions (m) Proceeds from long-term borrowings (n) 30 000 45 000 Net decrease in cash and cash equivalents (12 000) Cash and cash equivalents at beginning of year (o) 10 500 Cash and cash equivalents at end of year (p) (1 500) MANCOSA BCom HM Year One 24
(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: 75 000 46 500 = 28 500 (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: 55 500 45 000 = 10 500 (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: 57 000 46 500 = 10 500 (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 20.6 56 250 (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
(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 20.6 13 500 (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: 75 000 52 500 = 22 500 (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): 150 000 105 000 = 45 000 MANCOSA BCom HM Year One 26
(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 (9 000 + 1 500) 10 500 Bank overdraft 0 Net favourable balance 10 500 (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 1 500 Bank overdraft (3 000) Net unfavourable balance (1 500) Other calculations Profit before working capital changes 162 750 + 28 500 = 191 250 Cash generated from operations: 191 250 49 500 = 141 750 Cash flows from operating activities: 141 750 21 000 + 19 500 22 500 72 000 = 45 750 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 10 500 (20.5) turned into a net unfavourable balance of 1 500 (20.6) resulting in a net decrease in cash and cash equivalents of 12 000. The net decrease can be verified as follows: 45 750 132 750 + 75 000 = 12 000 MANCOSA BCom HM Year One 27
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 80 000 Member s contribution: William 70 000 Member s contribution: Harry 50 000 etained earnings 12 440 Land and buildings 175 900 Vehicles (cost) 42 000 Equipment (cost) 66 000 Accumulated depreciation on vehicles 16 800 Accumulated depreciation on equipment 13 400 Mortgage bond: Gen Bank (15% p.a.) 100 000 Loan from William (12% p.a.) 20 000 Loan from Harry (12% p.a.) 16 000 Loan to Charles (14% p.a.) 15 000 Investment (10 000 shares in IBN Ltd at market value) 22 000 Inventory (31 December 20.5) 109 200 Debtors control 40 100 Provision for bad debts 1 910 Bank 47 895 Creditors control 74 200 SAS Income tax 13 800 Nominal accounts section Sales 631 000 Purchases 449 400 Import duty 3 100 ailage on purchases 5 000 Maintenance 2 630 ates 1 420 Commission on sales 3 000 Delivery expenses 1 300 Discount allowed 2 700 Wages and salaries 67 830 Stationery 1 040 Bad debts 920 Sundry expenses 440 Insurance 950 Telephone 3 400 Water and electricity 4 305 Dividends received 900 Interest expenses on loans 19 320 ent income 12 000 1 098 650 1 098 650 MANCOSA BCom HM Year One 28
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 116 600. 3. 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 4 320 interest paid to William and Harry on the loans they made to the CC on 31 December 20.5. The loans are repayable in full on 30 June 20.8. 20 000 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 20.6. Provide for outstanding interest on loan. 6. 20 000 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 19 800. 9. Provision must be made for a profit distribution of 20 000 to the members. equired Prepare the following for egal CC: 1. Income statement for the year ended 31 December 20.6 2. Statement of changes in equity for the year ended 31 December 20.6 3. Balance sheet at 31 December 20.6 4. The necessary notes to the financial statements The statements must comply with Generally Accepted Accounting Practice. MANCOSA BCom HM Year One 29
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 20.8. 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 20.8 662 500 72 000 105 000 490 000 265 500 64 500 52 500 46 500 45 000-70 500 19 500 7 500-16 500 22 500 20.7 562 500 22 500 150 000 390 000 330 750 73 500 75 000 75 000 52 500 4 500-37 500 9 000 3 000 13 500 56 250 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 170 250 28 500 19 500 750 19 500 64 500 Extract from Statement of changes in equity for the year ended 31 December 20.8 Profit distribution 56 250 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
Solutions 5.1 EGAL CC INCOME STATEMENT FO THE YEA ENDED 31 DECEMBE 20.6 Note Sales Cost of sales 631 000 (450 100) Opening inventory Purchases Import duty ailage on purchases Closing inventory 109 200 449 400 3 100 5 000 (116 600) Gross profit Operating expenses 180 900 (109 530) Maintenance ates Commission on sales Delivery expenses Discount allowed Wages and salaries (67 830-20 000) Stationery Bad debts Sundry expenses Insurance Telephone Water and electricity Provision for bad debts adjustment Depreciation (6 300+13 200) Salary to Harry 2 2 630 1 420 3 000 1 300 2 700 47 830 1 040 920 440 950 3 400 4 305 95 19 500 20 000 Operating profit Other income: ent income : Interest on loan to Charles : Dividends earned Interest expense: on mortgage bond : on loans from William and Harry 2 2 71 370 12 000 1 050 900 (15 000) (4 320) Profit before tax 66 000 Income tax (19 800) Profit for the year 46 200 MANCOSA BCom HM Year One 31
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 2 005 1 910 = 95 Provision for bad debts (40 100 X 5%) = 2 005 2. Closing inventory 116 600 Trading inventory 116 600 3. Depreciation on: Vehicles (42 000 16 800) X 25% = 6 300 Equipment (66 000 X 20%) = 13 200 Note 3 Depreciation for the year: Vehicles 6 300 Equipment 13 200 4. Interest on mortgage bond 19 320 4 320 = 15 000 Interest on loans from members 4 320 Mortgage bond 100 000 20 000 = 80 000 Current portion of loan 20 000 5. Interest on loan to member Accrued income 1 050 15 000 X 14% X6/12 = 1 050 6. Salary to Harry 20 000 - Wages and salaries 20 000 7. - atio is 8:7:5 for profit distribution 8. Income tax 19 800 South African evenue Services 19 800 13 800 = 6 000 (owing) 9. - Profit distribution 20 000 Profit distribution payable 20 000 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 () 200 000 () 12 440 46 200 (20 000) () 212 440 46 200 (20 000) Balance at 31 December 20.6 200 000 38 640 238 640 MANCOSA BCom HM Year One 32
EGAL CC BALANCE SHEET AS AT 31 DECEMBE 20.6 Notes ASSETS Non-current assets 271 200 Property, plant and equipment Financial assets Loans to members 3 4 5 234 200 22 000 15 000 Current assets 203 640 Inventories 6 116 600 Trade and other receivables 39 145 Trade debtors Provision for bad debts Accrued income (1 050) 40 100 (2 005) 1 050 Cash and cash equivalents 47 895 Bank 47 895 Total assets 474 840 EQUITY AND LIABILITIES Members interest and reserves 238 640 Members contributions etained earnings 7 200 000 38 640 Non-current liabilities 116 000 Long-term borrowings Loans from members 8 9 80 000 36 000 Current liabilities 120 200 Trade and other payables 74 200 Trade creditors 74 200 Current portion of long-term borrowings Profit distribution payable South African evenue Services (19 800 13 800) 8 20 000 20 000 6 000 Total equity and liabilities 474 840 MANCOSA BCom HM Year One 33
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) 2 400 20 000 1 920 20 000 4 320 (1 050) (1 050) 2 400 21 920 23 270 3. Property, plant and equipment Land and buildings Vehicles Equipment Total Carrying value at beginning of year 175 900 25 200 52 600 253 700 Cost Accumulated depreciation 175 900 42 000 (16 800) 66 000 (13 400) 283 900 (30 200) Depreciation for the year (6 300) (13 200) (19 500) Carrying value at end of year 175 900 18 900 39 400 234 200 Cost Accumulated depreciation 175 900 42 000 (23 100) 66 000 (26 600) 283 900 (49 700) MANCOSA BCom HM Year One 34
4. Financial assets Investment in 10 000 shares in IBN Ltd at market value 22 000 5. Loans to members Charles William Harry Total Balance on 01 January 20.6 Advances during the year 15 000 15 000 epayments during the year Balance on 31 December 20.6 15 000 15 000 6. Inventories Inventories consist of: Merchandise 116 600 7. Members contributions Members interest Members contributions Transactions during the yr Total Charles William Harry % 40 35 25 () 80 000 70 000 50 000 () - - - () 80 000 70 000 50 000 Total 100 % 200 000-200 000 8. Long term borrowings Secured Mortgage bond from Gen Bank secured by a first mortgage on land with instalment payable from 31 May 20.7. Interest rate is 15% p.a. 100 000 Less: Instalment payable within one year, transferred to current liabilities (20 000) 80 000 9. Loans from members Charles William Harry Total Balance on 01 January 20.6 20 000 16 000 36 000 Advances during the year epayments during the year Balance on 31 December 20.6 20 000 16 000 36 000 MANCOSA BCom HM Year One 35
10. Members net investment statement for the year ended 31 December 20.6 Balance at the beginning of the year 212 440 Movements during the year Net profit 46 200 Distributions (20 000) Balance at the end of the year 238 640 epresented by: Members contributions 200 000 etained earnings 38 640 238 640 MANCOSA BCom HM Year One 36
5.2 Vista CC Cash flow statement for the year ended 31 December 20.8 Cash flows from operating activities 69 000 Profit before interest and tax (a) 170 250 Adjustments to convert to cash from operations Non-cash flow adjustments 29 250 Add: Depreciation (b) Loss on disposal of asset (c) 28 500 750 Profit before working capital changes Working capital changes 199 500 22 500 Decrease in inventory (d) Decrease in receivables (e) Decrease in payables (f) 28 500 12 000 (18 000) Cash generated from operations 222 000 Interest paid (g) (21 000) Dividends received (h) 19 500 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) 22 500 Additions to land and buildings (l) (100 000) Proceeds from sale of equipment (m) 27 000 Cash flow from financing activities 55 000 Proceeds from increase in members contributions (n) Long-term borrowings redeemed (o) 100 000 (45 000) Net increase in cash and cash equivalents 73 500 Cash and cash equivalents at beginning of year (p) (3 000) Cash and cash equivalents at end of year (q) 70 500 MANCOSA BCom HM Year One 37
(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: 75 000 46 500 = 28 500 (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: (52 500 + 4 500) (45 000) = 12 000 (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: 37 500 19 500 = 18 000 (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 20.8 7 500 (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
(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 20.8 22 500 (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 20.8 16 500 (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: 75 000 52 500 = 22 500 (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: 490 000 390 000 = 100 000 MANCOSA BCom HM Year One 39
(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 (330 750 73 500) 257 250 Additions 0 Disposals at carrying value *(27 750) Depreciation (28 500) Carrying value of equipment on 31 December 20.8 (265 500 64 500) 201 000 *Disposals at carry value is calculated as follows: (257 250 + 0 28 500) (201 000) = 27 750 However, the equipment was sold at a loss of 750. Therefore the proceeds from the sale of equipment is 27 000 (27 750 750). Proceeds from increase in members contributions The amount is obtained from comparing the figures for Members contributions from the Balance sheet for both years: 662 500 562 500 = 100 000 Long-term borrowings redeemed The amount is obtained by comparing the figures for both years for Mortgage bond in the Balance sheet: 150 000 105 000 = 45 000 (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 70 500 Bank overdraft 0 Net favourable balance 70 500 MANCOSA BCom HM Year One 40
Other calculations Profit before working capital changes 170 250 + 29 250 = 199 500 Cash generated from operations: 199 500 + 22 500 = 222 000 Cash flows from operating activities: 222 000 21 000 + 19 500 90 000 61 500 = 69 000 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 3 000 (20.7) turned into a favourable balance of 70 500 (20.8) resulting in a net increase in cash and cash equivalents of 73 500. The net increase can be verified as follows: 69 000 50 500 + 55 000 = 73 500 MANCOSA BCom HM Year One 41
MANCOSA BCom HM Year One 42
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 44-58 2 Financial statements of a company 59-88 MANCOSA BCom HM Year One 43
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 45 2. Formation of a company 45-46 3. Share capital 46-51 4. Debentures 51 5. Dividends and reserves 52 6. Tax provisions 52-53 7. Self-assessment activities and solutions 53-58 MANCOSA BCom HM Year One 44
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 1973. 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. 500 000) into small units called shares (e.g. 500 000 shares of 1 each or 250 000 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